Crunchtime Corporations Outline

Corporate Summary
 Limited Liability - Usually limited to the amount invested
o Exception: See piercing the corporate veil
 Centralized Management – Shareholders elect Board of Directors, Board appoints
officers
 Continuity of Existence – Survives the death or withdrawal of shareholders
 Transferability – Easily transferred (shareholders can buy/sell stock)
 Federal Income Tax: Corp. is taxed as a separate entity (can decide to skip that and tax
only shareholders as a Subchapter S Corp.)

Corporate Form
Where & How to Incorporate
 Delaware – Best for publically held corps (well-defined, predictable law, and pro-
management bias)
 Headquarter State – Best for closely held corps
 Incorporate via Articles of Incorporation (“AOI”) filed with the Secretary of State.
o Can be amended via majority shareholder vote (Model Business Corporation Act
§ 10.04

Pre-Incorporation Transactions/Liability
 Promoter Liability
o Promotor may be liable if they enter into a contract and the other party is not
aware that corporation hasn’t been formed (MBCA § 2.04)
 Exceptions: If a Corp adopts the contract or liability, then promotor will
no longer be liable.
 Adopts can be implied by continuing to receive a benefit
o Promoter has a fiduciary duty to the to-be-formed Corp

Piercing the Corporate Veil

 Individual Shareholder Liability Factors
o Tort vs. Contract – Court more likely to pierce if creditor was involuntary
o Fraud – Piercing is more likely if there is grievous fraud or wrongdoing by
shareholders
o Inadequate Capitalization – Isn’t sufficient alone.
o Zero Capital – Shareholders invested no money whatsoever in the Corp
o Siphoning – Corp profits are being systematically siphoned out.
  Failure of Formalities – Shares never formally issued, no Board meetings, co-mingling
funds
 Parent/Subsidiary Liability Factors
o Dominance over the subsidiary isn’t enough
o Parent & subsidiary fail to follow separate corporate formalities
o Parent/Subsidiary are operating pieces of the same business & sub is
undercapitalized
o Public is misled about which is operating which business
o Assets are intermingled
o Subsidiary is operated in an unfair manner (forced to sell to parent as cost pricing)
o Delaware Courts: if the two companies are operating as a “single economic
entity”

Corporate Structure
General Allocation of Powers
 Traditional Scheme
o Shareholders – (1) elect/remove Directors, and (2) approve/disapprove
fundamental/non-ordinary changes (i.e. mergers)
o Directors – Manage the Corp’s business. Create policy and appoint directors
o Officers – Administer day-to-day functions under supervision of the Board
 Power of Shareholders
o Directors:
 Normally elected at annual shareholder meeting (MBCA § 8.05(b))
 May fill vacancies (Board can often do this as well)
 May remove Directors without cause (MBCA § 8.08(a))
o AOI and Bylaws
 Delaware – Shareholders may not specify what substantive business
decisions are made via bylaws, only the procedure.
o Fundamental Changes – shareholders approve/disapprove fundamental changes
no in the ordinary course of business (i.e mergers, sale of most Corp assets,
dissolution)
 Power of Directors
o Shareholders cannot order any particular action of the Board
o Board appoints officers and supervises the day-to-day but does not operate
 Power of Officers – Carry out day-to-day affairs

Board of Directors
 Elections
o Most states allow for cumulative voting (aggregate total votes (slots*number of
shares) to cast for fewer directors than there are slots)
 Used to elect minority Director. Cannot be used to remove.
  Number of Directors – Typically set by AOI or Bylaws
 Removal – Done by majority shareholder vote with or without cause
 Directors’ Meetings
o Regular vs. Special – Regularly Scheduled vs. Other
 Notice is required only for special meetings (MBCA requires 2 days)
o Quorum – Most jurisdictions require majority present (some allow more/less)
 Act of the Board
o Most actions require simple majority vote and present meeting
 Nearly all states allow action without meeting with unanimous written
consent in approval of specific action (MBCA § 8.21(a)). May also meet
via telephone conference.
o A Director may disassociate themselves from Board action by verbally saying so
in a meeting to have that reflected in the minutes, or filing a written dissent. Both
can shield that director from liability.
 Committees – Board may create committees with the full authority of the Board with
limitations (cannot fill Board vacancies, amend AOI or bylaws, propose actions for
shareholder approval, authorize share repurchases  MBCA § 8.25(e))

Officers
 Agents of the Corporation
o Express Actual Authority – Can be given by the bylaws or a resolution of the
Board
o Implied Actual Authority – Authority inherent to the position:
 President – can engage in ordinary business transactions (i.e. hiring)
 Secretary – certify records of Corp and resolutions of Board
 Removal – Board my explicitly remove implied authorities
o Apparent Authority – Given if (1) Corp indicates to the world officer has the
authority, and (2) officer is aware of that.

Shareholder Action
 Nearly all states require annual meeting of shareholders (MBCA § 7.02(a))
o The Board may call a special meeting or anyone else allowed by the bylaws
 Delaware allows shareholders to write in their votes
o Also shareholder meeting can be held via computer (Del. GCL § 211(a)(2))

Shareholders’ Informational Rights & Proxy System

Shareholder Inspection of Books and Records
 Generally, shareholders have the right to inspect the corporation’s books and records
o Some jurisdictions limit which shareholders (time, amount of stock owned, etc.)
o MBCA § 16.02(b) limits this from sensitive documents. Shareholder must (1)
show proper purpose, and (2) records must be directly connected to that purpose.
  Proper Purpose
 Evaluation of investment – Can look at accounting documents to
show stock price fairly reflects true value
 Deal with other shareholders – Contact info of other shareholders
 Social/Political goals – generally not considered proper
 Multiple purposes (one proper) – Delaware says one is sufficient
 Financial Reports – Other than public Corps under federal law, Corps
aren’t generally required to provide annual financial information
 Directors right of inspection – Very board, almost automatic right

Reporting Requirements for Publically Help Corporations

 “Public” Companies – (1) Traded on a national stock exchange, or (2) has more than $10
million in assets and a class of stock held by at least 500 people.
 Proxy Solicitation Requirements:
o Filing – Must be filed with the SEC
o Proxy Statement – Must be included with every proxy solicitation. Includes
conflicts of interests, amount paid to 5 highest-paid officers, details of major
change voted on.
o Annual Report – Must also include and annual report
o Anti-Fraud – Cannot have false or misleading statements
 Requirements for Proxy:
o Function – Is the physical process of casting vote (on a card)
o Broad Discretion – Must be specific (cannot allow unduly broad discretion in
recipient)
o Revocation Proxies – Generally revocable, unless coupled with an interest.

Implied Private Actions Under Proxy Rules

 Civil Relief allowed for proxy violations:
o (1) Materiality - Must show there was a material misstatement or omission
o (2) Causation – Must show causal link between misleading proxy and damage to
shareholders. Showing falsehood or omission and the fact that the proxy
solicitation was an essential part of the transaction.
o (3) Majority Vote – No member of the minority has a claim for relief
o (4) Fault – Must show D is at fault. If D was insider (Corp, officers, employees),
need only be negligent.
o (5) Remedies – May get (1) an injunction, (2) a completed action set aside, or (3)
money damages

Communications by Shareholders
 Shareholder Bears Expense
o Corp must either mail materials at shareholder expense or provide mailing list.
Cannot censor content or limit amount sent. SEC 14a-7.
  Corporation Bears Expense
o Corporations may exclude certain shareholder proposals from their proxy
materials.
 Improper subject under state law
 Not significantly related to Corp’s business (less than 5% total assets and
earnings/gross sales)
 Does not include moral/social issues
 Routine Matters
 Election of Directors – cannot include a specific individual in company’s
proxy materials for election or affect upcoming election. SEC 14-8-8(i)(8)
 Procedural election changes may not be excluded

Proxy Contest
 Definition – Competition between management and group of outside insurgents
 Regulation – Must follow all regulations of proxy statements

Improved Public Disclosure by the Corporation

 Regulation FD – Corps cannot disclose material information to professional investors
without disclosing to the public simultaneously
 Sarbanes-Oxley Act
o CEO/CFO Certification – Must certify the accuracy of quarterly & annual filings
o Rules about Audit Committee – Each company’s audit committee must be
independent
o Auditor Independence – Must be outside auditors that do not do other tasks
o Whistleblower Protections – Full protection from (firing, demoting, harassing)

Close Corporations
Introduction
 Definition – (1) small number of stockholders, (2) lack of ready market for Corp’s stock,
and (3) substantial participation by majority stockholders in management, direction, and
operations of the corporation.

Shareholder Voting Agreements, Voting Trusts & Classified Stock

 Voting Agreements – Agreement to vote together
o Proxy – each signatory must give irrevocable proxy to third person to cast vote
o Specific Performance – courts can compel specific performance (MBCA §
7.31(b))
 Voting Trust
o Transfer legal title of share to voting trustees. They become “beneficial owners”,
receive dividends/sale proceeds but no voting rights.
 o Most states require: (1) maximum term of the trust, (2) terms of trust must be
publically disclosed, and (3) trust must be in writing and be of formal transfer.

Duty of Care/Business Judgment Rule

Introduction
 Generally: Board of Directors and Officers must behave as a reasonable person in similar
circumstances
 Damage vs. Injunction – If director or officer violates duty, will be personally liable to
corporation. If Board approves transaction without due care, may seek injunction.
 Directors vs. Officers – Duty exists for both, but standard can differ as officer knows the
business better.

Standard of Care
 Egregious Case – Director/officer behaves recklessly or with gross negligence
 Objective Standard – Reasonable in the director/officer’s position.
 Directors will not be held liable for failing to detect wrongdoing by officers/employees
o If Director is on notice, then they would be liable
o Lack of monitoring mechanisms in large Corps may be a violation
 Delaware – Corps can elect in the AOI to not hold Directors personally liable for lack of
due care. Cannot forgive breach of duty of loyalty or lack of good faith. Director liable
for poor oversight if:
o Utterly failed to implement any reporting/information system or controls
 Or if such system exists, consciously failed to monitor or oversee the
system’s operation
o Utterly failed to attempt to obtain best price for sale of company

Business Judgment Rule

 Substantively unwise decisions by directors or officers will not by itself constitute a lack
of due care if:
o No Self-Dealing: Director/Officer has an interest in a transaction
o Informed Decision: Director/Officer gathered at least a reasonable amount of
information.
o Rational Decision: Director/Officer must have rationally believed it in the Corp’s
best interest.
 Exceptions – Transaction/Action was criminally prohibited.

Duty of Loyalty
Self-Dealing Transactions
  Definition – (1) Key Player and corporation are on opposite sides of transaction, (2)
Key Player helped influence corporation’s decision to enter transaction, and (3) Key
Players personal financial interests are at least potentially in conflict with those of the
corporation’s
 Modern Approach:
o Fair – If it’s fair for the Corp, likely will be upheld
o Waste/Fraud – In Delaware, if the transaction is so one sided that no business
person of ordinary, sound judgment could conclude that the corporation has
received adequate compensation, then it may be voided.
 Middle Ground – Courts look to presence or absence of shareholder/director approval
 Damages – Courts will either rescind the deal or award restitution damages if too
complex to rescind.

Executive Compensation
 Typically protected by business judgment rule so long as it is rational, informed, and in
good faith.
o Courts may overturn if excessive or unreasonable (rare)
 Use of Corp Assets – May not use corporate assets if it (1) harms the Corp, or (2) gives
the Key Player a financial benefit. May not be a violation if (1) it is approved by
disinterested directors (after full disclosure), (2) ratified by shareholders, or (3) Key
Player pays fair value of the benefit.
 Corp Opportunity Doctrine:
o Director or Officer may not usurp business opportunities from Corp
o Delaware Test – (1) Corp is financially able to exploit opportunity, (2)
opportunity is within Corp’s line of business, (3) Corp has an interest/reasonably
expectancy in the opportunity, and (3) if director/officer took opportunity, it
would place them in conflict with other Corp duties.
o Other Factors:
 Deal offered to individual or as corporate manager
 Whether insider used Corp resources to get opportunity
 Outside director or full-time executive

Sale of Control
 “Controlling” Shareholder – Someone with majority shares OR someone with the largest
interest (20-40% shares but no one else has anything close to that)
 Controlling Shareholder cannot sell if:
o They know, or has reason to know, or negligently disregarded knowing buyer
wishes to illegal siphon assets to themselves.
o Sale of vote – Small shareholder selling vote or influence is prohibited
o Cannot deprive Corp of opportunities using sale of control
o Parent/Subsidiary – Cannot self-deal or take Corp opportunities for itself
Insider Trading
Introduction
 Typically, buying/selling on undisclosed good/bad material news about a company is
illegal
o SEC 10b-5 (prohibits) & Securities Exchange Act § 16(b) (return earned profits)

SEC Rule 10b-5

 It is unlawful to (1) employ any device, scheme, or artifice to defraud, (2) make any
untrue statement of a material fact or to omit to state a material fact, or (3) to engage in
an act, practice, or course of business which operates or would operate as a fraud or
deceit upon any person. These are unlawful in connection to sale/purchase of securities.
 Intentional misrepresentations can cause liability as well even without buying/selling
 Relief – Criminal, SEC can seek injunction, individuals can potentially have civil claim
o Civil Action:
 P must be buyer or seller
 D must have misstated or omitted a material fact
 D must be known to have a special relationship with issuer of stock
(fiduciary duty)
 D must have intent to deceive, manipulate, or defraud
 P must show reliance on misstatement
 “Tippee” – Someone who (1) receives information in breach of the insider’s fiduciary
duty, (2) knows or should have known the breach occurred, and (3) insider/tipper has
received some benefit from the breach or intended to make a gift.

Shareholders’ Suits, Derivative Suits

Introduction
 Derivative Action – Individual shareholder brings suit on behalf of Corp against someone
who violated fiduciary duty
o Examples: (1) against directors for failed due care, (2) against officer for self-
dealing, (3) suits to recover excessive compensation, (4) suit to reacquire
corporate opportunity
o Examples of Direct: (1) enforcing holder’s voting rights, (2) pay dividends, (3)
prevent management from taking suicide pill, (4) prevent oppression of minority
shareholders, (5) compel inspection of company’s books/records.
 Delaware 2 Part Distinction Test:
o Who suffered the alleged harm? The Corp or the suing shareholder?
o Who would receive the benefit of any recovery or remedy? Corp or shareholders
individually?
Requirements for Derivative Suit
 Plaintiff must satisfy all three of the following requirements to sustain a derivative suit:
o Contemporaneous Ownership – Owns stock at the time of the complained acts
o Continuing Ownership – Must continue to own until final judgment
o Demand on Board – Must provide written demand on Board to seek action, once
they refuse P may sue
 Often excused if the Board is involved in the wrongdoing
 Delaware Standard – must show reasonable doubt that board (1) was
disinterested and independent, or (2) was entitled to the business
judgement rule

Indemnification and D&O Insurance

 Corps must indemnify directors/officers that are successful in defending themselves
against charges or when they bind themselves to by AOI or contract.
o Corps may indemnify against third party suits if they (1) acted in good faith, (2)
pursued what they reasonably believed to be the best interests of the Corp, (3) had
no reason to believe his conduct was unlawful (MBCA § 8.51(a)).
 May also indemnify against derivative actions for attorney expenses only.
 D&O Insurance – Insurance that reimburses directors/officers for expenses not covered
by indemnification. Does not include claims against dishonest actions, illegal
compensation, or self-dealing.

Structural Changes, Mergers & Acquisitions

Merger-Type Transactions
 Statutory Merger
o Procedure follows statute
o Disappearing Corp ceases to have legal identity
o Shareholders now own stock in Surviving Corp (or received cash)
o Both Boards must approve. Majority shareholders of both must approve.
o Exceptions:
 No shareholder approval needed if Big Corp is MUCH larger.
 Delaware – Doesn’t increase outstanding shares by more than 20%
 Short-Form Merger – If Big Corp owns 90% or more shares of Little
Corp, no shareholder vote needed from either. Little Corp minority
shareholders will have right of appraisal.
 Stock-for-Stock Exchange
o Separate deals made with each shareholder of “Little” Corp.
o A stockholder need not participate. Some states allow forced plan of exchange
via director and majority shareholder approval.
o Must be approved by Big Corp Board only.
  Stock-for-Assets Exchange
o Surviving Corp gives stock to Disappearing Corp.
o Disappearing Corp gives all assets to Surviving Corp.
o Disappearing Corp dissolves and gives Surviving Corp stock to shareholders.
o Surviving Corp Board approval required. Little Corp Board and majority
shareholder approval required.
 Triangular or Subsidiary Mergers
o Forward Triangular Merger
 Big Corp creates subsidiary (Big-Sub) and gives 100 shares to Big-Sub in
exchange for all of its shares
 Little Corp then merges into Big-Sub and receives the 100 shares.
 This avoids minority interests and does not have to be approved by
shareholders.
 Must be approved by Big-Sub Board and majority shareholders
(formality), Big Corp Board, and Little Corp Board & majority
shareholders.
o Reverse Triangular Merger
 A Big Corp subsidiary merges into Little Corp
 Little Corp survives merger but becomes subsidiary of Big Corp.
 Same approval needed as Forward Triangular Merger
 Advantages:
 Big Corp does not assume liabilities of Little Corp
 No shareholder approval needed
 Little Corp survives as a legal entity, thus preserving contract and
tax rights.

Sale-Type Transactions
 Asset-Sale and Liquidation
o Board and Majority Shareholders (of votes that could be cast) approve sale of all
or substantially all of Little Corp’s assets to Big Corp in exchange for cash. Also,
Board of Big Corp must approve buy (does not need majority shareholder vote).
o Little Corp will then dissolve and pay out in liquidating distribution.
 Stock Sale
o Big Corp purchased stock from each shareholder until they have majority.
o No Board approval necessary just to purchase.
o From there, they can force a merger or dissolve and distribute.
o Tender Offer – Big Corp publically announces they will buy stock offered by
Little Corp shareholders
 Differences Between Sale Types
o Asset Sale requires Board approval but Stock Sale does not.
o Asset Sale requires majority shareholder approval but Stock Sale does not
o Minority Shareholders may still exist under a Stock Sale
 o Will likely absorb liabilities in a Stock Sale but not an Asset Sale
o Tax treatment for a Stock Sale is a lot more favorable.

Merger Taxation
 Merger-Type Transactions
o Considered a “Reorganization”
o No taxes paid at time of merger
o Taxed on difference between amount paid for Little Corp share and amount
received for Big Corp share from sale.
o Three Types of Tax-Free Reorganization:
 Type A – Statutory merger provisions are followed and Little Corp
shareholders has continuity of interest (most of their compensation is in
the form of Big Corp stock).
 Type B – Stock-for-Stock exchange with Big Corp having at least 80%
voting power in Little Corp and no compensation given other thank stock.
 Type C – Stock-for-Assets exchange where Big Corp acquires
substantially all of Little Corp’s assets in exchange for stock. May make
some payment in cash so long as 80% of price is in stock.
 Sale-Type Transactions
o Asset Sale – Little Corp pays tax on the difference between the amount received
for the assets and the original cost of the assets. Then, if remainder is paid in
liquidation to shareholders, they pay tax on difference between the pay out and
what they originally paid for the Little Corp shares.
o Sale of Stock – Only pay tax at the shareholder level (difference between payment
and original cost of shares). Buyer tax consequences are worse under this
model. Sell prefers sale of stock; buyer prefers asset sale.

Federal Securities Law

 Merger-Type Transactions
o Statutory Merger or Stock-for-Assets Exchange – In addition to Stock-for-Stock
Exchange requirement, Little Corp also will have to send proxy statement to all
shareholders for approval.
o Stock-for-Stock Exchange – Considered a public issue of stock by acquirer and
therefore will have to file a registration sttae4ment and give new shareholders a
prospectus.
 Sale-Type Transactions
o Asset Sales – If Little Corp is publically held, need only send a proxy statement to
shareholders to approve sale.
o Stock Sale – If proceeding by tender offer, Big Corp will have to send special
tender offer documents to each Little Corp shareholder.

Mergers: Protecting Shareholders

  Appraisal Rights
o Mergers – Typically, if shareholder had right to vote on the merger, they have
right of appraisal.
 Exception: Short-form mergers
o Asset Sales – Delaware does not give appraisal rights to the shareholders of a
Corp that sells its assets.
o Publicly-Traded Exception – Typically no appraisal rights for shareholders of a
company whose stock is traded publically.
o Triangular Mergers
 Forward – Big Corp doesn’t get appraisal rights but Little Corp does
 Reverse – Big Corp doesn’t get appraisal rights but Little Corp does only
if Big-Sup is statutorily merging into Little Corp (not if Little Corp is
exchange its stock for Big-Sub’s stock in Big Corp).
o Valuation – Court determines fair value of the shares and Corp must pay it.
 Value is not influenced by current transaction or the fact that it’s a
minority share.
 Delaware Block – Courts consider 3 factors: (1) market price prior to
transaction, (2) net asset value of the company, and (3) the earnings
valuation of the company. Delaware doesn’t follow its own factors.
Allows other factors such as expert testimony of “takeover premium”.
o Judicial Review – Courts can review substantive fairness of proposed merger.
 If buyer/seller do not have close preexisting relationship - Delaware
Standard: (1) plaintiff bears the burden of proof on the fairness issue, and
(2) must show price was so grossly inadequate as to amount to
constructive fraud.
 If transaction involves self-dealing (which can include Big Corp buying
majority and approving merger):
 Delaware Test – Proponents of the transaction must demonstrate
entire fairness.
o Two-Step Acquisition: Big Corp announce intent to buy
51% then tender offer for less to remaining shareholders.
After acquiring 51%, Big Corp attempts to merge. Court
will likely uphold because first 51% of shareholders knew
what was going to happen.
o Parent/Subsidiary: If Big Corp owns 80% of subsidiary
Big-Sub, attempting to merge back into Big Corp will be
heavily scrutinized by the court for a showing of being
entirely fair.

Freeze Outs
 When controlling shareholders legally compel non-controlling shareholders to give up
their ownership.
 o Examples: (1) the second step of a two-step acquisition, (2) long-term affiliates
merge (controlling parent eliminates minority interest), and (3) where the
company goes private.
o Courts will (1) try to verify the transaction was basically fair, and (2) look extra
close if minority shareholders are being cashed out.
 Techniques:
o Cash-Out Merger – Insider causes Little Corp to merge with shell using cash-out
merger.
 McKeown owns 70% of Little Corp. McKeown creates Fake Corp and
funds it with $1 mill. McKeown then forces Little Corp to merge into
Fake Corp by cash-out merger (Fake Corp buys all of Little Corp 1mill
shares for $1 mill). Therefore, McKeown gets $700K and minority
shareholders get $300K. Now McKeown uses $700K to repay part of
bank debt incurred to fund Fake Corp (now he only has to pay $300K total
out of pocket).
o Short-Form Merger – If Big Corp owns 90%(+) of Little Corp, they can force the
merger and pay cash to minority shareholders.
o Reverse Stock Split – All outsiders end up with fractional share in new Corp.
Then Corp forces all fractional shares to be exchanged for cash.
 Federal Law:
o 10b-5: Minority shareholder may assert a violation of this statute, however,
Courts are VERY unlikely to agree even if the freezeout is unfair unless insiders
concealed or misrepresented material facts about transaction.
o SEC Rule 13e-3: All going-private transactions must meet extensive disclosure
requirements or risk damages or injunction.
 State Law:
o General Test – Transaction must be basically fair when taken in its entirety, and
(2) it must be taken for some valid business purpose. (Second part is abandoned
in Delaware).
 Basic Fairness – Must be (1) a fair price, (2) fair procedures by which
approval was achieved, and (3) adequate disclosure to minority.
o Best defense is use of Special Committee of Independent Directors
o Closely held Corps are more strictly scrutinized. Especially during squeezeouts
(non-legally compelling minority. Typically through coercion).

Tender Offers & Hostile Takeovers

 Tender Offer – Offer to shareholders of publically held Corp to buy shares at higher-than-
market price.
o Eight Factors from Courts and SEC:
 Active and widespread solicitation of target’s public shareholders.
 Solicitation for a substantial percentage of target’s stock.
 Offer to purchase for a premium or prevailing price.
 Firm terms rather than negotiable terms.
  Offer contingent on receipt of a fixed minimum number of shares.
 Limited time period of offer.
 Pressuring of offerees to sell their stock.
 Public announcement from buyer.
 Hostile Takeover – Acquisition of publically help Corp against the wishes of target’s
management.
 Any person who acquires more than 5% of a publically held Corp must disclose that via a
Schedule 13D statement to the SEC.
o Some info required (among others) is source of funds and purpose for buying the
shares.
o Must be filed by the beneficial owner even if not the record owner.
o Must be filed within 10 days following acquisition (can buy more during).
o Must file additional SEC statements if the person acquires more stock, over a 12
month period, if it would amount to more than 2% of the total stock).
o A “group” must also file if together their shares are more than 5%. No written
agreement is necessary to be considered a group.
 Federal Law
o Williams Act (part of Securities Exchange Act of 1934)
 Disclosure – A tender offer than would result in more than 5% being
owned must make extensive disclosures.
 Withdrawal – Any shareholder who tenders to a bidder has a right to
withdraw while the offer remains open.
 Pro Rata Rule – If buyer offers to buy only a portion of target’s shares and
receives more tenders than they offered to buy, buyer must in the same
proportion from each shareholder.
 If Big Corp gives tender offer to buy 51% of Little Corp but
receives tender from 70% of the shareholders, they must buy 51%
of the shares of each of those shareholders who offered.
 Best Price Rule – If buyer increases tender offer price, he must pay all
shareholders that price (not just those who sell after the price increase).
 Must keep tender offer open for at least 20 business days. Must keep open
for an additional 10 days after any change in the offer (price or number of
shares).
 Prohibited Private Actions under § 14(e):
 Cannot (1) make an untrue statement of a material fact, (2) omit to
state a material fact, or (3) engage in fraudulent, deceptive, or
manipulative acts in connection with a tender offer.
 Standing: target can seek injunction against deceptive buyer
conduct, buyer can seek injunction against target management,
non-tendering shareholder can get injunction or damages, or
person who buys/sells shares in reliance.
 Scienter - Plaintiff must show defendant had intent to deceive.
  Reliance – P relied on misrepresentations (not necessary with
omissions).
o Hart-Scott-Rodino Act – Requires (1) buyer to notify government of proposed
deals in which one party has sales/assets of $100+ million and one party has
sales/assets of $10+ million and (2) imposes a waiting period.
o Delaware Anti-Take Over Statute – No Corp may engage in business
combinations with any interested shareholder for at least 3 years after they
became an interested shareholder unless they own at least 85% of the stock.
 Therefore, if they own less than 85% they cannot use target’s assets to
secure loan to finance acquisition or target’s cash to pay off acquisition
debt.
 Defense Maneuvers
o Pre-Offer Techniques (most require majority vote of shareholders):
 Super-Majority Provisions – amend AOI to say need more than majority
to approve merger or major sale of assets (or majority of disinterested
shareholders).
 Staggered Board – Only some Directors are up for election each year.
Prevents new majority shareholder from immediately filling Board.
 Anti-Greenmail Amendment – Amend AOI to prohibit paying greenmail.
 New Class of Stock – Give new stock to people who agree with
management and require both classes agree to merger.
 Poison Pill – Bad events that are triggered when someone gains control.
Typically no shareholder approval is necessary.
 Call Plans – Gives shareholders right to buy cheap stock under
certain circumstances. For example, if buyer buys more than 20%
of stock, other shareholders have right to buy shares of buyer at
cheap price.
 Put Plans – If a buyer buys some but not all of target’s shares,
target shareholders will have right to sell back shares to the target
at a pre-determined “fair” price.
o Post-Offer Techniques:
 Defensive Lawsuits – Generally just used to buy time.
 White Knight Defense – Target will find a “white knight” to acquire the
company instead of the buyer. Typically white knight is given some
special incentive (buying an asset at below-market price).
 Special Incentives (lock-ups) are invalid if they make approval of
merger a mathematical certainty (absolute lock up). Instead, they
can use lock-ups to create an auction when there was none
previously. Now, shareholders have more options to vote on.
 Defensive Acquisition – Make the target less attractive by taking on a lot
of debt.
 Corporate Restructuring – Actions to raise short-term value of shares
(makes acquisition more expensive).
  Greenmail – Little Corp buys back shares from buyer at above-market
price with contract to say they won’t try and reacquire for a certain
number of years.
 Friendly Party – Selling non-controlling shares to a friendly party that can
be trusted not to accept the tender offer from Buyer (like your employees).
If Little Corp gives 16% to friendly party, Big Corp can’t acquire 85%.
 Share Repurchase – Little Corp can repurchase shares from the public.
May refuse to buy back buyers recently purchased shares.
o Federal Law Response – Typically no remedy for buyer against defensive Corp
during hostile takeover. Only way is if target violates §14(e) and misleads
shareholders.
o Delaware Law:
 Defensive measurers typically protected by business judgment rule.
 In order to hold up defensive measures, Board must show:
 They had reasonable grounds for believe there was danger to the
Corp’s welfare (didn’t use measures merely to entrench themselves
in power)
o Examples: (1) reasonably believed buyer would change
business practices in a harmful way, (2) reasonable fear that
takeover attempt is unfair or coercive, or (3) reasonable
fear takeover will leave target with unreasonably high
levels of debt.
 Must show defensive measures were reasonable in relation to the
threat posed (proportionality rule).
o Defensive measure cannot be preclusive or coercive.
 Preclusive – would prevent virtually all possible
take-over attempts.
 Coercive –Crams down target shareholders’ throat a
management-sponsored alternative.
 Board must act upon a reasonable investigation in response to
takeover.
 Defenses stronger if created/approved by independent directors
 If requirements not met, Court will not strike it but they cannot use
business judgement rule. Board now has burden to prove transaction is
entirely fair.
 When Board Wants To Sell (Level Playing Field Rule):
o Courts give enhanced scrutiny when Board is willing to sell or finds selling
inevitable. Enhanced security also applies when “selling control”.
o Level Playing Field Rule Responsibilities:
 Insiders must treat all bidders equally.
 Cannot use defensive measures and instead must achieve best price.
 Cannot use lock-ups or divulge confidential financial information to one
bidder over the others.
 Sole responsibility is to get highest price for shareholders. Cannot look
for protections for employees, creditors, management, or Board at
shareholder expense.
o Obligation to shareholders begins after a formal offer for the company is made

Dividends and Share Repurchases

Dividends – Protection of Creditors
 Dividends – Cash payment of current earnings made to shareholders (pro rata).
 Stated Capital/Legal Capital – Equals par value times outstanding shares
 Earned Surplus/Retained Earnings – Total profits of Corp (after paid dividends)
o In Delaware, typically Corp must pay dividends from profits Corp has
accumulated (earned surplus) but may give nimble dividends (payments from
current earnings even if there is no earned surplus).
 Payment of Dividends must (1) not impair Corp’s stated/legal capital, and (2) will not
render Corp insolvent.
o Insolvency – When Corp is unable to pay its debt as it comes due.
 Liability:
o Directors may be personally liable for approving prohibited dividends.
o If approved knowing they were prohibited, usually will be liable. Some states
hold negligent good faith Directors liable too.
o Shareholders may be required to return dividend or be liable to creditors.

Dividends – Protection of Shareholders

 Courts rarely orders higher dividends to be paid when (1) low-dividend policy is not
justified by any reasonable business objective, and (2) policy results from improper
motives.

Stock Repurchases
 Generally, courts will not overturn a repurchase unless (1) the Board behaves
unreasonably (they fail to make reasonable inquires as to value of stock), or (2) violates
its duty of loyalty (directors own the stock being unfairly repurchased). Typically
restricted by same financial limitations as dividends.

Issuance of Securities
State Laws on Issuance
 Par Value – If shares have par value, Corp may not sell shares for less.
o Watered Stock Liability: Shareholders who get shares at less than par value may
be liable to Corp’s creditors.
  Preemptive Rights – Corp can give shareholders right to purchase newly issued stock so
they own same percentage of Corp.
o Doesn’t apply to treasury shares
o When Corp does not offer right, Court may use fiduciary obligation of Corp to
protect minority shareholder during dilution.

Public Offerings
 Introduction
o Regulated by Securities Act of 1933
o §5 requires statement made to SEC for any securities sold using mail or interstate
commerce. Also must provide prospectus to buyer.
 Mechanics
o Filing of Registration Statement with SEC
 No one may sell or offer to sell pre-filling.
o 20-Day Waiting Period after Filing
 Offers to buy/sell can be made but no binding agreement.
o Price Amendment – Statement is usually filed without price, then amended later.
 Exemptions
o No filing needed when sold by someone other than issuer, underwriter, or it is a
private offering.
o Private Offerings:
 Statutory Exemptions (§4(2)) – Will be considered private if (1) not many
offerees, and (2) the offerees have a significant level of sophistication and
knowledge of company’s affairs.
 SEC Rule 506 – issuer may sell an unlimited amount of securities to
accredited investors and up to 35 non-accredited investors.
 Accredited = $1 million in personal residence or $200K annual
income.
 Non-accredited investors must be sophisticated.
 Cannot make general advertisements (unless only willing to sell to
accredited investors).
 Disclosure to all investors is necessary if unaccredited investors
are involved.
o Small Offerings
 Rule 504 – may sell up to $1 million, to unlimited investors, with no
disclosure, and no advertising.
 Rule 505 – may sell up to $5 million, to up to 35 unaccredited investors,
disclosure to all if 1 investor is unaccredited, need not be sophisticated.
o Sales by Non-Issuer:
 Controlling Shareholder:
 Rule 144 – No §5 registration with SEC needed if
 o Limited Sale – Sell less over a 3 month period than 1% of
outstanding share or average weekly trading volume from
past 4 weeks.
o Must hold shares for at least 2 years (unless bought in
public offering).
o Issuing company must be public.
o Must be sold via ordinary brokerage transaction (cannot
solicit orders to buy the stock).
o Notice to sell must be filed with SEC.
 Non-Controlling Shareholder:
o Cannot have bought shares with intent to resell.
o Rule 144 – Available if (1) shareholder has held shares for
less than 3 and meets all other requirements, or (2)
shareholder has held shares for more than 3 years.
 Civil Liabilities
o §11 – Liability for material errors or omissions in a registration statement.
 Standing – Anyone who bought stock covered by faulty registration.
 No reliance needed.
 Those Liable: everyone who signed registration statement, directors at
time of filing, every expert who consented to being named in preparing it,
and every underwriter.
 Issuer’s liability is absolute. Others may raise due diligence defense.
 Portions Prepared by Expert:
o Experts – conducted reasonable investigation
o Others – no reasonable ground to believe
misstatement/omission
 Non-Expertise Portions:
o Must have made a reasonable investigation & after
investigation, reasonable ground to believe.
o §12(1) – Liability for anyone who sells security that should’ve been registered.
o §12(2) – Liability for untrue or omission of material fact (negligence standard).
o §17(a) – Government actionable anti-fraud provision.