I.

INTRODUCTION
a. Theory of the firm
i. Coase The nature of the firm (1937)
1. Corps are a way of hierarchically organizing an exploitation of assets that can produce products in an
efficient way - A way to eliminate the costs produced by imperfect info
ii. Williamson Transaction cost economics (1989)
1. Suppose A chooses contractor B among many competitors; when A needs the same task repeated, he may
have incentives to use B again
2. Over time, B learns to do what A wants; B cannot be redeployed easily
3. Given this situation between A and B, it makes sense for these two parties to become one this explains
vertical integration
b. Objective of Corp Law
i. To maximize efficient use of firm assets for shareholders
ii. Pareto Efficiency: all parties experience a net utility gain for the transaction (or at least no loss), no one
experiences a loss, so its better for everyone (asset owners, laborers, etc) to get together and produce this new
asset without any of them losing anything in the process
1. NOTE: here were talking about the parties to the transaction only, we do not contemplate 3rd parties, etc
2. Problems
a. This is difficult to achieve in practice because its common that someone will suffer a loss
b. Severely limits the negotiation space for welfare-improving trades
c. Assumes that the original wealth distribution is legitimate
iii. Kaldor-Hicks efficiency: transaction produces total gains sufficient to provide compensation to all those who
suffered any loss, i.e. total welfare increases (pie gets bigger) even if losers are not actually compensated.
1. Total amount of wealth for all parties involved increases, however there are some people who might lose and
who might not be compensated for their losses
2. still assumes initial wealth distribution is legitimate
3. more workable and generally accepted as the proper definition of efficiency.
4. The fact that the aggregate wealth increases means that we do have enough to compensate if we wanted to,
but it doesnt mean that we do this
5. Efficiency means that the aggregate wealth increases, the pie gets bigger, but there still might be some
losers
iv. In reality Judges refer to other concepts: fairness, good faith, loyalty decisions have moral foundation rather
than economic
c. Fairness: in corp law means fairness to shareholders
1. We know that shareholders are looking for ways to maximize their returns, which means getting a larger pie
KEY: shareholder maximization = kaldor-hicks efficiency
d. Three Key Relationships (basic problems) in Corporations
i. Among shareholders
1. Need to manage the relationship between all the contributors to the corp
ii. Between shareholders and managers
iii. Between firm and outside parties (mostly creditors, clients, etc)
e. Agency Cost Economics (Jensen & Meckling 1976)
i. Main tool of analysis for these relationships
ii. Uneconomic decisions for the firm may be in the interest of the manager
iii. Types of Agency Costs
1. Monitoring costs: Principals incur costs to ensure agent loyalty - To make sure that he is only using money
for benefit of firm and not himself
2. Bonding costs: Costs not incurred by corp, but incurred by agents themselves who are trying to ensure the
shareholders/principals about their abilities
a. EX paying a law school, then law firms know you will know the law
3. Residual costs: Agents have diff incentives from principals and may use firm assets differently

II.

AGENCY
a. Agent (A) can bind the principal (P) to a third party (T)
i. P - Principal party who wants to achieve something
ii. A - Agent hired party: Has ability to contract with third parties on behalf of the principal
iii. T - Third Party: Enters into a K with the agent
b. Background Rules:
i. Formation of an agency relationship
1. Special agents (limited to a single act or transaction) v. general agents (series of acts or transactions)
2. Disclosure to T:
a. P disclosed; P undisclosed (T believes the agent is the principal); P partially disclosed T knows that
there is a P but doesnt know his identity
3. Right to Control:
a. Employee (or servant): P can supervise the agent very closely
b. Independent contractor: P takes no interest in what agent does or how he goes about achieving the goal
set out by the principal
ii. Termination at Will
1. Termination is always at will because these relationships are based on consent - Any party can terminate the
relationship
iii. Ps liability for As authorized and unauthorized contracts, and for torts committed by A
iv. As duties to P
c. Agency Definition: RS3 1.01: Agencyarises whena principal manifests assent to an agent that:
i. The agent shall act on the principals behalf and subject to the principals control
ii. The agent manifests assent or otherwise consents so to act
d. Arises out of consent and may be terminated at will
i. Consent may be manifested by actions of the parties that demonstrate Ps control over A thus can be express
or implied
ii. Jason Farms v. Cargill: Question was whether Cargill became liable as principal on contracts made by Warren
with Jason Farms (was there consent to create an agency?). Cargill acted in a way that implied consent:
Cargills approval required for mortgages or dividends; Constant recommendations; Criticism about finances,
salaries, inventory; Financing all warrens grain purchases. The point of the relationship was better access to
grain for Cargill from Jason Farms, they were not going to make much from the loan, so this was more than a
mere loan from a bank. Cargills course of dealing with Warrenwas paternalistic (pg. 12).
e. Liability in Contract (P must perform contract entered by A)
i. Actual Authority: that which a reasonable person in As position would infer from Ps conduct
1. Express if communication was explicit
2. Implied (or incidental) if As actions were reasonably calculated to discharge Ps explicit instructions
a. Including actions that are necessary in order to achieve Ps express desires, but are not specifically
included in the express orders
ii. Apparent Authority: T could reasonably infer from Ps actions that A had the power to enter into the contract
(White v Thomas)
iii. Inherent Authority: T could reasonably infer from As actions that A had the power to enter into the contract
(Gallant Insurance v Isaac)
1. RS2 8A: inherent agency power indicates the power of an agent which is derived not from authority, but
solely from the agency relation and exists for the protections of persons harmed by or dealing with a servant
or other agent (equitable concept)
2. RS2 161: A general agent for a disclosed or partially disclosed principal subjects his principal to liability for
acts done on his account which usually accompany or are incidental to transactions which the agent is
authorized to conduct if, although they are forbidden by the principal, the other party reasonably believes that
the agent is authorized to do them and has no notice that he is not so authorized .
3. KEY: only discuss Inherent Authority once its clear that there is no actual or apparent authority
4. T believes that A is authorized to do these actions because they customarily are authorized to do such
actions
f. When is it reasonable for T to infer authority from Ps or As actions?
i. Examine monitoring costs:
1. White v. Thomas: T were unreasonable to rely on As oral conrmations about authority; they should have
asked to see evidence of authorization, because it was expedient for them to do so (monitoring costs lower
for T, higher for P). FACTS: P had authorized A to buy up to $250k worth of land, A ended up buying $327k
worth and negotiated and sold part to T (white) to make back difference; P wanted to rescind sale of extra
land to T.
2. Gallant Insurance v. Isaac: T was reasonable in believing that A was authorized to verbally conclude contract
because of past dealings (monitoring costs higher for T, lower for P). FACTS: Car insurance case where

Gallant EE gave insurance without complete paperwork, accident before paperwork was complete but
promise of insurance was already made.
3. Manifestations dont have to be direct verbal communications either: where the principal clothes or allows a
special agent to act with appearance of possessing more authority than is actually conferred (pg. 21)
g. Ps Liability for As torts: Respondeat Superior
i. KEY: Control distinguishes independent contractors (no liability for P) from employees (liability for P)
ii. RS3 2.04: An employer is subject to liability for torts committed by employees while acting in the scope of
their employment (Respondeat Superior) thus not all agents can generate tort liabilities for their Ps
iii. RS3 7.07(3)(a): An employee is an agent whose principal controls or has the right to control the manner
and means of the agents performance of work
iv. NOTE: Same product (e.g. painting a house) can be structured either as an independent contract or as
employment the relationship is defined by the parties
1. If you watch over the house painter all day and control his actions he is an EE
2. If you leave with basic instructions and come back later and the house is painted, then he is an IC
v. Other alternatives besides control
1. Strict liability P is always liable - By imposing this, the P starts to care what the A is doing, wants to create a
safe environment for him to perform his task
2. No Fault P is never liable - but typically s want to hook liability on the Ps because they have deeper
pockets than As generally
h. Elements of Control: Humble Oil v. Sunoco
i. Direct Control Ownership
1. Humble Oil: Setting hours of operation; sold only Humble products; Humble held title to goods that Schneider
sold on consignment; Lease was terminable at will; Rent was based on the amount of Hs products sold,
and H paid a big share of Schneiders operating costs; Humble could require periodic reports
ii. Independent Ownership
1. Sunoco: Barone set hours of operation; B could sell non-sunoco products; Barone took title to goods; Lease
was terminable annually; B had overall risk of profit and loss, though subsidies from Sunoco ensured
competitiveness; No reports, but rep visited weekly to advise
i. Degree of Control as a strategic choice for running business
i. Ownership
1. Owner has direct control over all aspects of business
2. But this involves high monitoring costs to ensure quality of service by EEs
ii. Independently Run
1. Company Owner less involved in day-to-day of each biz
2. Manager/EE more invested in quality of service, more incentive to make a better biz
3. Low monitoring costs for Owner BUT they must decide who would make a good/bad manager/EE
j. The Governance of Agency Relationships: The Duty Principles
i. Agents Conduct towards P
1. Express agreement btw parties ex ante
2. Exit rights (termination) by either party
3. Fiduciary relationship in Agency - As Fiduciary Duty to P: to always act in Ps interests
a. In types of agency relationships where goals are open ended, its difficult to determine ex ante all the
actions that A must take, to stipulate all the outcomes and determine all the scenarios A might face and
dictate solutions; So Fiduciary principle is a general concept that controls this area
b. Duty of Loyalty
c. Duty of Care
ii. Duty of Loyalty: not to acquire a material benet from a third party in connection with Ps business
1. RS3 8.02: An agent has a duty not to acquire a material benet from a third party in connection with
transactions conducted or other actions taken on behalf of the principal
a. If there is a material benefit to the transaction, its all for P, A cannot take or keep anything for herself
2. RS3 8.03: An agent cannot act as an adverse party to principal... UNLESS
3. RS3 8.06:...
a. Agent acts fairly, and in good faith (corp law)
b. Agent discloses all material facts to P (securities regulations)
iii. Tarnowski v. Resop: hires to investigate value of a biz, defrauds by taking money from biz to overvalue
firm. HELD: court gives more than he originally invested as punitive measure to discourage behavior by A that
would harm P.
1. Very difficult to monitor fraud because people are purposely evading you with their behavior so cost to
monitor is very high. Thus court is harsh because its so hard for P to monitor A
iv. In re Gleeson: HELD: no matter what, a person cannot be both a trustee and tenant, effectively dealing with
himself it violates the rights of the trustees

1. Monitoring costs are infinite the P is dead, theres no way to monitor. Thus the court here was also harsh
and this is why in cases of Trusts courts take decisions to extremes because of these high costs to monitor

III.

PARTNERSHIP
a. Key Features of Partnership
i. All owners - partners - are liable as principals
ii. All partners are general agents of the partnership
1. all can bind the partnership to third parties
iii. All partners are jointly and severally liable for the debts of the business, exactly like single principals
1. Third parties can sue any or all partners for repayment of a loan
iv. All partners share equally in control, unless they agree otherwise this can be changed by contract
b. Motivation for joint-ownership
i. Borrowing costs associated with merely taking a loan instead of giving a stake
ii. Different areas of expertise
iii. Sharing the work
iv. Sharing contacts or other resources
c. Relationship between co-owners
i. Meinhard v. Salmon: M and S joint-venture partners for 20yr lease; 4 mos before termination of lease S gets
option to extend from Gerry, who doesnt know about M (silent partner); S extends lease for himself.
1. HELD: S owed M a higher fiduciary duty and should have let him know about lease option. S excluded M
from having even a chance from competing for the K, and as a partner/co-venture, S could only purchase
that part of the partnership with his partners knowledge. Opportunity to enter into lease is an asset of the
joint partnership.
ii. Role of Fiduciary Duties
1. Default rules that govern contracts
2. Cardozos view of co-ownership as mandating the highest standards of honesty
a. The perception is that partners are there for the longrun like married couples
b. Many forms of conduct permissible in a workaday world for those acting at arms length, are forbidden to
those bound by duciary ties. A trustee is held to something stricter than the morals of the market place.
Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to
this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been
the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the
disintegrating erosion of particular exceptions...
iii. Does this rule yield the most efcient outcome?
1. Incentives of Salmon - as the manager - to appropriate rm assets
a. Most efficient approach because S has the most incentive to make the biz prosper
b. Correct outcome but not one taken by court
2. Incentives of Meinhard to introduce monitoring structure
a. Additional monitoring costs would make the business less efficient
b. Incorrect outcome but this is approach court took
3. NOTE: in spite of the rhetoric of the fiduciary rules in this case the correct outcome is not as clear as it
seems
d. Partnership Formation
i. Formed by agreement btw the parties - No formalities necessary
ii. Sharing in net prots indicates partnership
iii. UPA 6(1): A partnership is an association of two or more persons to carry on as co-owners a business for a
prot
iv. UPA 7: Rules for Determining the Existence of a Partnership
1. (3) The sharing of gross returns does not of itself establish a partnership...
2. (4) The receipt by a person of a share of the prots of a business is prima facie evidence that he is a partner
[unless interest payments, wages, rent, etc.]
v. NOTE: big distinction between net profits and gross returns because the whole partnership is an attempt to
make a profit, so the person taking the profit has incentive to run the partnership in the most efficient way. Thus
the person taking net profit is the person who is in control
vi. Vohland v Sweet: V had hired S to work for him, eventually he told S he would compensate him with 20% net
profits as commission; eventually S wanted to get out; 10 years prior they had planted the nursery stock; so S
wanted a share of the investment in the nursery stock because he was a partner. HELD: S is held to be a
partner.
1. If S was just getting a commission, he would not have incentive to keep the biz running. Thus by making
him a co-owner, he would know that he would be able to recoup the investment in the inventory, 10 years
later, for the betterment of the biz
e. Partners liability for partnership debts: joint & several
i. RUPA 306(a): all partners jointly and severally liable unless otherwise agreed or provided by law
1. Jointly: means each partner is liable for the debts of the partnership to the full amount

2. Severally: each partner is only liable up to their share

3. Jointly and Severally: this means that the 3rd parties can sue each partner up to the full amount and they
have to pay, but THEN that partner has a claim against the other partners for the share they are responsible
for
ii. UPA 15: Joint and several liability for torts, joint liability only for Ks
iii. RUPA 307(d): Must exhaust partnership assets before pursuing personal assets
1. In order for a creditor to sue one of the partners directly, the creditor has to first prove that the partnership
doesnt have enough assets to pay the claim in full
iv. Partners actions in the ordinary course of business of the partnership are binding for the partnership
1. UPA 13: A wrongful act or omission of a partner acting in the ordinary course of business of the
partnership is regarded as a partnership omission.
v. UPA 18(g): No person can become a member of the partnership without the consent of the others.
vi. UPA 16: Partnership by estoppel
1. IF: A person represents itself as being partner in an enterprise (or consents to others making the
representation)
2. AND: a third party reasonably relies on the representation (actual reliance required) and does business with
the enterprise
3. THEN: the person who was represented as a partner is personally liable on the transaction, even though that
person is not in fact a partner.
4. NOTE: UPA 16 refers only to those who give credit while RUPA expands this to all transactions; case law
has made this clear even in the UPA context
vii. Retiring Partners Liaiblity
1. UPA 36(2): a retiring partner is not liable for partnership debts, if there is an agreement between
partners and partnership creditors
2. UPA 36(3): a retiring partner is released of liability even when the terms of repayment of debt change
materially, provided that creditors are in agreement
a. Usually when one of the partners leaves they need to think again about who to repay who and when and
why this rule prohibits creditors who agreed to this repayment structure to go back and try to fight it
viii. Claims Against Partner Property when independent or partnership assets are insufficient
1. UPA 40(h) & (i): The Jingle Rule original rule
a. Partnership creditors can get to indy assets only after the indy creditors are satisfied first
b. Similarly, indy creditors get to the partnership assets only when the partnership creditors are satisfied first
2. Bankruptcy Act 1978 (723) RUPA 807(a)
a. Partnership creditors do not have to wait for the indy creditors to be satisfied first to claim the assets, they
can go and seize indy assets immediately as if they were individual creditors
b. HOWEVER the indy creditors have to wait for the partnership creditors to be fully satisfied to lay claim
on the partnership assets
3. Thus IF RUPA is controlling state law OR 723 applies, THEN use bankruptcy act rules. If UPA controls
AND 723 does not apply, use UPA rules.
f. Partnership Governance
i. Ordinary matters: majority decisions binding for all
1. UPA 18(h): Any difference arising as to ordinary matters connected with the partnership business may be
decided by a majority of the partners; but no act in contravention of any agreement between the partners
may be done rightfully without the consent of all the partners.
2. UPA 9(1): Every partner is an agent of the partnership for the purpose of its business, and the act of every
partner... for apparently carrying on in the usual way the business of the partnership of which he is a member
binds the partnership, unless the partner so acting has in fact no authority to act for the partnership in the
particular matter, and the person with whom he is dealing has knowledge of the fact that he has no such
authority.
3. Requires a majority of the partners, so even minority partners are bound by decision regardless of
consequences
4. Nabisco v Stroud: Strouds Food Center run by S and Freeman (equal 50% partners); at some point S
decided to leave the partnership so he went out and told Nabisco that he would not be liable for any products
sold; Freeman went ahead and ordered products from Nabisco. HELD: Fs actions binding on S because F
was acting as an agent of partnership in the ordinary course of biz. So even tho neither can have a majority,
the fact that F is acting in the ordinary course of biz of the company, he has the power to bind the
partnership.
ii. Extraordinary Matters
1. UPA 9(2): An act of a partner which is not apparently for the carrying on of the business of the partnership in
the usual way does not bind the partnership unless authorized by the other partners.

2. The RULE is consent - All partners need to agree every partner can block the decision if it is something
that the partnership doesnt do in its ordinary course of biz
3. NOTE: silence by a partner is implied consent, and this is binding
4. If a partner disagrees with a decision, then third-party should cease work, otherwise only authorizing
partners would be liable individually but the partnership would not
5. NOTE: Minimum due diligence required by third party - they should check the authorization of the partner
thats ordering the work to be safe
g. Partnership Dissolution:
i. Under UPA
1. Dissolution (29): any change of partnership relations including withdrawal, e.g., the exit of a partner
2. Winding up (37): orderly liquidation and settlement of partnership affairs EX selling assets, satisfying
creditors, etc
3. Termination (30): partnership ceases entirely at the end of winding up
ii. Under RUPA
1. Dissociation (601): a partner leaves but the partnership continues, e.g. pursuant to agreement
2. Dissolution (801): the onset of liquidating of partnership assets and winding up its affairs
iii. RULE: Parties can contract to avoid statutory winding-up of assets following dissolution (Adams v Jarvis)
1. UPA 37: Unless otherwise agreed the partners... have the right to wind up the partnership affairs...
2. Adams v. Jarvis: Tomahawk Clinic has three partners, including Jarvis and Adams. There are specific terms
for the partnership, however this K has one term that says what will happen in case of dissolution, and a
second term that says what happens when a partner withdraws and they dont vogue. HELD: the court
gives precedent to what the parties agreed to, the court wanted to maintain the bargain of the parties, so it
allowed a withdraw.
iv. RULE: Distribution in-kind rejected in Dreifuerst (EXCEPT under special circumstances like Rinke)
1. UPA 38(1): When dissolution is caused in any way, except in contravention of the partnership agreement...
each partner, unless otherwise agreed, may have the partnership property applied to discharge its liabilities,
and the surplus applied to pay in cash the net amount owing to the respective partners.
2. Dreifuerst: three bros were running these feedmills; partnership called DDD Partners; they had two feedmills,
one in one location and one in another; later they bros decided to dissolve the partnership; Lower court said
theyd cut the assets in two, cutting them in kind. HELD: the court interpreted the statute - 38(1): if the
partnership is dissolved then the law doesnt allow distribution in-kind, rather requires payment of assets in
cash
3. Rinke: RULE: special circumstance where in-kind distribution is fair. Where no creditors will be paid by the
proceeds and the former partners are the only people who will buy the assets. Breaking up assets destroys
value, so in-kind here is most equitable solution.
4. POLICY: ultimately the court says the best rule is sale if we believe the best solution is to get the partners to
buy each other out.
v. Value of Partners Stake at time of Dissolution
1. UPA 42: partnership stake is valued at the time of dissolution and treated as a debt of the partnership to the
retiring partner
a. NOTE: If the value of the firm as a whole is more than the value if the assets are broken up and sold off,
then the withdrawing partner suffers a penalty because his stake based on liquidation value is less than
the stake of the other partners valued by the firm as a whole
2. Compare with RUPA 701(b): The buyout price of a dissociated partners interest is ... [the] greater of the
liquidation value or the value based on a sale of the entire business as a going concern
a. NOTE: Here there would be no withdrawal penalty
vi. RULE: Partners right to dissolve the partnership can be limited by term, or by their duciary duties to other
partners (Page)
1. Page: two bros (43K each invested) had a partnership for linen supply; Big Page had been in the biz for a
long time and had another corp Page Corp, an investor in the partnership (47k demand note). Biz picked
up and BP wanted out to run Page Corp solo. The court realized that Little Page had a bad side of a deal and
tried to amend this by amending the term. HELD: Each partner can exercise her right to dissolve, but they
have a fiduciary duty to act in good faith towards the other partners. The implication is that Big Page should
chip in just a little extra so Little Page has something extra and is satisfied.
2. Problem: we dont know exactly how the fiduciary duty will operate. Its sort of vague we dont know what it
entails, could lead to further disagreements, etc
h. Limited Liability Modications of the Partnership Form
i. Limited Liability in Partnership
1. They ALL require registration as opposed to partnerships
2. But there is never doubt about who is a partner and who is not

3. They, just like partnerships they are only taxed once, not twice the partnership itself doesnt get taxed,
just the partner themselves
ii. Three Types
1. Limited Partnership - apply all the rules we learned about partnerships to the general partner
a. A partner with unlimited liability combines with partners whose liability is limited to their contribution
b. But the limited partner is only liable up to their contribution
c. Typically the limited partner does not have control
2. Limited Liability Partnership
a. All partners have same type of liability and are protected from certain kinds of liabilities (EX law firms,
audit firms)
i. So there are certain debts where theyre liable with their personal assets, and certain debts for which
theyre liable for only their partnership assets
3. Limited Liability Company
a. Four-Factor Test:
i. Limited liability for owners of a biz
ii. Centralized management
iii. Freely transferable ownership interest
iv. Continuity of life
b. Advantage you could be a lot like a corp in a lot of ways but there were key advantages regarding the
tax framework - Main issue being avoiding double taxation of corps
c. After 1997 any limited liability company could declare itself a partnership and just pay partnership tax
check the box - Where as before 1997 you were LLC if you satisfied three of four factors
i. Why a Partnership?
i. Who makes decisions in a partnership?
1. All contributors want a piece of the action - control:
a. They have a lot at stake (poor little Page!)
b. They contribute their professional skills or services either at the outset (Meinhard, Adams) or later on
(Sweet)
ii. What initial investment does a partnership require?
1. Initial start-up costs are low (cant pay an employee!) no registration required
iii. When does a big rm adopt the partnership form?
1. Unlimited liability guarantees high quality
a. Commitment device towards co-partners
b. Strong signal to everyone else
iv. Elements that indicate that a partnership is a good idea
1. Partnerships are more appropriate when there are more similarities, and theres a lot of trust among the
partners EX family situations
2. You need people with differing skill sets that they can offer to the partnership
j. Limitations of Partnership Structure
i. Unlimited liability?
1. Requires high levels of trust to co-partners (or low possibility of a major debacle)
2. Insurance can help - but up to a point
3. LLCs might be a solution
ii. Governance of partnership?
1. Consent for extraordinary matters, for accepting new partners, for amending terms ex post
iii. Dissolution of partnership?
1. Few limitations in the rights of partners to dissolve: partnerships are unstable
2. Contractual variations are possible

IV.

THE CORPORATE FORM

a. Key Characteristics of the Corp Form
i. Investor ownership; legal personality (meaning theyre treated as persons, they can own property, assets, etc);
limited liability; transferable shares; centralized management under an elected board
b. History of the corporation: from state entity to a for-prot enterprise that can accommodate many small investors
i. 1776-1820
1. Initially corps were entities of the state not private
2. They were created to deal with state biz and colonial trade
3. Were established for specific purposes EX salt, tobacco
4. Incorporation required a lot of burdensome legislative action
ii. 1820-1850
1. Core features start to appear limited liability, legal personality
2. General incorporation statutes appear broadened reasons why someone could set up a corp (Corps could
serve any lawful purpose)
iii. Late 19th century
1. New Jersey takes the lead: permits corporations to own stock in other corporations
2. Pres. Lincoln ver suspicious of corps
iv. Early 20th Century
1. Wilson scaled back a lot of corporate privileges
2. Thus Delaware jumped in and became the new leader in corp charters
3. Anti-trust law comes into force FTC established
v. 1930s: Berle and Means
1. Corps at this time have changed completely and were owned by many smaller investors
2. Theres a separation of ownership from control a key problem of the corp form from these two guys
3. They argue that Corporate law should protect shareholders from managers who might attempt to seize
wealth and power
c. Procedure for establishing a corporation (Incorporation)
i. Firms can incorporate in the state of their preference: no connection necessary with headquarters, place of
business, or other factors
ii. The law of the state of incorporation governs all rms incorporated there (internal affairs doctrine).
iii. Incorporation:
1. A document (articles of incorporation or certicate, a.k.a. charter) is led with state authorities and the fee is
paid
2. Secretary of state issues the charter
3. Board of Directors convenes, adopts by-laws and appoints ofcers
iv. Articles of Incorporation: Name of corporation, address, purpose (usually any lawful act), capital structure
(classes of shares, number of common shares, rights of preferred shareholders if any), other miscellaneous
provisions.
1. skeletal info about the corp
v. Bylaws (sample structure): More detailed info on the workings of the corp
1. Article I: Stockholders
2. Article II: Board of Directors
3. Article III: Committees
4. Article IV: Ofcers
5. Article V: Stock
6. Article VI: Indemnication
7. Article VII: Miscellaneous
d. Reincorporation
i. Its easy for corps to essentially move from state to state - States have incentives to allow firms to join their
charter, because they charge an annual fee
ii. How this works
1. A new firm is created in the destination state a completely new corp
2. Once this is in place, the new firm merges with the old one, tax free
3. Theres some set up costs
4. Then you get shareholder approval for the move
e. Corporate law as state law
i. Delaware as the leader
ii. Theories of regulatory competition and federalism
iii. Key Question: how can states get firms to change preferences
1. States offer the type of law that works best for the firms interest that is a race to the top
a. State is always working really hard to offer the firms whats best for them, the best product possible

2. States offer the type of law that works best for the firms interests, but disregards other constituents then
that is a race to the bottom
3. States offer the type of law that works best for the firms management, to the detriment of shareholders a
race to the bottom
f. Delaware Corporate Law
i. Corporate law provides a set of default rules:
1. Wide margin for contractual variation they can typically be amended by K
2. Shareholders agreements typically focus on the exercise of voting rights
a. Most typical variation is shareholders agreements that affect the voting structure
3. Important background common law rules, like duciary duties, come into play
ii. RMBCA has been adopted by 24 states but not DE
g. How does a corp get funded
i. Share (stock): an ownership stake over the assets of the rm
1. To raise $10m, a rm can issue 1m stocks for $10 each
2. Stocks used to be represented by a certicate; they can also be in digital form
ii. The issue of stock to investors
1. Requires a board decision
2. May require a ling with the Securities and Exchange Commission (SEC) if the rm plans to offer securities
to the public
iii. Public companies (wide SHer base) v. privately held companies (only a few SHers)
1. Stock ownership provides key rights to shareholders:
a. To receive dividends (paid out of net prots)
b. To receive information about the rm
c. To participate in annual meetings and vote
2. Types of stock
a. Common
b. Preferred: increased dividends, increased voting rights, other privileges
h. Benefits of the Corporate Form
i. No personal liability
1. creditors can only rely on business assets
ii. Investors can easily enter and exit the rm
1. all they have to do is buy or sell shares
iii. No minority investor has the right to dissolve the business
1. with no consent requirement, decisions are easily reached
iv. Third parties can easily ascertain whether they are dealing with an authorized agent of the corporation
1. They only need a board resolution
i. Limited liability
i. Investors are only liable up to the amount of their contribution to the corporation, i.e. the purchase price for their
stock
ii. Advantages of limited liability
1. Reduces risk for investors (creditors? - the bigger the company the more likely you will get paid out of their
larger pool of assets)
2. Reduces monitoring costs, both towards managers and towards other shareholders
3. Helps transferability of shares - turns a stock into a revenue stream
4. Helps diversication - With stocks, you can diversify your exposure to various firms and hedge your risk more
iii. NOTE: there are some circumstances where courts have agreed to look at the assets for shareholders pierce
the corporate veil
iv. Is limited liability a problem for tort claims?
1. Creates incentive for firms to invest too little in precautions
2. It also encourages investment in hazardous industries
a. So if youre never going to risk more than youre investing then you take that into account when you invest
initially
3. Solution more regulations for what is happening
j. Transferability
i. Advantages
1. Firm can continue undisrupted as shareholders join or leave makes markets more liquid
2. Reduces liquidity risk
3. Allows small investors to participate - A system that basically democratizes wealth
4. Facilitates change of control over business resources - This allows exploitation of resources more efficiently
5. Allows takeover mechanisms
ii. Easy exit for shareholders

10

k. Centralized management
i. Investors elect board of directors who then supervise the CEO
ii. The board is the main repository of power in the corporation
iii. Board Duties board owns a series of fiduciary duties to investors
l. Corporate hierarchy
i. Shareholder democracy elective powers of shareholders
ii. Board Composition
1. Directors elected by shareholders in Annual Meeting, but typically nominated by the CEO (check bylaws)
a. distinct from ofcers: key positions in management that are not necessarily members of the Board
b. Notice here the inherent COI
2. Chairman of the Board responsible for convening meetings and setting agenda (check bylaws)
a. sometimes CEO is also Chairman of the Board
3. Inside Directors: members of the Board that have employment, ownership, or other relationship with the rm
4. Outside Directors: members of the Board with no relationship with the rm
a. Idea is that these guys are in a better position to care for the interests of the shareholders because
theyre not invested in any particular strategy they own no shares
iii. Board Powers and Structure
1. Typical Board powers
a. appoints CEO and other ofcers
b. makes key decisions (strategy, products)
c. declares dividends
d. amends bylaws
2. Board Committees
a. The board meets maybe 10 times a year, but not more, usually less
b. But sometimes they form small committees that convene more often and deal with specialized things
c. Executive Committee they meet often
d. Audit Committee - usually has outside directors only, supervise the companys financial statements
e. Compensation Committee - outside directors only, sets remuneration of CEO and other management
3. Key Ofcers (appointed by the Board)
a. Chief Executive Ofcer (CEO)
b. Chief Financial Ofcer (CFO) - not usually member of the board, job is to draft financial statements for
company
4. Policy behind Board structure
a. Two main justifications
i. Expertise - Board typically has more info about a company that shareholders do including value of
the company
ii. Protect minority from whims of majority - - and especially from the majority extracting private benets
of control: loans, pay-outs, luxurious suites, private jets, etc.
b. Problem: The power structure in practice may not be the one that is what the rules intend
i. A lot depends on the voting structure of the board
m. Case law on corporate hierarchy
i. RULE: Directors are agents of all shareholders, not the majority (Automatic Self-Cleansing Filter)
1. Automatic Self-Cleansing Filter Syndicate: Majority shareholder (M) had 55% of the votes, and wanted to sell
this companys major asset; the Board said no; so the Board went against M and agreed with the 45%
owners. HELD: Court finds that directors are agents of the firm, not of the majority it enforces the K struck
among shareholders in the bylaws.
a. There is no obligation to reflect the desires of the shareholders. Rather it is an independent organization
that should make its own decisions and be on the lookout for the desires of the minority as well.
ii. RULE: Board Resolution required for representing the corporation under Agency Law principles (Jennings)
1. Jennings: Egmore was repping a company had a meeting with Jennings, a real estate agent; when E went to
J, he told him that he was the CFO and member of exec committee; J, on Es word alone, went and found
some offers for sale and leaseback; M (corp) refused the third sale, but J had already been paid a
commission by E; HELD: J was not justified in believing that E was a rep of the firm officially he had no
apparent authority. The board had not voted on whether E would officially rep the corp M. Court did not want
to undermine the M Boards authority by extending apparent authority to E.
2. Court did not find apparent authority because there were no similarities in deals or repetitiveness, inherent
authority not an issue.
n. Citizens United v. FEC
i. 441b Bipartisan Campaign Reform Act of 2002 (McCain-Feingold Act)
1. This tried to limit contributions and expenditures on elections
2. Corps were prohibited from conducting electioneering communications

11

ii.

iii.

3. Violations = civil and criminal penalties

FACTS: Citizens United: a non-prot corporation, on the conservative side, very active; Produces a lm about
Hillary Clinton to be shown on DirecTV for free around the time of the democratic primary; Hopes to place ads to
promote the lm; Citizens United brings a case against the FEC, asking the court to declare that the placement
of these ads does not violate the Act or that the Acts provision is unconstitutional
1. CU invoked 1A stating that corps had rights protected free speech they have legal personality
Majority (Kennedy)
1. Majority saw this as some sort of equality between corps and natural persons. Constitution does not allow
Congress to disadvantage a certain class of speakers compared to another
2. Court has long recognized 1A rights for corps
3. Discusses three rationales as a potential justication for withholding rights from corporations
a. Anti-distortion Rationale
i. Government interest in preventing the corrosive and distorting effects of immense aggregations of
wealth that are accumulated with the help of the corporate form (Austin) that will drown out the
voices of everyday Americans (Obama)
ii. Majority (Kennedy) - Public must be informed about the views of business leaders
1. Cannot restrict the speech of some elements of society to enhance the relative voice of others
2. Of course the idea is that corps will accumulate wealth and use it to push their political agenda But the majority saw this as a way to limit peoples ability to use their wealth, and it wasnt a
question of limiting speech but using your money to get access to speech
iii. Dissent (Stevens) - What is needed is not simply to restore balance, but to limit corruption (folds antidistortion into anti-corruption)
1. So effectively the idea of balance between wealthy corps and non-wealthy people collapsed at
the higher level
b. Anti-corruption Rationale
i. Corporations wield enormous power -> threat of corruption and of public perception of corruption
ii. Majority (Kennedy)
1. May justify limits on contributions but not on expenditures (Buckley)
2. Lack of prearrangement and coordination... alleviates the danger that expenditures will be given as
a quid pro quo for improper commitments by the candidate
iii. Dissent (Stevens)
1. Quid pro quo is a very limited conception of corruption: Business interests who supported a
politician will have preferential access to her after the election
2. Large uninvited expenditures are in effect quid pro quo
c. Shareholder Protection Rationale
i. Shareholders are not the ones actually deciding what the corp will actually spend their money on Even in the ordinary biz of the corp, like biz decisions the majority cannot affect the views of the
board
ii. Why should dissenting shareholders fund corporate speech
iii. Majority view
1. Rules of shareholder democracy offer protection
a. Meaning that shareholders can elect new boards, etc
2. They can always sell their share and exit
iv. Dissent
1. Directors and ofcers dictate the corporations political message, not the corporation
2. They may foster their own agendas, using corporate funds for personal ends
3. Management may ll compelled to support a politician, thus creating an arms race with competitors
4. Its difficult for even a majority cannot get the board to change its view the shareholders actually
have to elect a new board if they want a real change
5. Plus shareholders have to know where money went for funding - Shareholders would have to
supervise more closely the dealings of the corp and so this creates another agency cost
4. How Corps are different than people
a. They are not citizens, but creations of the state
b. Have limited liability and perpetual life
c. Favorable treatment for accumulation of assets
d. Cannot vote or run for ofce
e. Can be controlled by foreigners
f. Have technical knowledge of the details of the legislative process and the resources to mobilize experts
and lobbyists
g. No conscience, no beliefs, no feelings, no thoughts, no desires -> can support campaign messages that
have little or no correlation with the beliefs held by actual persons

12

h. Not members of We the People

i. Their personhood is a useful legal ction
j. Freedom of speech protects individuals right of self- expression: helps free men develop their faculties But corporations have no such faculties
k. Instead, corporations must engage in the electoral process with the aim to enhance the protability of the
company, no matter how persuasive the arguments for a broader or conicting set of priorities
l. Centralized management structure provides an easy ready- made way to overcome collective action
problems that will plague ordinary citizens
5. Benefits of PACs as solution
a. All participants share a commitment to its stated political goals
b. Subject to a set of rule and limitations common to all PACs which ensure fair access to the political
process
6. Problems with PACs
a. Establishing a PAC is costly and time-consuming; cannot be done in time for an election
b. Treasurer administers donations
c. Must keep detailed records of donors
d. Must le monthly reports with the FEC
e. NOTE: contributions capped at $5k
o. Political Speech and Agency Problems
i. Default rule in DE is no shareholder approval - Managers can make these decisions on their own
ii. No independent director involvement required
1. Boards delegate to management - only 37% of public rms require board approval for political contributions
iii. Potential for differences between shareholders and managers on corp law
1. When managers give money to politicians, the politicians might produce the type of laws more beneficial to
managers than shareholders

13

V.

DEBT, EQUITY, AND ECONOMIC VALUATION

a. Most transactions include two ows of cash:
i. Money owing into the corporation from shareholders, creditors, clients, etc. (typically at an earlier stage)
ii. Money owing from the corporation towards such parties
b. Hierarchy of Claims on Corps Cash Flows
i. Secured debt paid off first - If theres anything left after they are satisfied, move on
ii. Debt
iii. Subordinate debt
1. Loan holders who have a claim below unsecured debt holders
2. Then after all debt holders have been satisfied, only then will assets be distributed to equity holders
iv. Preferred Stock
v. Common stock
c. Typical Characteristics of Common and Preferred stock (DGCL 151)
i. Common Stock (statutes require them all corps have)
1. Pays dividends (share of prots) at the Boards discretion
2. Grants voting rights at annual meetings (e.g., for electing the Board)
a. Common stock holders bear the highest level of risk, so they get the voting rights
3. Residual claim over corporations assets after all other creditors have been repaid
ii. Preferred Stock (issued at rms discretion)
1. Fixed dividends
2. Ranks higher than common stock in liquidation
3. Typically grants NO voting rights
d. Valuation Basics
i. Two Elements: Time & Risk
1. 5 dollars today is worth more than 5 dollars tomorrow this is time-value of money
ii. Present value: the value Today of funds to be paid out at some future point
iii. Discount rate: the rate I earn for allowing someone else to use my money for a year, or some period of time
iv. Future and Present Values
1. Future value for 1 year = PV +r(PV) = PV(1 + r) ->
a. PV = FV/(1+r)
2. Future value for multiple (n) years
a. FV = PV(1+r) + PV(1+r)(1+r)= PV(1+r) to nth degree ->
i. PV = FV/(1+r) to nth degree
v. NOTE: When r (rate) increases, the PV decreases
vi. WORK THROUGH PROBLEMS IN SLIDES (#10, slides 9 onward)
e. Valuing Investments
i. NOTE: This is the timing element
ii. When we have $X today, we expect to receive r($X) in a year that is Xs value in a year
iii. When we ant to invest X in a biz, a company, a project, we should expect to make more than r(X) in a year
iv. For an investment to make sense it must yield a profit (a rate of return) higher than r
v. Net Present Value: difference btw PV of the amount invested and the PV of the amounts received in return
(Profit)
vi. NPV problem p. 122, slide 12
1. $10k investment
a. If r = 7% then NPV 10,140.19
b. If r = 8.5% then NPV 10,850
c. If r = 10% then NPV 9,863.64
2. Now, if you borrow $10k now at 8.5%, what is NPV at above possible rates
a. If r = 7% then NPV -140.19
b. If r = 8.5% then NPV 0
c. If r = 10% then NPV 136.36 this is a good investment
f. Expected Returns and Risk Aversion
i. NOTE: this is the risk element
ii. Here you add a new discount, in addition to the above discount - You add in the risk that something might go
wrong
iii. Example - Company C is considering two investments, A and B, with the same initial investment, $5m.
1. Project A has a 50% possibility of success, yielding returns of $3m. If it fails, the value of the investment will
be $2m.
a. PV=0.5($5m+$3m) + 0.5($2m)=$5m
2. Project B has a 50% possibility of success, yielding returns of $1m. If it fails, the value of the investment will
be $4m.

14

a. PV=0.5($5m+$1m) + 0.5($4m)=$5m
NOTE: the NPV for each is the same, but one is more risky
Those who choose project A are risk neutral, theyre interested in the expected return and the upside
Those who choose project B are risk averse, most economic models assume that rational actors are risk averse
Why People are risk averse
1. Declining marginal utility of wealth
a. The more money you have, the less money is worth to you, OR
b. The less money you have, a further loss is more painful to you, and thus the more money is worth to you
2. Variable outcomes inflict large transaction costs
a. This volatility makes you uncertain and you have to prepare for alternative scenarios
b. EX buy insurance, find alternative employment, move houses - This can be costly
3. Because most people are risk averse we need to find a way to discount for the risk factor
viii. Two ways to value risk
1. Two-step process
a. STEP ONE: Discount for risk
b. STEP TWO: discount for time, using the risk-free discount rate, the money you would earn by letting
someone else use your money (typically, interest rate on 1-year T-bill)
2. One-step process
a. use a single rate, that reects both the risk discount and the risk-free discount
b. single rate = risk-free discount + risk premium
3. SEE EXAMPLE IN NOTES (pp. 3-4)/SLIDES 16 & 17, prob. P. 125
4. Nominal interest rate = total premium that is being offered in order to lend money today
g. Diversification
i. Non-systematic risks those that can be controlled by spreading money among several investments
1. Because the bank is dividing its assets over several bizs the less likely it will be that they will default
ii. Systematic Risks those that cannot be controlled
1. Recessions, natural disasters, wars
2. However much you diversify you cannot mitigate this risk because they affect all investments
iii. SEE Questions on Systematic/Unsystematic Risk p. 127, Slides 19 & 20
h. Reason for Valuation
i. Helps rms decide what is a good investment
1. Managers identify positive NPV ideas
2. Board can assess them using these tools
3. Shareholders can better monitor the Board
ii. Monitoring can help shareholders decide whether they want to buy stocks in a rm, continue holding any stocks,
or sell - They trade!
i. Market Efficiency
i. A market is efcient when the prices fully reect available information
ii. Three formulations:
1. Weak: all past stock prices and returns - a random walk
a. Looking at what the company has made in the past, you cannot predict what is going to happen in the
future - Youre only looking at past info, so whether the stock goes up or down is random
2. Semi-strong: all publicly available information
a. the stock price reflects info from past, but also reflects all info currently available
b. EX at moment Steve jobs makes announcement of new product, the price of the stock goes up
3. Strong: all information (even non-public) Essentially insider trading
iii. Semi-strong is the most widely studied - It essentially assumes that you cannot beat the market
j. Problems with Market Efficiency Theory
i. Rationality
1. Investors do not perform the stock valuation exercise we just discussed
a. Its hard to make these calculations and incorporate all pertinent info all the time
2. Biggest problem presupposes rational actors, when in reality people are not always rational
a. They are inuenced by other factors: external needs, friends, advisors, etc.
b. They are subject to psychological biases, such as loss aversion, a trend to see patterns, etc.
3. Liquidity problems - This theory assumes that for everyone who wants to buy or sell a stock, there is always
someone on the other side but this is not always the case
k. Noise Traders: Random or not?
i. They trade randomly, so they cancel each other out
1. But some patterns are systematic:
a. Individual Investors
b. Institutions
iv.
v.
vi.
vii.

15

ii.
iii.

If there is an opportunity in the market, smart investors will snatch it, restoring balance - but do they have the
resources to do so?
1. Arbitrage techniques (such as short-selling, or derivatives) help smart investors to intervene
Limits to arbitrage: availability of substitutes and risk

16

VI.

PROTECTION OF CREDITORS
a. Creditor Protection
i. Question: How to protect creditors, given rms limited liability?
b. Mandatory Disclosure
i. Rules that requires companies to provide to the market important changes to their business
ii. This helps creditors assess whether the company is healthy or not
c. Capital Regulation
i. Shareholder Equity Accounts
1. Balance Sheet a snapshot of a companys specific value at a specific date/time
2. DGCL154: ...The excess ... of the net assets of the corporation over the amount so determined to be capital
shall be surplus. Net assets means the amount by which total assets exceed total liabilities. Capital and
surplus are not liabilities for this purpose
3. Stated capital account = the par value of each stock multiplied by the number of stocks for each class, plus
any cumulative dividend or liquidation preference
a. This is the value of all the stocks, but not the market value, nor the issuing value but rather the Par
Value - Par used to be the price SHers paid for the stock. These days, par values are very low and the
diff between the price shareholders pay and the par value goes to Capital Surplus account
b. RULE: CANNOT be distributed generally to shareholders, it requires approval to do so
4. Capital surplus account = the excess of the net assets over capital
5. Retained Earnings account = Profits that the firm does not distribute to shareholders but places them on this
account
6. RULE: Capital surplus and retained earnings CAN be distributed to shareholders; The more money the
company can distribute the less will be available to creditors
ii. Distribution Constraints:
1. How much of the funds in these accounts can actually be distributed?
2. Distribution only though funds recorded in Capital Surplus or Retained Earnings, not Stated Capital
(Delaware)
3. Four Rules to choose from:
a. DGCL 170(a) Nimble dividend test: rm may pay dividends out of capital surplus and retained
earnings, or net prots in current or preceding scal year (whichever is greater).
i. BUT DGCL 244(a)(4) allows board to transfer funds out of stated capital into surplus for no par stock.
1. Even for amounts recorded as stated capital, even these amounts can be transferred to an account
from where there could be distribution if the board decides to do so
b. RMBCA 6.40(c): rm may not pay dividends if it cannot pay debts as they come due, or if assets would
be less than liabilities plus the preferential claims of preferred shareholders
i. But board free to use a fair valuation or other method that is reasonable in the circumstances
ii. NOTE: Here, no reference to these accounts, but its a reference to debt, So long as a co has enough
to pay its debts, it has enough to pay out everything else. BUT board decides how to value these
assets
c. OLD New York Bus. Corp. Law 510 (capital surplus test): may only pay distributions out of
surplus, and distributions cannot render the company insolvent (NOTE: Only from one account and with
this additional condition that company cant be insolvent)
i. BUT NYBCL 516(a)(4) allows board to transfer funds out of stated capital into surplus if authorized
by shareholders
d. Cal. Corp. Code 500: (modied retained earnings test): may pay dividends either out of its retained
earnings or out of its assets, as long as ratio of assets to liabilities remains at least 1.25, and current
assets are at least equal to current liabilities
i. NOTE: They are trying to allow distribution only after certain conditions are fulfilled, only after there is
some assurances that there are enough assets to cover liabilities
4. Boards can manipulate accounts or valuation methods
5. SEE Example Alpha Inc Balance Sheet SLIDES 15 & 16 in #11
iii. Minimum Capital Requirements
1. In order to set up a corporation, shareholders must put down a minimum amount
2. Is this a good idea?
a. Law sets a uniform minimum capital, but every corporation has different needs; why not let shareholders
bargain?
b. Increases barriers to entry to corporate form for entrepreneurs
c. No real effect; capital is invested right away
3. Very popular in Europe; non-existent in the U.S.
iv. Capital Maintenance Requirements
1. To prevent capital from dissipating, these rules order action when certain minimum levels are met

17

a. Call a shareholders meeting for dissolution or additional contributions

b. Require board to le for bankruptcy
2. Is this a good idea?
a. Why force a business that is still struggling to go into dissolution/bankruptcy?
b. Main beneciaries of the rule are unsuspected creditors of the rm - typically tort victims - but see US
approach below
d. Standard-based Duties
i. RULE: Directors owe Duty of Loyalty to the Corporation (Credit Lyonnais)
1. RULE: Directors should consider welfare of the corp as a whole, not just the Shers
2. Credit Lyonnais: Firms single asset $51m judgment; its on appeal so it could get modified or reversed; firm
also has $12m bond liability to bondholders; board considered settlement offers of $12.5m & $17.5m
a. SEE Slide 6 (#12) for payouts, probabilities, etc
i. With valuation SHers would want to litigate because they would only get paid if that happened, but
bondholders would take any payout over $15.5 so theyd want 17.5 settlement, not 12.5
3. Should there be special rules for corps nearing insolvency to allow SHer primacy?
a. Possible counterarguments
i. Hard to dene nearing insolvency
ii. Creditors should have protected themselves by security interests, other contractual provisions
iii. Creditors could simply charge a higher risk premium
iv. Hard to dene difference between duciary duty to corporation and to its creditors
e. Attempts to Alter distribution of assets in the event of bankruptcy or liquidation
i. Fraudulent Conveyance Doctrine: Renders void transfers effected to remove corporate assets from the asset
pool available to creditors
1. Fraudulent conveyance is made when corp is selling part of its assets before the creditors can get to it
2. UFTA 4: Allows creditors to render these transfers void under specific circumstances
a. (a) A transfer made... by a debtor is fraudulent as to a creditor, whether the creditors close arose before
or after the transfer was made... if the debtor made the transfer...
i. (1) with actual intent to hinder, delay, or defraud any creditor of the debtor; or
ii. (2) without receiving a reasonably equivalent value in exchange for the transfer... and the debtor:
1. (i) was engaged or about to engage in a business transaction for which the remaining assets of the
debtor were unreasonably small... or
2. (ii) intended to incur.. or reasonably should have believed that he would incur debts beyond his
ability to pay as they came due
3. Leveraged Buyout: Where corp enters into a debt and uses it to buy shares from its own shareholders,
which they then retire
a. Is remaining equity unreasonably small? Court came out both ways:
i. Bankruptcy creditors were not able to recover purchase price of shares bought from public
shareholders
ii. but were able to recover funds from controlling shareholders and financing lenders
b. There are criticisms of whether Fraudulent Conveyance Doctrine should be extended to LBOs
ii. Equitable Subordination Doctrine: Shareholder extends loans to the corp; She is now a creditor, along with
other creditors, over the corps assets and as such will be repaid proportionately with the others
1. RULE: shareholders can extend loans to rms, but courts may order subordination
2. This doctrine subordinates loans by shareholders to those of creditors, puts them down on the level with
equity
3. You have the same size pie, but you have new creditors who get to have an additional claim to the assets.
So effectively the pie thats left to the creditors of the corp is smaller, just like in fraudulent conveyance.
4. In Trusts? Self-dealing transactions prohibited (Gleeson) - Trustee cant give a loan to the trust and expect to
be repaid for the loan
5. In Partnerships? All partner claims rank below those of outsider creditors by default UPA 40(b)
6. POLICY: it is possible that shareholders would have info about the corp, but they dont have as much
decision-making power on the same level as partners
a. So it could be that shareholder might be willing to lend to the corp at a lower risk premium because their
insider info about the corp allows them to better assess making this loan to the corp
b. Also in the case of a corporation creditors can protect themselves by other means contract, security,
etc
7. Costello v Fazio: Fazio, Ambros, Leonard started partnership plumbing biz; F invested 43k, A 6k, L 2k;
started to lose money so they decided to incorporate; F and A turned their capital investments into
promissory notes on the corp reducing their investments to 2k each; total initial investment in corp 6k.
Eventually corp filed for bankruptcy and F and A wanted their loans to be on same level as outside creditors.

18

iii.

Report in lower court said 6k was adequate capitalization of corp. HELD: Clearly erroneous that corp was
adequately capitalized, thus F and As loans were equitably subordinated.
a. KEY: The fact that you dont have sufficient capital is not by itself enough to trigger equitable
subordination, BUT the difference with Costello is that it was clear from the facts that they were
exploiting corporate form to avoid liability.
i. The Ongoing biz just changed a legal form: same reputation, same creditors
ii. However had the corp lived for 5 years, gotten new creditors who were aware of the actual financial
situation, then equitable subordination would not necessarily apply.
Reason for two doctrines
1. Fraudulent conveyance has 2 s - When the assets have been transferred away, then you need to try to get
at both the corporation and the where the assets are now
2. Where as with equitable subordination, the assets are still held in the name of the corp but you just change
the order of the names so only one

19

VII.

PIERCING THE CORPORATE VEIL AND MULTINATIONAL CORPORATIONS

a. Disregarding the fiction of the corporation and getting to the actual personal assets of the shareholders
i. Allows creditors to set aside the corporate entity and hold shareholders directly liable
b. Conditions required to pierce the veil:
i. Evidence of Lack of separateness (assets, accounts, formalities): shareholder domination, thin capitalization,
no formalities, co-mingling of assets
1. The shareholder and the entity are actually not separate but one; Theres not independent life in this corp
2. This includes the lack of formalities very important to courts
ii. Unfair or inequitable conduct or results (typically fraud or abuse by the board)
1. UNLESS plaintiff reasonably assumed risk of dealing with the corporation
iii. NOTE: This is a fact intensive enterprise so you look for types of situations where the veil is likely to be
pierced
1. Very unlikely that a public corps veil could be pierced - This is because its so unlikely that a single
shareholder would be in total control
a. Same with a class of SHers
2. Formalities when the corp seems to be functioning normally, even if there is single shareholder domination,
this makes piercing much more difficult
iv. Probably no piercing when: against public corporation; against passive shareholders; minority shareholders;
nothing strange in assets or accounts
v. Reverse Piercing: When a goes through the directly liable individual/entity to access assets of other
related/owned corps.
vi. TEST: Van Dorn Test (Sea-Land Svcs):
1. Separate existence or mere instrumentality AND
a. In Sea-Land, the corps were not separate from nor each other same locations, liberty with accounts
2. Failure to pierce would sanction fraud or promote injustice
a. EX - Incorporating to evade partnership liability OR Shifting assets or liabilities to subsidiaries
vii. Sea-Land Svcs v. The Pepper Source: SL is a carrier who enters into a contract with to ship items; doesnt
repay the carriage fees to SL, so SL wants to sue, but Pepper Source is bankrupt. is run by Marchese, who
also owes a series of other corps, and hes generally 100% shareholder in all, except for Tie-Net in which he
shares 50% ownership with another. sues Marchese directly, as well as the other corps owned by (this is
reverse piercing).
1. HELD: Court applied Van Dorn Test, mere fact of not having sufficient funds along with bad conduct by is
not enough to satisfy the 2nd prong alone. s had to show some specific fraud or make more specific claim
about this injustice.
c. Contractual context: emphasis on whether plaintiffs were misled about the creditworthiness of the
corporation
i. TEST: Laya Test (Kenny Shoe Corp):
1. Company does not have a separate existence or is a mere instrumentality
2. Retention of corporate entity would produce injustice
3. Has reasonably assume risk of dealing with this shell corp?
a. NOTE: 4th Circuit held that the 3rd prong is permissive and not mandatory
ii. Kenny Shoe Corp. v. Polan: was manufacturing co, they leased a plant in WV and had been for about 25
years; about 10 years into it they abandonded it so they found a company called Industrial to sublet; within a few
months Industrial sublets 50% to Polan Industries Inc this agreement was negotiated by Polan (), the owner
of BOTH companies. Industrial goes bust and cannot make sublease payments, so wants to pierce and go
after .
1. HELD: Court applies Laya Test. Prong 1: NO - there were no formalities, they were shell companies; Prong
2: YES because Industrial was under capitalized, it never had any real assets, there were never any
contributions to it; it was incorporated but that was it; just a paper company
a. Prong 3: Dist Court: YES - had effectively assumed the risk of dealing with Polans corps. knew that
they were dealing with Polan, and they knew that industrial had no real assets because they knew that no
corp formalities were followed so they knew that Polan was in fact running the game
i. BUT Circuit Court NO, because Industrial never had any real assets. Polan set up paper companies
on purpose, thus evidence of fraud.
iii. POLICY: What should brightline rule be
1. Creditors should be able to confirm and expected to rely on debtors assets
2. If the assets disappear due to regular biz risks, creditors cannot pierce mere insufficiency of assets is not
enough to pierce the corp veil
3. If there is an element of fraud or misrepresentation, then pierce

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d. Tort context: corporate form acts as liability insurance, removes incentives to monitor or to refrain from
investing in hazardous industries
i. Walkovsky v Carlton: NYC Cab case. Tort victim sues Seon (cab corp), Carlton (main SHer in all related cab
corps), and the other cab corps. HELD: No sufficiently particularized statements that Carlton was doing biz in his
own individual capacity. There was no prob with formalities, they were following the laws, they had separate
taxes and loans; so there was no question that these were real individual (separate) companies. NOTE: corp
form acts as liability ins, cabs only required to have 10K minimum liability ins by state law, thus incentives to
monitor drivers or for more safety are removed.
1. Dissent proposes default rule of allowing piercing where there is a tort and the corp serves a public interest
and its assets are insufficient UNLESS initially adequate finances dwindle under competitive pressures. In
essence, a minimum capital maintenance rule that exists elsewhere.
ii. Relevance of Tort context
1. Kinney shoe was able to observe the corp structure before entering into a deal
2. But here had no choice in who he was dealing with, it was an accident that was out of his control
iii. Benefits of Limited Liability
1. By having LL for a corp, the tort victims are paying a huge cost, as demonstrated above
2. But the benefits of LL are
a. Reduces needs to monitor agents (managers), other shareholders
b. Makes shares easily transferable makes investment easier
i. Permits takeover (further discipline for managers)
ii. Minimizes disruptions when shareholders exits biz
iii. Facilitates stock market creation, lowering costs of financing
c. Facilitates diversification
d. Enlists creditors in monitoring managers (since creditors bear the downside risk)
e. Parent-Subsidiary Structure - POLICY
i. Contains liability for each separate business venture
ii. Helps comply with local laws or sector-specic regulations
iii. Isolates claims and assets of each business from creditors of others business in the same group
1. Construction projects
2. Mutual funds & hedge funds
3. Foreign investments
4. Basically this means that other subsidiaries will not be affected by bad accidents of one subsidiary corp
iv. Facilitates transfers of businesses
v. Helps with joint ventures
vi. Reduces monitoring costs for shareholders
1. EX only need to pay attention to one corp, parent corp doesnt need to monitor everything closely
f. Torts and Multinational Corps
i. A corporation internalizes fewer costs resulting from a tort in a foreign country, compared to a tort in its home
country
1. Impact on immediate environment, community is lower
2. Impact on key personnel is lower
3. Reputational costs are lower
g. Regulatory environment in foreign countries might be more favorable
i. Less stringent regulatory standards
ii. Flexible labor laws
iii. Lax enforcement
iv. Legal framework in foreign countries might allow some type of forum shopping for the corp
h. Union Carbide Case Study
i. UCEastern was the holding company for the subsidiaries, and owed 50.9% of UCIL, the other 49.1% was traded
on Indian stock exchange. Plant was operated by UCIL; Net assets of Bhopal plant at time of accident were 27
million.
ii. Pierce the Corp Veil of UCC? KEY Shows step-by-step analysis for piercing
1. Lack of separateness
a. Observe Corp Formalities? YES
b. Adequately capitalized? YES
c. Suspicious shifting of assets? Unsure
d. UCIL dominated by UCC? MAYBE
i. How much was the parent company involved in the day-to-day operations, as far as decision making,
etc
2. Abuse of Corporate Form
a. Was there fraud in setting up UCIL? NO was not a sham corp in any way

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b. Was UCIL an attempt by UCC to evade certain laws or obligations? NO

c. Would failure to pierce promote injustice?
i. If you didnt pierce the corp veil here, the injustice would be huge considering the major amount of
money that could be potentially paid out
ii. Sub-question: Would the corp form allow UCC to be negligent in its supervision over UCIL?
iii. Other Theories of Liability for UCC
1. Agency Law: UCIL could be an agent for UCC in India
2. To determine existence of agency, look at control: U.S. v. Bestfoods (524 U.S. 51 (1998))
a. Ownership of majority stake at UCIL is not sufcient; need to establish actual control
b. Bestfoods Test:
i. How was the subsidiary run? Did it make its own decisions or did it always defer to parent?
ii. How strict were parent guidelines? Did they ask sub to produce specific products in any way?
iii. Who appointed sub officers? Did parent and sub share any officers?
c. NOTE: these are similar to first prong of piercing because they all refer to separateness
iv. NOTE: now the agency rules are much more important, when before the piercing doctrine was more important
that was a significant change after Bhopal
v. Which Courts have Jx
1. US courts may decline jx based on forum non conveniens if:
a. An adequate alternative forum exists (fair trial)
b. The alternative forum is more appropriate because of:
i. Private interest reasons (e.g., expedience of trial)
ii. Public interest reasons (e.g., which courts care more about the outcome of the case)
c. In intl disputes, there are additional considerations (Piper)
i. The choice of should not be given extra weight
ii. Courts will not examine differences in substantive law between the US and the alternative forum
2. Result was that Indian lawyers were arguing for US courts, so trying to show inadequacy of Indian courts,
while UCC was arguing for Indian courts.
3. Ultimately the court declined Jx but imposed certain restrictions on UCC
a. UCC will consent to the jurisdiction of Indian courts
b. UCC will satisfy any judgment rendered in India
c. UCC will be subject to discovery under the U.S. Federal Rules of Civil Procedure
vi. Resolution
1. Amount of money UCC gave - $470m
2. Impact UCC became a much smaller company, sold off or spun off other divisions, and was eventually was
bought by DOW Chem in 2001 for about $5BN
i. Global Value Chains
i. New trend is to enter into agreements with local providers
ii. EX NIKE finds a company in China that makes sports gear and they order their shoes
iii. However this doesnt leave the agency question unanswered - This is why agency law is more relevant today
iv. Level of Control determines applicability of agency law
1. First set of questions has to do with the product and the production of the things
a. How specic is the product? How engaged is the buyer in the production process?
i. Is a buyer representative supervising production?
ii. How strict are the specic requirements for the product?
iii. Is the buyer involved in selecting personnel, setting work-safety standards, setting salaries?
iv. Is the buyer providing raw materials?
2. Second set of questions has to do with the producer itself
a. How captive is the producer?
i. Does the producer have other clients?
ii. Are there any other buyers in this market? Can the producer invest in know-how to attract them?
b. Who develops the technology used in production? The seller, the buyer, both?

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VIII.

NORMAL GOVERNANCE: THE VOTING SYSTEM

a. Voting System Basic Features
i. Shareholders vote required on:
1. Election of directors
2. Organizational issues -Organic or Fundamental changes: mergers, sales of all assets, dissolutions,
charter amendments
3. Shareholder resolutions: Issues that shareholders propose and issue their recommendations
4. Shareholder advisory votes: e.g. (14A of 1934 Securities Exchange Act on executive pay and golden
paracutes)
a. Votes on which SHers have to be consulted but the board doesnt have to follow their recommendation
b. These are a measure to inform SHers formally regarding issues like how much managers are paid and
their golden parachutes, etc
c. Derived from Dodd-Frank
ii. Each share gets a vote the org registers the owners of all shares (no bearer shares)
iii. SHers vote in meetings but if they cannot attend they vote by proxy (representative)
b. Annual and Special Shareholder Meetings
i. Annual Meeting to elect directors
1. Required by DGCL 211(b), RMBCA 7.01(a) and most other states
2. DGCL 211(c) allows 13 months
3. Flexibility doesnt have to be every 12 months exactly but close
4. Other issues can be discussed, but directors are always elected in annual meetings per the bylaws
ii. Special Meeting to discuss other topics, at the initiative of:
1. DGCL 211(d): the Board, unless otherwise provided
2. RMBCA 7.02: the Board or 10% of shareholders
iii. Action by written consent
1. DGCL 228: any action required to be taken at a shareholder meeting can also be taken by written consent
of the majority of eligible shareholders
2. RMBCA 7.04: requires unanimity for written consent
3. These usually happen in smaller corps, rather than bigger ones
4. This differs from proxy in that here the SHer is expressing their view, while the proxy votes how they want
and the SHer just authorizes proxy to vote for them
c. Election of Directors
i. Shareholder vote for the election of the board -> most efcient conduct of the rms business
ii. Straight Voting: one share/one vote for each topic, or seat on the board
1. They basically vote each candidate up or down
2. Effect whoever has the majority can control whos on the board
iii. Cumulative Voting: each shareholder can cast votes = total number of shares owned x number of seats
1. But they dont have to cast for each seat, they can concentrate on one candidate
2. This can make it a little easier for a minority SHer to ensure some representation on the board
3. SEE Slides 5 & 6 for example (#15)
d. Removal of Directors under Delaware law:
i. Requires majority of shareholders
ii. DGCL 141(k): Directors may be removed with or without cause by a majority of the shareholders, but...
1. Directors may be removed only for cause if the board is classied (staggered) (i.e., directors are elected for
terms of varied duration)
2. Staggered means that all members of the board have terms of varied duration
iii. RMBCA 8.08(a): Directors may be removed with or without cause by a majority of the shareholders, regardless
of whether a board is staggered
1. Here Directors can be removed with or with out cause even when the board is staggered not distinction
between classified and unclassified board
iv. POLICY: A manager or CEO, because of worry of SHer revolt, would prefer DGCL 141(k) with a staggered
board its much harder to throw the manager out, it would take more rounds of voting to take over the company
v. If a board is staggered, cumulative voting, and majority SHer wants to take over board, they have options:
1. Strategy #1 can she amend the charter to eliminate cumulative voting to win all seats
a. DGCL 242(b)(1): all amendments have to be proposed by the board
b. There isnt any cause to fire any, she does not control the board, so she cannot amend the charter
2. Strategy 2 Can she amend bylaws?
a. DGCL 109(a): Conferring the power to amend bylaws to the board cannot divest shareholders from that
power
b. What if she amended the bylaws to increase the size of the board?
i. DGCL 223(a)(1): the current board will elect the new members unless otherwise provided

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ii.

She would have to amend the bylaws so that the new members are elected not by the board, but by
the shareholders
iii. By increasing the number alone, she could not elect so many people because the current board would
elect new members
c. She would need a really big board 9 current members, so shed need another 27
3. Strategy 3 remove one or more directors
a. As board is classified she cannot remove board members without cause
b. BUT she can amend the bylaws to declassify the board, creating a one-term board
c. Then she could remove each director without cause
d. Then with new election, cumulative voting, and 51% of the vote, she could elect 2/3 of the board
4. Strategy 4 Dissolve company and distribute assets
a. DGCL 275: The Board has to propose dissolution
b. She cannot dissolve without boards vote, so no
vi. Staggered Boards as takeover defense
1. Result in delays: takes 1-2 years to gain control of the board
2. Bidder cannot get an up-or-down vote on its bid at a single point in time
3. A rm offer provides target shareholders a free put option for their shares for the duration of the bid
a. SHers can wait and see how the strategy plays out for 1-2 years and then offer their shares before having
to commit early
vii. NOTE: For the takeover defense to operate, boards must be staggered ahead of the takeover bid, or acquisition
of stock
1. Otherwise, if CEO tries to do it too late, the bidder might already have enough shares to block the
amendment from passing
e. The Proxy System
i. An absent shareholder can authorize a representative (proxy) to vote
ii. Proxy Solicitation and Expenses
1. Before the meeting, corporations mail or put online materials that provide information to shareholders
a. Proposals, recommendations, supporting materials
2. Incumbents and insurgents try to gain votes by convincing shareholders to grant proxy to them
3. SHers can also send out proposals and recommendations to other SHers
a. BUT Proxy solicitation is expensive - who gets reimbursed?
iii. New eProxy RULES:
1. Incumbents and insurgents can le proxy materials on a website, substantially reducing proxy solicitation
costs
iv. Shareholder proxy access makes contested director elections more likely:
1. Under SEC Rules, shareholder(s) with 3% of the vote can place their nominees on the companys proxy
statement
2. So instead of SHer having to have her own independent proxy solicitation, they can use the companys for
their own purpose this limits expenses
v. New RULE on broker voting:
1. In the past, broker-investor agreements allowed brokers to vote on behalf of investors in routine issues,
including director elections
2. A 2009 SEC rule reclassied director elections as a non- routine matter; explicit authorization required - more
power to insurgents
3. Now shareholders have to authorize someone to vote for them, even if its the broker, they have to authorize
them specifically
vi. Froessel RULE:
1. If contest is over policy, not personal matters, then:
a. Incumbents get reimbursed always
b. Insurgents get reimbursed when shareholders ratify this (i.e., when they win) (Rosenfeld v. Fairchild)
i. Insurgents can also get reimbursement by the board, but this expense is more easily attacked
(Datapoint) hard for the board to decide this because they might be violating a duty
2. POLICY: This is sort of a filtering rule if youre insurgent you should mount an attack only if you have a
good enough idea to convince a majority to vote for you
a. Screens out some insurgents those with unworthy proposals
f. Class Voting
i. When a corporation has more classes of stock (e.g. common, preferred), certain topics require approval of the
majority of shareholders of each class
ii. DGCL and RMBCA provide minimum default rules for class voting - charters/bylaws may require more
iii. DGCL 242(b)(1)&(2): class vote when proposed amendment to charter would change number of shares or
rights, powers, preferences of shareholders

24

1. EXCEPTION: Mergers - When a corp is trying to merge with another corp, which of course affects the rights
of shareholders, this class doesnt need to vote separately because its a change that affects the corp as a
whole
iv. RMBCA 10.04: class vote on wide list of issues, including mergers
v. NYBCL 804: class vote is required when authorizing shares having preferencessuperior to class rights
vi. EX A corp has 6% cumulative preferred stock and common stock, A wants to fund a new project by creating
superior class of stock 11% cumulative preferred
1. Under NYBCL 804 a class vote would be required because this new class would have superior rights to the
6% class
2. Under DGCL 242 NO vote required, only when the classs rights are altered
a. So if they were going to change to 5% from 6%, they would get to vote because of the direct effect, but
creating a new class of stock is not directly alter their rights
b. NOTE: The right that they had originally was the right to be preferred to common stock holders but they
did not have a right to be the top tier class
3. Proposal #2: issue more 6% cumulative preferred stock to fund the project
a. Under NYBCL 804(a) & 801(b) NO vote required as there are no new shares that get preference over
the current shares
i. 804(a) & 801(b) do not require class vote (unless par value of existing class is reduced, e.g. when
stock is issued at discount)
b. Under DGCL 242(b) YES because now this class will have more people, the composition of the class
changes, this is internal ot the class, and thus they get to vote as a class
g. Access to Shareholder List and books & records
i. State law provides limited information rights to shareholders
1. Access to shareholder list
2. Inspection of books & records
ii. DGCL 220:
1. For books and records, shareholder must show proper purpose
2. For Shareholder list, burden is on corporation to show improper purpose
3. THUS its very hard to get access to books and records, but getting access to names/addys of other SHers
is very easy
iii. RMBCA 16.01-2: shareholder list, excerpts from board minutes and shareholder meeting minutes, accounting
records, if shareholder shows proper purpose
h. Separating Control from Cashflows
i. Common stock shareholders have the strongest incentives to maximize gains out of corporate assets; as such
corporate law relies on them to elect the board - They want to make as much profit as possible because only if
everyone else is repaid they get paid
ii. Problem is that there are many ways to separate the right to vote from ownership of common stock
iii. Board has superior information about the company; corporate law often grants them agenda-setting powers
(proposals for amending bylaws, etc)
iv. Controlling shareholder votes -> Controlling the company
v. Proxy solicitation can help gain votes; but its a lot of work
vi. RULE: DGCL 160(c) prohibits managements ability to swing extra votes by having the corporation owning its
own stock
1. If sub owns stock in parent and is controlled by the parent, then these stocks do not get to vote and do not
get counted for quorum purposes thus the votes dont count at all
2. Courts have interpreted this rule widely to cover schemes not caught by the wording of 160(c) (Speiser v.
Baker)
3. EX of violating this rule say MBP owns 10% of A Corp and is director of B Corp, so MBP has B Corp
purchase 45% stake in A Corp, which in turn purchases 30% stake in B Corp. The 30% stake is NOT
enough to constitute a subsidiary to A Corp, therefore MBP would effectively control both.
4. Speiser v Baker: Shareholders of HealthChem: 40% public, 10% S, 8% B. At HealthChems IPO S and B
wanted to maintain control so they sold 42% to HealthMed, which they were equal owners of and S was also
director. To avoid 160(c) violation they started Medallion, 100% sub of HealthChem. The way they
maintained control in health Med, they created a new class of stock in HealthMed and separated the voting
right from economic benefits right so they had 9% of the vote with this convertible preferred stock, but if
converted it had 95% of the vote in HealthMed.
a. So and had control of Med and thus they had total of 60% of votes on Chem, 18% directly and 42%
via control of Health Med. Because Med was not a sub of Chem, S and B could exercise this 42% voting
right. This hurts public SHers in Chem because they lose voting right, but not economic rights.
b. S can use 45% + 9% vote to oust B because he is CEO of both Medallion and Med, BUT needs a quorum
to hold a vote, and B refuses to show up to make a quorum.

25

c. DGCL 211(c): [In a court ordered meeting] the shares represented at such meeting... shall constitute a
quorum...
d. HELD: Effectively court holds that this 42% cannot vote. Interprets 160(c) belonging to a corporation
language broadly
i. Shares of its own capital stock belonging to the corporation or to another corporation, if a majority
of the shares entitled to vote in the election of directors of that other corporation is held, directly or
indirectly, by the corporation shall neither be entitled to vote, nor counted for quorum purposes
i. Vote Buying
i. Vote buying: Is the SHers ability to sell their vote/proxy to whoever is will to pay the highest price
1. Problems
a. The incentives of person exercising the vote and the owner of the stock might not align
b. Idea is that owners want to maximize profits
i. But vote buyers dont care about this, they might have a reason to get the company to follow a diff
strategy besides to maximize returns like they are competitors or they want to buy the corps assets
at a low price
c. NOTE: now DGCL specifically prohibits vote buying but its judicially created law
2. RULE: Transactions are voidable under Brady, but only if there was injury to the shareholders (Schreiber)
a. Vote buying poses a concern for common law (Brady):
i. Because it is a fraud against other investors, particularly if they were not aware of the deal
ii. Because it sends the wrong signal to the remaining shareholders: they believe that votes express
approval for the proposal, when in fact votes were bought
iii. NOTE: This test is very fact specific analysis
b. Schreiber v Carney: Board wanted to merge Intl with Air; prob was that Jet was majority Sher and didnt
want to pay taxes with merger, so Intl Board decides to give a loan to Jet to mitigate their tax liability in
the transaction; Indy committee evaluates the loan and approves; SHers approve merger in vote. HELD:
Yes, there was vote buying with the granting of the loan at a favorable interest rate this is the extra
benefit for Jet for getting this interest loan from intl as opposed to a loan from another bank.
ii. Vote Buying Through Derivatives
1. EX - P buys some stock from M SHers on the market. They then find a broker willing to buy the new M stock
that P just bought anytime P wants them to sell them. So theyre buying and selling at the same price but
with a small commission paid. With this commission they get to control the stock of the M at the time they
want them to. This leaves the broker with the stock in the end who then sells it back in the end to the
market
2. In this way P gets to control the voting rights in Ms stock right when it wants to, thus forcing M to agree to
acquisition of K at price they want to make a profit.
3. NOTE: this is a problematic structure if indeed M SHers were injured
j. Controlling Minority Structures
i. Pyramid and cross-owning structures
1. Pyramiding - A wants to hold control of a corp
a. She can sell 50% +1 vote, OR
b. She can create a new company where she owns 50% +1 vote, thus giving her control of the lower
company as well, and so on
c. Thus in effect the owner has only kept control of 12.5% of the main company, but still retains total
control
d. In the US you lose a lot in taxed by doing this, so you dont see this but in Europe you see structures
like this
e. SEE Slide 10 (#17)
ii. Dual class structures under U.S. corporate and federal securities law:
1. EX S issues two classes of stock - Class A (60% share capital, 20% voting rights) and Class B (40% share
capital, 80% voting rights)
a. Thus Class B shareholders can do anything they want because they have so much vote
2. Reason for buying stock like Class A
a. SHers believe that B holders know what they are doing and you want to own the stock because they are
in control (EX Google, NYT)
b. Or Class A stocks are discounted, cheaper and the vote doesnt matter so much to the SHer
3. RULE:
a. Prohibits issue of new shares with higher voting rights (or recapitalizations for higher voting rights), but...
b. Allows issue of new shares with lower voting rights
k. Collective Action Problem
i. No single shareholder can hope to affect the vote -> shareholders have limited incentives to monitor the board->
shareholders typically vote for the boards proposals (including the election of directors)

26

ii.

Solving the problem

1. Make it a single shareholder by selling to outside bidder
a. A fall in stock price would effectively invite a takeover, thus solving the prob by itself
2. Merger with another corp
iii. Problem takeover market was not very efficient
1. Plus the companies developed a defense to takeovers legally even when the price is cheap. The result of
this legal tool is that takeovers didnt happen at the rate that the theory expected
iv. Institutional investors cant solve problem - wrong incentives
1. Rules limit powers to acquire too high a stake and their fees are too low
v. Can Hedgefunds solve the problem?
1. They have better incentives to be active
a. They dont face regulatory limitations
b. Their fees are much higher - So if they get a company to change a strategy and they make more earnings
and more dividends, then they get a higher percentage of these
c. Managers typically have a lot of their personal wealth invested in the fund
2. However success has been moderate at best
l. The Federal Proxy Rules
i. Federal Securities Laws: Overview
1. Securities Act of 1933 basically deals with disclosure rules when securities when being sold for first time
a. Establishes disclosure requirements for companies when selling securities (stocks, bonds, notes, etc.) to
the public
2. Securities Exchange Act of 1934 basically lays out rules that firms must follow after securities have been
issued
a. 12(a): Companies with stocks listed on a national exchange are covered by 1934 Act OR
b. 12(g)(1): The Act covers those who have issued equity securites (stocks), or whose total assets exceed
10M AND has 500 or more SHers of record, AND whose business affects interstate commerce, or whose
securities are traded through means of interstate commerce
ii. RULE: Federal Proxy Rules apply to all companies subject to the disclosure requirements of the 34 Act
1. 14(a) prohibits proxy solicitation unless conducted under the rules promulgated by the Securities and
Exchange Commission (SEC)
2. Regulation 14A (Rules 14a-1 through 14a-12):
a. Substantive regulation of the process of soliciting proxies and communication among shareholders.
3. Schedule 14A: detailed disclosure requirement for proxies
4. Main Criticism: proxy rules have increased costs of communicating with other shareholders, thus impeding
shareholder democracy
iii. Regulation 14A Overview
1. 14a-1: solicitation includes any request for a proxy, as well as any communication reasonably calculated to
result in the procurement, withholding, or revocation of proxy.
2. 14a-2: exceptions to the application of the proxy rules
3. 14a-4: Form of proxy, recommendations from the Board
4. 14a-6: Filling with the SEC
5. 14a-7: Company must either provide to solicitors a list of shareholders or undertake to mail the materials
itself
a. Includes obligations of corp towards SHers about how to handle the whole process
iv. RULE: If a communication by a shareholder is deemed a solicitation of proxy, then it must conform with proxy
rules
1. Form of proxy and board recommendation
2. Fling with the SEC
v. SOLICITATION RULES: Wide denition of solicitation, but exemptions from denition (e.g., for a shareholder
who did not intend to solicit)
1. 14a-1(l)(iii): solicitation is any communication reasonably calculated to result in procurement of a proxy.
2. 14a-3(a): may not solicit a proxy unless you provide a proxy statement containing the information provided
in Schedule 14A, unless the communication is exempt
a. 14a-2(b)(1): solicitation on behalf of any person who does not... seek directly or indirectly... the power to
act as proxy is exempt from the ling requirements
b. 14a-2(b)(2): solicitation to ten or fewer other shareholders is exempt from the ling requirements
3. 14a-6(g): Even if exempt, a shareholder who owns more than $5M worth of stock must still le the
communication and Notice of Exempt Solicitation after sending it out
4. EX - Problem p. 212 TarPERS has stock in HLS, has 1% of vote. Wants to monitor more closely what the
board does. But first, TarPERS wants to test the waters, so they plan on:
a. FIRST STEP: Circulate a memo to 15 other institutional investors to see where they stand

27

b. SECOND STEP: Line up endorsement from Institutional Investor Services

c. THIRD STEP: Send out proxy solicitation and statements to other HLS shareholders
d. Answer: it would not make sense for them to test the waters at this point because they would likely have
to make public their intensions pursuant to the above rules, and theres too much risk in that.
vi. RULE: Rules allow shareholders to solicit proxies not only for nominating directors, but also to coordinate
support for directors nominated by management
1. 14a-4(d)(4): Coordination a shareholder can solicit proxies for its own nominees
a. NOTE: coordination is very helpful to HSers with majority support get their board members elected
vii. RULE: Firms have option to mail solicitation or to provide list of shareholders - but remember Delaware law
1. 14a-7: Firm may choose to provide list of shareholders or coordinate the mailing itself
i. Firms typically prefer to hold on to the list and organize the mailing themselves
ii. 14a-7(e): insurgent shareholders pay for the mailing
b. Federal rules are stricter than Delaware law: DGCL 220 requires only proper business purpose to
mandate handing over the list so DE law actually gives less power than Fed law
c. In practice, rms typically organize the mailing
viii. RULE Shareholder Proposals: When can shareholders submit proposals that the company must bring to the
annual meeting for a vote
1. Main requirements for bringing proposals:
a. Hold $2,000 or 1% of rms stock for a year
b. File with management 120 days before release of proxy statements
c. Not exceed 500 words
2. Main grounds for excluding proposals from rms solicitation materials (thirteen grounds in total):
a. Involves less than 5% of rms business
b. Is a matter of ordinary business
c. Relates to an election of directors or procedure for election
d. Conicts with rms proposal
e. Often brought by institutional investors who have specic concerns but do not seek to subvert the Board
f. Nevertheless, Board may decide to exclude a proposal if it falls under any of 13 exclusion grounds
3. Shareholder proposals often deal with corporate governance
a. Corporate Social Responsibility proposals:
i. Example: rm should take measures against climate change
ii. Proposals about employment practices (e.g., discrimination on the basis of sexual orientation) were
controversial; SEC examines exclusion case-by-case
iii. About 30% of all proposals; often unsuccessful
b. Corporate Governance proposals:
i. concern the internal operation of the rm
ii. About 70% of all proposals; more often successful
ix. DGCL 216: prevents the Board from subsequently amending bylaws to change voting rules passed by
shareholder vote
1. This rule gives extra protection to SHer proposals about election of board members. Gives some additional
comfort for proposals that have managed to get through the meeting and get to a vote
x. Rule 14a-11: Shareholders holding 3% of voting power for 3 continuous years may nominate directors for up to
25% of the seats (NOTE: this is a new rule from Sept 2010)
1. This means basically that in 4 years a shareholder group could take full control of the board if they win in
each election
2. Shareholder group must not have a purpose to gain control, but rather to supervise
3. If there are multiple qualied proposals, largest shareholder group gets to nominate - Only 1 group (the
biggest) gets to nominate 25% of the seats, not each 3%
4. Shareholders seeking to form a nominating group are excluded from proxy solicitation rules (but written
communications are subject to ling requirements)
5. NOTE: Also amended the 14a-8 exclusion of shareholder proposals relating to an election to accommodate
the new rules
m. Shareholder Proposals and Board Powers
1. Who nominates directors?
a. Previous board
b. Shareholders who can bear costs
i. reimbursed only if they win
ii. e-proxy has reduced costs
iii. shareholders can now coordinate support for directors
c. In publicly traded companies, 3% shareholders can nominate up to 25% of board seats
2. What percentage of votes must directors win in order to be elected?

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a. DGCL allows cumulative voting

b. DGCL allows plurality standard
c. shareholders can pass majority requirement through bylaw amendment that the board cannot
subsequently alter
3. Can shareholders remove directors at will?
a. Not if Board is staggered
b. De-classifying the board requires amendment of bylaws (i.e. majority)
4. Who brings proposals in the meetings?
a. The Board
b. Shareholders who can bear the costs
c. In publicly traded companies, eligible shareholders can use the companys own proxy materials - but
Boards may exclude proposals in certain cases
5. How do shareholders vote?
a. Either present or by proxy
b. Default broker proxy abolished

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IX.

NORMAL GOVERNANCE: THE DUTY OF CARE

a. General Duty of Care: In handling the ordinary business of the corporation, directors must show such care that a
reasonable person would believe appropriate under the circumstances
i. Judicial mechanism to constrain directors, ofcers and controlling shareholders
ii. Concerns business decisions in the rms ordinary course of business everyday decisions and strategy that
the biz makes
iii. Allows courts to intervene in the most egregious violations of the shareholders interests
iv. Courts have signicantly watered down its application by following the business judgment rule
1. Courts have introduced limitations to the general reach of the duty of care
b. Duty of Care (ALI 4.01(a))
i. A director or ofcer has a duty to the corporation to perform the directors or ofcers functions:
1. (1) in good faith,
2. (2) in a manner that he or she reasonably believes to be in the best interests of the corporation, and
3. (3) with the care that an ordinarily prudent person would reasonably be expected to exercise in a like position
and under similar circumstances.
ii. RMBCA 8.30(b): care that a person in a like position would reasonably believe appropriate under similar
circumstances
iii. Courts have introduced limitation in the Biz Judgment Rule so that this negligent-sound standard is not always
used
c. The Business Judgment Rule (ALI 4.01(c))
i. A director or ofcer who makes a business judgment in good faith fullls the duty under this section if the director
or ofcer:
1. (1) is not interested in the subject of the business judgment
2. (2) is informed with respect to the subject of the business judgment to the extent that the director or ofcer
reasonably believes is appropriate under the circumstances; and
3. (3) rationally believes that the business judgment is in the best interests of the corporation.
ii. KEY: Directors and ofcers do not violate their duty of care if they reach a business decision where:
1. they have no interest in the subject
2. they have full information and thorough deliberation
iii. Policy for limiting the Duty of Care
1. Shareholders have most go gain
2. Directors have very little at stake, as they usually dont have many shares in the company
a. If things go badly, they risk their job, maybe their reputation
b. But really they risk liability for violation of the duty of care
3. Thus without limitation theyd choose less risky projects, but SHers want to maximize gains so they want
more risky projects, which can be diversified and that risk limited
d. Framework for D&O Liability - Tools for limiting the reach of the duty of care
i. Smith v. Van Gorkom: nds director liability for negligence in handling a transaction, despite very limited harm to
shareholders
1. Board had no prior information about the proposed merger, spent only 90 minutes debating, never looked at
a draft merger agreement
2. Delaware legislature reacts by passing 102(b)(7)
a. Corporations can waive liability of directors for negligence
b. Requires charter amendment, i.e. shareholder approval
c. 90% of Delaware-based corporations pass a waiver
ii. KEY ON EXAM: these principals are listed in order of importance as far as analyzing on the exam - Go down
this list one by one start at the top and move down through each, if you cant use the first category, move on,
etc.
iii. Business Judgment Rule: presumes that the duty of care standard has been met
1. Kamin v AMEX: Amexs board invests 30M in DLJ company, buying a ton of shares; stocks value plunged to
4M; instead of selling stock and claiming 26M loss but gaining 8M tax advantage, they distribute the shares
to AMEX stockholders directly. HELD: Boards decision is valid pursuant to the Business Judgment Rule.
Board fully informed, they knew about the impact on tax, they discussed it and took it into account and made
decision to do something else. Fact that 4 board members had compensation tied to stock not enough to
trigger breach of duty of care because they didnt have sway over 24 member board.
a. Motivations of the board do not matter unless there was self-dealing here, there was none.
Although some members of the board were not necessarily independent, this was not enough to prove
they had sway over the board.
2. Smith v. Van Gorkom: Trans Union wanted to take advantage of Net Operating Loss for tax purposes,
decided to merge with Pritzker for 20% market premium. CEO of TU calls special board meeting, very short,
approved merger without looking at docs or agreement. SHers sued for duty of care violation. Valuation

30

showed stocks were worth slightly more than merger price. HELD: Board violated of duty of care. First time
a board had ever been held to violate duty of care.
a. Reasoning: Bad process by board.
b. CEO gave the Board no prior notice of the meetings topic, nor any information on the two companies or
the merger
c. They spend only 90 minutes debating the issue
d. They did not even look at a draft merger agreement
iv. Waiver of Liability Statutes
1. DGCL 102(b)(7): [The Charter may contain] a provision limiting or eliminating personal liability of a
director... for breach of a duciary duty... provided that such provision shall not eliminate liability:
a. (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of
the law...
b. (iv) for any transaction from which the director derived an improper personal benet
c. NOTE: this provision MUST be included in the charter, not the bylaws - Meaning that it requires
shareholder approval
d. KEY: ONLY directors can benefit from this NOT Officers
2. Ohio: A director shall be liable... for any action he takes or fails to take... only if it is proved... that his action
or failure to act involved an act or omission undertaken with deliberate intent to cause injury to the
corporation or undertaken with reckless disregard for the best interests of the corporation.
3. About 90% of DE companies passed this waiver after this statute was passed by DE Legislature
v. Indemnication: may indemnify for D&O actions in good faith (DGCL 145(a)) and for those beyond those
provided by statute but still in good faith (145(a))
1. NOTE: can only be used for actions in good faith BUT if they settle and dont admit their bad faith then they
can still be indemnified
2. 145(f): The indemnication and advancement of expenses... pursuant to... this section... shall not be
deemed exclusive of other rights to which those seeking indemnication... may be entitled under any bylaw,
agreement, vote of stockholders or disinterested directors or otherwise
a. (f) refers to the flexibility of the corporation - The corp may decide whether or not they want to indemnify,
but good faith remains the upper limit in this power
b. Thus (f) operates only within the limits set by (a) (Waltuch)
c. If the corp cannot indemnify the D&Os, the corp can still insure through a 3rd party
vi. D&O Insurance: corporation may buy D&O insurance from 3rd parties whether or not the corporation would
have the power to indemnify such person against liability. (DGCL 145(g))
1. NOTE: can be used for all actions, whether or not in good faith
2. KEY: whether or not meaning bad faith corps can buy insurance for their D&Os
vii. Reimbursement of legal expenses: even if not in good faith, success in a legal action requires indemnication
for legal expenses (DGCL 145(c))
1. NOTE: can be used for all cases where defendants succeeded
2. Reimburse expenses D&Os incur while defending themselves
3. RULE: when determining success on the merits, the court wont look at background of the case, only the
result of the case (Waltuch)
e. Waiver in Courts Cede v. Technicolor Rules
i. Shareholders can establish a violation of the duty of care by:
1. Showing injury (Cede), OR
a. Cede: Absent proof of self-interest that casts upon the director the burden to prove the entire fairness of
an interested transaction, a shareholder-plaintiff must prove by a preponderance of the evidence that
director negligence did cause some injury and must introduce sufcient evidence from which a
responsible estimation of resulting damage can be made.
2. Gross negligence with respect to process is sufficient to put burden on directors to show Entire
Fairness of the deal (Cede II) Thus duty of care doesnt always require a showing of injury.
a. TWO Aspects to Entire Fairness
i. Price (substantive)
ii. Process - the board has to go through the steps of actually considering what a proposal is worth even
tho the price looks really good
ii. If shareholders show negligent process, the burden of proof shifts on directors, who must now show that the
transaction was fair (Cede II)
1. Cede II:[B]reach of the duty of care, without any requirement of proof of injury, is sufcient to rebut the
business judgment rule... A breach of either the duty of loyalty or the duty of care rebuts the presumption that
directors have acted in the best interests of shareholders, and requires the directors to prove that the
transaction was entirely fair.

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iii.

If directors establish that there was no injury to shareholders, then the transaction is deemed entirely fair
(Cede III)
iv. If directors fail to establish that there was no injury to shareholders, then they can show that their conduct
was the result of negligence, and not bad faith or self-interest.
v. KEY: Its up to the directors to show entire fairness. If they fail to do so, THEN the court can discuss the waiver
of liability. (Emerald Partners v. Berlin)
1. Once directors show negligence, they can take advantage of the waiver of liability under 102(b)(7)
2. If you take the economical approach and decide that from the beginning that the directors dont face liability
then you dont actually enter the discussion of whether or not this is a fair price and you dont consider the
possibility that there is bad faith lurking. SO the time to ask this question is only after it has been asserted or
proved that the price paid for the stock was actually a low price.
f. The duty of care as a duty to monitor: Losses due to passivity
i. Focus: circumstances where company ofcers made wrong decisions and the Board failed to supervise them
effectively
1. No biz judgment rule protection to begin with because theres no actual judgment the board is not deciding
to act one way or another they just arent acting. This is the board just overlooking whats going on in the
company
ii. Francis v. United Jersey Bank: PB had creditors; four members in board; After Sr.s death, sons took over and
started abusing the established loan practice, not returning the money in time and putting the creditors at risk;
As a result; corp went bankrupt and creditors went on to sue Mrs. P, the mom. HELD: board liable because their
failure to supervise was but for causation of creditors loss.
1. RULE: Directors must show reasonable efforts to be informed about the company and ensure that
shareholders are not defrauded
2. RULE: If an individual director nds evidence of misconduct but cannot gain enough support to change
management, she should nd ways to protest, such as:
a. Resign
b. Notify shareholders or the SEC
iii. Graham v. Allis-Chalmers: has two main divisions industry group and power equipment divisions; they have 12
plants, tons of EEs, its just a huge corp; the board is supposed to oversee everything; 20 years prior to incident
board is warned by SEC to monitor the problem company; One EE in one of the plants of the problem company
gets into some sort of anti-trust violation.
1. HELD: Not liable.
2. The Red Flag doctrine: Directors are entitled to rely on the honesty and integrity of their subordinates until
something occurs to put them on suspicion that something is wrong.
3. Further, 20 year old warning too remote.
iv. NOTE: Bigger companies are allowed more leeway in supervision of lots of EEs. Unclear if Red Flag Doctrine is
raise where the board put extreme pressure on subordinates to make profits/meet earnings goals.
v. In re Marchese: Chancellor Corp. had an joint venture agreement with MRB since 1998, but acquired it in 1999;
Chancellors auditors believed that the two companies nancial statements could be consolidated for 1999, but
not for 1998; Chancellor CEO asks the Board to re auditors and hire new ones; CEO then forges some
documents, so that new auditors agree to consolidate nancial statements for 1998; Marchese, a director,
certies annual statements but then resigns from the Board and noties the SEC; The SEC and Marchese settle
for recklessly ignoring signs pointing to improper accounting treatment
1. KEY POINT: the core function of the board is to at least monitor the CEOS or top managers, so this is diff
than the huge buffer between the board and the EEs of the huge company
vi. Importance of Monitoring Under Federal Law
1. U.S. Sentencing Guidelines for Organizations:
a. Firms with an Effective Compliance and Ethics Program (ECEP) can achieve a downward adjustment in
punishment
2. DOJ Policy on Charging Organizations (a.k.a. Thompson Memo)(2003):
a. Government prosecutors will look at the depth and quality of a companys compliance program before
making charging decisions
3. Under Sarbanes-Oxley 404, CEO and CFO must certify that
a. they have evaluated the effectiveness of the companys disclosure controls and internal audit procedures
b. they have informed the outside auditors of any material weaknesses
vii. ADDITIONAL OBLIGATION: Requirement that Board take additional action to ensure it is reasonably
informed under duty of care
1. In re Caremark: Caremark provided in-house care for patients; but some Caremark EEs were paying
kickbacks to docs to suggest Caremark to patients to use; this was not illegal unless the docs were being
paid by Medicaid. Caremark had an audit system to monitor what was going on and to prevent fraud; ethics
book, internal audit, and ethics hotline. There were no red flags raised.

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a. in addition to responding to red ags, the duty of care requires the Board to take further action to
ensure that it is reasonably informed:
i. set up information and reporting systems that allow the Board to reach informed judgments
ii. actually perform the actions envisaged in these systems (Stone v. Ritter)
b. The Catch - Whether these systems exist is a question that has to be decided under the biz judgment
rule
viii. Board Best Practices (ABA Securities Reporter)
1. 1.Establish an appropriate supervisory and compliance structure
2. 2.Create a sophisticated inventory of regulatory and reputational risks faced by the rms businesses
3. 3.Establish an early warning system to identify emerging areas of regulatory focus
4. 4.Communicate the boards and senior managements compliance message throughout the organization
5. 5.Conduct specialized training for supervisors
6. 6.Ensure that information concerning regulatory and reputational risks is promptly surfaced to senior
management and compliance personnel
7. 7.Use internal discipline to reinforce the compliance message
ix. Stone v. Ritter: A group of employees puts together a scheme which results in a $40M ne against the company;
Shareholders bring suit against directors for failure to monitor
1. HELD: Absent any red ags, directors cannot be found liable unless they either:
a. utterly failed to implement any reporting or information system or controls, OR
b. having implemented such system or controls, consciously failed to monitor or oversee its operations,
thus disabling themselves from being informed of risks or problems requiring their attention.
2. In either case, imposition of liability requires a showing that the directors knew they were not discharging
their duciary obligations
3. For a board to be liable negligence is not enough it has to be that they decided not to follow up with their
monitoring system or actions
x. In re Citigroup: This case is about failure to monitor and how it interacts with risks; Citi had nothing, in theory, to
do with these SIVs other than to make the transactions happen; However, as the SIVs started to not be able to
repay investors because mortgages were not paying, Citi decided to bail out the SIVs, thus buying them in
effect;
1. HELD: not liable per biz judgment rule. This was a failed business judgment, it was an investment decision
gone bad, it was not a failure to supervise the EEs
2. RULE: Duty of care only requires Board to monitor ofcers so as to ensure compliance with legal obligations
3. RULE: Obligation to monitor does not extend to risks arising out of business decisions, which are assessed
under the business judgment rule
g. Duty of Care and Knowing Violations of the Law
i. Miller v. AT&T: The Democratic National Committee owed to AT&T $1.5M for services provided during the 1968
convention; AT&T takes no action to collect this debt; Shareholders bring suit, claiming that AT&Ts failure to
collect the debt represents a violation of federal law regarding campaign contribution limits.
1. HELD: Biz judgment rule not applied. SHers entitled to recover.
2. The action that the board decided to pursue was unlawful. Makes no difference that it was an omission.
3. But was this a knowing violation?
ii. The biz judgment rule does not protect the board from doing illegal activities
iii. Waiver of liability under 102(7)(B) does not apply for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of the law.
iv. No indemnification
v. NOTE: if director can prove negligence then waiver or indemnification can apply.

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X.

CONFLICT TRANSACTIONS: THE DUTY OF LOYALTY

a. Overview
i. Corp law delegates all decision making power to board, but there are certain cases where board might not be
proper organ to make this decision in this sitch. Two areas of high risk for SHers:
1. Situations where the directors and ofcers personal interest might be in conict with those of the corporation
2. Decisions that affect the corporate contract itself, such as mergers and takeovers
ii. Thus Duty of Loyalty offers this additional protection
b. Board ought to put shareholders interests rst
i. Courts require the board to put shareholders rst: shareholder primacy is the norm
ii. Boards cannot take actions that explicitly benet other constituencies while harming shareholders (Ford v.
Dodge)
iii. States enacted constituency statutes which enable boards to balance the interests of shareholders with
those of other constituencies
1. Rarely invoked as defenses to takeover
2. Delaware does not have one
iv. Instead, boards can recast their actions as benecial to shareholders. So they can justify decisions that might
not seem like profit maximizing on their face
v. Ford v. Dodge: HELD: a corporation is run primarily for benefit of the stockholders, so the directors must use
their powers to achieve that end.
vi. eBay v. Newmark: eBay had made a cash contribution to Craigslist and in return got 28 of the share-votes; had
agreement that provided for increase quoroum and other rules so that eBay would have more control over
decisions, etc; later eBay set up a competitor company; Ultimately eBay said that craigslist isnt making any
money its free.
1. HELD: Craigslist opted for a for-profit corp form so they need to make money for stockholders. Having
chosen a for-prot corporate form, the craigslist directors are bound by the duciary duties and standards
that accompany that form. Those standards include acting to promote the value of the corporation for the
benets of its stockholders.
c. But Board does not violate duty of loyalty by taking actions that benet shareholders only indirectly:
i. Make donations to universities, charities (A.P. Smith v. Barlow)
1. A.P. Smith v. Barlow: Shareholder argues that rm cannot make donations because charter does not allow
donations. Statures authorizing corporate donations were passed after incorporation.
a. HELD: rm can make donation. Tho this decision is in tension with Ford.
b. Corporations can pursue the greater good, now that wealth has passed on to them
c. Corporations have an interest in operating in a society that encourages free enterprise and education
d. State can change the corporate contract by statute ex post
2. NOTE: Charities that are related to the biz or fave charity of a customer is okay, BUT NOT Pet Charities of a
D&O or relative of a D&O. Problem is that the directors wife might benefit her in some way or be run in a
way that might benefit her. Must be in furtherance of corporate, not personal, ends.
ii. Follow high-cost workplace policies that satisfy employees
d. Transactions between the corporation and a director:
i. Not automatically void
ii. Director should disclose interest in transaction
iii. Director may be liable even if transaction is fair to the corporation (Hayes Oyster)
iv. Hayes Oyster Co: Coast Oyster had run into financial trouble; Verne couldnt run a biz that was in competition
with what Coast did, but he did own 25% in Hayes Oyster, with the remaining 75% owned by Sam; to raise
money Verne wanted to sell some oyster beds. V proposes to Engman to buy oyster beds together; so they set
up Keypoint 50% controlled by Engman and 50% owned by Hayes Oyster. This deal of sale goes through from
Coast to Keypoint. SHers in Coast sued Hayes Oyster once they found out about the deal.
1. HELD: Non-disclosure by an interested director or ofcer is in itself unfair. Court orders 50% of Keypoint to
be returned to Coast. The secrecy, lack of disclosure by V about his participation in Keypoint, he didnt say
he was basically on both sides of the deal. THUS court is skeptical about Vs motives.
2. KEY: Moreover although the price was fair, maybe if they had looked for other buyers they could have
gotten an even better price
e. Self-Dealing and Controlling Shareholders
i. Transactions between the corporation and a controlling shareholder (including a parent corporation) not
automatically void
1. Benet/detriment TEST: is controlling shareholder gaining a benet that minority shareholders are not
gaining?
a. If yes, there is self-dealing, and entire fairness review required
i. Use where court wants to ensure that everything is okay for all parties involved and theres a strong
COI

34

b. If no, there is no self-dealing, and business judgment rule is the standard... (Sinclair)
i. Use when you dont have a strong COI, you have good faith, but something goes wrong
c. ...UNLESS Courts are suspicious about facts (McMullin) and require entire fairness review
2. Sinclair Oil v Levien: Sinclair (US) owns 97% of Sinven (Venezuela), 3% owned publicly, Sinclair controls
Sinven board; board decides to pay dividends; Sinclair wants this money to fund other opportunities around
the world; minority SHers complain that Sinven is being drained of cash with dividends in order to fund
Sinclairs other operations. Sinven could pay dividends out of capital surplus these are earnings they had
stashed away from prior seasons.
a. HELD: Since Sinclair received nothing from Sinven to the exclusion of its minority shareholders, there
was no self-dealing (Benefit/detriment test).
b. NOTE: Court is saying that this was a subsidiary working exclusively in Ven. If Sinclair was taking this
money and putting it into another oil company in Ven, then that would be a violation. However each
country had a separate subsidiary so all these other opps did not belong to the Ven minority, they were
totally unrelated. So they couldnt claim a connection to the biz opp in Alaska, thus these biz opps do not
create a conflict.
3. McMullin v Beran: ARCO owns 80.1% of Chemical Corp.; it solicits interest for its stake; Lyondell is
interested, but only if it can buy 100%; Chemicals board authorizes ARCO to run the negotiations, and then
it approves a price of $57.75 per share, as agreed by ARCO and assessed by its nancial advisor; Minority
shareholders sue; although they got as much as ARCO, they argue they would have gotten more if they sold
later
a. HELD: DEL Supreme Ct says Entire Fairness test should be applied. Chems board did not have
adequate information to assess price. There was nothing that would seem to help the board to reach an
informed decision. Court sees a COI and remands.
b. NOTE: controlling shareholder can be just a person, not just a company
c. KEY: the court saw a problem from the facts the transaction was the problem, but whether or not its a
problem is fact-heavy inquiry
f. The Effect of Approval by a Disinterested Party
i. How to Rectify Self-Dealing Transactions by Board Approval
1. DGCL 144(a): No contract or transaction between the corporation and one or more of its directors or
ofcers... shall be void or voidable solely for this reason, if:
a. (1) the material facts as to the directors or ofcers relationship or interest and as to the contract or
transaction are disclosed... and the board authorizes the contract or transaction by the afrmative vote of
a majority of disinterested directors... OR
i. If all other (disinterested) people look at the facts and say the transaction is fair, then the transaction is
not void or voidable
b. (2) [material facts are disclosed and] the contract or transaction is specically approved in good faith by
vote of the shareholders... OR
i. you can get the shareholders to approve
c. (3) the contract or transaction is fair as to the corporation...
2. Full Disclosure Required
3. Two main alternative interpretations Safe Harbor Statutes
a. Assume that the transaction is interested, and that this interest is fully and adequately disclosed
i. Interpretation #1: Transaction not voidable solely because it is interested, if it has gotten a board or a
shareholder approval. But court still needs to do a fairness inquiry
ii. Interpretation #2: Once a transaction has gotten board or shareholder approval, it not voidable any
further. Court does not need to do a fairness inquiry. Court only applies the business judgment rule
4. Board approval TEST: Can the Board reach an independent judgment about the self-dealing transaction?
a. Are there enough independent directors, with no connection to the director or ofcer in question?
b. Is the company completely dominated by this director or ofcer (e.g., is he the CEO, Chairman of the
Board, Majority shareholder?)
5. If the Board cannot reach an independent judgment: Entire fairness review required (Cookies)
6. If the Board can reach an independent judgment: Business judgment rule applies
7. NOTE: Courts differ on whether fairness review is required
ii. Cookies Food Products v Lakes Warehouse: Lakes owner invested in Cookies; Cookies asked Lakes owner to
help distribute the BBQ sauce; this worked really well; owner started marketing it all around the country;
overtime he became very important to the company and became majority SHer (53%) and was CEO; Offered
storage facilities and came up with taco sauce which included royalty for him; He was also paid consultancy fee.
1. Court follows the first interpretation (#1) it must be approved by the board but must be fair, engages in
Entire Fairness review. Board approved the transaction, doesnt matter about SHer approval because Herrig
had 53% of vote.

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2. HELD: No evidence that payments to Herrig were exorbitant, even if other providers could have offered the
same services at a lower cost. Emphasis on tremendous success of the company under Herrig suggests
that it was important for SHers to maintain Herrig he created this company in essence
iii. Cooke v Oolie: ALN tv network had board with four members Oolie, Salkind, and two disinterested members;
O and S had provided some credit to ALN, so they had diff relationships with ALN besides being on board; ALN
was considering three possible acquisitions; Decided to go after USA but SHers didnt like this and sued,
arguing that this was a transaction where O and S were instrumental in buying of USA. Board should have
chosen deal that would maximize SHer profit, not the safest deal because of O and Ss creditor status.
1. HELD: Biz Judgment Rule applied, no fairness review. Court draws analogy with 144(a).
2. KEY: Court emphasizes vote by disinterested directors.
3. Criticism: is that always necessarily the case? Maybe not there are tight relationships between members
of the board which make them actually relax standards of review a bit. This is a point where state case laws
split. CA case law says you should apply Entire Fairness in this situation, but DE case law sides with this
court.
iv. KEY DIFFERENCE: In Cooke, concerns that Oolie and Salkind would inuence other directors are less
pronounced; but Herrig had control of the board in Cookie, so court more inclined to do a fairness review.
v. POLICY: Disinterested Directors Approval
1. Why should we maintain fairness review, even when disinterested directors have approved the transaction
(Eisenberg)?
a. Directors collegial relationships would prevent them from treating fellow directors with same degree of
wariness that they would show to a third party
b. It is hard to establish whether directors are disinterested
2. Any arguments in support of scrapping fairness review and going only with business judgment rule?
a. Boards are better able than courts to reach business decisions
b. Creates risk of liability for otherwise valuable transactions
c. Wastes judicial and corporate resources
g. Remedying Self-Dealing Transactions by Shareholder Approval
i. If the transaction is a corporate waste: shareholder vote must be unanimous (Lewis v. Vogelstein)
1. Shareholder ratication is ineffectual if:
a. the majority of those afrming the transaction had a conicting interest with respect to it, OR
i. The same people voting for the transaction would be the same people benefiting, so minority must
approve it
b. the transaction that is ratied constitutes a corporate waste, in which case ratication requires a
unanimous vote
i. If its so unbalanced as to be corp waste, then all SHers (including minority) have to agree unanimously
2. Corporate waste: an exchange of corporate assets for consideration so disproportionately small as to lie
beyond the range at which any reasonable person might be willing to trade. Essentially giving corp assets
away for free or almost for free.
ii. If the transaction is between the corporation and a controlling shareholder: shareholder vote must amount
to a majority of the non-controlling (minority) shareholders (Wheelabrator) - otherwise, entire fairness review
1. Wheelabrator: the ofcers of the acquiring company were also 22% shareholders and directors of the target
(4 out of 11 board members)
a. Court establishes rst that they did not exercise control
b. It then articulates different effects of shareholder ratication, depending on who is on the other end
iii. Transaction between Corporation and Directors/Ofcers: shareholder ratication is effective (standard of
review is business judgment rule), unless constrained by Lewis v. Vogelstein
h. Executive Compensation
i. How stock options work
1. Call Option: right to buy a share at a specied xed price (strike price)
a. Corporation issues options to employees (including CEOs)
b. option holders may exercise the option at any time
i. pay the strike price
ii. get the stock in return
c. EX - Suppose strike price is $100, but market price is $150
i. option holder exercises the option: buys stock from the company at $100 and sells immediately after at
$150
d. at the money: strike price = current market price
e. in the money: strike price < current market price
f. out of the money: strike price > current market price
ii. Regulatory Reasons behind growth of Option-Based Compensation

36

iii.

iv.

1. Tax code 162(m): Compensation above $1M for CEO and other four top ofcers is not tax deductible but
performance-based compensation is tax-deductible
2. If options were at the money (strike price = market price)
a. they are not an expense
b. they do not affect earnings per share
c. Today, companies are required to treat options as an expense
3. SEC required disclosure of CEO compensation: name & shame
a. instead, CEOs started wondering why they are getting paid less than their friends
b. boards wanted to pay CEOs more than average
c. average started going north
Dodd-Frank Executive Compensation Reforms
1. Say on Pay: non-binding shareholder advisory vote at least once every three years to approve
compensation
2. Golden Parachute:
a. Firms must disclose golden parachutes when soliciting votes for a sale of the company
b. First must have a non-binding shareholder advisory vote on any new parachutes
3. Clawback provisions: if the company restates its earnings, CEOs must pay back earnings-based
compensation
4. Additional disclosure: companies must disclose ratio of CEO pay to median employee, and structure of
performance-based compensation
Defining Good Faith
1. CONDUCT: Conduct motivated by an actual intent to do harm; RESULT: Clearly bad faith - nonindemniable liability
2. CONDUCT: Intentional dereliction of duty, a conscious disregard of responsibilities; RESULT: Probably bad
faith - non-indemniable liability
3. CONDUCT: Fiduciary action taken solely by reason of gross negligence and without any malevolent intent;
RESULT: Clearly NOT bad faith - indemniable under 102(b)(7)
4. In re Walt Disney Co: Eisner is CEO of Disney; Has health problems; Ovitz is his old friend; Ovitz is an
inuential agent; Has never run a company; Has denied in the past; He accepts now; Becomes President; At
the news, Disney stock goes up $1B. Ovitzs ideas do not appeal to Eisner, But Ovitz has severance
package; Eisner asks Litvack, Disneys GC, whether he can re Ovitz for cause; he cannot. Eisner res
Ovitz nevertheless. For 454 days Orvitz gets $140M from Disney; Shareholders argue that severance
package is waste and board violated duty of care.
a. This is a duty of care case not loyalty.
b. HELD: The board was negligent in hiring Ovitz, but NOT in bad faith.
i. Compensation committee meeting was brief
ii. Board did not discuss the details of the hiring agreement:
1. Board did not require a role in ring
2. Bonuses to Ovitz were misrepresented as mandatory, whereas in fact were discretionary
3. Did not request outside counsels view on reasons of termination for cause
c. HELD: The board did not act in bad faith in firing Ovitz.
i. Board had no duty to act because it had authorized Eisner to do so at the hiring stage
5. The duciary duty violated by a showing of a bad faith conduct is the duty of loyalty
a. No independent duty of good faith.
6. NEW RULE: [T]he duciary duty of loyalty is not limited to cases involving a nancial or other cognizable
duciary conict of interest. It also encompasses cases where the duciary fails to act in good faith.
(Stone v. Ritter)

37

XI.

SHAREHOLDER LAWSUITS
a. Direct v. Derivative Suits
1. Different remedies
2. Often arising from the same facts
ii. Direct Suits
1. Regular law suits Brought by shareholders for harm that they have suffered themselves
2. Often certied as class actions
iii. Derivative Suits
1. Brought on behalf of the corporation by some shareholders
2. Any remedies benet the corporation as a whole, not just the shareholders who brought suit
3. For SHers to bring this they must argue that corp or board is incapacitated to bring it itself
iv. How to distinguish between them (Tooley v. Donaldson) two questions to be asked:
1. Who suffered the alleged harm
2. What is the appropriate remedy for the goals of the SHers
v. Example - #26, slide 9
1. Yellow SHers are ready to mount an insurgent takeover and are ready to vote board down, so Board offers
stock to Friendship Inv. @ 10% discount, this is enough stock to guarantee reelection of board.
2. Derivative suit
a. First identify the type of harm the firm suffers
i. Here the asset is issuing stock at discount, so this is a loss of assets. This is violation of duty of
loyalty board gave away 10%.
b. Appropriate remedy: damages in the amount of the 10% discount
3. Direct suit
a. First what is direct harm that the shareholders suffered
i. Here - the SHers lose the power of the vote, they get diluted, so they lose power to change board
b. Appropriate remedy: Void vote by friendship inv. and install insurgents on the board
4. CONCLUSION: Direct suit is more appropriate in this case
a. Bc what SHers want most is to oust the board, they dont care as much about the 10%
b. How to solve shareholders collective action problem?
i. Problem usually no individual Sher is willing to take on costs of litigation because they dont have a big
enough interest
ii. Solution
1. Attorneys fees contingent upon recovery 20-25% perhaps
2. Awarded by the Court; discretionary in settlements
a. If there is a settlement, award of attys fees is at the discretion of the courts, in vast majority (90%) of
cases courts do award fees
3. Awarded even when remedies are non-pecuniary but the lawsuit resulted in a substantial benet to the
corporation
iii. Computer Associates (1999): Stock option grants given to top execs did not include provision for stock splits, so
the firm adjusts them for splits. atty sues and court order return of 560M to company. Atty got 47M out of that,
less than 10% but.
1. Justification: high risk suits so they should have high returns.
2. Alternate Solution: pay attys an hourly rate plus expenses
iv. BUT NOTE: differences in incentives one would lead to more protracted litigation, while the other leads to
quick profitable settlements
v. Fletcher v AJ Industries: Shareholders bring a derivative suit arguing that Ver Halen dominates the board and
damages the corporation in various transaction. Further, Malone receives excessive pay.
1. Settlement: Ver Halen will elect only two members of the Board. Malone is removed. All monetary claims
referred to arbitration.
2. How calculate awards for attorneys?
a. Common fund TEST: paid out of funds awarded for recovery
i. HERE: they would not be paid at all, so there is no incentive for atty to settle at all
b. Substantial benet TEST: rm may be ordered to pay attorneys fees to plaintiffs even if the benets
were not pecuniary
i. HERE: they decided to award because benefit to them is that they got rid of board
3. POLICY: Arguments in favor of substantive benefit test
a. Finds way to compensate the attys and end the litigation
b. Allows s to negotiation for results that are more important for them than for their lawyers, such as the
way the corp is managed
c. NOTE: not all benefits are quantifiable
4. POLICY: Arguments against the substantive benefit test

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a. There is a cost of the litigation to the corp. These kinds of claims end up solving problems for the future,
but not for the past
b. In practice, attys often settle for governance reforms and do not pursue damages
c. Allows misbehaving CEOs to get away with past pecuniary benefits and only agree to changes in the
future
d. Non pecuniary benefits, such as reforms, are easier to bring about; this might encourage strike suits
c. Standing Requirements to bring a suit
i. Shareholders who:
1. Continue to be shareholders for the duration of the action
2. Have been shareholders at the time of the alleged injury
a. Courts dont want SHers to buy a lawsuit
ii. POLICY:
1. Very easy to find SHers who fulfill these requirements all you need is 1 share
2. This is in contrary to purpose of standing requirements which try to limit suits
d. The Demand Requirement
i. RULE: To bring a derivative suit on behalf of the corporation, shareholders must establish either that:
1. they demanded action from the Board but it did not act; or
2. demanding such action would be futile
ii. Aronson/Levine Test: To show demand futility, plaintiff must either:
1. FIRST: establish that the directors are interested or dominated - and hence incapable of passing on a
demand; OR
2. SECOND: create a reasonable doubt, with particularized facts, that the challenged transaction is protected
by the business judgment rule, and thus the Board would be suing itself
a. NOTE: 2nd prong of Levine test: is actually a quick judgment on the merits, Applies Biz judgment rule to
see if its a good idea to litigate the case or not
iii. In Levine, the Court follows a mechanical denition of independence, and nds that board was independent and
could respond to demand, so pleading of demand futility fails
1. Levine v Smith: Ross Perot founded EDS; GM buys EDS (merged), as a result Perot became largest
individual SHer of GM, and was also a member of the board; Perot started trashing GM and the way they
operated; so board wanted to buy Perot out to shut him up; Subcommittee made of indy directors tried to
work out a deal with Perot; they settled on 742M and Perot left; One SHer sued saying it was waste in paying
Perot like this.
a. Prong 1 - Ct Holds: Everyone else is indy, there are 22 members fo the board, forget about the 2 others
b. Prong 2 a subcommittee was formed, they made serious efforts, collected info, etc
c. HELD: This is not a corporate waste
iv. POLICY for Futility
1. High threshold because the board is an impartial actor catering to the interests of ALL shareholders;
derivative lawsuits represent the views of some shareholders
a. Shareholders are more likely to bring strike suits, compared to the Board
2. We typically allow the board to run the company and dont give that power to the SHers
a. We care about all of the SHers so we cant allow one SHer control decisions at expense of all others
b. The board is supposed to be an impartial body, SHers are more likely to bring strike suits, compared to
the board
3. What happens when a SHer makes a demand
a. Spiegel v Buntrock (1990): If SHers actually go through the trouble to make a demand then it must be that
they acknowledge the independence of the board
b. Scattered Corp v Chicago Stock Exchange (1997): suggest that the Spiegel rule is not conclusive
i. But even here outcome is that its not a good idea to make a demand unless they SHer believes
there is a high likelihood that the board will accept the demand
v. Alternative Approaches to Demand
1. RMBCA: Demand Mandatory: must make demand and wait 90 days unless risk of irreparable injury (7.42)
a. if demand is refused, shareholder may continue by alleging with particularity that the board is not
disinterested or did not act in good faith (7.44(a)&(d))
2. ALI: Demand Mandatory: must make demand unless risk of irreparable injury (7.03)
a. if demand is refused, shareholder may continue:
i. for duty of care violations, court applies business judgment rule (7.10(a)(1))
ii. for duty of loyalty violations, court examines reasonable belief in fairness (7.10(a)(2)) unless selfdealing was not disclosed, in which case shareholders proceed (7.10(b))
3. NOTE: In this sense DEL is actually more permissive. People can argue a demand through futility, they
dont have to effectively warn of a lawsuit coming, more suits can be brought
a. Problem DEL courts usually find that boards are independent and so rule against futility

39

vi.

Double Derivative suit: SHer of a parent company makes the parent bring suit against subsidiary as a SHer of
subsidiary
vii. Rales v. Blasband: Easco Handtools (E) run by Rales bros at 52%, B also owns part of the company. Rs wanted
to get E to invest $100M in Drexel; inevitably D collapsed, so the value fo the notes was decreased by $14M. Rs
also SHers in Danaher (44% of stock and 2/8 board spots). At some point Rs decided to merge E and Danaher.
So E becomes 100% subsidiary of Danaher, and Blasband now owns stock in Danaher
1. Issue: B wants to sue about Drexel deal, 3rd Cir. certifies question of demand to Delaware through Erie
Doctrine. Here B made Danaher bring suit against E, the subsidiary, as the SHer of E
2. RULE: in a double derivative suit, 2nd prong of the Aronson/Levine test does not apply; even if plaintiffs
showed that the transaction in question was not sound, that transaction was the work of the subsidiarys
board, not the parents board which is the one sued
a. By asking board whether there was violation of Biz judgment rule, youre asking the same people whether
there was a violation in essence youre asking the board whether it would sue itself
3. First Prong: requires examination of the boards independence: is it impartial enough to decide whether to
bring a suit?
a. RULE: must examine each board member individually. In determining independence, the Rales Court
looks at factors beyond the legal connections between the rm and its directors (e.g., connections
between the directors outside the rm)
viii. Rales & Levine
1. The two approaches clearly in tension
2. Which approach is better
a. Rales to an extent there is no board in the country that is not somehow linked
b. The requirement of demand might not even be useful because therell be so few cases where it would be
really required
c. Ability of board to take matter in its own hands and act independently and act for all SHers as a whole
might be thrown away
3. Implication of the Rales decision was that SHer suits would be allowed to go forward more
ix. Standing in Double Derivative Lawsuits
1. Lambrecht v. ONeal: Merrill/BofA suit govt forced marriage, BofA actually bought shares from Merrill
SHers. Lambrecht wanted to sue as former SHer in Merrill, but could he sue as former SHer? L never was a
SHer of BofA.
a. HELD: Standing in a double derivative action does not require holding shares of the parent company at
the time of the alleged injury (citing Rales and noting the importance of preserving double derivative
litigation)
b. RULE: after a stock-for-cash merger, shareholders of the target have standing in a double derivative suit
even if they were not shareholders of the parent at the time of injury.
c. He should be allowed otherwise this would be a very easy way to stop derivative suits, payment
mergers would be impervious to derivative suits
e. Special Litigation Committees:
i. Created by the Board consisting of independent directors who operate on the advice of outside counsel
ii. May choose to support or (more often) le a motion to dismiss the case
iii. NY TEST: Courts apply business judgment rule to assess the SLCs motion (Auerbach v. Barnett)
iv. Committees and Delaware Law: 141(c)
1. ...The Board of Directors may, by resolution passed by a majority of the whole Board, designate 1 or more
committees, each committee to consist of 1 or more of the directors of the corporation...
2. ...Any such committee, to the extent provided in the resolution of the board of directors, or in the bylaws of
the corporation, may exercise all the powers and authority of the board of directors in the management of the
business and affairs of the corporation...
v. Delaware TEST: two-step test in Zapata v. Maldonado
1. First, Court examines the independence of the SLC: ...the Court should inquire into the independence and
good faith of the committee and the bases supporting its conclusion... The corporation should have the
burden of proving independence, good faith, and a reasonable investigation.
a. NOTE: this is opposite of Aronson/Levine test
2. Second, Court uses its own business judgment to assess, based on the ndings of the SLC, whether it is
worth pursuing the litigation: ...the Court should determine, applying its own independent business
judgment, whether the motion should be granted.
a. Will look as suits as if it was the client itself if I was client, given these facts, would I go on with law suit?
b. Its the one place in DE law where court is required to exercise its own biz judgment as opposed to
deferring to someone elses
3. Zapata v. Maldonado: Plaintiff les a derivative suit in Delaware. All insiders in the Board, so demand is
futile. Four years later, the Board appoints two new independent directors and creates a Special Litigation

40

Committee with these two directors. The SLC investigates the action and recommends that the court dismiss
the suit
vi. KEY ON EXAM: SEE ATTACHED Delaware Derivative Suit Tree Print Out - #27 slide 19. Think through each
step of process on exam to answer.
f. In re Oracle
i. FACTS: Oracle board, CEO, Lucas (CFO) and Boskin chose SLC consistening of Grundfest and GarciaMolina, both from Stanford. SLC did a very thorough job, gave court long report. Court is concerned about
financial connections of board to Stanford, although no direct connections to the SLC members themselves.
ii. First step of Zapata Test: Determining Independence
1. Determination of independence should not be based exclusively on economic relationship, but also on a
wider spectrum of considerations that affect human behavior. Social norms, peer pressure, etc.
2. Here: SLC members both had tenure so they couldnt be fired. They did not get money directly from the
donations to the school.
3. Nonetheless court finds connections. Donations to Stanford. Elevate status of Oracle and Ellison in
Silicon Valley and thus among Stanford academics.
iii. HELD: SLC is not independent fails Zapata test and motion is denied.
g. Zapatas 2nd Step: Joy v North
i. The court should weigh the probabilities of success versus the costs for the corp
1. Attys fees and other expenses, Time spent by corp personnel, Mandatory indemnification, discounted by the
probability of such finding
h. Final step for Zapata: Public Policy considerations
i. Deterrence - corps have an interest in deterring their directors from proceeding with these kinds of lawsuits
ii. If violations of duties of care and loyalty become a problem then D&O insurance will go up
1. A settlement that requires Ds to pay and be indemnified will raise the insurance costs
2. Corp has incentive to make D&Os pay out of pocket
i. Zapata Test: this is not a very clear test but its the best we have right now
j. Definitions of Independence (Beam v. Martha Stewart)
i. Demand Futility: use lower standard from Rales
ii. Special Litigation Committees: use higher, more broad definition including social factors from Oracle
k. Under what circumstances would the Court nd that the SLCs creation and work were independent, but decide not
to follow its recommendation to dismiss the suit?
i. Court should think of lawsuit as asset of the company - Which means what is the net present value of the
lawsuit. Chance of success, how much company will gain from suit, and discount to present day
ii. BUT also give consideration to matters of law and public policy
iii. This should be determined through use of the discretionary discovery process (Kaplan v. Wyatt)
l. Settlement and Indemnification
i. SHers Double Agency Problem
1. Current SHers may have an obligation to indemnify the board AND they might have to pay the expenses of
the attys
2. NOTE: two SHers harmed and current
a. Harmed they have standing
b. Current they bought shares later
c. So effectively these suits are transfers of money from current to harmed SHers, OR from members of the
board to harmed SHers
ii. DGCL 145: A corporation shall have power to indemnify any person who was or is a party... to any threatened,
pending or completed action, suit or proceeding... by reason of the fact that the person is or was a director,
ofcer, employee or agent of the corporation...
1. [145(a)] ...against expenses (including attorneys fees), judgments, nes and amounts paid in settlement...
2. [145(b)] ...against expenses (including attorneys fees) actually and reasonably incurred by the person in
connection with the defense or settlement of such action or suit...
iii. NOTE: Provision wording gives clear motivation to settle. Currents have to indemnify members of board, so
really transfer is only from currents to harmed.
iv. Carlton Inv v TLC Beatrice Holdings: Lewis wants to invest in BH, gets loan from a bank to do so; L buys 45% of
company; wants to repay the loan by making a profit in the corp thru dividends. Bank also gets 20% of BH
bank is doing this as an investment thinks L will run company well. L dies shortly after acquisition but right
before he dies he gets paid 19.5M for his work as CEO. Bank sues BH, saying that the CEO pay is a complete
waste. SLC is hired they propose settlement to pay back 14.9M. THUS Bank brings another suit and
challenges the settlement.
1. SLC proposed a settlement instead of motion to dismiss. Should court apply biz judgment or should it fall
committees view because this is such a rare occurrence?
2. HELD: Court applies Zapata test, court finds SLC reasonably independent

41

3. NOTE: Court does not apply the Zapata test very rigorously - in this situation this is how its supposed to
work.
m. Assessing Derivative Suits
i. How its envisioned by law
1. Board violates fiduciary duty, they pay out of pocket expenses to attys and to harmed SHers
ii. In reality
1. Current SHers indemnify the board through a settlement, thus they do not pay out of pocket. Thus, ultimately
its the current SHers who are transferring payments for atty fees (via the corp) and to the harmed SHers.
iii. Out-of-Pocket Payments for Outside Directors
1. However, ultimately if bad faith is established Ds will have to pay out of pocket, making the outcome
closer to the types of sitch envisioned by the law. BUT this is rare.
2. EX Worldcom and Enron some directors required to pay out of pocket because they manipulated
earnings statements. So personal payment was a condition of settlement.
a. IMPORTANT because suddenly the threat to directors that they might have to pay out of pocket became
very real
b. press praised out-of-pocket payments; many fear a heightened standard
c. in practice extremely rare: 13 cases between 1980-2005, most involve an insolvent company and 11
liability
d. D&O insurance is available even if no indemnication
iv. KEY Sarbanes-Oxley Reforms
1. Certication requirements for 1934 Act reports for CEOs and CFOs (302):
a. reports do not contain any untrue statement of material fact
b. reports fairly represent the operating results and nancial condition of the company
2. Auditors must attest to the adequacy of internal controls (404)
3. Audit Committees by independent directors and nancial experts

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XII.

TRANSACTIONS IN CONTROL
a. How to gain control of a Corp
i. Elect members of the board cause a special meeting for reelection
1. Need 50% +1 share then youd have total control of corp
2. But in public corps that are huge where many SHers are not repped, then youd only need less
3. Could be a much lower percentage depending on the size of shareholders individually
ii. Control Premium: Paying extra per share to gain control
b. Sellers Duties
i. DEFAULT RULE: Market Rule: Seller can obtain a control premium unless such a sale would occur in bad faith,
such as some sort of fraud, looting of corp assets, conversion of corp assets.
1. Zetlin v Hanson Holdings: Market Price: $7.38 per share, Price for 44.4% of share capital: $15 per share.
Minority SHers bring suit claiming they should share in premium.
a. HELD: Court applies freedom of contract. SHers can sell stock at any price they want, unless such a sale
would occur in bad faith, such as some sort of fraud, looting of corp assets, conversion of corp assets.
Thus, short of this control premium belongs to controlling SHer only.
b. In real world transfer of control lots are regulated by market controlling shers get to keep the premium
they get, unless there are specific circumstances or exceptions
ii. EXCEPTION 1: Collective Opportunity (Perlman, Digex): Controller cannot benet alone from a corporate
asset or if theres Harm to shareholders caused by a looter on the other side
1. Equal Opportunity Rule: Control premium should be divided equally among minority SHers
a. Perlman v. Feldmann: Newport F was CEO, director, 33% SHer; 4% held by Fs friends; this 37%
conferred control of Newport to F; This company was engaged in production of steel sheets, during
Korean war when steel prices were heavily regulated; Wilport was buying steel from Newport with
interest free advance for steel not yet produced; Newport used this money to buy equipment, pay
personel, and invest in the company, etc; Wilport wanted to figure out how to get more steel from Newport
and get away from the interest free advance; At this time, market price was $12, book value $17; Wilport
offers $20 per share. Trial court says freedom of K, F can sell for $20.
i. Courts worry: The corp itself is losing the benefit of the interest free advance, and this hurts the
minority SHers; Newport used the advances to modernize facilities; Newport might sell more of its
steel to Wilport, thus losing the opp to build long-term relationships with other customers
ii. HELD: minority SHers have right to take advantage of interest free payment, SO the remedy share
control premium with minority SHers individually, not the corp
iii. Court thought Wilport was a looter due to prior relationship with the company, and through that they
thought they could turn the terms of that relationship around.
2. NOTE: The same concept (equal opp rule) can be used not only for the actual sale but for other conditions
attached to the sale like waiver of 203. Waiving 203 is a corollary of control but it is subject to the
collective opportunity limitations
a. In re Digex: Intermedia owns 52%; Worldcom wanted this block; Ds board sets up special committee to
deal with this transaction; Controlling SHer of Intermedia thinks he wont get that much, so he cuts his
own deal with Worldcom; and Worldcom buys controlling shares in Intermedia; Upon 203 waiver
Worldcom wants to give a low price to the 48% SHers in Digex and push them out
i. HELD: Court prevents the transaction from happening because 203 primarily harms minority SHers,
who could be squeezed out of the company very soon
ii. Minority Shers lose the opp to participate in Worldcoms successful management of the corp waiving
203 would allow Worldcom to push them out.
iii. EXCEPTION 2: Sale of Corporate Office
1. Prohibited: If you are CEO you cannot sell the CEO position to someone else but could be upheld if change
in corporate ofce results from a sale of a control block
2. RULE: Size of control block exchanging hands determines validity of the transaction (Brecher)
a. If its 10% or more then courts are more willing to let corp offices change as well
i. If buyer has substantial interest in the company then his interests are more aligned with remaining
shareholders
b. If the controlling block is less than 10%, they tend to not allow the transaction
i. They see the shareholding as a side deal for becoming a CEO this is buying the position
ii. If interest was not substantial, then buyers CEO would have shot to loot the company
iv. EXCEPTION 3: Looting
1. When the buyer intends to literally appropriate corp assets
2. RULE: Duty of care on Sellers: If there is a red ag, a controlling shareholder who sells owes a duty of care
to minority shareholders to ensure that the buyer is not a looter.
3. Harris v Carter: Carter was majority SHer of Atlas, Mascolo had ISA, which had subsidiaries; Mascolo
proposed to exchange shares with Carter, so that Carter would have ISA, and Mascolo would have Atlas;

43

Carter tried to investigate ISAs legitimacy, Mascolo promoted LICA but upon investigation it turned out LICA
did not really exist; The exchange went through, new board was instituted, board started looting the corp,
minority SHers sued board and Carter claiming Carter should have been aware that Mascolo was a looter,
violating duty of loyalty.
a. Red Flags: Failure to include LICA, other financial statement problems.
b. HELD: board held liable to minority shareholders for violating duty of care
4. NOTE: This is a duty owed by the board; if the transaction did not entail replacement of the Mascolo directors
by the Carter directors then open question as to whether the duty would still be owed.
c. Buyers Duties: Tender Offers
i. Regulatory Framework Under the Williams Act
1. 13(d) Early Warning System: Obligation to disclose acquisition of 5% or more and to update upon further
acquisitions
a. Basic Rule (d-1(a)): Investor must le a 13D report within 10 days of acquiring 5% (including benecial
ownership)
i. Partial exemptions for Qualied Institutional Investors and passive investors
b. Updating Requirement (Rule 13d-2): Investor must amend 13D report promptly upon material change in
shareholding (over 1%)
c. Benecial ownership: A benecial owner has power to vote or dispose of stock even if she is not the
registered owner (13d-3(a)). Investors who act together to buy, vote, or sell stock form a group (13d-5(b)
(1)); each group member is deemed to benecially own each members stock
i. Beneficial owner is the entity who really controls the stock, usually brokers, or custodians
ii. Basic idea is that regardless of registered owner, this counts the real owner. You also count every
other entity who decides to act together in this action they also are included in the basic 13D report
rule
iii. These rules exist so you cant get around having to disclose if youre trying to take over a company or
buy more than 5% of the stock
d. Early Warning Systems Effect on Price
i. If theres a tender offer like this wed expect the price to go up, of course this affects the buyers
willingness to buy as theyd have to pay more.
ii. So they are loath to make an announcement of the offer thus 13D is sort of a problem for them
2. 14(d)(1) General Disclosure (goals, plans): Requires offeror to disclose her identity and future plans,
including any subsequent going-private transactions
3. 14(e) Anti-fraud Rule: Prohibits any fraudulent, deceptive, or manipulative practices in connection with a
tender offer
4. 14(d)(4)-(7) Terms of the Offer: governs the substantive terms of the tender offer, e.g. duration, equal
treatment
a. 14(e-1): Offer must be open for at least 20 days
b. 14(d-10): Must be open to all shareholders for the same price and at highest price
c. 14(d-7): Shareholders who tender may withdraw while the tender is open
d. 14(e-5): Bidder may not negotiate outside the offer or buy outside of tender offer
e. Bidder may set minimum threshold but no ceiling
f. NOTE: these terms are good for SHers: they have opp to get more info, to rescind offer if they want not
locked in. Bidder must find a price that would entice a lot of shareholders to tender their stock.
i. Bad for bidders, they might be discouraged because of fear that someone else will swoop in and
take over, offer a better bid. Which might also be bad for SHers.
ii. Strategy
1. Its best to make a tender offer if corp is made up of many small SHers control premium tends to be smaller
2. Conversely its best to make an offer for a controlling block if theres one big dominating SHer among smaller
ones but control premium will be bigger
iii. Wellman Eight-Factor Test
1. Active and widespread solicitation
2. The solicitation is made for a substantial percentage of the issuers stock
3. A premium over the prevailing market price
4. Whether the offer is open only for a limited period of time
5. The terms of the offer are rm rather than negotiable
6. Whether the offer is contingent on the tender of a xed minimum number of shares
7. Whether the offerees are subjected to pressure to sell their stock
8. Whether public announcements of a purchasing program precede or accompany a rapid accumulation
iv. Wellman v. Dickinson: Sun was considering open market purchases, a conventional tender offer, and private
purchases. Sun goes for a brilliantly designed lightning strike: simultaneous calls to 30 large institutional
shareholders and 9 wealthy individuals; xed price; offer open only for an hour. Lawyers thought the law was

44

murky. Wachtell and Cleary agree that it wont be a tender offer if the number of offerees is below 40 (NOTE:
there is no clear definition of what a tender offer is). Sun buys 34% of Becton, Dickinson. Wellman sues he
didnt get a call.
1. Court applies eight-factor test above. Factor 1: seemed very active, but was it widespread? They limited it to
40 people (out of 55k SHers). 2: 34% is substantial. 3: yes. 4: yes. 5: yes. 6: yes. 7: this was vague. 8:
no.
2. HELD: This was a de facto tender offer subject to the Williams Act
v. Brascan v. Edper Equities Ltd: Bs stocks were traded on both US and Canadian exchanges. Edper was 5%
SHer of B and wanted to take over, so they made friendly bid to take over, but SHErs rejected as low. E hired
Connacher (broker on US exchange) and asked C to buy shares in B at what it considered a good price. At first,
C managed to get about 10% of companys stock at the price point; then Canadian regulators ask whether E is
planning to take over B, then the next day they buy another 15%. So B says that E misled minority SHers, sued
under US law arguing that the statement made to Canadian regulators was a fraud.
1. Court applies Wellman factors. 1. No, they only looked at institutional investors. 2. Yes 29% is substantial.
3. Yes BUT it was a relatively small one. 4. No people bought at diff price points. 5 thru 8: No.
2. HELD: it was not a tender offer. This was a rare case, but good example of what is not a tender offer.
vi. KEY Point: the 8 factor test is relatively vague, you dont have to fulfill all the factors but there is no guidance as
to which are the most important or how many need to be fulfilled, all this is left to the discretion of the court.
d. Hart-Scott-Rodino Act
i. Who must le (18a(a)(2))
1. The acquirer in all deals in excess of $260M
2. An acquirer with assets or sales in excess of $130M and a target with assets or sales in excess of $13M or
vice versa, if the deal involves assets or securities in excess of $65M
ii. Minimum waiting period before closing a transaction (18a(b)(1)(B))
1. 30 days for open market transactions, mergers and negotiated deals
2. 15 days for cash tender offers
3. May be extended for another 30 days (10 days for cash tender offers) if DOJ or FTC make a second request

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XIII.

MERGERS AND ACQUISITIONS

a. Fundamental Transactions
i. Fundamental transactions typically require approval by shareholders
ii. Types of Fundamental Transactions
1. Amendments of the charter
2. Dissolution
3. Mergers and acquisitions
iii. POLICY: Why require shareholder approval in these transactions?
1. They are very important decisions in the life of a corporation
a. All these decisions really determine whether the set of corp assets can produce a viable outcome
b. So they are more likely to determine for a SHer whether or not to purchase a stock
2. They do not require managerial expertise - they are more like investment decisions
3. They pose special agency problems: their outcome will affect the managers future
b. M&A Motives
i. Increase efciency (exploit corporate assets more effectively)
1. Economies of scale/scope; Vertical integration; Replace bad management - If SHers decide to sell to another
company, that means they trust the other cos management then their own
ii. Redistributive motives
1. Tax incentives (EX NOL for tax purposes); Availability of credit (typically through leveraged buyouts)
iii. Bad motives
1. Hubris; Empire building
c. M&A Structures
i. Statutory Merger (251): The target and acquirer corporations merge into one; Either one of these corporations
survive or they set up a new one - Steps:
1. Negotiation and agreement between the boards in Acquiror and Target
a. Each board reviews and approves a merger agreement, and adopts a resolution as to the advisability of
the merger
2. Shareholder votes required:
a. Target shareholders always vote (251(c)) - Target shareholders must approve the deal
b. Acquiror shareholders vote if Acquirors outstanding stock increases by more than 20% (251(f))
3. Proxy materials are distributed to shareholders as needed
4. Merger must be approved by majority of shares outstanding
5. Target assets merged into Acquirors; Target shareholders become Acquiror shareholders; certicate
of merger led
a. Shareholders of the old corporations are now shareholders in the new one
6. Dissenting shareholders may request a judicial appraisal
a. examine whether the target SHers represented the target correctly
7. NOTE: here there is no cash exchanged, only stocks
ii. Asset Acquisition (271): All assets of the target are transferred to the acquirer one by one - Steps:
1. Negotiation and agreement between the boards in Acquiror and Target
a. Each board reviews and approves a sale agreement; consideration may be cash or stock to the Acquiror
2. Shareholder vote required only for the Target (Target is the one being bought)
a. Proxy materials are distributed to Target shareholders
3. Merger must be approved by majority of shares outstanding
4. Target assets sold one by one to Acquiror, according to the formalities for the transfer of each asset; Target
receives consideration either in cash or in acquirer stock
5. After completion, Target usually goes into liquidation and transfers consideration to its shareholders
6. NOTE: so target SHers do not become Shers in the acquiror they just get consideration
iii. When is a sale of corporate assets substantial enough to trigger 271 that requires a shareholder vote?
1. Katz v. Bregman: 51% of assets is substantial enough (NOT GOOD LAW)
a. FACTS: Bregman CEO of Plant Ind with subsidiary Plant National; PN was a big asset of PI; B wanted to
sell PN; got an offer from Vulcan (cash offer) and another from Universal (more cash). However B
decides to sell to Vulcan, the assets get sold to V at a lower price, SHers tried to stop this deal as there
was no SHer vote.
i. If SHers could prove to court that this was a merger, then a SHer vote would be required. As opposed
to a violation of duty of care, which is only for board to decide, in a merger SHers need to vote.
ii. KEY RULE: 271 says you have an asset acquisition if all or substantially all of targets assets get
transferred to acquiror
iii. HELD: YES this was an asset acquisition, granted injunction even tho it was only 51% of the
assets that were actually transferred
1. NOTE: This has not been repeated since courts have shifted away from this holding

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2. Thorpe v. Cerbco: Transaction must be out of the ordinary course for the corporation; 68% of assets deemed
substantial but NOT Almost All
a. NEW TEST: Almost All (NOT: substantially all) Whether the transaction is out of the ordinary course of
business and substantially affects the existence and purpose of the corp
b. FACTS: 68% of Cerbcos assets was Insituform subsidiary. Under Katz holding this would require a
SHer vote. Controlling SHer here would want to sell his controlling block, and he would get all of the cash
instead of just selling the sub, where the cash would just go back to Cerbco.
i. HELD: 68% substantial but not enough to trigger vote.
iv. Triangular Merger
1. The target corporation merges with a subsidiary of the acquirer
2. Target receives shares in acquirer as a consideration for the merger
3. These shares are passed to target shareholders
4. KEY ON EXAM: the outcome is the important part to know that the target becomes a sub of A, but the
SHers are SHers in A itself, dont worry about the steps.
5. Forward: the acquirer subsidiary is the entity that survives
6. Reverse: the target is the entity that survives as a subsidiary of the acquirer
7. Advantage: they limit liability to the Acquiror and have no cost
d. Structuring the M&A Transaction
i. Typically starts with a term sheet: Summarizes the whole deal, its main points; valuation of the company,
consideration, payment structure, timing
ii. Major problems in an M&A
1. Accuracy of the valuation is the company worth what the clients think its worth
a. Public filings concerning various assets
b. Future profits, strategic planning
iii. Due diligence get a sense of the assets a corp has
iv. Representations and warranties: A description of the assets if something in the asset was not the way it was
described in the K, then the buyer can claim damages
1. Description of fact, something unchanged static conditions
v. Indemnication this is more conditional
vi. Opinions from lawyers and accountants
1. Whether the company and its subs are well set up
2. Accuracy of financial statements
vii. Clawback arrangements - Where the seller can get back a part of the consideration
viii. How is the money going to be paid?
1. Arrange for escrow accounts
2. Negotiate timing of payments - Usually this deals with the things that need to happen before the payment is
released
ix. Other necessary steps
1. List of Regulatory Approvals and Public Announcements
2. Shareholder Votes
e. The Second-Step Merger
i. FIRST STEP: Tender Offer, SECOND STEP: Merger
1. If they get 100% at this step then the 2nd step doesnt really matter
2. IF they dont get 100%, then we have to consider the remaining shares and what their rights might be
depending on the agreement but they will either receive the tender offer value for their shares after the
offer is closed UNLESS they are dissenters
a. Fate of all the other shares: They get retired and cancelled, replaced by shares in new corp
3. POLICY: why have two-step process?
a. Speed: Because this is faster. With tender offer you get 20 days by law to let the acquirer know.
i. With a merger alone, that can take many months which opens up opp for others to bid as well
b. Rules for voting are different:
i. In tender offer theres no actual vote, when the tender offer is successful, the vote becomes a mere
formality
ii. In merger there has to be special meeting, SHers decide whether they want to merge or not
iii. KEY: DGCL 253 Short-Form Merger: allows to avoid a vote if the acquirer has over 90% of the
share capital of the target
c. Board might want to avoid a vote on a statutory merger
i. The management has agreed to keep their jobs, they have cut a deal with the new acquirers but
they dont want this personal deal to be public immediately. If there were a vote it would be a
referendum on management.

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4. FINAL STEP required by SEC: Notice to other SHers after successful tender offer that merger is going
forward and no votes will be required.
5. NOTE: If you dont get 100% of the stock in the merger then there might be taxation issues
ii. What are my clients main concerns?
1. Timing: perhaps a tender offer?
2. Shareholder vote: silent acquisition? Second-step merger? Asset Acquisition?
3. Companys value: Due diligence, reps and warranties,... Potential liability: Triangular merger (+ piercing the
veil doctrine)
4. Greater concerns about potential liability: Asset Acquisition
5. Taxation: all stock merger?
6. Regulatory approvals: enter into a binding agreement early on
f. Appraisal Rights
i. To protect minority SHers who were forced into a transaction at the wrong price
1. Less justified when there is an active market for the stock
2. More justified in sales of control blocks, or situations where some SHers act in concert
3. But private investors do not take advantage of 262(c) which allows for a contractual appraisal process in
case all of substantial all the corps assets are sold
a. People dont care very much about appraisal rights
4. This is just another illustration of a violation of the duty of loyalty - The court is asked to value a company
here, just as they are when they make entire fairness/biz judgment rule decision
5. NOTE: appraisal rights are not there by default, they are only there if put into the charter
ii. DGCL 262 Appraisal Process
1. Shareholders get notice of appraisal right at least 20 days before shareholder meeting (262(d)(1))
2. Shareholder submits written demand for appraisal before shareholder vote, and then votes against (or at
least refrains from voting for) the merger (262(d)(1))
3. If merger is approved, shareholder les a petition demanding appraisal in Chancery Court within 120 days
after merger becomes effective (262(e))
4. Court holds valuation proceeding to determine fair value exclusive of any element of value arising from the
accomplishment or expectation of the merger (262(h))
5. No class action device available, but Chancery Court can apportion fees among plaintiffs as equity may
require (262(j))
iii. RMBCA 13: Corporation pays dissenters a price, and they bring action only if they disagree
1. NOTE: This is a different process than DGCL 262. Where corp can offer ahead of time a specific price to the
dissenters only if they dont want to take this higher price then they can bring the action anyway
iv. 262(b) The Market-Out Rule in Appraisal
1. Shareholders get appraisal rights in a statutory merger (262(b))
2. 262(b)(1): No appraisal rights if:
a. shares are listed on a stock exchange OR
b. company has 2,000 shareholders OR
c. shareholders of the surviving corporation were not required to vote on the merger
d. NOTE: These exist because the court doesnt have to interfere to appraise as their exit options are ample
3. BUT: even if the 262(b)(1) conditions are fullled, shareholders will still get appraisal rights if the merger
consideration is anything other than:
a. shares in the surviving corporation
b. shares in a third company listed on a stock exchange
c. shares in a third company that has 2,000 shareholders
d. cash in lieu of fractional shares
4. KEY: SEE PRINT OUT OF SIMPLIFIED MARKET-OUT RULE: SLIDE 109, #32
a. First question if company is publicly traded?
i. If No Always get appraisal rights
ii. If Yes: consideration?
1. If all stock no appraisal rights
2. If anything else appraisal rights
v. Valuation in an Appraisal
1. Court will assess value of each stock as a pro rata claim on the companys total value as a going concern at
the time of the vote:
a. no minority discount
i. Valuation for stocks is effectively a valuation for assets each stock has a share there is no minority
discount
b. no claim on the benets of the deal
i. Will not take into account that the SHers will not control the corp

48

2. Really its a valuation of the aggregate value of assets and liabilities rather than of the stocks themselves
3. This type of valuation is inconsistent (theoretically) with justifications for appraisal and market-out exception
a. If you just relied on market youd get a control premium or a minority discount
4. Method of Valuation: Typically on advice from investment banks courts use experts
g. De Facto Mergers
i. Hariton v. Arco Electronics: L wanted to make offer for A, decided to purchase all the assets and give stock in
consideration to A SHers; A would disappear and old A SHers would own L stock. Hariton was not happy, sued
and argued that because this had effect of a merger he should have been allowed to ask for appraisal
shouldnt matter that this was an asset acquisition.
1. HELD: 271 is clear: sets out a strict process that the parties followed - No appraisal rights in asset
acquisition
h. POLICY: Why should there be appraisal rights in some but not all transactions Why should there be appraisal rights
in some but not all transactions
i. In asset acquisition the target votes this is why its not a good candidate for appraisal
ii. Its legislators work to change the statute court will not change the SHers contract ex post
iii. SHers knew that this was a possibility when they bought the stock
iv. All mergers are de facto mergers: slippery slope - Courts wary to issue appraisal rights everywhere
i. Freeze-Out Mergers
i. Key question: the controlling shareholder is trying to acquire the remaining share capital in the company
through some sort of M&A; the board has a duty to protect minority shareholders (duty of loyalty) - but it is in fact
under the control of the controlling shareholder; how do the boards duties tie in with the M&A process?
ii. POLICY: Should Freeze-Out Mergers be allowed?
1. Concerns
a. Controlling shareholders know more about the company than minority shareholders, so they might strike
an unfair price (self-dealing)
b. Controlling shareholders will look after their own interests rather than the interests of the corporation as a
whole
2. Arguments for freeze-out mergers
a. Sometimes selling to the controlling shareholder is the minoritys only option, or its best option
b. Controlling shareholders may be more successful in managing the company, so the transaction may be
benecial from the perspective of aggregate social welfare
iii. DGCL 251: Basic Freeze-Out Merger
1. Typically controlling SHer will set up another corp, this new corp will acquire shares in target for cash, which
is distributed to minority and controlling Shers for the shares
2. Then typically all the stock to the target belongs to purchaser corp, which dissolves, and thus the target
becomes wholly owned by Controlling SHer
3. Other options apart from statutory merger:
a. Tender offer, stock split, asset acquisition
4. Freeze-outs are common when theres a dip in the stock price thus theres a need for higher protection
5. Initially DE law was tough on freeze-out mergers: getting rid of minority shareholders was not seen as a biz
purpose consistent with the entire fairness rule. But then DE courts started to back down
iv. Weinberger RULES to ensure Entire Fairness of Freeze-Out Transaction
1. Create Special Committee with independent directors
a. A special committee, combined with approval of the proposal by the majority of the minority shareholders,
shift the burden to the plaintiff to show unfairness of transaction
2. Obtain serious fairness opinion from investment bank
3. Have an arms length negotiation with controlling shareholder
4. Overlapping directors cannot pass on to controller information without the company without sharing it with the
board
5. Weinberger v. UOP: some of the board members at UOP were also directors at Signal; Signal was looking to
buy a company; Arledge and Chitiea came up with idea that Signal should get remaining 49.5% of UOP; they
drafted report to Signal saying that minority SHers should sell at price up to $24, this would be a good deal;
At time UOP stock was $14. Offer made to CEO of $21, Lehman Bros reviewed proposal for fairness review
in four days but inserted $21 number arbitrarily; proposal was made by board to minority, most approved but
some sued.
a. Standard of review for this transaction: Entire Fairness (remember Cookies and Hayes Oyster)
b. Fairness means both fair dealing and fair price; here concerns were:
i. speed in the negotiations; problems with the investment bankers opinion; and Arledge and Chitiea
used internal UOP data to produce report about valuation, but failed to report to the UOP board their
recommendation for a price up to $24.

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ii.

NOTE: no duty by controlling Shers to their upper boundary to minority UNLESS there are overlapping
directors who could use information that the other party would not necessarily have
v. Parent-Subsidiary Freeze-Out Mergers post-Weinberger: Typical Structure
1. Parent noties Target of the proposal: Parent issues press release announcing the proposal
2. Target sets up Special Negotiating Committee of independent directors
a. Special Committee hires investment bank and lawyers
i. Investment bankers make serious efforts to produce a credible fairness opinion
b. Special Committee makes serious efforts to understand the contours of the proposal and the rms value
3. Special Committee negotiates with Parent and there is evidence of bargaining at arms length
4. If Parent and Special Committee agree on a price, they bring the proposal to the minority shareholders
5. Majority of the outstanding minority shares must agree
vi. RULE: The Controlling SHer does not need to be majority Sher to be subject to Weinberger Freeze-Out rules
and can be made to submit to entire fairness review if there is something suspicious about the deal.
1. Kahn v. Lynch Communications: Alcatel owns 43.3% of Lynch Communications. Lynch wants to buy Telco,
but Alcatel has veto power and proposes that Lynch acquires Celwave - owned by Alcatel instead. Lynch
appoints Independent Committee; Alcatels banker recommends an exchange ratio of 0.95 shares;
Committees banker says its too high; Committee opposes merger. Alcatel makes a friendly proposal to the
Board to acquire 56.7% of Lynch @ $14 per share in cash. Lynch appoints Independent Committee again;
Committee rejects $14, rejects $15; Alcatel threatens directors with a tender offer; Independent Committee
approves $15.50. Minority shareholders sue the Alcatel directors alleging breach of the duty of loyalty
a. HELD: Weinberger rules for freeze-out mergers applied even tho Alcatel was NOT majority SHer.
b. Alcatel was a controlling shareholder subject to entire fairness review even though its shareholding was
only 43.3% because Lynch directors appointed by Alcatel exercised pressure to other directors, who felt
they had to comply with Alcatels wishes AND it threatened the board through a tender offer.
vii. RULE: all Weinberger protections arise only when there is something suspicious with the deal. So long as the
tender offer is pursued properly (free of coercion or disclosure violations), the free choice of the minority
shareholders to reject the tender offer provides sufcient protection.
1. In re Siliconix: Controllers tender offers are not subject to the Weinberger process because
a. the board does not have to take action at that price; price comes from controlling shareholder
b. since only shareholders who agree with the price tender their shares, the tender process is the functional
equivalent of a vote on a merger proposal
j. What happens to minority shares after:
i. A tender offer?
1. only the shares that are tendered change hands and go to the majority; the other shareholders keep their
stock
ii. A statutory merger?
1. if shareholders approve the merger, then all shares are merged, not only those that voted for the merger
iii. A second-step merger (rst tender offer, then merger)?
1. If controller has more than 90%, they can have a short form merger under 253
2. If controller has less than 90%, then a statutory merger is necessary; minority shareholders get another vote
iv. An asset acquisition (sale from the perspective of the target)?
1. the sale does not alter the status of the shares; the corporation may then decide to dissolve, in which case
shares cease to exist
k. Transaction Structure Motivations
i. KEY ON EXAM: there will definitely be a question on the exam about this
ii. Tender offer motivation
1. Interested in one specific price, in time, and they want to put pressure on SHers
2. But not interested in taking over entire corp, just a portion
3. RESULT: gets tendered stock only
iii. Statutory Merger Motivation
1. Full ownership: Interested in corp as a whole, want to take it over
2. Economic motivation for having 100% - for profit
3. RESULT: all stocks cancelled after merger
iv. Second Step Merger
1. Interested in avoiding a SHer vote
2. Also strategic advantage, timing and speed of deal
3. KEY: here think about what this advantage might be, in Timberjack it was that the CEO/board would keep
their jobs
4. RESULT: if tender offer greater than 90% then short-form merger
v. Asset Acquisition
1. Interested in avoiding liability

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2. RESULT: gets assets but no stocks

l. Bank of America/Merrill Case Study
i. FACTS: BofA agrees to buy Merrill day after Lehman collapse; this was a good price given the circumstances
70% premium over market price; at this point the board has agreed to go ahead with acquisition probably a
statutory merger but deal needs SHer approval from both companies because both were so big. Proxy
materials distributed a few days later in November 2008 stating that they expect losses of about $5B. A few days
after distribution ML tells BA that they expect even higher losses than $5B. Early December BA Shers approve
merger this is effectively last step but there are still things that need to be done like approval of regulators, etc.
3 days after that, ML announces $3.6B in bonuses. A few days later (Dec 17) Ken Lewis notifies authorities of
$16B ML loss and intention to use MAC Material Adverse Effect Clause he tried to withdraw from deal even
tho the SHers have approved but he is convinced to do otherwise. On Jan 2, 2009 the merger is finalized.
1. Issues in this case
a. 1. Approval of merger by BA SHers
i. KEY ON EXAM: start by analyzing the numbers, this is usually where the dispute starts
ii. Effectively BA paid 50B for a corp actually worth 10B
iii. Legal Doctrine
1. Proxy Rules disclosure has to be true and accurate
a. Anti-Fraud Provision of Fed Proxy Rules
b. Misrep of losses and value to SHers
2. Duty of Care hard to say whether they did enough to vet ML
iv. NOTE: no one tried to bring this case its very hard to prove
b. 2. The Bonuses
i. Duty of Loyalty
1. Usually self-dealing is some violation of duty of loyalty
2. But prob with bonuses is that they gave them ahead of time and it wasnt clear whether BA had
agreed to that or not
2. HELD: Ultiamtely there was a 33M settlement that went directly to harmed SHers of BA.

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XIV.

PUBLIC CONTESTS FOR CORPORATE CONTROL

a. Hostile Takeover: when the board opposes the bidder trying to take control
b. General Overview
i. Smith v. Van Gorkom: how the board should behave when considering a takeover, but in Van Gorkom, the board
is friendly to the bidder; what if there is a hostile bid?
ii. Moran v. Household: What the board can do BEFORE a bidder comes along?
iii. Unocal v. Mesa Petroleum: What the board can do WHILE the bid is running
iv. Revlon v. McAndrews & Forbes: What the board can do AT THE END to close and protect the deal
c. Unocal v. Mesa Petroleum introduces a two-step test:
i. First: Real Threat: directors must show that the bid poses a threat for the corporation, rather than for
themselves
1. Coercive offer, inadequate price, questions of illegality, etc.
2. The Court must be convinced that directors are not simply ghting for their positions
ii. Second: Proportionality: directors must show that the defensive measure is reasonably proportional to the
threat (reasonableness suggests business judgment rule)
1. Offering to shareholders a price corresponding to the boards justied valuation of the stock was deemed
reasonable
iii. Unocal: Unocals shares were at $33, Pickens tried to buy silently as many shares as he could of Unocal, got
13% before having to file 13D. Makes tender offer of $54 for 37% in cash, but for the remainder, he offered $54
but in bonds with PV of $45. Tender is conditional on TBP getting 37%.
1. Court finds TBPs offer coercive because there is a strong incentive to disparate SHers (collective action
problem) to go for $54 price even if they feel it is too low. This creates pressure to tender because if TBP
wins and you dont, youre stuck with $45.
2. Board gets valuation of $60-75. TBP is trying for Greenmail but board wont go for it. So they offer
eventually offer $72 to first 30% unconditionally and then to the remaining 19% ONLY if TBP wins, and they
exclude TBP from participating.
3. HELD: it was okay for Unocal to exclude TBP. Court says: if it is not unequal to offer a premium for a block of
stock, it is not unequal to offer a premium for many small blocks of stock. TBP does not need protection from
his own tactic purpose is to protect SHers who were actually hurt.
iv. Criticisms of Unocal Rule
1. Hostile bidders bring efficiency to a corp
2. This rule lets a board continue to manage itself in an inefficient way
3. Boards think this rule is too burdensome - It should be a biz decision they should be able to judge whether
they want to fight or give in to the bidder
v. KEY: Applying Unocal
1. FIRST ASK: What is the threat?
a. Coercive offer, inadequate price,
b. ...questions of illegality, the impact of constituencies other than shareholders (creditors, customers,
employees, and perhaps even community generally), the risk of non-consummation, and the quality of
securities offered in exchange.
c. NOTE: This is only place in corp law where you really see a concern for effect on EEs and community in
general
2. Second Step: is the defensive measure reasonably proportional to the threat?
a. In Unocal Yes, since the board is offering to SHers what it considers to be the fair price for the stock
b. IF you have a valuation of the company that fulfills this standard then the board is free to pursue that
c. Unocals second step (proportionality) is itself a two-step inquiry:
i. First: was the defensive tactic coercive or preclusive (Unitrin)
1. Whether the boards response is equally coercive creating incentives similar to that of hostile
bidders usually the answer is no.
ii. Second: if not, does it fall within a range of reasonableness (i.e. business judgment rule)
d. Burden of showing proportionality is on defendant directors
i. If directors must show that the tactic (a) was not coercive and (b) was reasonable (but the court will
defer to the boards business judgment on reasonableness)
1. Plaintiff can only respond by showing breach of duciary duty, i.e. lack of good faith, entrenchment,
or gross negligence in the sense of Smith v. Van Gorkom
ii. If directors fail to show proportionality, they can still try to show entire fairness
d. Poison Pills
i. A mechanism that allows the board to issue additional shares, typically aimed to alter the voting balance so as to
avert a takeover so whatever holding the bidder had would significantly disappear
1. The charter allows the Board to issue to shareholders rights to acquire newly issued stocks at heavily
discounted prices

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ii.

iii.

iv.

v.

2. Rights can be exercised when a triggering event occurs, typically a tender offer or an acquisition of a
sizeable block
3. Apart from the bidder, all other shareholders get to exercise their rights
4. Bidders shareholding is diluted, and thus takeover threat is averted
5. NOTE: Technically this is a right not an obligation to purchase
Implementing a Flip-In Poison Pill
1. Arrange for a rights plan:
a. Firm will issue to all existing shareholders a right to acquire a new share at a heavily discounted price
usually half price
b. Right attaches to the share and gets traded with the share; cannot be exercised before a triggering
event
c. Board can adopt the rights plan as long as the charter grants to it the power to issue preferred stock with
no shareholder approval requires a vote by the board
2. Distribute rights: Rights are distributed as dividend and remain tied to the stock
3. Triggering event occurs: Typically, an acquirer buys more than 10% of the stock
4. Rights are exercised: All rights holders are entitled to buy stock at the discount price except the acquirer,
whose right gets cancelled
Flip-over Pill: where board has to include in any merger agreement a term that requires the surviving corp after
merger to issue a lot of new stock to SHers of the target if triggers are met. NOTE: Flip-Over pill has never been
changed in court so validity still a question.
1. Moran v. Household Intl: HHs board was considering a flip-over pill. Two of the directors didnt want the pill
Moran and Whitehead, so they vote against but reason why was they were already planning on taking
over corp themselves by via a leveraged buyout. There was no triggering event here but M and W brought
suit against board arguing violation of fiduciary duties and could not take this action
a. HELD: Delaware statute grants to boards the power to adopt rights plans
i. 157(a): Subject to any provisions in the certicate of incorporation, every corporation may create and
issue, whether or not in connection with the issue and sale of any shares of stock or other securities of
the corporation, rights or options entitling the holders thereof to purchase from the corporation any
shares of its capital stock... as shall be approved by the board of directors.
ii. 151(g): When any corporation desires to issue any shares of stock of any class... of which the voting
powers, designations, preferences and relative, participating, optional, or other rights... have not been
set forth in the certicate of incorporation... but shall be provided for in a resolution... adopted by the
board of directors pursuant to an authority expressly vested in it by the provisions of the certicate of
incorporation... a certicate setting forth a copy of such resolution... and the number of shares of stock
of such class or series shall be executed, acknowledged, led, recorded, and shall become effective in
accordance with 103 of this title.
2. RULE: Boards decision to adopt such a plan is subject to Unocal review to determine if there was a violation
of fiduciary duties:
a. Threat: the Moran court was satised with mere discussions of a potential leveraged buyout as
constituting enough of a threat
b. Proportionality: Absent allegation of self-dealing, entrenchment, gross negligence, courts defer to
boards business judgment
3. KEY: A court will NEVER force a targers board to redeem its pill because it has arbitrarily rejected an offer
(Time Warner)
a. There will never be a situation where the board will be violating its fiduciary duties by allowing pill to
operate. Only the board knows what is low and what is high, as such there cannot be a sitch were the
board would be forced to redeem the pill.
After the pill is triggered, Board has two options:
1. If the Board believes the offer is inadequate, it can allow the pill to operate, issue stock to shareholders
(ip-in pill) or include conditions in merger agreement (ip-over pill)
2. If the Board believes the offer is a good offer, it can stop the operation of the pill by redeeming the Rights
a. THUS there is a 2nd later point in time after trigger event where board gets to decide whether to allow
pill to happen
b. THIS is where fiduciary duties kick in in deciding whether or not to redeem the rights
3. In Moran, the Court makes clear that the decision of the board to accept or reject the offer is also subject to
scrutiny
a. Since the pill is a defensive measure, the applicable standard will often be Unocal
b. Depending on the facts, other standards may be applicable
Forced Pill Redemptions
1. Interco RULE: if theres no threat and nothing coercive going on, then you cant have defensive measure like
the poison pill, you must let SHers decide whether or not they want the tender offer

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a. Interco: Intercos Board faces an all-cash, all-shares tender offer by the Rales Brothers (remember
them?) valuing the company at about $70. Interco has in place a poison pill. Intercos Board was
planning a recapitalization alternative: sell some subsidiaries and distribute proceeds to shareholders as
dividends, for a total value of $66 cash and $10 stock. Board decides to do nothing and let the pill
operate.
i. HELD: the offer is not coercive, and thus shareholders should be allowed to accept or reject it. Court
grants an injunction forcing Intercos Board to redeem the Rights and stop its recapitalization plan.
ii. NOTE: interco is an extreme situation so it is not normally followed though it can still be followed
b. Grand Metropolitan Pub. Ltd. Co. v. Pillsbury (Del. Ch. 1988): Pillsbury is undervalued: the total value of
its subsidiaries is higher than its market share. Grand Met is a major shareholder that launches a tender
offer valuing Pillsburys stock at $63. Pillsburys board has in place a poison pill; proposes a restructuring
that, if successful, would value the company at $68. Board decides to do nothing and let the pill operate.
i. HELD: Court nds that shareholders should be allowed to accept or reject it
1. investment bank opinions thought the $63 price as fair
2. tender offer was open for two months, no competitive bid emerged
2. NOTE: States legislatures have subsequently acted to protect the Poison Pill
a. States fear of capital flight DE has it, dont want ot lose more corps to DE tho this doesnt play out
b. Theres a rare occurrence here of mngt and unions being on the same side in favor of poison pills Unions are local so theres clear incentive to keep things local and thus the poison pill helps do that,
instead of letting corp raiders break up corps
e. Competing Offers
i. RULE: Revlon Duties require directors to sell the company to the highest bidder and become auctioneers, once
the sale or breakup of the company becomes inevitable
1. Revlon: Price of corp, $25 per share; Perelmann runs PP, he offers $47.50 to each shareholder; with this
threat, Revlon board adopts poison pill. Board takes defensive measures, including buying 20% of stock
using borrowed money (Notes), while Perelmann continues raising tender offer price to $56.25. Revlons
board looks for white night Forstmann. F buys for $57.25, with terms including asset lockup, no-shop,
break-up fee, and support value of Notes. P sues saying the lockup deal is a defensive measure thats not
allowed.
a. BOTH Duty of care and loyalty breached here. Remember: No indemnication for breach of the duty of
loyalty.
b. HELD: Violation of duty of loyalty for boards support of Noteholders.
i. The board is choosing to expend corp value a higher price for stockholders in order to support
noteholders and avoid personal liability law suits against them. The element of self-dealing was
avoiding a lawsuit by the noteholders that would have happened if P took over.
ii. There must be some minor benefit to Shers from boards action, they cannot completely ignore SHers
while paying attn to other constituencies.
c. HELD: Violation of duty of care Lock-up Provision.
i. Bound corp to sell 40% of assets to Forstmann if another bid succeeds. Thus, why would P want to
buy if that were the deal? He was effectively excluded. Its okay to enter friendly negotiations so long
as all sides have a chance.
2. RULE: Boards tactics cannot have the effect of excluding the other bidder from any bid
ii. Multiple Bidders: Revlon Duties Clarified
1. RULE: If there are multiple bidders, you can use defensive measures but not ones that will destroy the
auction process
a. You can favor one bidder but you cant use defensive mechanisms to do it
2. If single bidder
a. Then fairness requires the board to canvas the marketplace to determine if higher bids may be elicited
(Smith v. Van Gorkom)
b. EXCEPTION: When the directors posses a body of reliable evidence with which to evaluate the fairness
of a transaction, they may approve the transaction without conducting an active survey of the market.
iii. Time Warner claries that the concept of threat in Unocal includes:
1. Structural coercion: The risk that disparate treatment of non-tendering shareholders might distort
shareholders tender decisions (Unocal)
2. Substantive coercion: the price offered is inadequate because shareholders cannot correctly assess the
value of the company
a. The risk that shareholders will mistakenly accept an underpriced offer because they disbelieve
managements representations of intrinsic value (Unitrin, Paramount v. Time)
3. Opportunity loss: accepting the hostile bid would forego a valuable business opportunity, which would be
protable for the company

54

iv.
v.

vi.
vii.
viii.

a. A hostile offer might deprive target shareholders of the opportunity to select a superior alternative offered
by management (Paramount v. Time)
4. Time Warner: Time and WB wanted to merge, very friendly agreement for merger. SHers need to approve
deal, but good for them. Then Paramount comes in and offers 175 for Time, a significant premium over
$122. Time and Warner change structure of deal which is now tender offer for $250. Only requires vote
by Warner SHers and this price allows them to reject Paramount, they then borrow 10B to do the deal.
Paramount raises its tender offer to $200, but because Times offer is quicker they were able to do the deal
before any vote could possibly be taken because of requisite regulatory approvals that had to come in.
Paramount sues saying deal violates Unocal and Revlon.
a. HELD: Revlon not triggered what the board is doing here is not an abandonment of corps continued
existence, doesnt try to sell corp to Warner, it has instead longterm strategy of merging, has spent time
with figuring out whos best partner, had long negotiations.
i. They just changed the shape of the form of the deal from merger to tender offer, and for that reason
theres not event that would trigger Revlon
b. Revlon Triggers (Non-exclusive List):
i. When a corporation initiates an active bidding process seeking to sell itself or to effect a business
reorganization involving a clear break-up of the company
ii. Where, in response to a bidders offer, a target abandons its long- term strategy and seeks an
alternative transaction involving the break-up of the company.
c. HELD: There was a threat pursuant to Unocal
i. Not a threat: Paramounts all-cash one-step offer is not structurally coercive, and the price is adequate
so that is not coercive
ii. Court says that threat is that HSers wouldnt be able to see the value of the longterm benefits of the
alliance with Warner, theyd be lured by the cash and give away their stock for cheap.
iii. NOTE: emphasis is on biz merits of the deal so there is going to be more deference to the judgment
of the board because when it comes to biz, the board knows better
iv. Court also criticizes Interco: it must be up to judgment of board itself to decide when to redeem the pill
d. HELD: Defensive measure proportional to the threat
i. The board simply changed the form in which it was pursuing the long-term strategy of creating TimeWarner: from merger to tender offer
1. Emphasis on boards efforts to identify Warner as the best fit for Time
ii. AND the deal did not preclude Paramount from making a higher offer
KEY: transfer of control - Whatever value there is to acquiring a control block MUST be extracted before the
sale of that control block
Where there is not a merger of equals, the merger would be a transfer of control to the larger corp. Thus the
controlling SHers would benefit from the longterm biz plan, NOT the pre-merger SHers.
1. Paramount v. QVC: Paramount trading at $45, decides to merge with Viacom for $70; deal includes some
deal protection devices, No-Shop, Break-up fee (100M is big), 19.9% stock option lock-up if merger doesnt
happen then Paramount must sell 19.9% of stock to Viacom. QVC starts making tender offers, Viacom
raises to $85, QVC to $90, Paramount board decides to go with Viacom.
a. The merger in Time-Warner was a merger of equals; the Viacom merger would transfer control to
Viacom
i. After control is transferred, the benet of pursuing long-term business plan passes to controlling
shareholder rather than the pre-merger shareholders
b. Court found Paramount so set on Viacom they didnt re-negotiate any deal protections, thus they didnt
negotiate with both parties and keep a level playing field.
Unocal allows the board to continue putting up defenses - NOT SELL
Revlon mandates the board to SELL
Triggering Revlon
1. Consideration (Institutional Competence Theory Revlon)
a. Revlon-Mode Less Likely if: all stock
b. Revlon-Mode More Likely if: all cash
c. If the consideration is cash that is more easily valued by the board than stock for stock
i. So its more likely that a cash situation will trigger Revlon and force board to sell to highest bidder
2. Size of Target vs. Acquirer (Institutional Competence Theory Revlon)
a. Revlon-Mode Less Likely if: merger of equals
b. Revlon-Mode More Likely if: whale/minnow
3. Acquirer Shareholders (Sale of Control Theory QVC)
a. Revlon-Mode Less Likely if: Widely held
b. Revlon-Mode More Likely if: Controlling SHer
4. EXCEPTION for all More Likely categories: when Target has a majority SHer

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5. NOTE: first two factors have ot od with ability of board to understand deal, 3rd has to do with courts concern
for position of minority Shers
ix. Allocation of Stock in a 50% tender offer
1. Viacom offered cash for 50.1% - got 75%; does it have to give cash to all 75% shareholders?
2. No; it simply has to distribute the cash among all shareholders without discriminating against them.
3. Ratio of 50.1/75 is about 2/3.
4. So each Paramount shareholder who tendered stock got cash for about 2/3 of her tendered shares - the
remaining was treated as non- tendered stock
x. RULE: Only if the board knowingly and completely failed to undertake their responsibilities would they breach
their duty of loyalty...
1. Lyonell Chem v. Ryan: Bassell had a long-term interest in Lyondell; in 2006, it purchased an 8%
shareholding and led a Schedule 13D, alerting Lyondells board to an acquisition. Bassell CEO Blavatnik
offers to Lyondell CEO Smith $40 per share for a merger; Smith manages to raise the price to $48, but with a
$400M break-up fee. Lyondell board meets over a weekend, obtains a fairness opinion from an investment
bank suggesting it is a good price, and sends Smith back to renegotiate with Blavatnik; does not look for
alternative bids. Blavatnik does not offer a better price; Lyondell board takes the merger proposal to
shareholders; 99% of shareholders approve. A shareholder sues, but cannot allege violation of the duty of
care, because Lyondell has a 102(b)(7) waiver. Chancery Court allows claim to proceed on duty of loyalty
claims.
a. HELD: No violation; they did not look for an alternate bidder, but they had a fairness opinion, they were all
independent, they red an internal report valuing the company
f. Deal Protection Devices
i. In negotiations for the acquisition of a corporation, a potential acquirer seeks to extract some assurance that the
corporation will not be sold at the last minute to some third party
ii. Lock-Up Arrangements
1. Lockups: provide potential acquirers with the right to buy assets or stock in the corporation if the deal falls
through
a. Asset Lockup: Gives the acquirer the right to buy specied assets of the target at a specied (typically
discounted) price - extremely rare in the 1990s - This is very rare, courts find this too constraining.
b. Stock Option Lockup: Gives the acquirer the right to buy a specied number of shares of the target
(typically 19.9%) at a specied price. Stock option lockups are more common more common
2. Breakup fee: requires the company to pay a cash payment to potential acquirers if the deal falls through.
Breakup fees are the most common lockup very common, values have been rising
3. Motivation for Lock-Ups
a. KEY Motivation: Prevent bidder whos main goal is to upset the deal
b. From planning to negotiation theres a risk of pre-emptive bids
c. Through the remaining processing phase theres a risk of Bust-Up bids
iii. Exclusivity arrangements limit the ability of the corporation to enter into competing negotiations
1. No shop: Board cannot provide condential information to other interested parties
2. No talk: Board cannot even be in contact with other interested parties
3. Loyalty to merger: Board agrees to recommend the deal to shareholders
a. Safeguards the completion of the deal through various corporate procedure steps
b. DGCL 146 allows the board to commit to submit a matter to shareholders
4. Fiduciary out clauses prevent the breach of contract, allows the board to sidestep its exclusivity
constraints when required by its duciary duties
a. If the board recommends the superior bid, it avoids violating its duciary duties, but is in breach of
contract this is a way to avoid that
iv. RULE: A merger agreement with exclusivity arrangements that effectively eliminate the possibility of a third-party
merger is preclusive under Unitrin, and therefore fails the proportionality step of Unocal
1. Boards have a duty to negotiate a duciary-out clause
v. Omnicare v. NCS: NCS stock price is dipping, making it an acquisition target. In 2001, Omnicare offers to buy
NCS for $270M - but negotiations break down. In June 2002, Genesis offers to buy NCS, but insists on
exclusivity in negotiations up to the end of July 2002. On July 29, 2002, Genesis and NCS announce a merger
agreement: Outcalt (NCS Chairman) and Shaw (NCS) CEO have agreed to vote for the merger; they own 20%
of equity but more than 50% of voting rights, because of a dual class structure. Omnicare launches a competing
tender offer for double the price. On October 6, NCS board changes its recommendation in favor of the
Omnicare bid. But Omnicare loses the vote due to the agreement with Outcalt and Shaw
1. KEY ON EXAM: when talking about sales of companies, the first question is ALWAYS is Revlon triggered
determines what the duties of the board will be
2. Here Revlon not triggered
3. Unocal Application

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a. Threat? - Substantive opportunity loss: Threat of losing the only potentially interested party, Genesis
b. Proportionality? - Court applies Unitrin: seeks to establish whether the defensive measure precludes any
third party from making an alternative bid
i. HELD: because of the shareholders agreement and voting structure, the force-the-vote clause
effectively precluded any third party from participating
1. It invalidates the merger agreement as a result; board cannot contract to violate its duciary duties
2. The board should have negotiated Fiduciary-Out clause
3. BUT NOTE: doing that would have caused Genesis not to bid, this is highly controversial decision
vi. RULE: But shareholders may be free to enter into exclusivity arrangements (Orman v. Cullman)
1. Only the board has fiduciary duties
g. Anti-Takeover Statutes
i. Federal Preemption:
1. RULE: Anti-takeover statutes cannot favor incumbents over bidders, because this violates the neutral
posture of the Williams Act...
2. ..but anti-takeover statutes can introduces changes in a corporations governance, e.g. through voting rules
3. Edgar v. MITE (1982) Example of Statute that was preempted
a. The Illinois Business Takeover Act:
i. Requires registration of tender offers with the state
ii. Provides for a 20-day waiting period before taking effect
iii. During these 20 days, state secretary can call a hearing to adjudicate the fairness of the offer
b. HELD: SC strikes down the IL statute as preempted by the Williams Act
i. The Act protected SHers but was neutral towards the bidder and the target
ii. IL statute abandons neutrality and tilts the balance in favor of the target
iii. Thus, the IL statute violates the spirit of the W Act
4. CTS v. Dynamics Corp of America
a. The Indiana Control Share Acquisition Act:
i. Applies to companies headquartered in Indiana, and with significant shareholding among Indiana
residents
ii. In a sale of a block exceeding 20%, 33.3%, or 50%, the acquirer gets voting rights only equal to 20%
upon transfer
iii. In a special meeting, disinterested shareholders (other than the bidder, directors or officers) decide
whether to allow the acquirer voting rights for the remainder of its block
b. HELD: Supreme Court upholds the Indiana statute:
i. It does not upset the balance in favor of bidder or managers
1. Mngers are excluded, its not a significant departure from the W Act
ii. Its application is limited on Illinois corporations
iii. It affects only voting rights, not the ability to acquire shares
1. corporate governance rules are typically governed by state law, securities trading by federal law
2. The court draws a line between governance rules about control of corp and trading securities which
is preempted by federal law - Rules pertaining to corp governance is the essence of the biz and
should be left to them
ii. Common Anti-Takeover Statutes
1. Control share acquisition statutes (27 states)
a. Prevent bidders from voting, unless allowed by a majority of disinterested shareholders
2. Other constituency statutes (31 states)
a. Allow the board to consider non-shareholder constituencies
3. Pill validation statutes (25 states)
4. Business combination statutes (33 states)
a. KEY: Most important one - Prevent the bidder from merging with the target for 3-5 years after gaining a
control stake unless approved by the targets board
5. Fair price statutes (37 states)
a. Set procedural mechanisms that determine a fair price in freezeouts
6. NOTE: States with no takeover statutes: Alabama, Arkansas, Alaska, Montana, New Hampshire, W. VA, CA
iii. DGCL 203 prohibits business combinations (such as mergers) between acquirer and target for 3 years after
acquirers shareholding exceeds 15%, unless:
1. 203(a)(1): the targets board approved the acquisition before the bid was launched, OR
a. Easiest way to go
2. 203(a)(2): the acquirer gains more than 85% of the shares in a single offer (i.e., moves from below 15% to
above 85%) excluding inside directors shares, OR
a. Difficult to pull off

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3. 203(a)(3): after the acquisition, the acquirer gets approval to proceed with the business combination by the
targets board and 2/3 of remaining shareholders (i.e. the minority who remain after the takeover)
a. For all the people who decided that the initial price was low, now have to approve the squeeze out price,
which will be even lower this is VERY difficult to get
4. NOTE: 203 is a prime example of a takeover statute
iv. Best Takeover Strategy
1. Get a friendly bid: All friendly bids those approved by the board are free to proceed with a freeze-out
merger under 203(a)(1)
2. Tender offer: If an offeror can get 50% of the shares, perhaps it can also get control of the board BEFORE
the tender offer is launched
3. Might be able to win a proxy contest
a. Winning the proxy contest is definitely a better strategy if you can pull it off.
b. No problems with takeover statutes or poison pills (boards can redeem them)
c. but of course, sometimes to win a proxy contest an acquirer needs to first acquire some shareholding
itself, so the pill might be triggered after all
4. EX Sanoni-Genzyme
a. The French giant, Sanofi, started with a hostile bid for MA-based Genzyme valuing it $69 per share
($18.5B total value)
b. Genzyme board would first stagger the board, so that board control would be difficult
c. Genzyme had no pill (but could put one in)
d. Massachusetts had a 5% to 90% statute: business combinations were prohibited unless the controlling
shareholder had over 90%
e. Genzyme Board refused to provide any confidential information to Sanofi unless Sanofi raised its bid to
$80 per share
f. After nine months, Sanofi capitulated
v. Constituency Statues (EX: Indiana)
1. (d) A director may, in considering the best interests of a corporation, consider the effects of any action on
shareholders, employees, suppliers, and customers of the corporation, and communities in which offices or
other facilities of the corporation are located, and any other factors the director considers pertinent.
a. NOTE: creditors are NOT on this list
2. (f)...directors of Indiana corporations... are not required to approve a proposed corporate action if the
directors in good faith determine...that such action is not in the best interests of the corporation...Certain
judicial decisions in Delaware and other jurisdictions, which might otherwise be looked to for guidance in
interpreting Indiana corporate law, including decisions relating to potential change of control... are
inconsistent with the proper application of business judgment rule under this section.
a. First three lines duty of care
b. Remainder:
i. Unocal has test for other constituencies (DE) so thats not targeted here
ii. Revlon says when the duties are triggered, the board becomes this auctioneers and they have to sell
at highest price best for Shers, but NOT for other constituencies
iii. BUT HERE this says that Revlon does NOT apply in IN
iv. In practice this has turned out to be not so important rarely comes up
h. Proxy Contests for Corporate Control
i. Best takeover strategy Proxy Contest
1. Prospective acquirer starts a proxy contest to replace the targets directors over one or more election cycles
2. After winning board majority, the new directors redeem the pill and agree to a friendly takeover
ii. SHer Democracy in DE Takeover Jurisprudence
1. Shers have power to move the board at a later stage if they disagree with the boards handling
2. Unocal v. Mesa Petroleum: If the stockholders are displeased with the action of their elected
representatives, the powers of corporate democracy are at their disposal to turn the board out.
a. The court seemed to imagine that this isnt the end, the board is under continuous evaluation by Shers
and this is an important way out by SHers
3. Based on the legitimating power of corporate elections, Delaware Courts were more willing to accept the
boards decision on:
a. Whether to adopt a poison pill, or to redeem a poison pill (Moran)
b. Whether to pursue a long-standing plan instead of a short-term acquisition gain (Time-Warner)
iii. Schnell v. Chris-Craft Industries (1971)
1. FACTS: Board and insurgent shareholders negotiate up to the last moment; A couple months before the
meeting, Board amends bylaws to: 1. Move meeting date one month in advance, from January to midDecember, and 2. Hold the meeting in a remote town in upstate NY; Board argues that the change was not a
defensive tactic, but an effort to avoid the Christmas mail rush

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iv.

v.

a. They were really preventing insurgents from launching a revolt against the board and taking over
b. Chancery Court denies injunction
2. Boards bylaws allow it to set time and date of meeting
3. HELD: Court does not allow board to have its way grants injunction to dissident SHers to stop the meeting
a. Management contends that it has complied strictly with the provisions of the new Delaware
Corporation Law in changing the by-law date. The answer to that contention, of course, is that
inequitable action does not become permissible simply because it is legally possible.
b. Emphasis on deeper injustice of boards motivation
c. KEY TAKEAWAY: court decided that this was not effectively allowed
d. This case is like: Page v. Page, or Meinhart v. Salmon
RULE: The Board cannot abuse SHer voting rules to affect one specific SHer vote
1. Blasius Industries v. Atlas Corp (1988)
a. FACTS: A was a target right before the case; corp charter allowed for up to 15 directors, but at that point
the board consisted of only 7; B was 9% SHer in A, he wanted to take over board before they launched a
bid
i. Thus they issued proxies for 8 new directors; if successful theyd immediately have control of the
board
ii. As board elects 2 more directors, as a result they have majority and B cannot elect any new directors
B sues
b. NOTE: B could not solicit proxies to remove directors because, as board is staggered it can only be
removed for cause (141)
i. By electing 2 more people in the board, the A board had thwarted Bs strategy completely
c. Unocal analysis:
i. Threat YES Bs desire to have restructuring plan to sell corp
ii. Proportionality YES doesnt seem very extreme, just adding two new directors
1. Unitrin it was not preclusive under this (new directors could be convinced otherwise)
d. KEY: COURT says do not apply Unocal
i. Affecting a shareholder vote is not a matter of business judgment, but of the allocation of power
between the board and shareholders
1. Court sees it as the board trying to take over itself its not any form of trying to perfect the minority
ii. Board cannot use its authority on setting voting mechanism in order to sway one specific shareholder
vote
2. When Blasius Should Apply
a. NOTE: this standard is more exacting and strict than Unocal
i. So far no cases where the standard has been met
b. Any board action that interferes with voting structure is not automatically void
i. KEY QUESTION: is there a compelling justification for boards action
ii. Directors may offer a compelling justification for their actions
iii. Hint: inadequate price is not compelling enough
c. UNLIKELY TO APPLY: During a heated proxy contest, the incumbent board purchases stock selectively
from a large shareholder who is otherwise likely to vote for the insurgents
d. 50/50 CHANCE OF APPLYING: Under the same circumstances, the incumbent board issues a large
block of additional stock at market price to shareholders who are likely to support the incumbent board
e. MOST LIKELY TO APPLY: Under the same circumstances, the incumbent board delays the annual
meeting after the meeting date is set when its initial proxy returns suggest that the insurgents may win
f. NOTE: These are all things we need to consider when dealing with SHer votes
NOTE: Example of Blasius being applied instead of Unocal
1. MM Companies v. Liquid Audio
a. FACTS: Liquid Audio has $86M cash but a $52M market capitalization (LA perfect target for takeover). In
October 2001, the Liquid Audio rejects an all-cash merger proposal from MM, a shareholder, and instead
announces a stock for-stock merger with Alliance Entertainment. MM forces Liquid Audio to hold its
annual meeting so as to: 1. Challenge the two incumbent directors up for re-election, and 2. Propose a
bylaws amendment to expand the board from five to nine members. One month before the meeting,
Liquid Audio adds two directors. At the meeting, shareholders elect the two MM directors but reject the
proposal to add four more seats. Liquid Audio sues alleging both Unocal and Blasius violations.
i. There were five directors, then the remaining 2 seats got picked up by MM. MM wanted 4 more seats
so they could have control. But since this was rejected they were left with only two directors
b. NOTE: Theres a tension between these two standards Unocal gives board greater flexibility, while
insurgents argue B should apply because it will invalidate actions of the board
i. Remember: B is a higher standard so its to MMs advantage to have it apply
c. HELD: Although Chancery Court applies Unocal, DE Supreme Court reverses and applies Blasius

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i.
ii.

vi.

vii.

Doesnt matter whether the action actually helps or prevents Sher from getting control
Main issue is that the Primary Purpose of boards action is to reduce MMs directors ability to
influence board decisions
NOTE: Example of both Blasius and Unocal being applied
1. Hilton Hotels v. ITT
a. FACTS: January 1997: Hilton announces: 1. $55 per share tender offer for ITT and 2. a proxy contest to
replace all ITT directors at the 1997 annual meeting. ITT sells some assets and delays annual meeting
by six months to November 1997. July 1997: ITT announces plan to split ITT into three entities, 93% of
assets (87% of revenues) are transferred to a wholly owned subsidiary, ITT Destinations, AND Shares of
ITT Destinations are distributed to all ITT shareholders as dividend
i. ITT Destinations has all sorts of anti-takeover defenses: staggered board OR 80% vote to remove
directors without cause or repeal staggered board
b. Unocal Application
i. There was a threat, and the board could point to substantive coercion
ii. But the boards response was preclusive under Unitrin, because the staggered board did not allow
shareholders to take control at once
c. Blasius Application
i. No compelling justification for the boards actions stock for stock merger is not a clearly superior
alternative, nothing that suggests that SHers would be benefited so much more
Latest Front: Restrictions on the Use of the Pill
1. In March 2006, Professor Lucian Bebchuk submits a 14a-8 proposal to Computer Associates to amend its
bylaws so that:
a. adopting a pill requires a unanimous board vote
b. any pill would automatically expire in one year unless ratified by shareholders
2. SEC refuses to grant a no-action letter allowing the company to omit it from its proxy
3. In September 2006 41% of CA shareholders vote in favor of the proposal
4. What is the effect of this proposal on staggered boards?
a. If a board loses a vote, it cannot adopt a pill
b. Even if you win one battle, then the board is effectively staggered from the takeover perspective
i. Thus- the most effective takeover defense is not available to them
c. Many corps have adopted this very popular

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