Chapter One: Agency

§1 Who is an Agent?
Gorton v. Doty (Idaho 1937)
Doty expressly stated that Darst could use her car if he drove. Darst didn’t say he wouldn’t let
anyone else drive. But, manifested assent to Doty’s condition by following the condition.
Issue: Whether an agency relationship existed between Doty and Darst?
Why does it matter? Any act of the agent makes the principal liable.
Rule:
Rest § 1- Agency is a relationship that results from:
The manifestation of consent by P to A that A shall act
(1) on P’s behalf- her car that she could have driven but instead offered to him with him
as driver . She gave to him after the offer. and (2) subject to P’s control- implied that for
the trip to Paris and back for a particular game and particular day, and he is to drive
A’s consent to so act. He drove the car to and from the game.
Business Orgs is based on Contracts, but it is NOT Contracts. A K provision that tries to opt out
of an immutable rule, cannot be done! Look for this on the exam.
*It is the presumption that the driver is the agent of the owner of a car. Must look at other
factors, though. The fact that she made the condition that he drive, etc. Must apply all of the
factors.
On what grounds did defendant move for a mistrial? Implication by plaintiff that defendant Doty
carried insurance.
What effect does this decision have on Doty and other drivers? The incentive to insure.
If you know you’re going to be hit with a million dollar lawsuit for letting someone borrow your
car, you want to shift that risk and liability to another= the insurance company. In order to
establish an agency relationship, benefit is not specifically required.

Is a benefit the same as acting on a P’s behalf? Remember this for Jenson. Pay attn to the facts
the Court uses to determine if there is a relationship.

A. Gay Jenson Farms Co. v. Cargill, Inc (Minn. Sup. Ct. 1981)
Facts: Warren Seed and Grain Co. operated a seed business, grain elevator, and grain storage.
Warren entered a security agreement with Cargill, Inc. in 1964 to receive loan money for
working capital. Working capital represents operating liquidity so Warren probably didn’t have
enough assets on hand for day-to-day operations. Through the agreement, Warren would receive
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funds and pay its expenses by issuing drafts drawn on Cargill, but imprinted with both Warren
and Cargill’s names. Proceeds from Warren’s sales would be deposited to Cargill’s account.
Warren also appointed Cargill as its grain agent for transaction with the Commodity Credit
Corporation, and Cargill was given a right of first refusal to purchase grain sold by Warren.
3 yrs later in 1967, Warren and Cargill negotiated a new contract extending Warren’s credit line
and it allowed Cargill to keep annual financial statements and access to Warren’s books for
inspection and audit. Warren was also not allowed to make any capital improvements or
encumber its assets without Cargill’s approval. In 1970, Warren became Cargill’s wheat agent.
1971 Warren “contracted on Cargill’s behalf with various farmers” for seeds. Warren began
purchasing business forms from Cargill and used them to create its own business forms. Cargill
headquarters informed the regional office that it had right to determine the use of Warren’s funds
since it was financing Warren. So a regional manager from Cargill started working with Warren
daily and with monthly meetings. Warren’s credit line was continuously extended by Cargill and
reached 1.25m in 1976, a bank account was opened for Warren to draw checks, and at that time
Cargill was receiving 90% of Warren’s grain. In 1977, Cargill discovered through local farmers
that Warren was paying his vendors and after an audit determined that Warren was 4m in debt.
Warren ceased operations and was indebted to Cargill 3.6m and to the plaintiffs 2m.
Procedural Hist: 86 individual, partnership, or corporate grain farmers sued Cargill and Warren
Grain and Seed to recover the 2m in losses sustained by Warren’s breach of Ks with the Ps. The
Ps alleged that Cargill was jointly liable for Warren’s indebtedness because it acted as the
principal for the grain elevator. Jury trial. Judgment for the Ps. Cargill appeals the verdict.
Issue: Whether Cargill, by its course of dealing with Warren, became liable as a principal on Ks
made by Warren?
Held: Yes. By its control and influence over Warren, Cargill became a principal. Even if the
parties didn’t intend this to be an agency, circumstantial evidence showing the course of dealing
between the parties proves the existence of an agency. When an agency is proven through
circumstantial evidence, the principal must be show to have consented to the agency. Cargill
manifested its consent to the agency when it consented that Warren would be its agent. Cargill
had control over Warren because it interfered with Warren’s internal affairs and heavily financed
Warren. And Warren manifested assent by acting on Cargill’s behalf in procuring grain for
Cargill. This was not a buyer-supplier relationship because Warren cannot be an independent
business since all of Warren’s operations were financed by Cargill and almost all of its grain was
sold to Cargill. Cargill’s reason for financing Warren was not to make money as a lender, but to
establish a source of grain for its own business. Under Rest. § 14 O the Court also found that
Cargill was a creditor who assumed control of his debtor’s business. Cargill became the
principal because it assumed de facto control over Warren’s grain elevator.
Rules: Restatement 1.01. “Agency.” And (2nd) 14 O- A creditor who assumes control of his
debtor’s business may become liable as principal for the acts of the debtor in connection with the
business.
Immutable rules. Legal formality made Cargill an agent- de facto control makes him, the
creditor, also the principal.
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Cargill is the purported principal and Warren is acting as its agent. No contract saying that
Cargill would take over. Don’t need a K. Circumstantial evidence.
Agent- A person consents that another shall act on his behalf, subject to his control, and
with the other person’s consent.
What the Nine Factors listed by the Court show: (1) constant recommendations- Manifestation
of consent, (2) right of first refusal- control, (3) Cargill’s approval before Warren can enter into
mortgages- control, (4) right of entry onto premises to audit- control, (5) correspondence
regarding finances- control, (6) needs paternal guidance= control, (7) drafts (affiliated), (8)
financing (debtor) (9) power to discontinue (debtor/creditor). The Court was looking for
“control.”
You either argue the law or the facts, whichever is better for the case. Emphasize the facts that
need to be emphasized.
Simply that fact that one finances all of another’s purchases for operations and operating
expenses does not alone show an agency.
The fact that one has right of first refusal is not enough either. Right of first refusal happens a lot
in businesses. Doesn’t mean can’t sell to others just have to sell to one first.
Constant recommendation by phone. Not enough if advice. Could be if demanding.
Maybe what was going on is that someone from Cargill was making lots off commission off of
every deal so that’s why they kept extending credit etc.

§2 Liability of Principal to Third Parties in Contract

A. The Agent’s Authority
Mill Street Church of Christ v. Hogan
Facts: Mill Street Church hired church member Bill Hogan to paint the building and the church
provided all materials. It also decided to hire another church member if assistance was needed.
Bill had been hired for painting jobs in the past by the Church and was allowed to hire his
brother Sam to assist when he too was a church member. Bill discussed with an Elder of the
Church that he would need assistance when he reached a high and difficult area to paint. The
Elder mentioned the church member the Church had previously discussed but the Elder did not
tell Bill he had to hire him. SO Bill hires his brother Sam again. Thirty minutes into working,
Sam fell off of a ladder and broke his arm because a leg of the ladder he was on broke.
Hist: Sam filed for Workers Comp and was turned down because the Old Board ruled that he
was not an employee of the Church. The New Board, however, reversed. Mill St Church and
State Automobile Ins Co petition for review of the New Worker’s Comp Board’s decision.
The Church argues that the Board erred in finding that Bill Hogan possessed implied authority as
an agent to hire Sam Hogan.

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Default rule. Because of the facts. If they had said no Sam or must hire someone else, etc.
HELD: Affirmed. Hogan had implied authority as an agent to hire another worker because the
circumstantial evidence proves that the authority of Bill Hogan to hire another is necessary to
carry out his duties. Bill had hired Sam in the past at the Church (custom), never told Bill that he
could not hire Sam or had to hire the other guy, the painting could not have been done by just
one person. ALSO apparent authority because Sam relied on Bill’s belief that it was ok to hire
him as his assistant.
If third party has facts showing that there was no authority, then no agency exists.
Dweck v. Nasser (Del.Ch.2008)
Facts: Nasser, the chairman of the board of directors of Kids International, Inc. fired Dweck, the
president, CEO, and member of the board of directors for allegedly operating competing
businesses out of the Kids Intl offices. After an unsuccessful attempt to reach a settlement
agreement, Dweck sued Nasser in 2005. In 2007, Dweck retained Wachtel to facilitate a
settlement. Although Nasser’s attorney on record was Heyman, Nasser’s attorney of 20 years,
Shiboleth, executed a settlement agreement on Nasser’s behalf that required Dweck to pay
52.5% of aggregate profits generated by the entities that allegedly competed with Kids and to
pay $1.05m to Nasser for litigation expenses. Nasser was to compensate Dweck for her 30%
equity interest in Kids. But Nasser says he’s not bound to the agreement since Heyman didn’t
execute it.
Hist: In 2005, Dweck sued Nasser for unlawful termination. Nasser moved to dismiss several
counts of the complaint, granted in part. In 2007, the parties executed a settlement agreement.
Dweck moves to enforce the settlement agreement.
Held: Motion to enforce the settlement agreement is granted.
Issue: Did Shiboleth have authority to bind Nasser into a settlement agreement?
Reasoning: Yes. The Court says the attorney had actual authority, implied authority, and
apparent authority. Actual authority because of the 20 year relationship, Nasser told Shiboleth to
“do what he wants” with the agreement, both Shiboleth and Heyman testified that Nasser granted
Shiboleth the authority to settle the litigation, Nasser agreed to the settlement to Shiboleth 7
different times, and Nasser testified that he told Shiboleth that he could “act in [his] name.”
Shiboleth AT LEAST has Implied authority because of the course of dealings between the two
over a period of 20 years including Shiboleth having settled many cases for Nasser, and Nasser
permitting Shiboleth to speak in his name (act on his behalf) and directing him to settle the
action (control). LIKELY Apparent because Nasser knew Shiboleth was working with Heyman
on the settlement and Shiboleth believed he had the authority to act on Nasser’s behalf.
Three-Seventy Leasing Corp v. Ampex Corp.
Facts: 370 is a company that purchases and leases computer hardware. Kays, a salesman of
Ampex arranged a meeting between himself, Mueller, his superior at Ampex, and Joyce, the
owner and only active employee of 370. At the meeting, Joyce was informed that Ampex could
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only sell to 370 if 370 could pass certain credit requirements. Joyce informed Ampex that he
didn’t think passing the credit requirements would be a problem. While negotiations with
Ampex continued, Joyce began negotiating a lease agreement with EDS, and EDS committed to
lease six units of Ampex computer core memory from 370. Mueller directed Kays to submit to
Joyce a document containing the items for purchase, the price, payment and delivery method,
and signature blocks for a rep of 370 and for a rep of Ampex. 370 returned the document signed,
but Ampex never executed. A few days later, though, Mueller announced in an intra-office
memo that Ampex was awarded an agreement with 370 and that Kays would be handling all
matters with 370. Then about a week later, Kays sent Joyce a letter confirming the delivery date
of the memory units.
Hist: 370 sues for breach of K. Dist court found that there was an enforceable K because the
offer was accepted by Ampex. Ampex appeals because it considers the document to have been a
solicitation, which became an offer when executed by Joyce, but was not accepted by Ampex.
ISSUE: Did Kays have apparent authority to bind Ampex? For apparent agency, must
look at the principal’s manifestations to the third party. Before apparent
authority, there is enough that there is an indirect communication to the
third party by the principal. Like in Nasser, the letter from Shiboleth said
you’ve been telling all these people that I act on your behalf. Authorities
often overlap. Why do we care what type of authority? The type of authority
doesn’t change the liability but will change how you analyze your proof for a
case. The burdens are different for each authority. It’s just another lens for
looking at how the cases are processed and how you meet your burden.

HELD: Yes. Affirmed. Kays, a salesman of Ampex, had apparent authority to act for Ampex
because Ampex led Joyce to believe that Kays could act on its behalf. (1) Mueller directed Kays
to send Joyce the document. (2) Joyce said he wanted all communications to be through Kays.
Mueller agreed and even noted this in the intra-office memo. Even though Ampex testified that
Kays did not have the authority to accept and enter into Ks on Ampex’s behalf, Joyce was never
made aware of this limitations and thought that Kays could do so. The letter then, was a promise
to deliver the items set out in the document executed by Joyce and submitted to Ampex.
Watteau v. Fenwick (Queen’s Bench 1892)
Facts: Humble transferred his bar to Fenwick, but he remained the manager. The license was
always taken out in Humble’s name and his name was painted over the door. Humble and
Fenwick agreed that Humble only had the authority to buy bottled ales and mineral waters for the
bar, and any other goods would be acquired by Fenwick. However, Humble bought cigars, etc
for the business on credit with Watteau. Still acted like he was the owner even
though he wasn’t. Did Humble have actual authority to buy cigars and Bovril
from plaintiffs? No. Actual authority looks to the communications between
the P and the A.

Hist: Watteau sued Fenwick for monies owed, judgment for Watteau. Fenwick appeals.

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Issue: Is Fenwick liable for Humble’s acts when Humble acted contrary to his authority but
represented himself to Watteau that he had authority?
Held Yes. Although undisclosed to Watteau, and Watteau thought that Humble was the
business proprietor, Fenwick was the principal. Even though Humble exceeded his authority,
Fenwick is liable to Watteau. The Court said that this must be the rule or else all of the
Watteau’s of the world would be automatically defeated. Court says holding himself out
as the owner. Watteau reasonably believed that Humble had the authority
to purchase the cigars and Bovril. For manifestation of assent between the P
and the 3P, the 3P must be aware that there is a P. But if this is always the
rule, then Ps left off the hook too much. So there was no holding out by the
owner= the P= plaintiff didn’t even know that Ps existed. If you don’t know
that there is a P how can you be holding out?

No notice of the specific transaction necessary, just P needs to know about

A’s conduct generally.

In undisclosed principal cases, what is the scope of the agent’s authority?

Watteau: “The principal is liable for all the acts… which are within the
authority usually confided to an agent of that character.”

Rest § 195- “agent enters into trans usual in such business and on the
principal’s account”

Restatement § 2.06 Liability of Undisclosed Principal-- An undisclosed

principal is subject to liability when (1) 3P is induce to change position to
their determinant and (2) knowledge by the principal of the agent’s general
conduct.

B. Ratification
Agency by Ratification is an agency that occurs when : 1. A person misrepresents himself
or herself as another’s agent when in fact he or she is not and purported P ratifies.
Botticello v. Stefanovicz (Conn. 1979)
Facts: Mary and Walter Stefanovicz were tenants in common of a farm. Botticello offered to
buy the farm for $75k, but Mary said no way would she go less than $85k. Walter and Botticello
then entered a lease agreement with an option to purchase with a price of $85k. The agreement
was drafted by Walter’s attorney and reviewed and modified by Botticello’s attorney. Neither
Botticello or the attorneys knew that Mary had any interest in the property. The parties executed
the agreement and Botticello began possessing the property and making substantial
improvements. Botticello exercised his option to purchase, but Mary and Walter refused to
honor the option agreement.

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Hist: Botticello sued seeking specific performance, possession of the premises, and damages.
Trial court found for Botticello. Walter and Mary appeal claiming that Mary was never a party
to the agreement and its terms may not be forced against her.
Issue: Was Walter acting as Mary’s agent? Did Mary ratify the terms of the K by her conduct?
Did Mary ratify the terms of the K by receiving its benefits?
Held: No. No. No. Mary is not bound to the terms of the agreement. No specific
performance to 3P.

Agent- Cannot prove that Mary ever agreed or authorized Walter to act on her behalf in the
selling the farm and the execution of the agreement. Just because married; land jointly held;
Walter handled many of the business aspects of the property ownership including paying taxes,
mortgage, insurance. These do not create an agency- no delegation of power by Mary to Walter
to enter into the agreement on her behalf.
Ratification- (1) Mary did not affirm Walter’s execution of the agreement by knowing that
Botticello was occupying and improving the land, by receiving rental payments, and having a 1/2
interest in the property. Because Walter, having 1/2 undivided interest, is allowed to lease his
share. The facts aren’t enough to show that Mary was affirming the K execution.
(2) Mary did not ratify the agreement by receiving its benefits. In order for the receipt of
monies to constitute ratification, the agreement must have been purported to be entered on
Mary’s account. You have to know that you are ratifying to be able to do it.
Know that another acted without your manifestation of assent. Since that didn’t
happen, Mary’s receipt of its benefits does not make her a party to the agreement.

C. Estoppel
Hoddeson v. Koos Bros. (NJ 1957)
Facts: Hoddeson purchases a bedroom suit from Koos Bros. She paid the salesman with cash.
She did not get a receipt. Never received her furniture that she was told would arrive the next
month. Koos Bros allowed Hoddeson to look at all 5 of the salesman of that department. One
resembled the salesman, however, he was on vacation the week she bought the furniture. Koos
Bros. determines that it must have been an imposter salesman who sold the furniture.
Issue: Did the imposter have apparent authority to act on Koos Bros’ behalf, and is Koos Bros
bound?
Rule: Agency by estoppels= recklessness of duty= An agency exists between the company and
the imposter because if not for the company’s lack of reasonable surveillance and supervision,
the imposter would not have been able to conduct business on the company’s behalf. For
undisclosed principal, principal must know about the 3P. And you look at what happens at the
time. For agency by estoppel, the principal does not have to know about the 3P.
Held: No. No communication between Koos Bros and the 3P imposter. A business proprietor
has a duty exercise reasonable care and vigilance of protect customers from imposter salesmen.
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The business cannot avail itself of the impostor’s lack of authority because the business did not
prevent the imposter from holding himself out to be an agent of the business when it had a duty
to do so. The Court was concerned with policy.
Points to Consider:

Where agent had auth (of any kind) K is binding on both P and T.

Estoppel only binds P

Could the result in Watteau be explained on estoppel grounds?

Why did Koos Bros litigate this case so vigorously?

Precedent as a public good.

D. Agents Liability on the Contract

Atlantic Salmon A/S v. Curran (Mass. 1992)
Facts: Curran was the president, treasurer, clerk, a director, and the sole stockholder of a
corporation called Marketing, Designs, Inc. that was organized in 1977. In 1983 Marketing
Designs, Inc. dissolved. But in 1983, Marketing Designs, Inc. filed a certificate with the city
clerk declaring that it was conducting business under the name of “Boston Seafood Exchange.”
In 1985, Curran began purchasing salmon from Salmonor; and in 1987, from Atlantic Salmon.
Curran represented himself as working for “Boston International Seafood Exchange, Inc.” or
“Boston Seafood Exchange, Inc.” (Note: NOT the new name of Marketing, Designs, Inc.)
Curran paid Salmoner and Atlantic with checks imprinted with “Boston International Seafood
Exchange, Inc.” and he signed his name with the designation “Treas.” Wire transfers of payment
were also made in the name of Boston International Seafood Exchange, Inc. Curran even gave
representatives of the P’s business cards listing himself as the “marketing director” of Boston
International Seafood Exchange, Inc. And Curran advertised in trade journals for both “Boston
Seafood Exchange, Inc” and “Boston International Seafood Exchange, Inc.” One of the
advertisements appearing under “Boston Seafood Exchange, Inc” listed the Ps as suppliers.
Hist: Salmoner and Atlantic Salmon both sued Curran for monies owed to them for salmon sold
in 1988. The trial court determined that Curran was an agent of Marketing Designs, Inc., an
unidentified principal. Because he was an agent, the trial court held that he was not personally
liable to the Ps. Ps appeal.
Issue: Is Curran personally liable to the Ps because he did not disclose the true identity of his
principal?
Rule: An agent acting for an undisclosed principal is a party to the contract unless otherwise
agreed. § 4(2) (2nd) [(6.02 and 6.04- Third) “Unidentified Principal” and “Principal Does not
Exist”.] 6.04--If Curran had actually just hired a lawyer and gotten his
corporate filings straight then the principal would exist and he wouldn’t be
liable.

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Held: Yes. If an agent wants to avoid personal liability on a contract entered into on behalf of
his principal, then he has a duty to disclose the identity of his principal. The duty rests upon the
agent to disclose the identity of the principal or it may be presumed that he intended to make
himself personally responsible. Curran’s use of the fake business names does not sufficiently
identify the principal to protect him from liability.

§ 3: LIABILITY OF PRINCIPAL TO THIRD PARTIES IN TORT

A. Servant Versus Independent Contractor
Humble Oil & Refining Co. v. Martin (Tex 1949)
Facts: Mrs. Love dropped off her car at Humble for servicing. Before anyone had touched the
car, it rolled across the street and hit Mr. Martin and his three daughters as they were walking.
The Humble station was operated by an independent contractor, Schneider, and only one
employee, Manis, was present when the car rolled away.
Hist: Martin sued both Love and Humble Oil. The trial court found both Ds jointly and
severally liable and granted Love judgment over Humble for whatever she was to pay. The
Court of Civil Appeals affirmed but eliminated the “judgment over” in favor of Love. Humble
and Love appeal the judgment and seek full indemnity from each other (protection from the
other’s acts.. so they don’t want to be jointly and severally liable).
Issue: Is Humble liable for the negligence of the independent contractor?
Rule: A master-servant relationship exists where the servant has agreed (a) to work on behalf of
the master and (b) to be subject to the master’s control or right to control the “physical conduct”
of the servant.
Immutable, decided upon substantive facts= Humble’s substantial control
A party may be liable for an independent contractor’s tortious conduct if he exercises control
over the contractor’s operations.
Held: Yes. The relationship between Humble and the independent contractor is more like a
master-servant relationship than an independent contractor-type arrangement. This is because of
the amount of control that Humble exerted over the contractor. The “Commission Agency
Agreement” between Humble and Schneider required Humble to pay most of the operational
expenses, Schneider to perform duties directed by Humble, Humble furnished the station and
equipment, financed advertising, and controlled the hours of operation. The Agreement was also
terminable at the will of Humble. The Court said that, “The business was Humble’s business,
just as the store clerk’s business would be that of the store owner. Schneider was Humble’s
servant, and so accordingly were Schneider’s assistants who were contemplated by the contract.”
Hoover v. Sun Oil Company (Del 1965)
Facts: A gas station attendant was filling up the gas tank of Hoover’s car. Hoover’s car caught
on fire. The gas station was owned by Sun but leased by Barone. Barone and Sun had entered a

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dealer’s agreement that required Barone to purchase petroleum products from Sun, and in return,
Sun would loan equipment and advertising materials. The agreement did not restrict Barone
from selling competitive products. But all Sun products were to bear the Sunoco label. Barone
advertised that Sunoco products were sold at the station and his employee’s wore uniforms with
the Sun emblem. Barone attended a Sun school for service station operators. A Sun sales rep
would visit the station weekly for inspection, to take product orders, and to make suggestions to
Barone. Barone was under no obligation to follow the sales rep’s advice, though.
Hist: Hoover sued the gas station attendant, Barone, and Sun Oil Company. Sun moved for
summary judgment on the basis that Barone was an independent contractor and, therefore, the
negligence of Barone’s employee could not shift to Sun. Hoover argues that Barone was acting
as Sun’s agent and is therefore liable for his injuries.
Issue: Is a principal liable for the alleged tortious conduct of an independent contractor’s
employee when the principal is not involved with the day-to-day operations of the business and
has no control over the profit or loss of the business?
Rule: An owner is vicariously liable when he exerts substantial control over the independent
contractor’s business.
Held: Motion for summary judgment granted.
Reasoning No liability can shift to Sun for the allegedly negligent acts of Barone’s employee
because Sun had no control over the details of Barone’s day-to-day operation.
THE SERVICE STATION CASES

Principal Oil Company Master

Agent Franchisee Operator Servant

Sub-agent Local Employee (actual Sub-servant

tortfeasor)

If can establish a master-servant relationship, then the fact that Master isn’t present
doesn’t matter. Still liable for sub-servant’s tortious conduct.
Service Station Cases
Essentially similar facts: gas station, which also operates a car repair service, with substantial
ties to an oil company. Somebody gets hurt in an accident at the station and sues the oil
company. Is the nature of the case important?
Direct/indirect factors for determining existence of M/S
*Tax status of the A *amount of business risk borne by each
*term of the relationship *is A paid by job or with unit wage?
*Is As work part of Ps reg business? *Ps and As beliefs about the relationship.
*Who provides supplies, etc? *Location of work.
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 *Whether P in business herself. *Extent of Ps control over work details.
*Whether A has a distinct business. *Trade practice of supervision in locality- Is this
work typically done without supervision or with? *Skill required of A.
Apply Rest §220(2)
HUMBLE SUN OIL
(a) May give orders Recommendations
(b) H owns stock B may sell other products
© Local custom? Appearance relevant?
(d) Moderate Moderate
(e) H owns prop and stock SO owns prop NOT stock
(f) At will employee 30 day notice
(g) Volume-based rent Volume-based rent BUT cap
(h) Core part of business “
(i) ? ?
(j) H in business SO in business
If you want to put the liability on the person who can minimize the risk, then looking for
“control” makes sense.
Murphy v. Holiday Inns, Inc. (Va. 1975)
Facts: Murphy slipped and fell on a sidewalk outside of the Betsy-Lyn Motor Hotel Corporation
and sustained permanent injuries. The Betsy-Lyn and Holiday Inns, Inc entered into a license
agreement that allowed the Betsy-Lyn to use the name “Holiday Inns” subject to terms of the
agreement. Holiday Inns provies a name, quality assurance, national advertising, and a system of
operation, in return for fees from Betsy-Lyn.
Hist: Murphy sued Holiday Inns, Inc. for the negligence of its employees in maintaining the
sidewalk. Holiday Inns moved for summary judgment because it had no relations with the
operator of the motel other than the license agreement. The trial court granted summary
judgment in favor of Holiday Inns finding that no principal-agent or master-servant relationship
existed. Murphy appeals the decision.
Issue: Did Holiday Inns, Inc exert control over the Betsy-Lyn to the extent that it would
constitute an agency relationship?

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Rule: An agency is the fiduciary relationship that arises when one person manifests assent to
another person that the agent shall act on the principal’s behalf and subject to the Ps control, and
the agent manifests assent or otherwise consents so to act. §1.01
Held: No. No principal-agent or master-servant relationship exists even though specific
requirements were made in the franchise contract.
Reasoning: The franchise contract provisions are to standardize the business identity,
commercial service, and only for the benefit of both parties. Holiday Inns had no control over
the Betsy-Lyn’s day-to-day operations, maintenance, room rates, employee wages, etc. Betsy-
Lyn retained all powers that an owner and operator of a business has.
*The contract does not control. “If a franchise contract so ‘regulates the activities of the
franchisee’ as to vest the franchiser with control w/i the def of agency, the agency relationship
arises even though the parties expressly deny it.”
Holiday Inns “was given no power to” (1) “control daily maintenance of the premises” (2)
“control Betsy-Lyn’s current business expenditures, fix customer rates, or demand a share of
profits” (3) “hire or fire.. employees, determine employee wages or working conditions, set std
for employee skills or productivity, supervise employee work routine, or discipline
employees…”
Level necessary to create a master-servant relationship? Looked at franchise agreement to
determine whether Betsy-Lyn a servant or independent contractor per the Restatement
definitions.

B. Tort Liability and Apparent Agency

Miller v. McDonald’s Corp. (Ore. 1997)
*Apparent agency in tort. This comes up a lot in franchiser/franchisee relationships.
Facts: Miller sustained injuries when she bit into a heart shaped sapphire stone while eating a
Big Mac. The McDonald’s location was a franchise owned by 3K Restaurants. Under the
franchise agreement, McDonalds Inc mandated several provisions regarding the business’s
operations, and it had the right to revoke to franchise license for non-compliance. Some of the
requirements include: following specs and blueprints provided by McD, maintaining adequate
supplies and employees during the required hours of operations, all employee’s wear McD
uniforms, only designated food and drinks to be sold, food handling and preparation methods
were designated by McD, and employees had to be clean and courteous. McD would send field
consultants to inspect the operations and ensure conformity with the standards of the Agreement.
The Agreement provided that 3K was not an agent, but an independent contractor and was
responsible for all liabilities of the restaurant.
Hist: Miller sues McDonald’s Corp. McDonald’s moved for summary judgment because it did
not own or operate the restaurant. The trial court granted. Miller appeals.

12
Issue: Did McDonalds have the right to control the performance of 3K under the Agreement?
Did McDonalds create an apparent agency by its standards that create a uniform appearance?
Rule: If a franchisor has the right to control the franchisee, then an agency relationship exists
and the franchisor is vicariously liable for the acts of the franchisee. If a franchisor holds out a
franchisee as to be its agent and other parties reasonably believe that the franchisee is acting as
an agent, then an apparent agency exists and the franchisor is liable.
Held: Reverse the trial court’s decision to grant summary judgment because issues of fact exist.
Reasoning: A jury may find that an agency exists because of the amount of control McD has
over 3Ks daily operations and the required uniformed standards and appearance of the franchise.
This would be an actual agency and McD vicariously liable. A jury needs to determine whether
there is an apparent agency. Whether McDs held 3K out as an agent and whether Miller relied
on that holding out.

C. Scope of Employment
*General Rules regarding
Was the conduct of the same general nature as, or incident to, that which the servant was
employed to perform? See §229
Was the conduct substantially removed from the authorized time and space limits of the
employment? “frolic and detour” Liable if reasonable to expect the agent to take the detour.
Whether the conduct was motivated at least in part by a purpose to serve the master.
Key Points: Certain activities can be within the scope even though they’re not subject to Ps
control. In particular, any activities that the A can be reasonably expected to perform when
carrying out Ps task out of an agent are within the scope even though P controls only a subset
Restatement (3d) View: §7.07: When Employer is Liable for Torts of an Employee
Ira S. Bushey & Sons, Inc. v. United States (2d Cir. 1968)
Facts: The US Coast Guard vessel Tamaroa was being overhauled in a floating drydock. A
drunken seaman returned to the drydock late at night and turned some wheels on the drydock
wall, causing the lock the flood, partially sinking Tamaroa, and damaging the drydock owned by
Bushey.
Hist: Bushey sued the Government and was granted compensation for its loss. The US appeals
on the ground that it is not liable because the drunken seaman was not acting within the scope of
his employment. And only if acting in the scope of his employment would the Government be
liable.
Issue: If the employee’s acts do not serve the employer’s interests, is the conduct in the scope of
employment and is the employer liable for the employee’s acts?

13
Rule: Respondeat superior- Employer liable for actions of employee performed within the scope
of employment. Determination of motive particular to discovering whether “within scope of
employment,” as that would mean acting with the purpose of serving the master. An employer
should expect risks, and although the conduct is unforeseeable, there is a risk that an employee
will cause damages.
Held: Affirmed. The US is liable.
Reasoning: Determining the motive of the employee is not a practical test. The conduct of an
employee may be in the scope of employment even if the specific act does not serve the
employer’s interest. The conduct was not so “unforeseeable” as to relieve the Government of
responsibility.
*Judge Friendly looked at whether the conduct was foreseeable. Old standard looked at the
purpose of the conduct. (Case where servant told to Get up and Fight by master. Direction,
scope of employment.) Friendly says if the Harm is foreseeable, then the P is liable regardless of
whether or not that particular type of harm was foreseeable.
*Was conduct the same nature as that authorized?
*Was Lane on a frolic and detour?
*Did Lane have a purpose to serve the US?
Manning v. Grimsley (1st Cir. 1981) *Intentional Torts
Facts: At Fenway Park in Boston, Manning attended the Orioles/Red Sox game. As Grimsley,
the pitcher for the Orioles, was warming up, Manning and other people sitting in the bleachers in
the right field were heckling him. Grimsley looked over at the hecklers several times and then
threw the ball toward the hecklers. The ball went through the mesh fence and hit Manning.
Hist: Manning sued both Grimsley and his employer, the Baltimore Baseball Club, Inc for
battery and negligence. The district judge directed a verdict for defendants on the battery count
and the jury returned a verdict for Ds on the negligence count. Manning appeals the directed
verdict on the battery count.
Issue: Is an employer liable for injuries to the victim of an employee’s assault?
Rule: To relieve himself of liability for injuries from an employee’s assault, the Employer must
establish that the assault was in response to the plaintiff’s conduct which was presently
interfering with the employee’s ability to perform his duties successfully.
Held: Vacated and remanded on the battery count.
Reasoning: A jury could have found that Manning’s conduct interfered with Grimsley’s ability
to perform his duties effectively so the battery issue needs to go to the jury.

D. Statutory Claims

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Arguello v. Conoco, Inc. (5th 2000)
Facts: Seven Hispanic and African-American consumers of Conoco, Inc. were subjected to
racial discrimination while purchasing gasoline and other services at Conoco-owned and
Conoco-branded stores. The three incidents: (1) Arguello and her father Govea entered a
Conoco-owned store after pumping gas to pay for the gas and to purchase other items. Arguello
was told by the store clerk that her out-of-state license was not an acceptable ID and then began
insulting Arguello, using profanities, knocking a 6-pack of beer off of the counter toward
Arguello, using the intercom system to continue to yell racial epithets after Arguello and Govea
went outside. Arguello called the Conoco customer service and then tried to walk back in to get
the clerk’s name, but the clerk and another employee locked the doors. A district manager
counseled the store clerk for her inappropriate behavior and then sent her to work at another store
for her protection because of an expected picketing in the near future. (2) Ivory, Pickett, and
Ross were followed by an employee in a Conoco-branded store. They commented about bein
followed and then they were refused service. The employee said “we don’t have to serve you
people” and “you people are always acting like this.” The men called the police and the police
ordered the store employee to serve the group. (3) The Escobedos experienced four incidents,
all at different Conoco-branded stores. First, when they were at a Conoco-branded store where
the employee refused to provide toilet paper for the restroom, screamed profanities to Mrs.
Esobedo like “you Mexicans need to go back to Mexico.” After calling Conoco customer
service, they were told that Conoco could do nothing since it’s not a Conoco-owned store.
Second, Escobedo was told by a store clerk, “You people steal gas.” And the last two incidents
involved employee’s telling him he must pre-pay for his gasoline when Caucasion customers
were allowed to pay after pumping gas.
Hist: The group filed suit against Conoco, Inc. The district court granted summary judgment to
Conoco. The group appeals on the grounds that the court erred in finding to agency relationship
between Conoco, Inc. and Conoco-branded stores; and it erred in finding no agency relationship
between Smith (Arguello) because she acted outside the scope of her employment.
Issue: Is there an agency relationship between Conoco, Inc. and Conoco-branded store and
Smith?
Rule: To impose liability under the Civil Rights Act for the discriminatory actions of a third
party, the plaintiff must demonstrate an agency relationship between the D and the 3d party.
A master is subject to liability for the torts of his servants while acting in the scope of their
employment.
Held: Affirmed in part reversed in part. (1) No agency relationship between Conoco and
Conoco-branded stores. (2) An issue of material fact as to whether Smith was acting in her scope
of employment, and summary judgment should not have been granted.
Reasoning: (1) The Court found that the Petroleum Marketing Agreement between Conoco, Inc
and Conoco-branded stores was not an agency relationship. Although Conoco set guidelines and
had debranding power, Conoco, Inc. did not participate in the daily operations of the branded
stores or the personnel decisions. (2) In determining whether Smith was acting within the scope

15
of her employment, the Court analyzed five factors: 1) Time, place, and purpose of the act=
Smith was on duty at work and processing Arguello’s transaction; 2) Smith’s acts were
authorized by Conoco= selling gasoline, running credit cards, using the intercom; [(3)] also
commonly performed by Conoco performed 3) Smith departed from normal methods of
performance= epithets, intentional tort; 4) There is no evidence as to whether Conoco would
reasonably expect such act would be performed.

E. Liability for Torts of Independent Contractors

Majestic Realty Associates, Inc. v. Toti Contracting Co. (NJ 1959)
Facts: Majestic owns a building and leases the first floor and basement to Bohen’s Inc., a dry
goods business. The Parking Authority of the City of Paterson acquired properties along the
same street, beginning with the property adjacent to Majestic’s building, for the purpose of
creating a public parking area. The Authority contracted with Toti Contracting to perform the
demolition work. Toti used a 3500 lb ball to demolish the building beside the Majestic building.
The crane operator swung the ball 15 feet below the wall, causing a 15x40 foot section to fall on
Majestic’s roof and a 25x40 foot break in the roof.
Hist: Majestic and Bohen’s sue Toti and the Parking Authority. The trial court held that the
work constituted a nuisance per se and ruled that the Authority could not be held liable for the
negligence of its independent contractor. The Appellate Court reversed.
Issue: Is the Authority liable to Majestic for the negligence of its independent contractor?
Rule: A person who hires an independent contractor is not liable for the negligent acts of the
contractor in the performance of the contract unless (a) the landowner retains control of the
manner and means of the performance (agent type), (b) he engages an incompetent contractor, or
where (c) the activity contracted for constitutes a nuisance per se.
Held: Authority is liable. The work performed constitutes a nuisance per se because it is
inherently dangerous.
Reasoning: Part B to the exception- incompetent contractor- was not raised at trial or in the
briefs. Although the Court seems to feel that the Authority would be liable for this, it renders no
decision on it and expressly reverses. It does say that a contractee should be liable to an innocent
third party for the negligence of the contractor because the contractee has the power to select his
contractor. Part C- Liability imposed if the work constitutes a nuisance per se- The Court
equates “nuisance per se” to “inherently dangerous.” It finds that the demolition of buildings is
inherently dangerous because it involves a “peculiar and high risk of harm to members of the
public or landowners unless special precautions are taken.” The Court adopts the NY rule that
says that the razing of buildings in a busy, built up section of a city is inherently dangerous.

§ 4: Fiduciary Obligation of Agents

A. Duties During Agency
Reading v. Regen United Kingdom (1948)
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Facts: Reading was a sergeant in the Royal Army Medical Corps stationed in Cairo. While
stationed, he started taking bribes from a man named Manole to transport goods. Reading, while
in uniform, would board a lorry (a big truck) and escort it through town so it could pass civilian
police without inspection. Then the contents would be transferred to another lorry. Reading did
this for Manole several times and received over 20,000 pounds in payment. The Special
Investigation Branch of the army got suspicious when several thousands of pounds were placed
in Egyptian banks in his name, several thousand pounds were in his apartment, and when he
bought a car worth 1500 pounds. Reading issued a statement and told the Army how he acquired
the money, and they possessed it.
Hist: Reading sues because he wants his money back.
Issue: Is a servant who takes advantage of his service and violates the duty of honesty and good
faith to make a profit for himself accountable to his master?
Rule: A servant who unjustly enriches himself by virtue of his service must account for his
profits to his master.
Held: Petition dismissed.
Reasoning: Reading was unjustly enriched by virtue of his service to the Royal Army. His
uniform and position are the only reasons why he was able to get the money, so he must hand
over the money to the Crown. *Misused his agency position to make money.
Problem 2 page 78. Hero has breached no fiduciary duties. Profit for being a hero, not a
soldier.
Problem 3 page 79. Maybe violating military regs for wearing uniform, but writing a book is
outside of his duty as an agent.

General Automotive Manufacturing Co. v. Singer

Facts: General Automotive is a business that does machine shop work. It hired Singer as a
machinist-consultant and manufacturer’s representative. Singer had 30 years of machine shop
experience, so he was skilled at machine work and was qualified in estimating the costs of
machine-shop products and the competitive prices for which products can be sold. In the
employment contract Automotive and Singer entered into, Singer was to receive a monthly
salary and 3% of sales. Singer was to devote his entire, time, skill, labor, and attention to his job
and not engage in any other business while employed with Automotive (moonlighting clause).
The K also said that Singer was never to disclose any business information for his own benefit or
to the detriment of the company. However, Singer began soliciting side business when
customers had orders that Automotive could not perform. He would make the customer a price,
have another machine shop do the work at a lesser price, and then he pocketed the difference.
He eventually set up his own business, brokering orders for Automotive products while still
employed at Automotive.

17
Hist: General Automotive sued Singer to account for secret profits he received while working
for Automotive. Trial court found Singer liable for 64k. He appealed.
Issue: Was Singer’s side business a violation of his fiduciary duty to Automotive?
Rule: Agents have a fiduciary duty to exercise good faith and loyalty so to not act adversely to
the interests of his employer by serving or acquiring any private interest of his own.
Held: Affirmed. A violation of fiduciary duty, so Automotive entitled to recover Singer’s
profits.
Reasoning: Singer had a duty of loyalty to Automotive. His position with Automotive was to
get customers, but instead he was getting customers for his own side business. This is
detrimental to Automotive and Singer is liable for the profits he made. *He never informed his
bosses that they couldn’t fill all the order they were receiving. *Why didn’t you just tell me?
*Pretty straight forward case, particularly because of the employment contract’s stipulations. If
you are profiting solely because of your position, almost always a breach of loyalty. Default
rule- you owe a limited amount of loyalty to your previous employer after employment ends-
such as confidential information, trade secrets.

B. Duties During and After Termination of Agency:

“GRABBING AND LEAVING”

Town & Country House & Home Service, Inc. v. Newberry

Facts: Employees of Town and Country, a home cleaning service, quit and formed their own
business. They began soliciting their accounts through the customer lists they obtained while
working for Town and Country.
Hist: Town and Country sued for unfair competition. The trial court dismissed the complaint,
and the appellate court reversed, holding that the employees had conspired to engage in unfair
competition and breach of fiduciary duties.
Issue: Can former employees use confidential customer lists of their former employer to solicit
new customers of their own?
Rule: Former employees may not use confidential customer lists belonging to their former
employer to solicit new customers.
Held: Affirmed in part, reversed in part. No.
Reasoning: Court doesn’t speak on unfair competition, only says that employees are only liable
for using the customer list. Says Newberry is liable for using the customer list to solicit business
because the list is a trade secret that was obtained through employment with Town and Country.
*Even after you leave, you have a duty not to disclose confidential information. What if hired a
PI to tail the truck to see where it stops? Open information, anyone can get it.
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Analysis
*The default rule in Town and Country is the law of trade secrets. Accordingly, ex-employees
may not use a customer list that qualifies as a trade secret. (Not all customer lists.. public info
no, etc)

CHAPTER 2: PARTNERSHIPS
- an association of 2 or more persons to carry on as co-owners a business for profit. UPA
(1914) 6.1
*Must have an agreement of some sort to form an association. *Must be for profit
business. *Co-owners- Risk of loss, profit.
Key Factors Establishing Partnership: (1) Profit sharing and (2) Control

§ 1: WHAT IS A PARTNERSHIP? AND WHO ARE THE PARTNERS?

A. Partners Compared With Employees
Fenwick v. Unemployment Compensation Commission (NJL 1945)
Facts: Fenwick hires Mrs. Cheshire as a cashier and receptionist with a salary of 15/wk. About
a year later, she requested an increase in pay. Fenwick and Cheshire enter an agreement stating
that they were entering a partnership for the operation of the beauty shop, Cheshire would make
no investment, Fenwick would have all control and management of the shop, Fenwick is liable
for all of the debts, Cheshire receives 20% of end of year profits and Fenwick 80%, and the
partnership could terminate on 10 days notice. Cheshire terminated the relationship three years
later.
Hist: Cheshire applied for Unemployment but was denied because the Commission said that the
agreement was just an agreement to fix compensation. The Supreme Court held that they were
partners because of the agreement. Fenwick appealed the judgment of the Supreme Court
reversing the determination of the Unemployment Commission.
Issue: Are Cheshire and Fenwick partners?
Rule: A partnership is an association of two or more persons to carry on as co-owners a
business for profit. UPA. Sharing of profits is prima facie evidence of partnership but no such
inference shall be drawn if such profits were receieved in payment.
*An agreement is necessary to create a partnership.
Held: Reversed. A partnership has not been established. The agreement was only to set
Cheshire’s compensation, and she had no authority or control in operating the business, not
subject to losses, and was not held out as a partner.
Reasoning: The Court looks at several factors to determine if a partnership relation exists. (1)
Intention of the parties= only to increase Cheshire’s compensation; (2) the right to share profits=
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did exist’ (3) obligation to share in losses= absent b/c Cheshire does not share in losses’ (4)
ownership and control of the partnership property and business= Fenwick reserved himself all
control and he contributed all capital and Cheshire had no right to share in capital upon
dissolution; (5) community of power in administration= Fenwick had the exclusive control of all
management of the business; (6) language of the agreement= although call themselves partners,
Cheshire excluded from most of the ordinary rights of a partner; (7) conduct of the parties toward
3d persons= filed partnership income tax returns and held themselves out as partners to the
Unemployment Commission but never held themselves out as partners to anyone else; (8) rights
of the parties upon dissolution= on Cheshire’s part, it would have been the same as if she had
quit.

B. PARTNERS COMPARED WITH LENDERS

Martin v. Peyton (NY Ct App 1927)
Facts: Peyton lended 500k in bonds to the firm Knauth, Nachod, and Kuhne, where Peyton and
other respondents work when the firm was in financial difficulties so that the money could be
used as collateral to secure bank advances. Peyton, Perkins, and Freeman wanted to become
partners in the firm, but were refused. Then Peyton, Perkins, and Freeman entered into three
agreements with the firm. The agreements stated that Peyton Perkins and Freeman would loan
the firm 2.5m in securities and in return would receive some of the firm’s securities and 40% of
the firm’s profits until the loan repaid and an option to join the firm if desired. They were
considered “trustees” and were advised and consulted on the firm’s matters, the firm members’
interest in the firm were assigned to the trustees, the trustees could inspect the books and veto
any business they thought would harm the firm.
Hist: Martin, a creditor of the firm sued Peyton, Perkins, and Freeman claiming that they were
partners and liable for the firm’s debt. Trial court said they were not partners and Martin
appealed.
Issue: Are the defendants partners in the brokerage firm?
Rule:
Held: Affirmed. Not partners.
Reasoning: The agreement was a loan of securities, and the authority granted to the trustees just
to safeguard the loan. The indenture just to secure the performance of the agreement. And the
option doesn’t reach the conclusion that they are a partnership.
*Different from Gay Jenson Farms v. Cargill. Here, control existed but was not regularly
exercised. Just the “right to control” is too vague here. Must analyze the extent of control.

C. Partnership Versus Contract

Southex Exhibitions, Inc. v. Rhode Island Builders Association, Inc. (1st 2002)

20
Facts: The Builders Association entered an agreement with Sherman, a professional show
owner and producer, for production of the Builders Association home shows. The agreement
stated that that both would participate in the shows as sponsors and partners. It also stated a 55-
45 sharing of profits, mutual control over designated business operations, and the respective
contributions of valuable property to the partnership. However Sherman’s president said he
wanted no ownership of the show, so Sherman became known as the producer. Southex then
acquired Sherman’s interest under the agreement . The Builder’s Association wasn’t happy with
Southex’s performance and refused to renew the agreement.
Hist: Southex sued the Builder’s Association alleging that the agreement between Sherman and
the Builders established a partnership and that the Builders breached its fiduciary duties to
Southex, its co-partner by wrongful dissolution of the partnership and appointment of another
producter. Judgment for Builders, Southex appealed.
Issue: Did the trial court properly use the totality of the circumstances test?
Held: Yes.
Reasoning: The Court analyzed the agreement and determined that there was no partnership.
Fixed term agreement, SEM agreed to advance all monies to produce the shows, SEM
indemnified RIBA for all show-related losses, Southex never filed a partnership tax return, no
concrete evidence that SEM or RIBA contributed any corporate property with the intent that it
become jointly-owned partnership property.

D. Partnership by Estoppel
In order to establish, must prove 4 elements:
(1) P must establish a representation, either express or implied, that one person is the partner of
another- ie that there was a holding out of a partnership.
(2) The making of the representation by the person sought to be charged as a partner or with his
consent
(3) A reasonable reliance in good faith by the 3d party upon the representation
(4) A change of position, with consequent injury, by the 3d person in reliance on the
representation.
Young v. Jones
Facts: Young deposited over 500k in a SC bank after receiving a letter from Pricewater-
Bahamas regarding the financial status of Swiss American Fidelity. The letterhead said “Price
Waterhouse” and had the PW trademark, and was signed Price Waterhouse. The financial
statement turned out to be fraudulent and Young’s money disappeared from the bank.
Hist: Young sues Price Waterhouse United States alleging that there waw a partnership between
PW-Bahamas and PW-US or in the alternative that they operated as partners by estoppel.

21
Issue: Are they partners by estoppel?
Rule: A person who represents himself or permits another to represent him, to anyone as a
partner in an existing partnership or with others not actual partners, is liable to any such person
to whom such a rep. is made who has, on the faith of the rep., given credit to the actual or
apparent partnership.
Held: Not a partnership and no partnership by estoppel.
Reasoning: There is no evidence that Young relied on the brochure to make the decision to
invest. No evidence that credit was extended on the basis of any rep. of a partnership existing
between PW-Bahamas and PW-US. No evidence that Young relied on any statement of a PW-
US partner indicating the existence of a partnership and no evidence that PW-US had anything to
do with the audit letter sent to Young.

§ 2: FIDUCIARY OBLIGATION OF PARTNERS

A. Introduction
Meinhard v. Salmon
Meinhard and Salmon entered into a joint venture to lease a hotel in NY from Gerry for a twenty
year term with reversion to Gerry. Under the agreement, Meinhard provided the majority of the
funding for the lease and Salmon managed and operated the property. Both were responsible for
any losses. Toward the end of the lease, Gerry approached Salmon (Gerry didn’t even know
about Meinhard b/c he was more of a silent partner) and offered a new lease which would cover
a larger tract of property and would last for a period of 20 years with options to renew to extend
up to 80 years. Salmon signed the lease for Midpoint Realty Company, a company Salmon
controlled exclusively. Salmon didn’t tell Meinhard until the new deal was completed.
Meinhard then demanded that the lease be held in trust as an asset of the venture to be shared,
but Salmon refused.
Meinhard filed suit to enforce his share and the trial judge ruled that he was entitled to 25%.
After cross-appeals, the appellate court enlarged Meinhard’s interest to 50% of the whole lease.
Salmon appealed.
Do joint adventurers owe to one another the highest fiduciary duty of loyalty while the enterprise
is ongoing?
CARDOZO: Yes. The fiduciary duty owed to co-adventurers is the same owed to a partner.
Salmon appropriated to himself, in secrecy and silence, an opportunity that should have belonged
to the joint venture. The subject matter of the new lease was the same as in the old lease only
extended and with a larger tract of property. Salmon excluded Meinhard from any chance to
compete or enjoy the opportunity that had come to him alone by virtue of their adventure.
Salmon should have told Meinhard what he was doing so that both of them could have the
opportunity to compete for the project.

22
Judgment affirmed but modified to provide for a trust attaching to shares of stock on the lease
and giving Salmon one share more than Meinhard.
DISSENT: Andrews: The joint venture between Meinhard and Salmon was entered into for a
limited scope, object, and duration of times. It was only designed to exploit a particular lease
and contained to mention of the venture continuing beyond the date of its termination. Since this
was not a general partnership then the majority is incorrect.

B. OPTING OUT OF FIDUCIARY DUTIES

Peretta v. Prometheus Development Company, Inc.
Prometheus Income Partners and Prometheus Development Company were a partnership
organized to manage two large apartment complexes. Prometheus Development is 100% owned
by DNS Trust. Peretta was a limited partner in the Partnership between the Prometheus
companies. Prometheus Development notified its limited partners that it was going to merge the
partnership into PIP Partners-General, which was owned by DNS Trust and by the daughter of
the director of DNS Trust. A proxy statement was sent to the limited partners describing the
terms of the merger and soliciting their vote to approve the merger. Proxy Statement said that
PIP Partners would vote neutrally, meaning that their votes would
Peretta alleges that the merger was a self-dealing transaction which violated PDC’s duty of
loyalty by setting an “unfairly low price.”
The partners were not harmed at the expense of the partnership. The partners properly
ratified, so there was no violation of the duty of loyalty.
Here, majority vote is sufficient for ratification, but ALL potential voters must be
included to determine the percentages and ALL votes were not included. Majority was not
achieved.

*A partnership agreement provision that allows an interested partner to count its

votes in a ratification vote would be “manifestly unreasonable” and therefore the
Court construes the Partnership Agreement provision as requiring a majority vote
of the outstanding limited partner units owned by unaffiliated partners. Construing
it as so, the merger was not approved by a majority and the ratification was not
valid.
A partnership may vary or permit ratifications of violations of the duty of loyalty if not
manifestly unreasonable. BUT CA law will not allow interested parties to count their votes in
ratification. The interested partners, by voting were not “neutral” and there has not been a valid
ratification. Burden on Prometheus to show complete good faith and fairness to the other limited
partners.

C. GRABBING AND LEAVING

Meehan v. Shaughnessy
23
Meehan and Boyle were partners in the the Parker Coulter law firm. They left to start their own
firm and they sued Parker Coulter to recover amounts they claim their former partners owed
them under the partnership agreement and to obtain a declaration as to the amounts they owe the
former partners for work done at Parker Coulter on cases they removed to their new firm. The
former partners counterclaim that Meehan and Boyle violated their fiduciary duties, breached the
partnership agreement, and tortuously interfered with their advantageous business and
contractual relationships. Parker Coulter also filed an action against Cohen and Schafer who left
the firm to work for Meehan and Boyle and Cohen’s new firm, MBC.
Trial court rejected all of Parker Coulter’s claims for relief and held that Meehan and Boyle were
entitled to recover amounts owed to them under the partnership agreement. Also, Parker Coulter
was entitled to recover for time billed and expenses incurred on the cases M and B removed to
their own firm. Parker Coulter appealed claiming that the judge erred in finding that M, B,
Cohen and Shafer fulfilled their fiduciary duties to the former partnership.
M and B violated fiduciary duty by handling cases for their own benefit and intentionally
not resolving cases while with Parker Coulter but moving them to their new firm. REJECTED.
Breached fid duty not to compete by secretly setting up a new firm while still at Parker
Coulter. REJECTED>
Breached fid duties by unfairly acquiring consent from clients to remove cases from
Parker Coulter. AGREED. They breached their fiduciary duty by unfairly acquiring consent
from clients because the notice letters sent to the clients didn’t let the clients know that they had
a choice to remain with Parker Coulter or to move to MBC.

D. EXPULSION
Lawlis v. Kightlinger & Gray
Lawlis was a partner for Kightlinger and Gray. He became an alcoholic and told the Finance
Committee of the firm. The Firm immediately sought help for him and then drafted a document
called “Program Outline” that set forth conditions for Lawlis’s continuation with the Partnership,
stating that there is no second chance. Lawlis later relapsed and he was given a second chance.
At the Firm, compensation is based on a unit system, and each year a Partner is with the firm
gives him more units. Lawlis’s units were reduced while he was battling is alcoholism. Lawlis
was told he would return to full partnership status if he complied with treatment and
consultations with specialists and if he could provide favorable reports from the specialists. He
has been sober since his second treatment. So Lawlis went to the Finance Committee and
proposed that his units of participation be increased from his then 60 units to 90 units. Instead,
the Finance Committee decided to recommend Lawlis’s severance as a partner. Two days later,
all files removed from his office. At the Senior Partners Meeting, the partners voted to accept
the severance recommendation.
*As long as they follow the provisions set forth in the Partnership Agreement then acted in good
faith. Here, they had the “guillotine” severance provision, but actually didn’t use the method to
sever the Partnership, were more compassionate.

24
*Wrongful dissolution claim
*Breach of fiduciary duty
When a partner is involuntarily expelled from a business, his expulsion must have been
‘bona fide’ or in ‘good faith’ for a dissolution to occur without violating the partnership
agreement. There was a no-cause expulsion clause in the agreement, and the partners acted in
good faith b/c their conduct did not cause a wrongful withholding of money or property of the
expelled partner. The Firm was compassionate, not greedy by recommending a step-down
severance rather than an immediate severance.

§ 3: PARTNERSHIP PROPERTY
Putnam v. Shoaf
Putnam severed her relationship as partner with the Frog Jump Gin Company. When Shoaf
employed a new bookkeeper, he discovered that the old bookkepper had embezzled a lot of
money from the company. The company sued the old bookkeeper and Putnam intervened
claiming an interest in any fund paid to the banks. 68k was paid and Putnam claims 50%.
The partnership owns the property or asset. Putnam conveyed all of her interest in the
partnership so she has no interest in the lawsuit. A co-partner may only convey an undivided
interest in the value or deficit of the partnership, and the transfer agreement to Shoaf cannot be
changed because of Putnam’s ignorance of the embezzlement.

§ 4: Raising Additional Capital

The only way to get around obstacles regarding raising additional capital is to place provisions in
the partnership agreement. There are no default rules in UPA or RUPA.
Some common provisions:
(1) “Pro Rata Dilution”-- Permits the managing partner to issue a call for additional funds and
provides that if any partner does not provide the funds called for, his/her share is reduced. Ex:
Originally there were 1,000 points, contributed by 40 partners with 12.5 points at $1,000
($12,500) each= $1,000,000. Additional share points are sold at the original price of $1,000,
requesting an additional 12.5 points per contributing partner= $12,500. If 20/40 partners do so, a
total of 500 (25 points * 20 partners) new points added to the original 1,000 points= extra
$500,000. Then each person’s shares are now equal to the total points divided by total dollar
amount of shares. So, contributors get $25,000/1500 =$33,333. A non- contributing partner
now has $12,500/1,500= $16,666. **So even non-contributors’ point value goes up.
(2) “Penalty Dilution”—Permits the managing partner to offer the partners new points at a lesser
cost that the original price. Ex: Offer for 50 points at $250 each (a 4 to 1 dilution= $1000
original cost/4= $250). This would be a $12,500 contribution by the 40 partners. The total
number of points offered is 50 points* 40 partners= 2,000. So the total points would equal 3,000
(1,000 original plus 2,000 new). The equity value= (12,500+ new 12,500)*40 partners=
$1,000,000. Each point will be worth $1,000,000/3,000 points= $333. Contributors can now
25
have 75 points (50 new and original 25) worth $333*75= $25,000. Non-contributors (if all
offered points are bought) now have their original 25 points*$333 new point worth= $8,333.
**So in this case, if contribute amount requested, value doesn’t change. If don’t contribute,
point worth decreased by one third.
(3) Pro Rata Loans-- Permits the managing partner to require partners to make pro rata loans.
The loans usually bear interest a few points above the prime rate, with no distributions to
partners until the full amounts of the loan and interest are paid. There is a problem with
specifying the consequences of a partner failing to comply with the loan request. One possibility
is to compensate nondefaulting partners by repayment of 150% of the loan plus interest.
(4) Selling new partnership shares to anyone at whatever price can be obtained. This is like a
corporation selling new shares in common stock on the stock market in order to raise new equity
funds.

§ 5: The Rights of Partners in Management

National Biscuit Company v. Stroud
Facts: Stroud and Freeman entered into a general partnership to sell groceries under the name of
Stroud’s Food Center. Stroud told Biscuit that he would not be personally responsible for any
additional bread sold to Stroud’s Food Center. However, Freeman requested bread from Biscuit
and Biscuit sold and delivered it to Stroud’s Food Center. Stroud and Freeman agreed to
dissolve their partnership. Per the dissolution agreement, Stroud was to liquidate the firm’s
assets and discharge the liabilities. He discovers that bread was sold to Biscuit and sues them.
Hist: Lower court found Stroud liable for the purchase of bread by Freeman.
Issue: Can a partner restrict another partner’s equal rights of management and conduct of the
partnership business?
Rule: Partners have “equal rights in the management and conduct of the partnership business.”
UPA
Held: Affirmed lower court. Stroud cannot restrict the power and authority of his co-partner to
purchase bread because the act was within the scope of the business. Stroud is not a majority so
his decision has no effect on Freeman. Stroud and Stroud’s Food Center are bound by the
purchases of Freeman.
Summers v. Dooley
Facts: Summers and Dooley entered a partnership agreement to operate a trash collection
business. The agreement provided that if either was unable to work, he could provide a
replacement at his own expense. Dooley became unable to work and hired an employee to take
his place. Summers asked Dooley if he could hire an additional employee, but Dooley refused.
Summers hired an additional employee anyway and paid him out of his own pocket. Dooley
found out and said that no additional help was necessary and he would not allow for him to be

26
paid out of partnership funds. Summers sued Dooley for $6000 because he was never
reimbursed from either partnership funds or by Dooley.
Hist: Summers granted only partial relief and appealed. Summers asserted that Dooley ratified
his act of hiring an additional employee because be retained profits earned by the help of the new
employee and should be estopped from denying the need and value of him.
Rule: UPA 18(h)- Any difference arising to the ordinary matters connected with the partnership
business may be decided by a majority of the partners.
Held: Since the decision was not made by majority of partnership and Dooley objected to the
hiring of the additional employee, it would be manifestly unjust to permit Summers to recover an
expense incurred individually and not for the benefit of the partnership.
Differences between National Biscuit v. Stroud and Summers v. Dooley:
National Biscuit Stroud

In a partnership to sell groceries. Hiring a third man is out of the

Buying bread is ordinary for this scope of the ordinary business.
type of business and within the
scope.

Deadlock: UPA 9(1): Every act of every partner binds the partnership unless
the person with whom he is dealing has knowledge of the fact that he has no
such authority. Under 9(1) and 9(4), a partner cannot have apparent
authority where the 3d party with whom the partner dealt knew he has no
actual authority to make the contract.

In Biscuit, notice to Biscuit doesn’t matter because Freeman still had actual
authority to purchase the bread. The partnership gave him actual authority,
which stands, even though another partner tried to diminish his authority.

What to do when there is a deadlock in decision-making between partners?

Lawyer to mediate.

Summer and Dooley had equal stakes in their partnership. Summer loses b/c
partnership matters are decided by majority vote.

National Biscuit Stoud

“Any difference arising as to “business differences must be

ordinary matters connected with decided by a majority of the partners
the partnership business may be provided no other agreement
decided by a majority of partners.” between the partners speaks to the
issues”

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Contract binding because: “Stroud Contract not binding because “a
was not, and could not be, a majority of the partners did not
majority of the partners.” consent to the hiring of the 3d man.”

Reconciliation:

Cases illustrate a clash of two principles:

(1) All partners are agents of the partnership with power to bind the
partnership. UPA 9(1)

(2) All partners have equal rights to participate in the management of the
partnership. 18(e)

As between the partners and some 3d party, the former principle controls
(Biscuit). As between the partners, the latter controls (Summers).
Day v. Sidley & Austin
Facts: Day was a senior partner for Sidley & Austin. S&A thought about merging with the
Liebman firm. Day was given notice of meetings to discuss the possible merger, but never
attended. The final Memorandum of Understanding and final amended Partnership Agreement
were executed by all partners, including Day. Once the merger took place, the executive
committee decided to consolidate the Washington offices and the Washington offices
committees. Once this happened, a co-chairman was appointed of the Washington office. Day
resigned because of the appointment of co-chairman.
Hist: Day alleges that misrepresentations about the merger void the approval of the merger. He
also alleges that S&A breached their fiduciary duty by negotiating on the merger without
consulting the other partners who were not on the executive committee.
Held: No misrepresentation or breach of fiduciary duty. Fraud- Day says that he was told that
no S&A partner would be worse off because of the merger. Him losing his status as the sole
chairman does not support a c/a for fraud because he was not deprived of any legal rights as a
result of his reliance on the statement. Also, the Partnership Agreement that he signed makes no
mention of status, and his unwritten understanding cannot contravene the Agreement. The
Agreement also gave the executive committee the authority to decide questions of firm policy,
like appointing chairmen. Day couldn’t have reasonably believed that no changes would be
made following the merger. Duty- Day says that breach because not fully disclosed to all
partners. Here, he’s alleging failure to reveal information regarding the internal structure of the
firm. This is not a breach because there was no advantage at the expense of the firm.

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§ 6: Partnership Dissolution
A. The Right to Dissolve

Owen v. Cohen
Facts: Owen and Cohen entered oral agreement to become partners in the operation of a bowling
alley. No duration expressed. Owen advanced $6986.63 as a loan to repaid out of business
profits. Soon after opening the bowling alley, differences arose regarding management and
rights and duties under their agreement. Cohen told Owen that he would act as manager and that
Owen should do all manual labor. Owen asked Cohen if he would either buy out his interest or
sell him his. Cohen said it would cost too much to get rid of him. Cohen started taking money
out of partnership funds for his own use without Owen’s knowledge, approval, or consent.
Rule: Any partner at anytime can walk away. UPA 31(1)(b)- “Dissolution is caused…By the
express will of any partner when no definite term or particular undertaking is specified.”
UPA 32:
Hist: Owen brought an action for the dissolution of the partnership and for the sale of the
partnership assets. Trial court found that the partnership was dissoluble and ordered the assets
sold by the receiver. Owen received 1/2 the proceeds, reimbursement for the loan he made, and
$100 for his costs. Cohen sues alleging that the dissolution was unwarranted, and if Court
doesn’t agree, then Owen should not be reimbursed for the loan since agreement that only repaid
from profits, not upon proceeds of the sale of partnership assets.
Held: Court held that pursuant to UPA § 32 cause was found for judicial dissolution. The bitter
feelings between the parties, lack of cooperation, and under the condition the parties were
incapable of carrying on the business. Loan reimbursement in “complete accord with estd
principles of equity jurisprudence” because if not for Cohen’s acts, then dissolution wouldn’t
have been necessary.
Why sue? Judicial determination of status of loan required. Potential for wrongful dissolution:
UPA 31(b) v. 31(2). 31(1)(b): Without violation of the agreement between the partners,
dissolution is caused by the express will of any partner when no definite term or particular
undertaking is specified. 31(2): In contravention of the agreement between the partners, where
the circumstances do not permit a dissolution under any provision of this section, by the express
will of any partner at any time.
Collins v. Lewis
Facts: Lewis and Collins leased a basement for a term of 30 years to open up a cafeteria. They
entered a partnership agreement stating that Collins would furnish all the funds to build, equip,
and open the cafeteria (no $ cap) and Lewis was to plan and supervise construction and manage

29
the cafeteria operations as long as the lease term. (Express term of 30 years.) Lewis guaranteed
repayment to Collins of at least $30k plus interest the first year and $60k plus interest each year
thereafter. Lewis would surrender his interest to Collins upon default, and Lewis guaranteed
against loss up to $100k. The costs incurred to build the cafeteria exceeded the amount
estimated by Lewis, but Collins paid. After opening, cafeteria in a lot of debt, so Collins
demanded that Lewis make it profitable or he would not advance any more funds. He threatened
Lewis that he would lose all his interest.
Hist: Collins brought an action for dissolution of the partnership and foreclosure of a mortgage
upon Lewis’s interest in the partnership assets. The trial court found that Lewis was competent
to manage the business, there was no reasonable expectation of profit under Lewis, and but for
Collins’s conduct there would be a reasonable expectation of profit under Lewis’s management.
Held: Collins has no right to dissolution because if not for his conduct, Lewis could have
performed his partnership obligations. Collins was to furnish the money and Lewis the
management. Collins’s extended credit with the bank was his financial responsibility and Lewis
only obligated to pay the rate agreed upon. Collins’ failure to protect Lewis on his obligation to
the bank is a breach of K by Collins. Collins can’t say that he should not be forced to endure a
continuing partnership with no reasonable expectation of profit. He has the inherent right, as a
partner, to terminate the relationship.
*Be careful how you draft agreements, particularly when it comes to contributions. Should have
put a monetary cap on Collins’ contributions.
Page v. Page
Hist: Brothers in a linen supply business, oral partnership agreement with no expressed duration
(at will). Plaintiff sought a dissolution and the trial court held that no right to dissolution because
the partnership was set for a term. P appealed.
Rule: UPA- A partnership may be dissolved “by the express will of any partner when no definite
term or particular undertaking is specified.”
Held: Trial court erred when it held that the term was such reasonable time as necessary to
enable the partnership to repay from profits the indebtedness. Court says no term because every
partnership hopes for a profit. This is a partnership at will and either partner can dissolve with
express notice to the other as long as exercised in good faith (meaning subject to fiduciary
duties).
*Options: Foreclose on note; put partnership into bankruptcy, which dissolves it by operation of
law; buy partnership assets in liquidation; continue business. Get appraisal and offer to buy out
George at fair price, of George is willing.
B. The Consequences of Dissolution
Prentiss v. Shefel

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Facts: 3-man at-will partnership owned by Prentiss, another, and Sheffel. Prentiss and other
partner sought dissolution because Shefel derelict in partnership duties by failing to contribute
his share of the operating losses. They also requested permission to continue the business and a
fixed value for Shefel’s interest. Shefel counterclaims for a winding up of the partnership and
the appointment of a receiver b/c his rights as a partner violated since wrongfully excluded from
the management of the partnership.
Hist: Trial court found that a partnership-at-will existed and was dissolved as a result of a
freeze-out or exclusion of Shefel from the management of the partnership. Trial court appointed
a receiver to sell, partition, and distribute assets. Shefel’s request to forbid Prentiss to bid on the
sale was refused. Prentiss won the bid, and trial court entered an order confirming the sale to
them. Shefel appeals the order alleging that since he was wrongfully excluded from the
management of the partnership, Prentiss should not be allowed to purchase the partnership assets
at a judicial sale.
Held: Court affirms. No indication that wrongful expulsion was done to obtain partnership
assets in bad faith. Shefel’s interest was enhanced by the sale because Prentiss’s participation
raised the final sales price significantly compared to the two initial bids.
*At will partnership, have the right to dissolve, can buy it at judicial sale.
Pav-Saver Corp. v. Vasso Corp.
Facts: Pav-Saver Corp, Dale,their majority shareholder, and Vasso Corp. entered a partnership
agreement to manufacture and sell Pav-Saver (concrete paving) machines. Partnership
agreement stated that Meerman, Vasso’s owner, would provide all financing, Pav-Saver grants
exclusive right to its trademark, patent rights and license to use its specs and drawings, and
licenses granted under any patents for the term of the agreement. Also said that specs and
drawings the property of Pav-Saver and to be returned at the expiration of the partnership. Also,
permanent partnership (=express term) only terminated or dissolved by mutual approval of both
parties, and the terminating party to pay 4 times the gross royalties received by Pav-Saver Corp
in the 1973 fiscal year, paid over 10 years. By mutual consent, it was dissolved and replaced by
PSC and Vasso. PSC then terminated the partnership. Meersman ousted Dale and assumed
management.
Hist: PSC sued for a court-ordered dissolution, return of its patents and trademarks, and an
accounting. Vasso cc’d for wrongful partnership termination. Trial court found PSC wrongfully
terminated the partnership, Vasso could continue the business using the patents and trademarks,
and Vasso entitled to liquidated damages pursuant to the dissolution clause in the partnership
agreement. Both appealed.
Held: Terminated in contravention of the agreement since a “unilateral” termination. Pursuant
to UPA § 38, the party who did not cause the dissolution wrongfully may continue the business
and with the partnership’s property. Vasso decided to continue the business, and he gets to keep
the property. The paragraph of the partnership agreement regarding the return of PSC’s patents
is void b/c in contradiction of UPA 38 since the partnership never really ended.

31
Stouder dissent: Clear intention of the parties, as stated in the agreement, is that when the
agreement is terminated, so will the right to use the patents. The option to continue a business
carries with it no guarantees.
Never, ever, ever draft or enter into a “permanent partnership” agreement.
Early dissolution of a term partnership constitutes a wrongful breach. 31(2)
and 38(2): When in contravention of the agreement, damages for breach:
other partner may continue the business and with partnership property, and
paid by wrongful partner his interest and damages for breach.

C. The Sharing of Losses

Kovacik v. Reed
Facts: Partnership in a business to remodel kitchens, where Π invested $10k and Δ would be the
job superintendent & estimator. They would share 50-50 in profits, but the matter of sharing
losses was not discussed. After a year, Π tells Δ the venture had lost money & demanded that Δ
contribute to the losses. Δ said he never agreed to share losses & refused to pay.
Neither party is liable for any loss sustained to the other. The party who contributed $ isn’t
entitled to recovery from the party who contributed only services. Where one party contributing
$ and the other contributes service then in the event of a loss each would lose his own capital –
one his $ the other his labor.
RUPA (1997) § 401(b) expressly cites and rejects Kovacik: “Each partner is entitled to an
equal share of the partnership’s profits and is chargeable with a share of partnership losses
in proportion to the partner’s share of the profits.” [losses follow profits]

D. Buyout Agreements
G&S Investments v. Belman
Facts: Limited partnership to receive ownership of an apt complex. One of the partners
(Nordale) starts using cocaine & caused a lot of problems that affected the business. Other
partner, G&S files a complaint, seeking dissolution. Before it went to court, Nordale dies.
Nordale’s estate says the complaint was a dissolution of the partnership, so partnership needs to
be liquidated & net proceeds go to partners. Filing a lawsuit does not lead to
dissolution.

Court says filing of the complaint was not a dissolution; only a court decree could do that. But
Nordale dies before such decree could be entered, so partners have the option of a buyout, as per
the partnership agreement. Even if he hadn’t died, the Court determines that
Nordale’s conduct breached the partnership agreement. Hence, wrongful
dissolution.

i. Because partnerships result from contract, the partners’ rights and liabilities are
subject to the agreement made among them. The agreement here provided for a
buyout if one of the partners’ died. Although the exact provision in the
32
 agreement calculated the value of the interest as less than the fair market value,
court says that parties must be bound by the contracts into which they enter,
absent a showing of fraud or duress in the inducement.
a. Buyout provision here – if the remaining partners choose to continue the business,
it must purchase the interest of the departed partner (interest that belongs to the
estate). Here, the buyout formula is the capital account of the deceased partner
plus the average of the prior 3 yrs’ earnings. (Capital acct = partner’s capital
contribution to partnership minus losses and reduced by any distributions already
made).
When it comes to the duration of a partnership, courts have recognized three
types: (1) Defined Partnership--Specified in Agreement, Permanent is a
type of Defined (Pav-Saver; Collins v. Lewis)
(2) Explicitly “At Will”—No terms; no breach or penalty for dissolution;
terminates upon death of partners
(3) Implied Term—The partnership ends when the implied erm has been
fulfilled. (Owen; Page)

§ 7: Limited Partnerships- can be considered a general partnership depending on the amount of

control

Chapter 3: The Nature of the Corporation

§1 Promoters and the Corporate Entity
A “promoter” is a person who identifies a business opportunity and puts together a deal, forming
a corporation as the vehicle for investment by other people.
Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc.
Facts: Southern entered into a purchase agreement with Camcraft for a supply vessel from
Camcraft. The agreement stated that Southern was “a company to be formed.” The agreement
was signed by Barrett, individually and as President of Southern, and Bowman, as President of
Camcraft. Southern then incorporates in Texas. Later, Southern and Camcraft executed a Vessel
Construction Contract with a condition stating that Southern warranted that it was a citizen of the
US within the meaning of the Shipping Act of 1916. The next year, Southern incorporated in the
Cayman Islands of the British West Indies, and Barrett wrote Bowman a letter telling him this
and that Southern’s Board of Directors have ratified, confirmed, and adopted the previous
agreements. Bowman signed a written acceptance and agreement to the letter. Camcraft never
delivered the ship.
Hist: Southern sued Camcraft for breach of K and requested specific performance and
consequential damages. Camcraft said Southern had no c/a since Southern was not of corporate
existence at the time of entering the K and now incorporated under British West Indies laws.
Trial court held that Southern was not incorporated at the time of the Vessel Construction
Contract so there was no K. Also, Southern never appeared as a TX corporation to approve of
any substitution of parties or assignment so its ratification of the agreements was ineffective.
33
Southern appealed, assigning error to the trial court for (1) finding that Camcraft did not agree to
be bound to the Vessel Construction K due to its acceptance of the letter, (2) finding that the
Vessel Const K was not a K at all, (3) failure to hold Camcraft estopped from denying the
corporate existence of Southern, and (4) failure to consider the letter as evidence of a valid
assignment if the trial court was correct in stating that Camcraft did not consent to the terms in
the letter. (Court says if had been argued, they would find merit in the arg that Barrett could
enforce the K individually.)
Rule: A D should not be permitted to escape performance by raising an issue as to the character
of the organization to which it is obligated, unless its substantial rights might thereby be affected.
Held: Reversed and remanded on the issue of incorporation in the Cayman Islands, rather than
in TX as represented by Southern. The substantial rights of Camcraft were not affected. Both
parties relied upon the Vessel Construction K. Camcraft probably only breached b/c the vessel’s
value appreciated between time of K and agreed delivery date. Camcraft is estopped from
denying Southern’s corporate existence in the execution of the K. Regarding the remand issue,
Camcraft has the right to raise the relevance of the incorporation due to Shipping Act of 1916
paragraph in the K. But that shouldn’t be grounds for avoidance of the K since Act prohibits
transfers during war or national emergencies, none of which existed.
§2 The Corporate Entity and Limited Liability
Walkovsky v. Carlton
Facts: Walkovsky sues Carlton after run down by a taxicab owned by Seon Cab Corporation.
Walkovsky alleged that Seon was one of ten cab companies of which Carlton was a shareholder,
and each of the ten only had two cabs in its name. He alleged that the corporations were
operated as a single entity with regard to financing, supplies, repairs, employees, and garaging.
Walkovsky named each corporation and its shareholders as defendants since the multiple
corporate structure constituted an unlawful attempt to “defraud members of the general public”
because each corporation only carried the minimum auto liability insurance required by law
($10,000).
Issue: Did the complaint state a sufficient c/a to recover against each cab corporation, Carlton,
and each corporation’s shareholders?
Held: No. The court will only “pierce the corporate veil” and hold the stockholders liable if it
can be shown that the stockholder was conducting business in his individual capacity. The
corporate veil may not be disregarded just because the assets of the corporation, together with the
liability insurance, are insufficient to assure recovery. Leave it to the legislature. Walkovsky,
who also wants all corporations to be liable, is asking for enterprise liability
so all treated as one corporation. Like PCV, but must show disrespect for
corporations vis a vis the corporations. Unlike PCV, where that is showing
disrespect vis a vis the shareholders.

Dissent: The corporations were formed by Carlton and intentionally undercapitalized for the
purpose of avoiding responsibility for acts that were bound to arise as a result of the operations

34
of a large taxi fleet. All income was drained out of the corporations for this purpose, and so
individual shareholders should be held liable.

Sea-land Services, Inc. v. Pepper Source

FACTS: After Sea-Land (P), an ocean carrier, shipped peppers for the Pepper Source (PS) (D), it
could not collect on the substantial freight bill because PS (D) had been dissolved. Moreover, PS
(D) apparently had no assets. Unable to recover on a default judgment against PS (D), Sea-Land
(P) filed another law suit, seeking to pierce the corporate veil and hold Marchese (D), sole
shareholder of PS (D) and other corporations, personally liable. PS (D) then took the necessary
steps to be reinstated as a corporation in Illinois. Sea-Land (P) moved for summary judgment,
which the court granted. Marchese (D) and Pepper Source (D) appealed.
ISSUE: Will the corporate veil be pierced where there is a unity of interest and ownership
between a corporation and an individual and where adherence to the fiction of a separate
corporate existence would sanction a fraud or promote injustice?
HOLDING AND DECISION: (Bauer, J.) Yes. The corporate veil will be pierced where there is
a unity of interest and ownership between a corporation and an individual and where adherence
to the fiction of a separate corporate existence would sanction a fraud or promote injustice. There
can be no doubt that the unity of interest and ownership part of the test is met here. Corporate
records and formalities have not been maintained, funds and assets have been commingled with
abandon, PS (D) was undercapitalized, and corporate assets have been moved and tapped and
borrowed without regard to their source. The second part of the test is more problematic,
however. An unsatisfied judgment, by itself, is not enough to show that injustice would be
promoted. On remand, Sea-Land (P) is required to show the kind of injustice necessary to evoke
the court's power to prevent injustice. Reversed and remanded.
Fraud is a crucial part of the PCV analysis. This additional injustice must be
found. If don’t PCV, look at whether promoting injustice through fraud,
unjust enrichment, etc.

Roman Catholic Archbishop of San Francisco v. Sheffield

Facts: Sheffield entered into an agreement with a monastery operated by a Roman Catholic
order (The Canons Regular of St. Augustine) for the purchase of a St. Bernard. The agreement
was that Sheffield would pay in installments. The monastery breached, and Sheffield sued The
Roman Catholic Church dba The Roman Catholic Archbishop of San Francisco, The Bishop of
Rome, The Holy See, The Canons Regular of St. Augustine, and Father Cretton. The complaint
alleged that there existed a “unity of interest and ownership between all and each of the
defendants” and they were all “alter egos” of each other.
Hist: The Archbishop moved to dismiss and for summary judgment. Trial court denied both.
Held: The court abused its discretion in denying summary judgment. No proof that Archbishop
had any dealings with the Canons Regular of St. Augustine for it to be liable under the alter ego
doctrine. Furthermore, when a parent corporation controls several subsidiaries, the corporate
veil of one subsidiary may not be pierced to satisfy the liability of another. The alter ego theory
cannot be applied simply because the plaintiff simply won’t be able to collect. To apply, a
requirement that the failure to pierce would lead to an inequitable result.

35
In Re Silicone Gel Breast Implants Products Liability Litigation
FACTS: Plaintiffs from many states claimed that they had been injured by breast implants
produced by Medical Equipment Corporation (MEC) (D), a wholly-owned subsidiary of Bristol-
Myers Squibb Co. (D). Although Bristol (D) itself had never manufactured or distributed breast
implants, plaintiffs claimed that Bristol (D) could be held liable by piercing MEC's (D) corporate
veil. The corporation MEC (D) was owned by a single shareholder, Bristol (D), which, as a
parent corporation, was expected to exercise some control over its subsidiary. Bristol (D)
contended that a finding of fraud or like misconduct was necessary to pierce the corporate
veil in Delaware.
ISSUE: In a corporate control claim seeking to pierce the corporate veil to abrogate limited
liability and reach the parent corporation, may veil-piercing ever be resolved by summary
judgment?
HOLDING AND DECISION: (Pointer J.) Yes. In a corporate control claim seeking to pierce the
corporate veil to abrogate limited liability and reach the parent corporation, summary judgment
could be proper if the evidence presented could lead to but one result. Because a jury could find
that MEC (D) was but the alter ego of Bristol (D), summary judgment must be denied. When a
corporation is so controlled as to be the alter ego of mere instrumentality of its stockholder, the
corporate form may be disregarded in the interest of justice. Many jurisdictions that require a
showing of fraud, injustice, or inequity in a contract case do not do so in a tort situation. The
totality of the circumstances must be evaluated in determining whether a corporation is so
controlled as to be the alter ego or mere instrumentality of its stockholders. Delaware courts do
not necessarily require a showing of fraud if a subsidiary is found to be the
mere instrumentality or alter ego of its sole shareholder. Therefore, Bristol (D) is not entitled to
dismiss the claims against by summary judgment.
Ignored corp formalities, no board meetings, Bristol set the employment
policies, Bristol helped MEC conduct market studies, Bristol lawyers regularly
worked for MEC. Under direct liability, a corporation can be liable if
negligently provides services to another.
EDITOR'S ANALYSIS: While limited liability is the rule, in many cases where a plaintiff seeks
to reach the assets of the parent to satisfy a judgment, piercing the corporate veil of the
subsidiary occurs. Factors the courts consider include: whether the parent and subsidiary have
common directors, officers, or common business departments; whether the parent and subsidiary
file consolidated financial statements and tax returns; whether the parent finances the subsidiary;
and whether the subsidiary operates with grossly inadequate capital. While the standards vary
from state to state, all jurisdictions require a show of substantial domination.

Frigidaire Sales Corporation v. Union Properties, Inc.

FACTS: Frigidaire (P) entered into a contract with Commercial Investors, a limited partnership.
Mannon (D) and Baxter (D) were limited partners of Commercial and also officers, directors,
and shareholders of Union Properties (D), the only general partner of Commercial. Mannon (D)
and Baxter (D) controlled Commercial by exercising day-to-day control and management of
Union (D). Commercial breached the contract and Frigidaire (P) filed suit against Union (D),
Mannon (D), and Baxter (D), asserting that they should incur general liability for the limited
partnership's obligations because they exercised day-to-day control and management of

36
Commercial. Mannon (D), and Baxter (D) argued that Commercial was controlled by Union (D),
a separate legal entity, and not by them in their individual capacities. The trial court declined to
hold Mannon (D) and Baxter (D) generally liable, and Frigidaire (P) appealed.
ISSUE: Do limited partners incur general liability for the limited partnership's obligations simply
because they are officers, directors, or shareholders of the corporate general partner?
HOLDING AND DECISION: [Judge not stated in casebook excerpt.] No. Limited partners do
not incur general liability for the limited partnership's obligations simply because they are
officers, directors, or shareholders of the corporate general partner. In Washington, parties may
form a limited partnership with a corporation as the sole general partner. To hold that Mannon
(D) and Baxter (D) incurred general liability for the limited partnership's obligations would
require the court to totally ignore the corporate entity of Union (D), when Frigidaire (P) knew it
was dealing with that corporate entity. Although Mannon (D) and Baxter (D) controlled
commercial through their control of Union (D), they scrupulously separated their actions on
behalf of Commercial from their personal actions and the corporations were clearly separate
entities. Frigidaire (P) knew that Union (D) was the sole general partner of Commercial and that
Mannon (D) and Baxter (D) were only limited partners. If Frigidaire (P) had not wished to rely
on the solvency of Union (D) as the only general partner, it could have insisted that Mannon
(D) and Baxter (D) personally guarantee contractual performance. When the shareholders of a
corporation, who are also the corporation's officers and directors, conscientiously keep the affairs
of the corporation separate from their personal affairs, and no fraud or manifest injustice is
perpetrated upon third persons who deal with the corporation, the corporation's separate entity
should be respected. Affirmed.

EDITOR'S ANALYSIS: The court's opinion does not preclude a finding of general liability of
limited partners where there is a showing of fraud or deception. Other courts have been less
lenient in protecting limited partners and have held them generally liable if their actions
constituted control of the corporation. In some states, on the other hand, a corporate entity is not
permitted to be a general partner because such arrangements are viewed as shams.

GENERAL PARTNERSHIP — A voluntary agreement entered into by two or

more parties to engage in business whereby each of the parties is to
share in any profits and losses therefrom equally and each is to
participate equally in the management of the enterprise.

LIMITED PARTNERSHIP — A voluntary agreement entered into by two or

more parties whereby one or more general partners are responsible for the
enterprise's liabilities and management and the other partners are only
liable to the extent of their investment.

§3 Shareholder Derivative Actions

A. Introduction
Cohen v. Beneficial Industrial Loan Corp.

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FACTS: Cohen (P) owned 100 of the more than two million shares of the Beneficial Industrial
Loan Corporation (D), a Delaware corporation. Cohen's (P) shares never had a market value of
more than $5,000. In 1943, Cohen's decedent (P) brought a derivative action in U.S. district
court in New Jersey, alleging that since 1929 certain managers and directors of Beneficial (D)
had engaged in a continuing and successful conspiracy to enrich themselves at the expense of the
corporation. Specific charges of mismanagement and fraud extended over a period of
eighteen years and the assets allegedly wasted or diverted exceeded $100,000,000. Cohen (P)
had demanded that Beneficial (D) institute proceedings for its recovery, but by their control of
the corporation the directors and managers prevented it from doing so, and the derivative
action was filed. In 1945, New Jersey enacted a statute that required a plaintiff having less than a
5% or $50,000 interest in a corporation to be liable for the reasonable expenses and attorney's
fees of the defense if he was unsuccessful in his suit and entitling the corporation to indemnity
before the case could be prosecuted. Beneficial (D) moved to require such security, seeking a
bond of $125,000, and Cohen's decedent (P) challenged the statute as unconstitutional. The
district court declined to fix the amount of indemnity, the court of appeals reversed, and the
Supreme Court granted review.
ISSUE: Is a statute holding an unsuccessful plaintiff liable for the reasonable expenses of a
corporation in defending a derivative action and entitling the corporation to require security for
such payment constitutional?
HOLDING AND DECISION: (Jackson, J.) Yes. A statute holding an unsuccessful plaintiff
liable for the reasonable expenses of a corporation in defending a derivative action and entitling
the corporation to require security for such payment is constitutional. A stockholder who brings
suit on a cause of action derived from the corporation assumes a position of a fiduciary character.
The Constitution does not oblige the state to place its litigating and adjudicating processes at the
disposal of such a representative, at least without imposing standards of responsibility, liability,
and accountability which it considers will protect the interests the representative elects himself
to represent. It cannot be said that the state makes such unreasonable use of its power as to
violate the Constitution when it provides liability and security for payment of reasonable
expenses if the litigation is adjudged to be unsustainable. Although it is perhaps not
the optimal determinant of liability for litigation, nothing forbids the state using the amount of
financial interest in the corporation of the litigant as a measure of his accountability. Such a
measure will undoubtedly prevent a number of the harassment suits the statute was
designed to target. Furthermore, the statute should be applied in a federal diversity case and
cannot be disregarded as a mere procedural device. Affirmed.

Eisenberg v. Flying Tiger Line, Inc.

FACTS: In July 1969, Flying Tiger (D) organized a wholly owned Delaware subsidiary, the Flying Tiger
Corporation (FTC), which in turn organized a wholly owned subsidiary, FTL Air Freight Corporation (FTL). The
three corporations then entered into a plan of reorganization under which Flying Tiger (D) merged into FTL, FTL
took over operations, and Flying Tiger (D) shares were converted into an identical number of FTL shares. The plan
was approved by the necessary two-thirds vote at the annual meeting on September 15. The effect of the merger was
that business operations were confined to a wholly owned subsidiary of a holding company whose shareholders
were the former shareholders of Flying Tiger (D). Eisenberg (D) filed a class action on behalf of himself and other
shareholders contending that the merger was a complex plan to deprive minority shareholders of any vote or
influence over the affairs of the new company and seeking to overturn the reorganization. Flying Tiger (D) moved
for an order to compel Eisenberg (P) to comply with a New York law that required a plaintiff suing derivatively on
behalf of a corporation to post security for the corporation's costs. The trial judge granted the motion, Eisenberg (P)

38
failed to comply, and his action was dismissed. Eisenberg (P) appealed, arguing that his class action was
representative, not derivative, and that the statute requiring security was not applicable.
ISSUE: Can a cause of action that is determined to be personal, rather than derivative, be dismissed because the
plaintiff fails to post security for the corporation's costs?
HOLDING AND DECISION: (Kaufman, J.) No. A cause of action that is determined to be personal, rather than
derivative, cannot be dismissed because the plaintiff fails to post security for the corporation's costs. The essence of
Eisenberg's (P) claim is that the reorganization deprived him and fellow stockholders of their right to vote on Flying
Tiger's (D) affairs. This was in no sense a right that ever belonged to Flying Tiger (D) itself. Eisenberg (P) argues
that the right belongs to stockholders per se, and that his action therefore cannot be deemed derivative. Although
there has been much debate over the precise definition of a derivative suit, the current codification deems a suit
derivative only if it is brought in the right of a corporation to procure a judgment in its favor. Such a definition
clearly supports Eisenberg's (P) argument that his suit is not derivative and therefore no security need be posted.
Reversed.
In most derivative suits, the shareholder is required to first make a demand,
and then post security. The Delaware supreme court adopted a two-prong
test to determine whether a stockholder’s claim is derivative or direct. Who
suffered the alleged harm, the corp. or the suing individual? Who would
receive the benefits of any recovery, monetary to the corp. or non-
monetary?

B. The Requirement of Demand on the Directors

Grimes v. Donald
FACTS: DSC created employment agreements with Donald gave him the right to declare a
constructive termination without cause in the event of unreasonable interference, as perceived in
good faith by Donald, through the Board or a substantial stockholder of the company. Grimes, a
shareholder, wrote to the Board, demanding that they abrogate the agreements as excessive
compensation. The Board refused and Grimes filed suit, seeking a declaration of the invalidity of
these agreements made between the Board of Directors and Donald, and requesting damages
from Donald and other members of the Board. Grimes alleged that the Board had breached its
fiduciary duties by abdicating authority, failing to exercise due care, and committing waste.
Donald claimed that the Board had made a business decision which was entitled to protection
under the business judgment rule. The Chancellor dismissed the abdication claim, which was a
direct claim. Contending that demand was excused, Grimes later filed a derivative suit alleging
waste, excessive compensation and due care claims. The Chancellor held that Grimes had
waived his right to argue that demand was excused with respect to those claims because he had
already made demand that the agreements be abrogated as unlawful. Grimes appealed.
ISSUE: If a shareholder demands that the board of directors take action and that demand is
rejected, is the board rejecting the demand entitled to the presumption that the rejection was
made in good faith unless the stockholder can allege sufficient facts to overcome the
presumption?
HOLDING AND DECISION: (Per curiam) Yes. If a shareholder demands that the board of
directors take action and that demand is rejected, the board rejecting the demand is entitled to the
presumption that the rejection was made in good faith unless the stockholder can allege sufficient
facts to overcome the presumption. Demand having been made as to the propriety of the
agreement, it cannot be excused as to the claim that the agreement constituted waste, excessive
compensation or was the product of a lack of due care. Since Grimes (P) made a pre-suit demand
with respect to all claims arising out of the agreements, he was required to plead with

39
particularity why the Board's refusal to act on the derivative claims was wrongful. The complaint
failed to include particularized allegations which would raise a reasonable doubt that the Board's
decision to reject the demand was the product of a valid business judgment. An abdication
claim can be stated by a stockholder as a direct claim, as distinct from a derivative claim, but
here the complaint failed to state a claim upon which relief could be granted. Affirmed.

First, if a shareholder has a beef against the corp., why not provide a day in
court (without a demand)? These are derivative actions, and the action is
representative. The other shareholders should have a say through their
corporate representatives. The shareholder should not be allowed to waste
the assets of other shareholders. Second, the purpose of the demand is to
allow the corp. to take over the c/a or resist it according to the judgment of
the directors. But where the directors cannot be expected to make a fair
decision, demand would be futile and is excused. Under WV law, the idea of
a written demand with a 90-day wait period is followed. Three, if a demand
is made, the P is deemed to have conceded that it was required, which in
turn makes the decision of the board on whether to dismiss a matter of
business judgment, which in turn means that the P inavariably loses
(Business Judgment Rule). And, where demand is required (or made) the P is
not entitled to discovery. Four, well-advised Ps in DE almost never make a
demand. So the issue is whether demand is excused.

Marx v. Akers
FACTS: Marx, a shareholder of IBM, commenced a derivative action against IBM alleging that
Akers, a former chief executive officer of IBM, and other directors violated their fiduciary duty
and engaged in self-dealing by awarding excessive compensation to other directors on the board.
IBM moved to dismiss the complaint for failure to state a cause of action and failure to serve a
demand on IBM's board to initiate a lawsuit based on these allegations. The supreme court
dismissed the complaint stating that Marx failed to show that demand would have been futile,
and the Appellate Division affirmed. Marx appealed.
ISSUE: Is a demand on the board of directors futile if a complaint alleges with particularity that:
(1) a majority of the directors are interested in the transaction; (2) the directors failed to inform
themselves to a degree reasonably necessary about the transaction; or (3) the directors failed to
exercise their business judgment in approving the transaction?
HOLDING AND DECISION: Yes. Demands on boards of directors are futile if a complaint
alleges with particularity that: (1) a majority of the directors are interested in the transaction; (2)
the directors failed to inform themselves to a degree reasonably necessary about the transaction;
or (3) the directors failed to exercise their business judgment in approving the transaction.
Directors are self-interested in a transaction if they receive a direct financial benefit from the
transaction that is different from the benefit to the shareholders generally. Voting oneself a raise
excuses a demand. However, the inquiry must still be made as to whether this is a sufficient basis
to support a cause of action. Courts have repeatedly held that a cause of action will not stand
alone on the basis of excessive salary raises unless wrongdoing, oppression, or abuse of a
fiduciary position is also demonstrated. The evidence presented is not ample to support Marx's
(P) allegations of wrongdoing, so the Appellate Division's order should stand. Affirmed.
40
C. The Role of Special Committees
Auerbach v. Bennett
FACTS: With the assistance of special counsel and Arthur Andersen &Co. (D), GTE's (D) audit committee
conducted an investigation into GTE's (D) world-wide operations. The audit committee subsequently released its
report, which stated that evidence had been found that, in the period from 1971 to 1975, GTE (D) had made
payments abroad and in the United States constituting bribes and kickbacks totaling more than $11,000,000, and that
some directors (D) had been involved. Auerbach (P), a shareholder, instituted a derivative action on behalf of GTE
(D) against GTE's directors (D), Arthur Andersen (D), and GTE (D), alleging breach of
corporate duties and seeking damages as reimbursement for the wrongful payments. The board of directors then
adopted a resolution creating a special litigation committee to investigate the derivative action and determine what
position GTE (D) should take. The committee comprised
three disinterested directors who had joined the board after the alleged transactions had occurred. The committee
concluded that Arthur Andersen (D) had acted in accordance with generally accepted auditing standards and in good
faith and that no proper interest of GTE (D) or its
shareholders would be served by continuing the claim against it. The committee also found that the claims against
the individual directors (D) were without merit. GTE's (D) general counsel filed for and was granted summary
judgment. Another shareholder, Wallenstein (P), was substituted as plaintiff and appealed.
ISSUE: May a court inquire as to the adequacy and appropriateness of a special litigation committee's investigative
procedures and methodologies?
HOLDING AND DECISION: (Jones, J.) Yes. A court may properly inquire as to the adequacy and appropriateness
of a special litigation committee's investigative procedures and methodologies, but may not consider factors under
the domain of business judgment. The business judgment doctrine recognizes that courts are ill-equipped to evaluate
what are and
essentially must be business judgments. However, the rule shields the deliberations and conclusions of a special
committee only if its members possess disinterested independence and do not stand in a dual relation that would
prevent an unprejudicial exercise of judgment. In this case there is nothing in the record to raise a triable issue of
fact as to the independence and disinterested status of the three directors on the special litigation committee, or as to
the sufficiency and appropriateness of the investigative procedures they employed. The derivative suit was brought
against only four members of the fifteen-member board, and the three members of the special litigation committee
joined the board after the alleged transactions occurred. To disqualify an entire board would be to render a
corporation powerless to make an effective business judgment with respect to prosecution of a derivative action. The
decision of the
disinterested special litigation committee forecloses further judicial inquiry. Affirmed.
DISSENT: (Cooke, J.) Summary judgment should not be granted prior to
disclosure proceedings, because the continuation of this suit is so
dependent upon the motives and actions of the board members (D) and the
special litigation committee, who are in exclusive possession of much of
the factual information concerning the case.

Zapata Corp. v. Maldonado

FACTS: In June 1975, Maldonado (P) instituted a derivative action against ten officers and/or directors of Zapata
(D), alleging breaches of fiduciary duty. Maldonado (P) did not first demand that the board bring the action,
believing that demand would be futile because all directors (D) were named as defendants and allegedly participated
in the wrongful acts. By June 1979, four of the directors (D) named in the action were no longer on the board, and
the remaining directors (D) appointed two new outside directors to the board. The board then created an independent
investigation committee, comprised solely of the two new directors, to investigate Maldonado's (P) allegations and
determine whether Zapata Corp. (D) should continue the litigation. The committee's determination was intended to
be final and binding upon Zapata Corp. (D). In September 1979, the committee concluded that the action should be
dismissed because it was not in Zapata Corp.'s (D) best interests. Zapata Corp. (D) filed a motion for dismissal or
summary judgment, which was granted by the court of chancery.
ISSUE: Should a court automatically grant a special litigation committee's recommendation to dismiss a derivative
action?

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HOLDING AND DECISION: (Quillen, J.) No. When assessing a special litigation committee's motion to dismiss a
derivative action, a court must: (1) determine whether the committee acted independently, in good faith, and made a
reasonable investigation, with the burden of proof on
the corporation; and (2) apply the court's own independent business judgment. A board has the power to choose not
to pursue litigation when demand is made upon it, so long as the decision is not wrongful. Where demand has been
excused, courts have struggled between allowing the
independent business judgment of a board committee to prevail and yielding to unbridled plaintiff stockholder
control. The test promulgated here allows for the balancing of these competing interests under appropriate court
supervision. While courts should be mindful of judicial overreaching, the interests at stake necessitate the fresh view
of a judicial outsider. Reversed and remanded.

In re Oracle Corp. Derivative Litigation

Facts: Shareholders of Oracle brought a derivative action asserting insider trading by four of Oracle’s board of
directors members. Oracle formed a special litigation committee (SLC) to investigate the charges in the derivative
action and to determine whether to press the claims raises, terminate the action, or settle. Two Stanford Professors
joined the Board after the allegations were made, and they were named to the SLC. The investigation was extensive
and produced a lengthy report explaining why Oracle should not pursue the claims. However, there were ties
between Stanford U, the Oracle, and the trading defendants.
Issue: Did the ties impair the independence of the SLC?
Held: The SLC has not met its burden of proving an absence of a material dispute of fact about its independence
where its members are professors at a university that has ties to the corporation and to the defendants that are the
subject of a derivative action that the committee is investigating. Motion to terminate the derivative action is
denied.

§4 The Role and Purposes of Corporations

A.P. Smith Mfg. Co. v. Barlow
FACTS: A.P. Smith Mfg. was a New Jersey corporation incorporated in 1896. Over the years it
regularly made donations to various community organizations and public universities. In 1951,
the board of directors adopted a resolution stating that it was in A.P. Smith Mfg.'s best
interest to donate $1,500 to Princeton University's annual fund. Shareholders of A.P. Smith Mfg.
questioned the corporation's authority to make the contribution on two grounds: (1) its certificate
of incorporation did not expressly authorize the donation and A.P. Smith (P) possessed no
implied power to make it; and (2) the New Jersey statutes that would have expressly authorized
the contribution did not constitutionally apply to A.P. Smith because it was created long before
their enactment. A.P. Smith Mfg. sought a declaratory judgment following the shareholder's
challenges. The court held that the donation was intra vires, and the shareholders (D) appealed.
ISSUE: Can state legislation adopted in the public interest be constitutionally applied to
preexisting corporations under the reserved power?
Held:Yes. State legislation adopted in the public interest can be constitutionally applied to
preexisting corporations under the reserved power. Fifty years before the incorporation of A.P.
Smith Mfg., the New Jersey legislature provided that every corporate charter thereafter granted
would be subject to alteration and modification at the discretion of the legislature. A similar
reserved power was incorporated into the state constitution. New Jersey courts have repeatedly
recognized that where justified by the advancement of the public interest, the reserved power
may be invoked to sustain later charter alterations even though they affect contractual rights
between the corporation and its stockholders. Therefore, a statute enacted in 1930 encouraging
and expressly authorizing reasonable charitable contributions is applicable to A.P. Smith Mfg.
and must be upheld as a lawful exercise of A.P. Smith Mfg.'s implied and incidental powers
under common law principles. Affirmed.
42
Barlow’s argument is basically that they are taking money away from the
working class peoples’ retirement funds (largest shareholders come from
pension funds) to give to artsy organizations, etc. This is free advertisement
for the corporation.

Dodge v. Ford Motor Co.

FACTS: Ford Motor Co. was incorporated in 1903 with Henry Ford as the majority shareholder
and the Dodge brothers owning ten percent of the common shares. In 1913, the Dodges formed
their own auto company, which competed with Ford. In 1916, despite having profits of almost
$174,000,000 and more than $50,000,000 cash on hand, Henry Ford announced that in the future
no special dividends would be paid, profits would be reinvested into the business to build a
smelting plant, and the price of the company's cars would be reduced. After the announcement of
the new dividend policy, John Dodge met with Ford to complain about the new policy and
offered to sell his and his brother's shares to Ford for $35,000,000. After Ford rejected the buy-
out offer, the Dodges filed suit, attacking both the dividend policy and Ford's plans to expand
manufacturing facilities. The trial court ruled in favor of the Dodges, and Ford appealed.
ISSUE: Is a corporation's primary purpose to provide profits for its stockholders?
HOLDING AND DECISION: Yes. A corporation's primary purpose is to provide profits for
its stockholders. The powers of a corporation's directors are to be employed to that end and their
discretion is to be exercised in the choice of means to attain that end. However, this discretion
does not extend to a change in the end itself, to the reduction of profits, or to the
nondistribution of profits among stockholders in order to devote them to other purposes.
The trial court was correct in ruling that a large sum of money should have been distributed to
the shareholders. Affirmed.

Shlensky v. Wrigley
FACTS: Wrigley was the majority shareholder and a director of the Chicago Cubs baseball team.
Shlensky, a minority shareholder, sought to bring a shareholders' derivative action to compel the
directors to equip Wrigley Field with lights so that night games could be played, and revenues
could be increased. The trial court sustained Wrigley's motion to dismiss over Shlensky's
contention that the refusal to install lights was a personal decision of Wrigley's and not in the
best interest of the shareholders.
ISSUE: Can a shareholders' derivative suit be based on conduct by the directors that does not
border on fraud, illegality, or conflict of interest?
RULE: A shareholder's derivative suit can only be based on conduct by the directors which
borders on fraud, illegality, or conflict of interest.
Held: No. Shlensky is attempting to use the derivative suit to force a business judgment on the
board of directors of the Chicago Cubs, but there is no showing of fraud, illegality, or conflict of
interest. There are valid reasons for refusal to install lights in the stadium. Though Shlensky
alleges that night games haven't been considered due to Wrigley's personal feelings about the
sport, Wrigley has suggested that night games in the Wrigley Field area would have a
43
detrimental effect on the neighborhood. Additionally, there is no showing that night games
would significantly increase revenues, or even that additional expenses wouldn't be required.

Chapter 4: The Limited Liability Company

§1 Formation
Water, Waste & Land, Inc. d/b/a Westec v. Lanham

§2 The Operating Agreement

Elf Atochem North America, Inc. v. Jaffari, 727 A.2d 286 (1999) – Elf (Π) and Jaffari (Δ)
entered into an agreement to form an LLC, Malek LLC. Agreement contained an arbitration
clause covering all disputes arising out of the agreement, and a forum selection clause providing
for exclusive jurisdiction of CA state & Fed Cts. Π later brings a deritative suit on behalf of
Malek LLC claiming that Δ breached its fidcuiary duty.
a. The statute involved here provides broad discretion in drafting the LLC agreement
& funishes default provisions only when the agreement is silent. It is designed to
give maximum effect to the freedom to contract & to the enforceability of LLC
agreements. Only when the agreement is inconsistent with mandatory statutory
provisions will the agreement be invalidated. The statute allows parties to
contract away their right to file suit in DE.
b. Another issue Π brought up was Malek LLC, although in existence when the
agreement was executed, did not sign the agreement, & thus never consented to
those clauses; this is a derivative suit on behalf of Malek. Ct disagrees & says that
since the members of the LLC executed the agreement, it is valid even though
Malek LLC never signed.
§3 Piercing the Corporate Veil
Kaycee Land and Livestock v. Flahive, (Wy. 2002)
Issue: In the absence of fraud, is a claim to pierce the LLC veil an available remedy?
Held: Yes. LLCs should not be treated differently than corporations. The various factors to
justify piercing the LLC veil would not be identical because of the differences in organizational
formalities, though.

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ULLCA §303 says no piercing the LLC veil. Minn. Stat. §322B.303(2) says case law conditions
for piercing corporate veil apply to LLCs as well.

II. Fiduciary Obligation

A. Limiting Fiduciary Duties by Agreement
McConnell v. Hunt Sports Enterprises, 725 N.E.2d 1193 (1999) - LLC operating agreement
provision states that”Members may compete. Members shall not in any way be prohibited from
or restricted in engaing or owning in any other businss ventrue of any nature, including any
venture which may be competitive with the business of the Company.” Hunt claims that
McConnell & other members violated a fiduciary duty by forming and joining their new limited
partnership.
a. Limited liability partnership involves same fiduciary relationship as a partnership.
1. Normally this relationship would preclude direct competition btwn members of
the company. However, terms of the operating agreement allow members
to compete w/ business of the company.
b. In competing, appellees didn’t engage in any acts that would constitute wrongful
behavior. There is no evidence that McConnell acted in a secretive manner or that
he tortiously interfered w/ prospective business relationship.

Chapter Five: The Duties of Officers, Directors, and Other Insiders

§1 The Obligations of Control: Duty of Care

Kamin v. American Express Company

Facts: Stockholders sue AmEx because they didn’t like what AmEx was doing with the shares
of DLJ that AmEx had acquired. If the company had sold the stock, it would have
recognized a $26m tax loss that could have been offset against its taxable
income. Shareholders wanted AmEx to take the benefit instead of issue the
stock as a dividend which would cause AmEx to lose the tax benefit. The
shareholders recognized the divided income equal to the FMV ($4m) of the
DLJ stock, and got a basis in the DLJ stock equal to that amount.

Held: The Court said no claim of fraud, self-dealing, bad faith or oppressive conduct in the
complaint. This was a business decision.
The courts will not impose liability for dumb decisions. Strong Abstention
doctrine use by the Court. Even if evidence of clear self-dealing by the four
directors, the Court would toss this out since can’t prove those 4 dominated
and controlled the other directors.

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Andrew M. Ballard, Majority of Companies Will Sacrifice Value to Meet
Earnings Expectations, Survey Finds; BNA Corporate Accountability Report-
Feb. 13, 2004: 3/4 of surveyed corporations would knowingly sacrifice
shareholder value to meet earnings expectations, according to a study
released by Duke U and U of Wash Feb. 9. According to “The Economic
Implications of Corp. Financial Reporting” financial executives are focused on
short-term results and are willing to sacrifice long-term value to achieve
them.

Smith v. Van Gorkem

FACTS: Van Gorkom (Δ), Trans Union CEO, began to explore the opportunity to sell to a
company w/ more taxable income. CFO tells him a leveraged buy-out by mgmt at $50/share
would be easy, but $60/share difficult. CEO said he would take $55/share for his shares. CEO
then met with a corporate takeover specialist, who agreed to make a cash-out merger offer at
$55/share. Senior mgmt & CFO responded negatively to this, but he still brought it to the Bd.
CEO gave the Bd a 20 min presentation & the Bd approved the proposed Merger agreement, w/o
reserving the right to actively solicit alternate offers ($55/share higher than market price of
$39/share).
HELD: Πs attacking a Bd decision must rebut the presumption that its business judgment was an
informed one. Directors are liable if they were grossly negligent in failing to inform
themselves. Directors did not adequately inform themselves as to (1) the CEO’s role in forcing
company’s sale & in establishing the per share purchase price, and (2) the intrinsic value of the
company (not necessarily $39/share market). They were grossly negligent in approving the sale
in such a short period of time & without important info.
a. The Bd breached their fiduciary duty of care to stockholders by (1) failure to
inform themselves of all info reasonably available to them and relevant to
their decision to recommend the merger and (2) failure to disclose all
material info such as a reasonable stockholder would consider important in
deciding whether to approve the offer.
b. Dissent - Experienced directors such as these are not easily taken in by a "fast
shuffle." Wouldn’t have entered into a multi-million dollar corporate transaction
without being fully informed.
Timeline: Aug-Sept 1980: Mgmt discussions. Sept 13-19 1980: Van Gorkem
agrees to LBO (leveraged buy-out). Sep 20 1980: Senior Mgmt Meeting and
TU BoD approves merger after 2 hour meeting. Oct 8 1980: BoD approves
revised deal. Feb 10 1981: TU shareholders approve merger by 69.9% to
7.25%.
The party must prove gross negligence by directors who failed to inform
themselves of “all material information reasonably available to them.”
The record, apart from the company’s historic stock market price and Van
Gorkom’s long association with Tran Union, is devoid of any competent

46
evidence that $55 represented the per share “intrinsic value” of the
company.
The board knew Pritzker was willing to pay a $17 premium over the
prevailing market price. Why wasn’t that enough? What is the firm worth to
Pritzker? Under Del. 141(e), BoD are able to defend actions like this on the
basis that they were lied to in the reports by directors. In this case, there
were no reports relied upon.

Francis v. United Jersey Bank

Creditors sue the trustee of Pritchard’s estate.

§ 2 Duty of Loyalty
A. Directors and Managers
Bayer v. Beran, 49 N.Y.S.2d 2 (Sup.Ct.1944)
Facts: The Doctors Dreyfus and their families own about 135,000 shares of common stock, the
other directors about 10,000 share of a total outstanding issue of 1,376,500 shares. Some of
these tother directors were originally employed by Dr. Camille Dreyfus, the president of the
company. His wife, to ho he has been married for about 12 years is known professionally as Miss
Jean Tennyson and is a singer of wide experience. All ofher suggestions as to personnel were
adopted by the advertising agency.

History: The advertising cause of action charges the directors with negligence, waste and
improvidence in embarking the corporation upon a radio advertising program beginning in 1942
and costing about $1 million a year. IT is further charged that they were negligent in selecting
the type of program and in renewing the radio contract for a second year. Additionally, there is a
charge that the directors were motivated by a noncorporate purpose in causing the radio program
to be undertaken in expending large sums of money therefore

Issue: Was there a breach of fiduciary duty on the part of the directors?

Holding: No. Directors acted in free exercise of their business judgment

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Rule: (1) The business judgment rule yields to the rule of undivided loyalty, to avoid the
possibility of fraud and to avoid the temptation of self-interest (2) included within the scope of
undivided loyalty is every situation in which a trustee chooses to deal with another in such close
relation with the trustee that possible advantage to such other person might influence,
consciously or unconsciously, the judgment of the trustee (3) Personal transactions of directors
with their corporations when challenged are examined with the most scrupulous care, and if there
is any evidence of improvidence or oppression, any indication of unfairness or undue advantage,
the transactions will be voided (3) Directors’ dealings with the corporation are subjected to
rigorous scrutiny and where any of their contracts or engagement with the corporation are
challenged the burden is on the director not only to prove the good faith of the transaction but
also to show its inherent fairness form the viewpoint of the corporation and those interested
therein (4) As a general rule, directors acting separately and not collectively as a board cannot
bind the corporation

Reasoning: The radio program was not adopted on the spur of the moment or at the whim of the
directors. They acted reading studies reported to them by the advertising department. Some care,
diligence, and prudence were exercised by the directors before they committed the company to
the program. The president knew his wife might be one of the paid artists on the program, but the
other directors did not know this until they had approved the campaign of radio ads and the
general type of radio program. Evidence fails to show that the program was designed to foster or
subsidize her career as n artist or to furnish a vehicle for her talents. Failure to follow formal
requirements was not fatal when the board was close working.

Benihana of Tokyo, Inc. v. Benihana, Inc., 906 A.2d 114 (Del.2006)

Facts: Benihana is a subsidiary of Benihana of Tokyo. Behnihana hired WD Partners to evaluate
its facilities and to plan and design appropriate renovations. Benihana hired Morgan Joseph &
Co. to develop financing options. On January 9, 2004, Fred Joseph, of Morgan Joseph, met with
Schwartz, Dornbush, and John E. Abdo, the board’s executive committee. Joseph expressed
concern that Benihana would not have sufficient available capital to complete the Construction
and Renovation Plan and pursue appropriate acquisition. The full board met with Joseph on
January 24,2009. He went over all the financing alternatives that he had discussed with the
executive committee, and recommended that Benihana issue convertible preferred stock, which
would provide the funds needed and also put the company in a better negotiating posistion if it
sought additional financing. Joseph gave the directors a board book, marked “confidential”
containing an analysis of the proposed stock issuance (the Transaction). The Board met again on
Bebruary 17, 2004, to review the terms of the transaction. Shortly after this meeting, Abdo
contacted Joseph and told him that BFC financial corporation was interested in buying the new
convertible stock. In April 2005, Joseph sent BFC a private placement memo. Adbo
(representing BFC) negotiated with Joseph for several weeks. On April 22,2004, Abdo sent a
memo to Dornbush, Schwatz, and Joseph listing the agreed terms of the Transaction. He did not
sent it to any other member of the Benihana Board. At its next meeting on May 6, 2004, the
entire board was officially informed of BFC’s involvement in the Transaction. Abdo made a
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presentation on behalf of BFC and then left the meeting. Joseph distributed an updated board
book, which explained that Abdo had approached Moran Joseph on half of BFC and included the
negotiated terms. On May 18, 2004, the stock issuance was publicly announced. Aoki’s counsel
then sent a letter asking the board to abandon. The letter was read at a May 20 meeting and the
board then approved the transaction in spite of the letter. June 8, 2004, Benihana and BFC
executed the stock purchase agreement. Board approved resolutions ratifying the execution and
approved the transaction again after suit was filed.

History: The trial court found that the board was not informed that Abdo had negotiated the deal
on behalf of BFC. But the board did know that Abdo was a principal of BFC. After discussion,
the board reviewed and approved the transaction, subject to receipt of a fairness option

Issue: (1) Section 144(a)(1) approval (2) Abdo’s alleged fiduciary duty (3) Dilution of BOT’s
voting power

Holding: (1) Directors understood that Abdo was BFC’s representative in the transaction (2) The
record does not support the claim that Abdo breached his duty of loyalty (3) There is ample
support for the trial court’s factual determination that the transaction was subjective and based on
the best financing vehicle

Rule: (1) Section 144 of Delaware General Corporation Law provides a safe harbor for interested
transactions if the material facts as to the director’s relationship or interested and as to the
contract or transaction are discloses or are known to the Board and the Board, in food faith,
authorizes the contract or transaction by the affirmative votes of a majority of the disinterested
directors (2) Corporate action may not be taken for the sole and primary purpose of
entrenchment

B. Corporate Opportunities

Broz v. Cellular Information Systems, Inc., 673 A.2d 148 (Del.1996)

Facts: Broz is the President and sole stockholder or RFBC. Broz was also an outside
director member of the Board of plaintiff, CIS, a competitor of RFBC at the time of the events at
issue. In May of 1994, Broz was contacted about RFBC’s possible acquisition of Michigan-2.
Michigan-2 was not offered to CIS, and directors of CIS told Broz that CIS was not at all
interested in the transaction. June 28, 1994 CIS directors entered into agreements with
PriCellular to sell their shares in CIS. PriCellualr’s interest in Michican-2 was fully disclose to
CIS’s chief executive. On Nov 14, 1994, Borz agreed to pay 7.2 million for the license, thereby
meeting the terms of Pri’s option agreement. An asset purchase was then executed between seller
and RFBC. Nine days later, Pri closed its tender offer for CIS. Prior to this, Pri owned no
equality interest in CIS
History: Court of Chancery held that Broz had usurped a corporate opportunity?
Issue: Did Broz breach his fiduciary duties to CIS by usurping a corporate opportunity?
Holding: No

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 Rule: (1) If there is presented to a corporate officer or director of a business opportunity
which the corporation is financially able to undertake, is, from tits nature, in the line of the
corporation’s business and is of practical advantage to it, is one in which the corporation has an
interest or a reasonable expectancy, and, by embracing the opportunity, the self-interest of the
officer or director will be brought into conflict with that of the corporation, the law will not
permit him to seize the opportunity for himself (2) Financially, the corporate opportunity
doctrine is implicated only in cases where the fiduciary’s seizure of an opportunity results in a
conflict between the fiduciary’s duties to the corporation and the self-interest of the director as
actualized by the exploitation of the opportunity (3) The It is not the law of Delaware that the
presentation to the board is a necessary prerequisite to a finding that a corporate opportunity has
not been usurped.
Reasoning: CIS was not financially capable of exploiting the opportunity. Although the
opportunity was within CIS’s line of business, it is not cognizable that they had an interest or
expectancy in the license. Broz took care not to usurp any opportunity which CIS was willing
and able to pursue. Broz was not obligated to refrain from competition with Pri.

In re eBay, Inc. Shareholders Litigation, 2004 WL 253521 (Del.Ch.)(Memorandum Opinion)

Facts: Defendants Omidyar and Skoll founded ebay. In 1998, ebay retained Goldman
Sachs and other investment banks to underwrite and IPO of common stock. Sachs was the lead
underwriter. Around 1998-99, ebay made a second offerind and Sachs again was the lead
underwriter. Sachs was asked in 2001 to serve as ebays financial advisor in acquiring PayPal.
During the same time period, Sachs rewarded the individual defendants by allocating to them
thousands of IPO shares at the initial offering price. Defendants were able to flip investments
into instant profits. Omidyar has been ebay’s CEO, CFO, and President. He is ebays largest
stockholder. Sahcs allocated him shared in at least forty IPOs at the initial offering price. Four
other defendants, each ebay officers or directors, or both, profited in the millions of dollars on
numerous issues of IPO allocated to them by Sachs.
History: (1) Plaintiffs claim that defendants usurped a corporate opportunity of ebay,
defendants argue that this is not a corporate oppornity within ebay’s line of business or one in
which ebay had an interest or expectancy
Issue: Did the defendants usurp a business opportunity?
Holding: Yes, defendant’s motion to dismiss denied
Rule: (1) Usurp rule above (2) A cognizable claim is stated on the common law ground
that an agent is under a duty to account for profits obtained personally in connection with
transactions related to his or her compnay
Reasoning: (1) Ebay financially was able to exploit the opportunities in question and
ebay was in the business of investing in securities (2) the conduct challenged involved a large
investment bank that regularly did business with a company steering highly lucrative IPO
allocations to select insider directors and officers at that company, agedly both to reward them
for past business and to induce them to direct future business to that investment bank (3)
Defendants breached duty of loyalty by accepting a gratuity that rightfully belonged to ebay, but
that was improperly diverted to them.

C. Dominant Shareholders - skipped

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D. Ratification

Fiegler v. Lawrence, 361 A.2d 218 (Del. 1976)

Facts: Defendant Lawrence in his individual capacity acquired certain antimony
properties under a lease-option for $60,000. Lawrence offered to transfer the properties to Agau,
but after consulting with Agau’s Board he and they agreed that the corporation’s legal and
financial position would not permit acquisition and development of the properties at that time.
Thus it was decided to transfer the properties to USAC, a closely held corporation formed just
for this purpose, a majority of whose stock was owned by the individual defendants. Agau was
gratned a long term option to acquire USAC if the properties proved to be of commercial value.
The option agreement was executed. Upon its exercise and approval by Agau shareholders, Agau
was to deliver 800,000 shares of its restricted investment stock for all authorized and issued
shares of USAC. The exchange was calculated on the basis or reimbursement to USAC and its
shareholders for their costs in developing the properties to a point where ti could be ascertained
if they had commercial value. Agau board resolved to exercise the option, and this was approved
by a majority of shareholders.
History: Derivative action brought on behalf of Agau against its officers and directors
and USAC to recover the 800,000 shares and for an accounting
Issue: Whether the defendants in their capacity as directors and officers of both
corporations wrongfully usurped a corporate opportunity belonging to Agau, and whether all
defendants wrongfully profited by causing Agau to exercise an option to purchase that
opportunity
Holding: Defendants proved the intrinsic fairness of the transaction
Rule: (1) Shareholder ratification of an interest transaction, although less than
unanimous, shifts the burden of proof to an objecting shareholder to demonstrate that the terms
are so unequal as to amount to a gift or waste of corporate assets, however this is not the case if
the majority of shares voted in favor were cast by officers and directors in their capacity as Agau
shareholders
Reasoning: Agau received properties which by themselves were of substantial value, and
received a promising potential self-financing and profit generating enterprise with proven
markets and commercial capability which could be expected to provide Agau with the cash it
needed to undertake further exploration and develop its own properties.

In re Wheelaborator Technologies, Inc. Shareholders Litigation, 663 A.2d 1194

(Del.Ch.1995)
Facts: Waste bought 22% of WTI stock and elected four of its own directors to serve on
WTI’s eleven member board. Waste and WTI negotiated a merger agreement in which Waste
would acquire another 33% of WTI stock, and WTI shareholders would receive .574 WTI shares
and .469 Waste shares for each WTI share they held. To consider the agreement, WTI’s board
held a special meeting. All members other than Waste designees attended. Investment bankers
and WTI’s attorney’s declared the transaction was fair. The seven non-Waste directors of WTI
then unanimously approved the merger agreement. Upon the completion of that vote, the court
Waste directors joined the meeting and the full board unanimously approved it as well. The two
firms the distributed a proxy statement explaining the transaction to WTI shareholders. At a

51
special shareholder meeting, a majority of WTI shareholders (not counting Waste) approved the
agreement
History: Plaintiffs brought suit, claiming that the defendants breached their duty of
disclosure because the proxy statement issued in connection with the merger was materially
misleading in several respects. The main focus of the complaint was that the WTI had
deliberated only three hours before voting to approve and recommending to shareholders.
Issue:
Holding: Summary judgment granted dismissing duty o disclosure claim. The review
standard applicable was business judgment with plaintiffs having the burden of proof
Rule: (1) The effect of an informed vote of disinterested shareholders it to extinguish the
claim that the Board failed to exercise due care in negotiating and approving a decision (here a
merger) (2) “Interested” transactions will not be voidable if approved in good faith by a majority
of disinterested shareholders. Approval by fully informed, disinterested shareholders pursuant ro
14(a)(2) invokes the business judgment rule and limits judicial review to issue of gift or waste
with the burden of proof upon the party attacking the transaction (3) In a parent-subsidiary
merger the standard of review is ordinarily entire fairness, with the directors having the burden
of proving that the merger was entirely fair, but where the merger is conditioned upon approval
by a majority of the minority stockholder vote, and such approval is granted, the standard of
review remains entire fairness, but the burden of demonstrating that the merger was unfair shifts
to the plaintiff
Reasoning: The argument lacked evidentiary support. IT is reasonable to infer that WTI’s
directors had, and were able to draw upon, a substantial working knowledge of Waste during the
March 30,1960 meeting. The merger was approved by a fully informed vote of a majority of
WTI’s disinterested stockholders. No evidence was presented that Waste, a 22% stockholder
exercise de jure or de facto control over WTI such that a fairness standard was necessary

§4 Disclosure and Fairness

A. Definition of a Security
Robinson v. Glynn, 349 F.3d 166 (4th Cir. 2003)
Facts: Glynn was GeoPhone’s majority shareholder and chairman. Geohone became a
LLC in September of 1995. Gylnn and his associates contacted Robinson, who pledged to invest
up to $25 million in Geophone, LLC if the field test indicated that CAMA worked in the
GeoPhone system. $14 million was to be invested after the field test. Engineers hired by Glenn
performed the test but, with Glynn’s knowledge, did not use CAMA. Glynn told Robinson that
the field test had been a success. Pursuant to agreements, Robinson received 33,333 of
GeoPhone’s shares. On the back of the share certificates the restrictive legend referred to the
certificates as shares and securities. It also specified that the certificates were exempt from
registration under the Securities Act of 1933 and that the certificates could not be transferred
without proper registration under the federal and state securities laws. In 1998, Robsinson
learned for the first time that the CAMA technology had never been implemented. Plaintiff,
Robinson, filed suit against Glynn, Glynn Scientific, Inc., and Geophone Compnay, LLC
alleging that Glenn committed federal securities fraud when he sold Robinson a partial interest in
GeoPhone Company.
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 History: The district court held that Robinson’s membership interest in GeoPhone was
not a security and dismissed his securities fraud claim.
Issue: Was the dismissal proper?
Holding: Affirmed, because Robinson was an active and knowledgeable executive at
GeoPhone, rather than a mere passive investor
Rule: (1) In order to establish a claim under Rule 10b-5, claimant must prove fraud in
connection with the purchase of securities (2) An investment contract is “a contract, transaction
or scheme whereby a person invests his money in a common enterprise and is led to expect
profits solely from the efforts of the promoter or a third party” (no court has required the investor
to expect profits “solely” from the efforts of others” (3) Agreements do not annul the securities
laws by retaining nominal powers for investors unable to exercise them (4) The question must be
whether an investor as a result of the investment agreement itself or the factual circumstances
that surround it, is left unable to exercise meaningful control over his investment (5) Agreements
cannot invoke laws simply by labeling commercial ventures as securities. It is the “economic
reality” of a particular instrument, rather than the label attached to it, that ultimately determines
whether it falls within the reach of the securities laws (6) Securities law applies when an
instrument is both called stock and bears stocks usual characteristics, typically:
i. the right to receive dividends contingent upon an apportionment of profits
ii. negotiability
iii. the ability to be pledged of hypothecated
iv. the conferring of voting rights in proportion to the number of shares owned; and
the capacity to appreciate in value
Reasoning: Robinson not only had the power to appoint two of the board members, but
he himself assumed one of the board seats and was named as the board’s vice-chairman. The
board, in turn, delegated extensive responsibility to a four-person executive committee of which
Robinson was also a member. Robinson carefully negotiated for a level of control antithetical to
the notion of member passivity required to find an investment contact under the federal securities
laws.
• Robinson v. Glynn
o investment contract analysis
 investment of money
 in a common enterprise
 with an expectation of profit
 from the efforts of others

Doran v. Petroleum Management Corp., 545 F.2d 893 (5th Cir. 1977)
Facts: PMC organized a California limited partnership. PMC contacted only four
other persons with respect to possible participation in the partnership. All but the plaintiff
declined. PMC periodically sent Doran production information on the completed oil wells of the
limited partnership. Throughout this period, the wells were deliberately overproduced, ultimately
resulting in decreased yields and default on a not for which Doran was primarily responsible. A
judgment was obtained against Doran, PMC and two other signatory officers of PMC for
$50,815.50 plus interest and attorney’s fees. Doran filed suit seeking damages for breach of
contract, rescission of the contract based on violations of the Act, and a judgment declaring
defendants liable for payment of the state judgment. It is established that no registration
53
statement had ever been filed. Defendants sold or offered to sell these securities, and defendants
used interstate transportation or communication in connection with the sale or offer of sale.
History: Investor brought suit to rescind a purchase of limited partnership interest.
The district court held that the offering was a private placement. Defendants raise an affirmative
defense that the relevant transactions were exempted from registration under 4(2).
Issue: Whether the sale was part of a private offering exempted by 4(2) of the Act,
from the registration requirement of that Act
Holding: It was not a private placement. Reversed and remanded so that the trial
court could determine if offerees knew or had a realistic opportunity to learn facts essential to an
investment judgment
Rule: (1) Defendants bear the burden of the affirmative defense that an offering
was private (2) Four factors are relevant to whether an offering qualifies for 4(2) exemption:
i. number of offerees and their relationship to each other and the issuer
ii. the number of units offered
iii. the size of the offering
iv. the manner of the offering
(3) The applicability of 4(2) should turn on whether the particular class of persons
affected needed the protection of the act, which turns on the knowledge of the offerees (4) The
number of offerees, not the number of purchasers, is the relevant figure in considering the
number of persons involved in an offering. A private placement claimant’s failure to adduce any
evidence regarding the number of offerees will be fatal to the claim (5) Evidence of a high
degree of business or legal sophistication on the part of all offerees does not suffice to bring the
offering within the private placement exception (6) If plaintiffs do not possess the information
requisite for a registration statement, they could not bring their sophisticated knowledge of
business affairs to bear in deciding whether or not to invest (7) There must be sufficient basis of
accurate information upon which the sophisticated investor may exercise his skills (8)
Availability of information means either disclosure of or effective access to the relevant
information
Reasoning: A small number of units were offered, with relatively modest financial
stakes, and the offering was characterized by personal contact between the issuer and the
offerees free of public advertising or intermediaries. The record does not show that defendants
proved that they were entitled to the limited sanctuary afforded by 4(2). The record indicated that
eight investors were offered limited partnership shares, a total consistent with a finding of a
private offering. However, not all of the offerees were informed of the facts.
• Doran v. Petroleum Management Corp
o Private Placement Test: applied
 Four factors
• number of offerees and relationship to issuer
• number of units offered (small number (4 or 8?) “a total…entirely
consistent with a private placement.” 25 person rule of thumb)
• size of the offering
• manner of offering
 Relationship to issuer:
• offeree’s knowledge and sophistication
• offerees’ access to information
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 •required of all investors or all offerees?
•(offerees)
•How much information required? (what would have been found in
a registration statement
• How may information be provided? (private placement
memorandum, access to files and records)
o The private placement test is the most predominant exemption for determining
whether a security needs to be registered

Escott v. BarChris Construction Corp., 283 F.Supp. 643 (SDNY 1968)

Facts: Plaintiffs allege that the registration statement with respect to the
debentures contained material false statements and material omissions. Defendants fall into three
categories: (1) those who signed the registration statement (2) the underwriters; and (3)
BarChris’s auditors. Bar Chris was in constant need of cash to finance its operations, a need
which grew more pressing as operations expanded. he proceeds of the sale of debentures
involved in this action were to be devoted, in part at least, to fill that need. Bar Cris filed a
petition for bankruptcy. BarChir defaulted in the payment of the interest due on the debentures.
History: Action by purchasers of 5 ½ per cent convertible subordinated fifteen
year debentures of BarChirs. Plaintiffs purport to sue on their own behalf and on behalf of other
present and former holders of the debentures. All defendants to which it was available, pleaded
the affirmative defense of due diligence.
Issue: (1) Did the registration statement contain false statement of fact, or did it
omit to state facts which should have been stated in order to prevent it from being misleading;
(2) if so, were the facts which were falsely stated or omitted “material within the meaning of the
act; (3) if so, have defendants established their affirmative defenses?
Holding: (1) Yes (2) yes (3) no. Defendants’ motions to dismiss are denied.
Rule: (1) It is a prerequisite to liability under section 11 of the act that the fact
which is falsely stated in a registration statement, or the fact that is omitted when it should have
been stated to avoid misleading, be “material” (2) “material” matters are those as to which an
average prudent investor ought reasonably to be informed, and which such an investor needs to
know before he can make an intelligent, informed decision whether or not the buy the security
(3) The liability of a director who signs a registration statement does not depend upon whether or
not he read it or, if he did, whether or not he understood what he was reading (4) Section 11
imposes liability in the first instance upon a director, no matter how new he is. He is presumed to
know his responsibility when he becomes a director. He can escape liability only by using that
reasonable care to investigate the facts which a prudent man would employer in the management
of his own property. (5) The statute imposes liability for untrue statements regardless of whether
they are intentionally untrue
Reasoning: There was an abundance of material misstatement pertaining to the
1961 affairs. The experts did not purport to certify the 1961 figures, some of which are expressly
stated in the prospectus to have been unaudited.
Affirmative Defense Analysis:
(1) Vitolo (president) and Pugliese (vice president)

55
 Could not have believed that the registration statement was wholly
true and that no material fact had been omitted. There is nothing to show
that they made any investigation of anything which they may not have
known about or understood. They have not proved their due diligence
defense.
(2) Kircher (treasurer and CFO)
Knowing the facts, Kircher had reason to believe that the expertise
portion of the prospectus was in part incorrect. he could not shut his eyes
to the facts and rely on Peat, Marwick (experts) for that portion
(3) Birnbaum (house counsel and assistant secretary, became secretary and
director on April 17,1961) Signed the later amendments, thereby becoming
responsible for the accuracy of the prospectus in its final form. Having failed
to make an investigation into the truth of all the statements in the
unexpertised portion of the document which he signed, he did not have
reasonable ground to believe that all these statements were true.
Birnbaum did not establish his due diligence defense except as to the
audited 1960 figures.
(4) Auslander (“outside” director)
knew that Peat, Marwick had audited the 1960 figures. He believed
them to be correct because he had confidence in P,M. He had no
reasonable ground to believe otherwise. As to the nonexpertised portions,
however, he made no investigation to the accuracy of the prospectus.
Had not established his due diligence defense with respect to the
misstatements and omissions in those portions of the prospectus other
than the audited 1960 figures.
(5) Grant (director, his law firm was counsel in matters pertaining to
registration of securities)
He drafted the registration statement for the debentures. He is sued as
both director and signer of the registration statement. Grant honestly
believed registration statement was true and that no material facts had
been omitted from it. There were things which Grant could readily have
checked which he did not check. There are too many instances in which
Grant failed to make an inquiry which he could easily have made which if
pursued, would have put him on his guard. He has not established his
due diligence defense except as to the audited 1960 figures.
(6) Peat, Marwick (specifically, Berardi, who did most of the work)
Peat, Marwick did not have reasonable ground to believe and did
believe that the 1960 figures were true and that no material fact had been
omitted from the registration statement which should have been included in
order to make the 1960 figures not misleading. Berardi simply asked
questions and got answers which he considered satisfactory, and
did nothing to verify them. He did not spend an adequate amount of time
on a task of this magnitude.

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Basic Inc. v. Levinson, 485 U.S. 224 (1988)
Facts: Beginning in September 1976, Combustion representatives had meetings and
telephone conversations with Basic officers and directors, including petitioners here, concerning
the possibility of a merger. During 1977 and 1978, Basic made three public statements denying
that it was engaged in merger negotiations. In December of 1978, Basic asked the NYSE to
suspend trading in its shares and issued a release stating that it had been approached by another
company concerning a merger. On December 19, Basic’s board endorsed Combustion’s offer of
$46 per share for its common stock, and on the following day publicly announced its approval of
Combustion’s tender offer for all outstanding shares. Respondents are former Basic shareholders
who sold their stock after Basic’s first public statement of October 21, 1977, and before the
suspension of trading in December 1978.
History: Respondents brought a class action suit against Basic and its directors, asserting
that defendants issued there false and misleading public statements and thereby were in violation
of 10(b) of the 1934 Act and of Rule 10b-5. Respondents allege that they were injured by selling
Basic shares at artificially depressed prices in a market affected by petitioners’ misleading
statements and in reliance thereon. The District Court certified the class but granted summary
judgment for the defendants. The Circuit Court affirmed the class certification, but reversed the
District Court’s summary judgment and remanded the case
Issue: (1) Whether the courts below properly applied a presumption of reliance in
certifying the class, rather than requiring each class member to show direct reliance on Basic’s
statements. (2) Whether the information concerning the existence and status of preliminary
merger discussions is significant to the reasonable investor’s trading decision. (3) Whether it was
proper for the courts below to apply a rebuttable presumption of reliance, support in part by the
fraud-on-the-market theory.
Holding: (1) The class, as certified, has established the threshold facts for proving their
loss. (2) There is no valid justification for artificially excluding from the definition of material
information concerning merger discussions merely because the agreement in-principle as to price
and structure had not yet been reached by the parties or their representatives. (3) An investor
may rely on public material representation.
Therefore, case remanded for reconsideration of the question whether a grant of summary
judgment is appropriate on the record. Judgment of the court of appeals vacated, and the case
remanded to that court for further proceedings consistent with the opinion.
Rule: (1) a private cause of action exists for violation of 10(b) and rule 10b-5 (2) an
omitted fact is material if there is a substantial likelihood that a reasonable shareholder would
consider it important in deciding how to vote (3) to fulfill the materiality requirement there must
be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the
reasonable investor as having significantly altered the “total mix” of the information made
available (4) Materiality will depend at any given time upon a balancing of both the indicated
probability that the event will occur and the anticipate magnitude of the event in light of the
totality of the company activity (5) An investor’s reliance on any public material
misrepresentations, therefore, may be presumed for purposes of a rule 10b-5 action
Reasoning: Merger negotiations, because of the ever-present possibility that the
contemplated transaction will not be effectuated, are contingent or speculative in nature, it is
difficult to ascertain whether the reasonable investor would have considered the omitted
information significant at the time.

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• Basic
o President of Basic made three public statements that they were not in
negotiations when, in fact, they were
o Basic entered a merger deal
o Combustion had been negotiating a merger with Basic for 2 year
o Rumors about the deal persistently circulated, but Basic consistently
denied them
o Merger announced December 19, 1978 - priced at $46
o Plaintiff class: investors who sold stock between time the rumors
started and time the announcement was made
 Claim they could have obtained a higher price had Basic not issued
denials
o Why did Basic deny the rumors?
 It made it a cheaper transaction
o Issues:
 Were Basic’s statements materially false?
• Standard: whether there is a substantial likelihood that a reasonable
shareholder would consider the fact important. TSC Indus., Inc. v. Northway,
Inc. (1976)
o Highly fact dependent inquiry
o Where 10b-5 liability is premised on an omission of material fact,
liability can only arise where the defendant had a duty to disclose
o Basic probably did not have a duty to disclose on these facts - Issue
not decided
o In a class action suit, under a fraud-on-the-market theory, reliance on
integrity of the market price is presumed - so investor need not have seen
misrepresentation (the fraud on the market theory is based on the premises
that, in an open and developed securities market, the price of a company’s
stock is determined by the availability of information)
o Efficient Capital Market Hypothesis
 Thesis: in an efficient market, current prices always and fully reflect all
relevant information about the commodities being traded
o Derivatively Informed Trading
 The market sometimes behaves as thought it knows nonpublic
information
 Often the result of derivatively informed trading:
• some market participants observe insider activity and follow
• volume and/or price ticks attract other investors
o Reliance
 Invoked when there is a material public misrepresentation and there is
an efficient market
o How do you rebut the presumption?
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 “market makers” not deceived
 corrective statements
 specific plaintiffs would have sold anyway

Deutschman v. Beneficial Corp., 841 F.2d 502 (3rd Cir. 1988)

Facts: Caspersen and Halvorsen, on Beneficial’s behalf issued statements which they
knew to be false and misleading about insurance division problems, to the extent that the
problems had passed. The claim is that these statements placed an artificial floor under the
market price of B’s stock and that purchasers of B’s stock and purchasers of call options in B’s
stock made purchases at prices which were artificially inflated by the market’s reliance on
defendant’s misstatements, and that purchasers of both stock and call options suffered losses as a
consequence.
History: 12(b)(6) dismissal of plaintiff’s class action complaint against Beneficial
Corporation, Finn M.W. Caspersen, Benificial’s Chairman and CEO, and Andrew C. Halvorsen,
its CFO. Complaint alleged violation of 10(b) of the Act
Issue: Did plaintiff have standing as purchaser of an option contract to seek damages
under 10(b) for affirmative misrepresentation?
Holding: Yes
Rule: (1) Section 10(b) prohibits use in connection with the purchase or sale of any
security any manipulative or deceptive device or contrivance in contravention of such rules and
regulations as the SEC may prescribe (2) Plaintiffs in 10(b) actions need not be in any
relationship of privity with the defendant charged with misrepresentation
Reasoning: The compliant satisfies every requirement for 10(b) damage action imposed
by the Supreme Court when dealing with affirmative misrepresentations which may affect the
market price of a security.

§ 5. Inside Information

Goodwin v. Agassiz, 283 Mass. 358 (1933)

Facts: Agassiz bought 700 shares (through a broker) of Cliff Mining Co., owned by
Goodwin at the time. Goodwin was a former stockholder who sold his shares
contemporaneously. Agassiz at the time knew of a geologist’s theory about the existence of
copper on the property that Goodwin did not know about. Goodwin sued.
Issue: Did Agassiz have the right to buy a stock from Goodwin without disclosing the
theory to him first? Did Agassiz have a duty under state law to disclose the information to
Goodwin?
Held: Agassiz had a right to buy and no duty to disclose the knowledge to Goodwin first.

SEC v. TX Gulf Sulphur Co. 401 F.2d 833 (2d Cir. 1969)

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 Facts: TGS began exploratory drilling in Canada. Decided to buy a promising area, and
told its employees to keep all of the drilling results secrets. After the purchase, TGS employees
and their “tippees” bought a significant number of shares. Rumors circulated through Canada.
On April 11, the NY Herald Tribune and NY Times reported on the rumored ore strike. So, the
VP Fogarty drafted a press release to quell the rumors on April 13. He stated that drilling and
examinations had been made, but nothing of value and more drilling would need to be done to
reach a definite conclusion. On April 16, official statement disclosing the discovery was made at
10am. Clayton purchases 200 shares on the 15th. Crawford purchased 300 on the 16th before
the release was published. Coates left the press conference and called and ordered 2000 shares
for family trust accounts.

Issue: Individual defendants in violation of 10b-5 for not disclosing material information? Did
the corporation violate Rule 10b-5 for the April 12 press release issuance?

Rules: Insiders: Anyone in possession of material information must either disclose to investing
public before trading or abstain from trading until it is disclosed. “Material” information is that
which a reasonable man would attach importance to determine his choice of action in the
transaction in question. Corporation: The release must have been “in connection with the
purchase or sale of any security” and have caused reasonable to rely on them.
Held: The Individual Ds are in violation of 10b-5. Remand for corporation.

Dirks v. SEC, 463 U.S. 646 (1983)

Facts: Dirks investigated into allegations of corporate fraud in another company after told by a
former officer of that company. Told Wall Street Journal all about it, but they didn’t believe
him. Dirks spread word, and the company’s stock fell. Wall Street Journal published story and
mentioned Dirks’s involvement. SEC filed a complaint against the company and began
investigating Dirks. ALJ found Dirks for aiding and abetting of 10b-5 by repeating the fraud
allegations to investors who later sold their stock.
Issue: Is a tippee who has no connection to a corporation liable for disclosure of information to
investors who relied on it in trading?
Held: Dirks had no duty to refrain from using the insider information he obtained. A tippee only
has a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic
information only when the insider has breached a fiduciary duty. The tippee’s liability is
derivative of the tipper’s, “arising from his role as a participant after the fact in the insider’s
breach of a fiduciary duty.” A tippee therefore can be held liable only when: The tipper

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breached a fiduciary duty by disclosing info the tippee, and the tippee knows or has reason to
know of the breach of duty.
United States v. O’Hagan 521 U.S. 642 (1997)

Facts: Lawyer at firm retained by Grand Met regarding a tender offer to Pillsbury purchased
shares, options before Grand Met made its tender offer.

Held: The misappropriation theory is a valid basis on which to impose insider trading liability.
A fid’s undisclosed use of info belonging to his principal, without disclosure of such use to the
principal, for personal gain constitutes fraud in connection with the purchase or sale of a security
and thus violates Rule 10b-5.

§6 Short-Swing Profits
Reliance Electric Co. v. Emerson Electric Co. 404 U.S. 418 (1972)
Facts: On June 16, Emerson acquired 13.2% of Dodge stock pursuant to a tender offer it
made in an unsuccessful attempt to take over Dodge. Then Dodge merged with Reliance, and
Emerson decided to sell enough shares to bring its holdings below 10% to immunize the
remainder of its shares from liability under §16(b). Emerson sold enough to reduce its holdings
to 9.96% on August 28, and sold the remaining shares to Doge on September 11. Reliance
demanded the profits Emerson made on both sales. Emerson filed an action for declaratory
judgment as to its liability under §16(b).
Hist: The trial court held Emerson liable for the profits from both sales. The court of
appeals reversed as to the profits from the second sale.
Issue: If a holder of more than 10% stock in a corporation sells enough shares to reduce
its holding to less than 10%, and then sells the balance to another buyer within six months after
its acquisition of the stock, is it liable to the corporation for the profit it made on the second sale?
Held: No. A person avoids liability if he does not meet 16(b)’s definition of “insider,” or
if he sells more than 6 months after purchase. The section states that a 10% owner must be “both
at the time of the purchase and sale . . . of security involved.” A person can sell enough shares to
bring his holdings below 10% and then, still within 6 months, sell additional shares free from
liability under the statute.
Foremost-McKesson, Inc. v. Provident Securities Company, 423 U.S. 232 (1976).
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 Facts: Provident decided to liquidate and dissolve. Foremost and Provident executed a
purchase agreement whereby Foremost would buy 2/3 of Provident’s assets for 4.25m and
49.75m in convertible subordinated debentures (long-term unsecured debt securities issued by a
corporation). Foremost would register 25m and participate in an underwriting agreement by
which debentures would be sold to the public. Provident distributed the cash proceedings to its
stockholders and dissolved. Provident’s holdings in Foremost debentures was large enough to
make it a beneficial owner of Foremost under §16. Thus, Foremost could sue Provident to
recover any profits on the sale of the 25m debenture to the underwriters under the statute.
Provident sued for a declaration that it would not be liable.
Hist: District Court granted summary judgment for Provident. Court of Appeals
affirmed. Foremost appealed.
Issue: In a purchase-sale sequence, must a beneficial owner account for profits only if he
was a beneficial owner before the purchase?
Held: Yes. Must be a beneficial owner before the purchase.

Ch. 6: Problems of Control

§1 Proxy Fights
A. Strategic Use of Proxies
Levin v. Metro-Goldwyn-Mayer, Inc., 264 F.Supp. 797 (1967)
Facts: MGM has a conflict for control between 2 groups (the Levin Group and the
O’Brien Group) in its mgmt with different ideas about how to run the company; each intending
to vote for their own directors at the SH meeting by introducing own slates. Each group actively
solicited proxies. Π-SHs filed action against one the groups (Δs) alleging they wrongfully
committed MGM to pay for attorneys, PR firms, and other proxy-soliciting orgs in connection
with the proxy fight. Π says the individual directors should pay these expenses personally.
1. Court’s concern is that shareholders are fully and truthfully informed as to
merits of contentions of contesting parties.
2. Sums are not excessive - $125k cost, and MGM big corporation worth over
$251mm.
Issue: Whether illegal or unfair means of communication, such as demand of judicial
intervention, are being employed by the present management.
Held: No illegal or unfair means of communication and sums were not excessive, so
injunctive relief sought is denied. Incumbent directors may use corporate funds and resources
in a proxy solicitation contest if the sums are not excessive and the shareholders are fully
informed. Such a rule protects incumbents from insurgent groups with enough money to take on
a proxy fight.
Just like a corporation can solicit proxies, shareholders may propose own
slate of candidates and solicit proxies as well. If the insurgent group wants
to do that, then they have to pay for it. Very expensive to enter a proxy
fight, so seldom happens. If mgmt wants to enter proxy fight, the
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corporation bears the costs. Theory behind the rule: The best
representatives of the company are the insiders since they know what’s
going on.

B. Reimbursement of Costs
Rosenfeld v. Fairchild Engine & Airplane Corp., 309 N.Y. 168 (1955)
Facts: Π-SH files a derivative action seeking to compel the return of $260k paid out of
corporate treasury to reimburse expenses to both sides in a proxy contest.
3. If in good faith, court will allow reimbursement of proxy fight expenses. To
hold otherwise would place directors at the mercy of anyone wishing to
challenge them for control so long as such persons have amply funds to
finance a proxy contest. Directors must have the right to incur reasonable
expenses for proxy solicitation and in defense of their corporate policies.
4. No reimbursement if the funds were used for personal power, individual
gain, or private advantage and not in the best interest of the corporation.

C. Private Actions for Proxy Rule Violations

J.I. Case Co. v. Borak, 377 U.S. 426 (1964).
Facts: Stockholder Borak sued alleging that the merger between Case and the American
Tractor Corporation was effected through the circulation of a false and misleading proxy
statement in violation of §14(a) of the 1934 Securities Exchange Act.
Hist: The trial court said it was limited to redress the violations solely with declaratory
relief under §27 of the Act. The Court of Appeals reversed.
Issue: Whether §27 of the Act authorizes a federal cause of action for rescission or
damages to a corporate stockholder with respect to a consummated merger which was authorized
pursuant to the use of a proxy statement alleged to contain false and misleading statements
violative of §14(a) of the Act. Whether or not you can have a private c/a under
14a-9.

Held: Yes, a private c/a is available under the Act.

Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970)

Facts: Mills asserted that corporate merger accomplished through the use of a proxy
statement that was materially false or misleading (like Borak). The district court granted an
interlocutory judgment in favor of Mills on the grounds that a causal relationship had been
shown between the solicitation and the injury. The court of appeals affirmed that the proxy
statement was materially misleading, but reversed on the causation issue.

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 Issue: Where a proxy statement is found in violation of §14(a), does the shareholder have
to prove that he relied on the misleading statements and that caused him to vote?
Held: No!

Materiality defined in Mills: Information “might have been considered

important by a reasonable shareholder who was in the proves of deciding
how to vote.” In other words, the statement of omission must have a
“significant propensity to affect the voting process.”

Modern definition: “Omitted fact is material if there is a substantial

likelihood that a reasonable shareholder would consider it important in
deciding how to vote.” TSC Industries v. Northway (U.S. 1976).

Seinfeld v. Bartz, 2002 WL 243597 (N.D. Cal. 2002)

Facts: Shareholders approved an amendment that raised the stock options granted to
outside directors. Seinfeld brought a derivative action against Cisco and its ten directors alleging
that they violated SEC proxy rules by failing to include the value of the option grants based on a
commonly used theoretical so-called Black-Scholes pricing model, were negligent in the proxy
solicitation statement preparations, and included a statement that is materially false and
misleading.
Issue: Are valuations of option grants to outside directors material information which
must be included in a corporation’s shareholder statement to solicit proxy votes?
Held: No, not material information. There was no substantial likelihood that the
disclosure of omitted facts would have been viewed by the reasonable investor as having
significantly altered the “total mix” of information made available.
Materiality discussed: “An omitted fact is “material” if “there is a substantial
likelihood that a reasonable shareholder would consider it important in
deciding how to vote.” A plaintiff does not have to demonstrate that
disclosure of the face in question would have caused a reasonable
shareholder to change her vote. Instead, it is sufficient to establish a
substantial likelihood that, “under all of the circumstances, the omitted fact
would have assumed actual significance in the deliberations of the
reasonable shareholder.”

D. Shareholder Proposals
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Lovenheim v. Iroquois Brands, Ltd. 618 F.Supp. 554 (D.D.C. 1985)
Facts: Lovenheim seeks to bar Iroquois from excluding a proposed resolution he intends
to offer at the upcoming shareholder meeting from the proxy materials sent to shareholder in
preparation for the meeting. His proposal calls upon the Directors of Iroquois to set up a
committee to study the methods its French supplier produces pate de foie gras. Iroquois refused
to allow info regarding his proposal to be included in the proxy statement relying on the
exception to 14a-8, Rule 14a-8(i)(5).
Rule: Rule 14a-8(i)(5): An issuer of securities “may omit a proposal and any statement
in support therof” from its proxy statement and form of proxy “if the proposal relates to
operations which account for less than 5% of the issuer’s total assets at the end of its most recent
fiscal year, and for less than 5% of its net earnings and gross sale for its most recent fiscal year,
and is not otherwise significantly related to the issuer’s business….”
Issue: Is the exception applicable when the proposal relates to operations accounting for
less than 5% of the issuer’s total assets but is significantly related to the issuer’s business, i.e.,
what does “otherwise significantly related” mean?
Held: The ethical and social significance of the proposal and the fact that it implicates
significant level of sales gives the P a substantial likelihood of prevailing on whether the
proposal is “otherwise significantly related” to Iroquois business.
Reasoning: Looking at the meaning of the Rule, the meaning of “significantly related” is
not limited to economic significance. Must be phrased in such a way as to not be
binding under state law.

AFSCME v. AIG, Inc. 462 F.3d 121 (2d Cir. 2006)

Facts: AFSCME, holder of almost 27k shares of voting common stock of AIG, submitted
a shareholder proposal to AIG to amend bylaws relating to the election of directors if approved.
AIG felt it did not have to include per the election exclusion of the Rule and sought the input of
the SEC Division of Corporation Finance. The Division sent a no-action letter indicating that the
proposal could be excluded. Usually it would end here. AFSCME sued, and District
Court affirmed the decision. Still didn’t end. Surprising to everyone that 2d
Circuit reversed contrary to SEC decision.

Rule: 14a-8(i)(8)Anything can be excluded, as long as it relates to an

election.

Issue: Whether a shareholder proposal requiring a company to include certain

shareholder-nominated candidates for the board of directors on the corporate ballot can be
excluded from the corporate proxy materials on the basis that the proposal “relates to an
election” under SEC Rule 14a-8(i)(8), when it seeks to amend the corporate bylaws.

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 Held: The proposal is non-excludable. The language of the regulation is ambiguous so
the Court looks to guidance by the agency’s interpretation. There have been 2: (1) in its amicus
curiae brief for this case and (2) in 1976 when the election exclusion was revised. The Court
uses the 1976 interpretation because the SEC has not explained its departure from prior norms.

E. Shareholder Inspection Rights

Crane Co. v. Anaconda Co. 39 N.Y.2d 14 (1976)
Facts: Crane proposed a tender offer (an acquisition offer denoting the
amount of share it will purchase at x amount over market price) of Anaconda’s
stock. Crane requested a copy of Anaconda’s shareholder list so it could inform other
shareholders of the tender offer, and to rebut misleading statements disseminated by Anaconda.
Crane had acquired over 11% of Anaconda’s common stock, making it Anaconda’s single largest
shareholder. Anaconda refused to give the list, claiming that Crane’s motives were not for a
purpose relating to the business of the corporation. Why would you want the
shareholder list rather than have the company send the proposal out? If
company does it, everyone gets the same. If shareholder gets the list, they
can choose who to “court.” This is all about control, how does it relate to
the business of the corporation?

Hist: Special term dismissed, but the appellate division reversed. Anaconda appealed.
Issue: May a qualified stockholder inspect the corporation’s shareholder list for the
purpose of soliciting a tender offer?
Held: (Affirmed.) Yes. Unless the shareholder list it sought for an objective adverse to
the company or its shareholders. A desire to make a tender offer does relate to the business of
the company and the shareholders should have the opportunity to make an informed decision
regarding the sale. “Whenever the corporation faces a situation having potential substantial
effect on its wellbeing or value, the shareholders qua shareholders are necessarily affected and
the business of the corporation is involved within the purview of section 1315 of the Business
Corporation Law. This statute should be liberally construed in favor of the stockholder whose
welfare as a stockholder or the corporation’s welfare may be affected.” Court said were
going to construe NY statutes liberally, in favor of the stockholders.

State ex rel. Pillsbury v. Honeywell, Inc. 291 Minn. 322 (1971)

Facts: Petitioner attended a meeting went to a meeting where participants believed that
Honeywell produces munitions used in the Vietnam War and Honeywell should stop the
production of munitions. So petitioner bought 100 shares of Honeywell for the sole purpose of
giving him a voice to be able to persuade Honeywell to cease production of the munitions.
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Before this suit, petitioner submitted two formal demands requesting its original shareholder
ledger, current shareholder ledger, and all corporate records dealing with weapons and munitions
manufacture. Honeywell refused.
Hist: Trial court dismissed the petition, holding that the relief requested (writ of
mandamus to compel) was for an improper and indefinite purpose. Petitioner appealed.
Issue: Did petitioner prove a proper purpose to inspect corporate records?
Held: No. A proper purpose regards investment return. Only those with a bona fide
interest in the corporation can have the power to inspect, since that power may be the power to
destroy. Petitioner did not have any interest in the affairs of Honeywell before he learned of its
production of fragmentation bombs. He had no interest in the long-term wellbeing of the
company or the enhancement of the value of his shares. Noneconomic Purposes:
There are limits on the scope of proper purpose.

Sadler v. NCR Corporation 929 F.2d 48 (2d Cir. 1991)

Facts: AT&T (NY corp with ppb in NY) placed a tender offer for stock of NCR (MD
corp with PPB in Ohio with ties to NY). NCR attempted to block the tender offer and AT&T
sought to call a special meeting in order to replace the board of directors. AT&T and the
Sadlers, NY residents and owners of 6k shares of NCR stock, attempted to acquire the NOBO
list (non-objecting beneficial owners who have consented to their identity being disclosed) and
other docs. NCR refused, so AT&T and the Sadlers sued.
Hist: The district court ordered NCR to comply with the request. NCR appealed.
Issue: May a state require a foreign corporation with substantial ties to its forum to
provide resident shareholders access to its shareholder list and to compile a NOBO list, in a
situation where the shareholder could not obtain such documents in the company’s state of
incorporation?
Held: Yes. Authorized under NY law and is not in violation of the U.S. Constitution’s
Commerce Clause. Though not required in every case, here NCR policy treats nonvoting shares
as voting in favor of mgmt and shareholder access is crucial. The NY law is not unconstitutional
because it does not impose an inconsistent regulation on interstate commerce. Issues
regarding stockholder lists are an exception to the internal affairs doctrine
(governed by state in which you are domiciled). AT&T entitled to both CEDE
and NONO. NCR must prepare NONO list even if not pre-existing. Delaware
is to the contrary, though. DE only requires preparation of CEDE list.
“Internal Affairs Doctrine”-- Corporate governance issues controlled by law of
state of incorporation.

(Skipped §§ 2-3)
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§4 Abuse of Control

Wilkes v. Springside Nursing Home, Inc. 370 Mass. 842 (1976)

Facts: Wilkes, Riche, Quinn, and Pipkin decided to jointly purchase a building and lot as
a real estate investment. They decided to turn it into a nursing home, and incorporated
Springside to own the property. Each invested equally, had the same number of shares, and each
was a director. Pipkin became sick and sold his shares to Connor. The stockholders decided to
sell a portion of the corporate property to Quinn, but Wilkes bought the property for a higher
price. This strained the relations between the four, and Wilkes gave notice of his intention to sell
his shares in January 1967. At a director’s meeting in February, the directors established salaries
for its officers and employees. Quinn was given a raise, Riche and Connor were given the same
as their weekly return had been, and Wilkes was left off the list. In March, Wilkes was not
reelected as a director or officer and was told that his services and presence in the nursing home
were unwanted. Note: Wilkes had Riche and Connor on his side, then they sided
with Quinn after they allowed Wilkes to procure a higher sale price for the
property instead of selling to Quinn.

Hist: Wilkes sued in the county Probate Court for damages based on breach of fiduciary
duties owed to him. The Court dismissed the complaint. Wilkes appealed.
Issue: Did the Probate Court err in dismissing Wilkes’s complaint?
Held: Yes. “[S]tockholders in the corporation owe one another substantially the same
fiduciary duty in the operation of the enterprise that partners owe to one another.” Donahue. In
Donahue, the Court acknowledged “a strict obligation on the part of the majority stockholders in
a close corporation to deal with the minority with the utmost good faith and loyalty.”
Terminating a minority stockholder’s employment frustrates that stockholder’s purposes for
entering the corporate venture and deny him an equal return on his investment. Balancing Test:
The burden is on the majority to demonstrate a legitimate business purpose for its action.
The burden then shifts to the minority to demonstrate a less harmful alternative course of
action. Here, the majority has not shown a legitimate business purpose for severing Wilkes from
the payroll or refusing to re-elect him as a salaried officer and director. This was a designed
“freeze out”. The judgment dismissing Wilkes’s complaint and awarding costs to the
defendants is reversed. Remanded to determine Wilkes’s damages based on inequitable
enrichment of the others, loss of salary, and any corporate funds of Springside to satisfy the
claim.
This is an odd case because this is a corporation that the court is
analyzing under partnership analysis.

Fiduciary Duties: At early common law, shareholders qua shareholders

had no fiduciary obligation to firm or fellow shareholders. Some erosion vis-
à-vis controlling shareholders of public corporations. More erosion in close
corporations.

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 BJR: Duty of Care, Good Faith, Loyalty. How to show a violation of
loyalty? Self-dealing or Conflict of Interest. The Board voted Wilkes out,
denied him any salary, and paid themselves! Quinn was paid a high amount
maybe not even commensurate to his worth. He could argue that Quinn’s
payment was an excessive salary in violation of the BJR. This would have
been a derivative suit had he sued the Board, by arguing excessive salary
but if he lost the corporation wins. Wilkes did bring this as a derivative
action, as a shareholder v. corporation. Amerson said this rule is bad
because it treats the majority as a homogenous group and each shareholder
votes with the same purpose.

Ingle v. Glamore Motor Sales, Inc. 73 N.Y.2d 183 (1989)

Facts: Ingle was hired as sales manager of Glamore Motor Sales, and later entered into a
shareholders’ agreement with sole shareholder, Glamore, to purchase 22 of Glamore’s shares,
with an option to purchase an additional 18 shares. Glamore nominated and voted for Ingle as
director and secretary. Glamore retained the right to repurchase Ingle’s shares if he should
terminate employment with Glamore Motor Sales for any cause. Ingle later exercised the option
to purchase, and a second shareholder agreement was executed. Glamore later issued an
additional 60 shares, which were purchased by Glamore and his two sons. The board of directors
then voted to remove Ingle as director and secretary, and to terminate him as operating manager.
Glamore then exercised his option to repurchase Ingle’s shares at a cost of 96k.
Hist: Ingle initiated two actions claiming breach of fiduciary duty that would protect him
against being fired and breach of K. The appellate division dismissed, and he appealed.
Issue: Is a minority shareholder of a closely held corporation who is also employed at-
will by the corporation entitled to a fiduciary duty by the majority against termination of his
employment?
Held: No. Ingle was an at-will employee. Common law does not recognize an
implied duty of good faith and fair dealing for at-will employment. There was no
employment K restricting the rights of Glamore Motor Sales to terminate him, or regarding the
repurchase of his shares upon termination.
Reconcile with Wilkes: Is there a legitimate business purpose for firing Ingle?
Glamore wanted to bring his sons in, that is not legitimate. If employment is
terminated for any reason, then the buyback provision kicked in. So at-will
employment superseded the duty of good faith. This is a case where you do
have a shareholder agreement, but it wasn’t good enough to mitigate some
potential issues.

Dissent: An employee’s status as a minority shareholder necessitates special safeguards

to protect his investment in the corporation. The relationship of a minority shareholder to a close

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corporation cannot be equated with an ordinary hiring, and without a K, regarded as nothing
more than an employment at will.

Brodie v. Jordan 447 Mass. 866 (2006)

Facts: Walter Brodie was a founding member of Malden, a corporation that produces
ball bearings. He was President from 1979-1992, when he was voted out as president and
director and Jordan was elected president. He was paid a consultant’s fee in 1994 and 1995, but
received no other money or compensation from the company since 1995. In 1997 Brodie died,
and his wife inherited his 1/3 interest in Malden. She nominated herself as a director, but
Barbuto and Jordan (the other two shareholders) voted against her. She also requested a
valuation of the company so she could ascertain the value of her shares, but the valuation was
never performed.
Hist: The Superior Court determined that this was a freeze-out because the defendants
interefered with Brodie’s reasonable expectations of benefit from her ownership of shares by
excluding her from corporate decision-making, denying her access to company information, and
hindering her ability to sell her shares in the open market. The Superior Court ordered Jordan to
purchase Brodie’s shares. The Appeals Court agreed. Defendants appealed to the Supreme
Court.
Issue: Whether the plaintiff was entitled to the remedy of a forced buyout of her shares
by the majority?
Held: No. Remanded to determine the remedy. The remedy for freeze-out of a
minority shareholder is to restore the minority shareholder those benefits which she
reasonably expected but has not received because of the fiduciary breach. The Superior
Court judge abused his discretion by creating a remedy that placed the plaintiff in a significantly
better position that she would have enjoyed absent the wrongdoing, and well exceeded her
reasonable expectations of benefit from her shares. On remand, the judge may determine Ps
reasonable expectations of ownership, money damages for deprivations, injunctive relief to allow
her to participate in company governance, and consider the fact that the P has enjoyed no
economic benefit from her shares.
In this case, the Court assumes liability and the whole discussion regards the
proper remedy. An understanding that the widow is owed some type up
remedy, and the question is what type or remedy upon remand to restore to
her, as minority shareholder, the benefits she reasonable expected to
receive.

Smith v. Atlantic Properties, Inc. 12 Mass. App. Ct. (1981)

Facts: Smith, Wolfson, Zimble, and Burke formed Atlantic Properties, Inc. to acquire
real estate. All had an equal amount of shares (25/100), but a clause in the articles of
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incorporation gave any one of the 4 shareholders a veto in corporate decisions because it stated
that any decision must be made by an 80% affirmative vote. Wolfson wanted earnings devoted
to building repairs, while the other 3 wanted a declaration of dividends in order to avoid penalty
taxes by the IRS. Wolfson consistently voted against dividends, and the IRS assessed a penalty
tax.
Hist: Smith and the others filed suit, seeking an order determining the dividends to be
paid, the removal of Wolfson as director, and an order that Atlantic be reimbursed by Wolfson
for the penalty taxes assessed against it. The trial court ruled in favor of Smith. Wolfson and
Atlantic filed a motion for a new trial and to amend the judge’s findings. The motion was
denied. Wolfson and Atlantic claimed an appeal from the judgment and Wolfson from the
denial of the motion. Smith requested payment for attorney’s fees. The motion was denied, and
plaintiffs appealed.
Issue: Do stockholders in a close corporation owe one another the same fiduciary duty in
the operation of the enterprise that partners owe to one another?
Held: Yes. In this case, the 80% provision reversed the usual role of majority and
minority shareholders, and gave the minority an ad hoc controlling interest. The damage caused
by Wolfson’s refusal to vote in favor of any dividends was beyond reasonable.
Reconcile with Wilkes: Legitimate business purpose for this deadlock?
In Wilkes, a freeze-out case. This is a deadlock case that was specifically
contracted by the parties by including in the Articles of Incorporation! Now
it’s not just majority shareholders who have a fiduciary duty, also minority
shareholders with veto powers designated via contract! Also, no evidence
put forth that Wolfson did this at the expense of others. He wanted to
improve the rental property. (Another case, SEC v. Wolfson, same Wolfson
shed light on a scandal and a judge resigned.) When he had the veto power,
he was in essence, acting as a majority shareholder. Therefore, the Wilkes
analysis applies. Extends fiduciary duty of majority shareholders to minority
shareholders who exercise majority powers.

Jordan v. Duff and Phelps, Inc. 815 F.2d 429 (1988)

Facts: Jordan, a securities analyst for Duff, purchases stock in the company at book
value. After informing Duff of his intent to resign, he stayed on until the end of the year in order
to receive the book value of his stock at the end of that year rather than the prior year per the
“Stock Restriction and Purchase Agreement.” (The Agreement stated that if employment
terminated for any reason, the Corporation shall buy back the shares. However, upon
terminating another employee, she threatened suit and they allowed her to keep her shares!)
After leaving, Jordan learned of a pending merger between Duff and another company for $50
million. He did not cash the check issued for the book value of his shares of stock and demanded
his stock back. Duff refused, and Jordan filed this suit for damages determined by the valuation
his stock would have under the terms of the acquisition. The merger never occurred though
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because the company who sought to acquire Duff was a bank holding company, so the Board of
Governors of the Federal Reserve would have to approve. The Fed granted the approval with a
particular condition that caused the firms to abandon the transaction. Duff asked the district
court to dismiss the suit, but Jordan was given permission to amend his complaint. Then the
firm’s management formed a Trust to borrow $40 million. Jordan asserts that the package was
worth almost $2000/share or $497k if he had held 250 shares in December 1985.
Issue: Do close corporations buying their own stock have a fiduciary duty to disclose
material facts?
Held: Yes. Jordan sold his stock in ignorance of facts that would have established a
higher value. A failure to disclose is a violation even if things later don’t turn out as planned.
The news that a firm was willing to pay $50m for Duff allows investors to assess the worth of
the stock. Just because one deal falls through does not mean that another is impossible at a
similar price. Less than a year later, Duff was sold to trust for $40m. To recover, Jordan must
prove causation. He must show that on learning of the merger negotiations, he would have
dropped his plan to resign and stayed for another year so he could receive payment from the
buyout. Causation is a question for a jury, and a jury could conclude that Jordan would have
stayed. Reversed and remanded.
Dissent (Posner): The existence of a fiduciary relationship between a corporation and its
shareholders does not require disclosure of material information to the shareholders. Jordan’s
status as a shareholder was contingent upon his employment. Jordan, in effect, gave Duff the
option to buy back Jordan’s stock at any time at a fixed price. That option denied Jordan the
right to profit from information Duff had about its prospects but preferred not to give him, since
it required Jordan to surrender his stock upon terminating his employment. In both this case
and in Brodie, if employment case, he loses. If this is a shareholder case,
then he wins. As a shareholder, he would have a right to know something
that is clearly material, and Ds liable for fraud. For final, establish fact
pattern that is similar. Discuss how the analysis affects the decision.

§5 Control, Duration, and Statutory Dissolution

Alaska Plastics, Inc. v. Coppock, 621 P.2d 270 (AK 1980)

Facts: Alaska Plastics was incorporated by Stefano, Gillam, and Crow, who each held
300/900 shares of stock. In 1920, Crow and Coppock divorced, and Coppock received 150
shares (1/6 interest in the corporation). Stefano, Gillam, and Crow have been the only directors
and officers of Alaska Plastics.
Coppock was not notified of shareholders meetings in 1971, 1972, or 1974. She was
notified of the 1973 shareholders meeting 3 hours prior to the meeting. At the 1971 and 1972
meetings, wives of shareholders were brought to the meetings at the company’s expense. In
1971, Stefano, Gillam, and Crow voted themselves each a $3k annual director’s fee. In 1974, the
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board members also authorized an annual salary of $30k/year to Gillam for his employment as
general manager. No dividends have ever been authorized, and Coppock has never received any
money from Alaska Plastics.
At the 1974 board meeting, the directors decided to offer Coppock $15k for her shares.
She retained a lawyer who demanded an inspection of the books and records of the corporation.
An accountant estimated the value of the shares to be between $23k-$40k. She also requested an
appraisal of Alaska Plastics’ property. Later in 1974, the director’s agreed to make a $50k offer
for another plastics firm, Broadwater Industries, which it later renamed Valley Plastics.
Coppock did not learn of the purchase of Valley Plastics until the 1975 shareholders meeting, but
she did not dissent from a shareholder vote ratifying all the acts of the directors for the previous
year. At that meeting, Coppock offered her stock to the corporation for $40k, but the board
would only raise its offer to $20k. Then, Alaska Plastics’ Fairbanks plant, which was uninsured,
burnt down. All manufacturing and sales of Alaska Plastics resumed through its subsidiary,
Valley Plastics. The fire essentially turned AK Plastics into a holding company for Valley
Plastics. In 1976, Stefano individually offered $20k to Coppock, but negotiations failed.
Hist: Coppock filed a suit. The trial court held that Coppock was oppressed because she
was forced to retain her shares since the Board’s offer was so low; it decided that the best
remedy would be to direct transfer of her shares in exchange for fair and equitable value. It
entered judgment against Stefano, Gillam, and Crow and AK Plastics for $52,314; $32k
represented the value of the shares, the rest was interests, costs, and attorney’s fees. Both sides
appealed.
Issue: May a court require a buy-out of a minority shareholder’s shares in a close
corporation?
Held: Yes. There are 4 ways in which a court may require a buy-out of a minority’s
shares: (1) If there is a provision in the articles of incorporation of bylaws providing for the
purchase of shares upon a particular event, (2) if the shareholder petitions the court for
involuntary dissolution of the corporation, (3) if there is a significant changes in corporate
structure the shareholder may demand a statutory right of appraisal, and (4) if there is a finding
of a breach of fiduciary duty between directors and shareholders and the corporation or other
shareholders. Method one does not apply because no existing provisions. Method 2 could apply
if Coppock amends her complaint to request a dissolution and can establish that the acts of
Stefano, Gillam, and Crow are illegal/oppressive/fraudulent or corporate waste. Courts are
reluctant to order involuntary dissolution, but could require the purchase of her shares at a fair
and reasonable price as an alternative remedy. The third method doesn’t apply because, in AK,
the statutory appraisal remedy is only available upon the merger or consolidation with another
corporation. The fourth method could apply if the trial court upon remand determines that the
payments to the directors and personal expenses paid for their wives were constructive
dividends, whether Coppock was deprived of other corporate benefits, or whether the majority
shareholders violates AK law. The derivative complaint was properly dismissed because
Coppock failed to allege any harm to AK Plastics. Remanded.
The Court found that not enough on the record to fulfill any of the 4
methods. Majority shareholders cannot derive a benefit at the expense of
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minority shareholders, especially with dividends. So if going to pay out a
dividend, you must pay it out to everyone equally (unless the class of shares
is specific). Excessive salaries, pay-outs that go to one person only, etc. The
court was hinting at the idea of benefits. Coppock was the only one who
didn’t get any benefit.

Take away point: Idea of dissolution as an extreme remedy. Often times, a

minority shareholder will feel frozen out, majority will low-ball them, minority
gets frustrated and takes to court for oppression, then majority will negotiate
a different price. If not, then court often will form its own buy-out remedy.

Haley v. Talcott, 864 A.2d 86 (Del. Ch. 2004)

Facts: Haley and Talcott are the only members of Matt and Greg Real Estate, LLC, each
owning a 50% interest in the LLC. In 2001, then opened the Redfin Grill; Talcott contributed
most of the start-up money and Haley managed the Grill without drawing a salary for the first
year. The Grill is owned solely by Talcott, but an Employment K and a Real Estate K defined
many rights granted to Haley.
The Employment K made it clear that the parties were operating a joint adventure; Haley
was given substantially full discretion to make management decisions, a bonus worth 1/2 of
profits once Talcott’s initial loan was repaid, Haley’s duties could not be lessened, 1/2 of any
proceeds from all sales, and a guarantee that he would not be terminated under any
circumstances.
The Real Estate Agreement granted Haley the option to purchase the property where the
Grill was situated at 50% of the cost as to make him either a 50% owner of the land or 50%
owner of the entity formed to hold the land. In 2003, the parties formed Matt and Greg Real
Estate, LLC and purchased the property. Each individually signed personal guaranties for the
entire amount of the mortgage to secure the loan.
Haley thought that he would be provided the opportunity to own stock in the Grill at
some point, and disagreements between Haley and Talcott resulted in Talcott sending Haley a
letter accepting his resignation and forbidding him to enter the Grill. Haley responded with two
letters denying his resignation, rejecting the new lease proposal for the Grill, voting to terminate
any lease of the Grill, and voting to sell the property. However, with 50% interest, there is a
deadlock. The exit mechanism of the LLC agreement provides for the remaining member to
purchase the shares of a member who has quit. However, it provides for neither a release from
the personal guaranties that both Haley and Talcott signed to secure the mortgage on the property
nor for a requirement that any dissatisfied member exit rather than file a suit for dissolution.
Rule: DE LLC Act §18-802: The court may dissolve an LLC whenever it isn’t
reasonably practicable to carry on the business in conformity with a LLC agreement.

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 Issue: May the court decree dissolution or is Haley limited to the exit provision of the
LLC Agreement?
Held: Dissolution is the adequate remedy. DE LLC Act 18-802 is similar to DGCL 273.
273 provides for dissolution when (1) the corporation only has two stockholders, (2) the
stockholders are engaged in a joint adventure, (3) and they are unable to agree on whether
to discontinue the business or how to dispose of its assets. Here, parties are 50% members in
a joint adventure (equal share of profits as provided in the Empl. K.), with each member of the
LLC having a 50% interest in acts of the company, and there is a deadlock regarding the future
of the LLC. However, this is not a corporation, but an LLC with an exit provision. Forcing
Haley to exercise the exit provision, though, would not permit the LLC to proceed in a
practicable way because he would not be relieved of his obligation under the personal
guaranty he signed to secure the mortgage of the property. This would not equitably
separate the parties because Haley would still have to make good on any future default of
the LLC over whose operations he would have no control. Although LLC making
money now, given the deadlock probably not long before not profitable. The
K was clearly negotiated with an exit provision. Haley only entered to make
money, he would get screwed if forced to take exit provision.

Pedro v. Pedro, 489 N.W.2d 798 (Minn. App. 1992)

Facts: The brothers Pedro each owned a 1/3 interest in The Pedro Companies (TPC), a
company that manufactures and sells luggage and leather products. Each brother received the
same compensation and benefit as the others as well as an equal vote in the mgmt of the
company. In 1987, Alfred, the respondent, discovered a $330k discrepancy between the TPC
accounting records and the checking account. In May 1987, the other brothers agreed to hire
an accountant, but dismissed the accountant after one month and no results. Alfred says
the accountant admitted to all three brothers that there was an unexplained $140-147k
discrepancy. During this time, Eugene would undermine Alfred’s management authority at the
TPC plant and was threatened to cooperate and forget about the discrepancy or he’d be fired. In
October 1987, the brothers hired another accountant who reported an unexplained $140k
discrepancy. At the end of October, Alfred was placed on a mandatory leave of absence from
TPC and was fired in December.
Hist: Alfred requested a dissolution of the corporation. Eugene and Carl moved
that the action proceed as a buyout. The jury awarded damages and Carl and Eugene
appealed. This court remanded because the jury’s verdict was merely advisory. On remand, the
trial court awarded damages for breach of fiduciary duty and for wrongful termination of lifetime
employment. Carl and Eugene appealed again.
Issues: Was there a breach of fiduciary duty? Did Alfred have a reasonable expectation
of lifetime employment? And did the TC make proper determinations regarding joint and
several liability, prejudgment interest, recusal of the trial judge, and attorney’s fees?

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 Held: (1) Yes. Eugene and Carl even admitted to acting in an unfairly prejudicial way
toward Alfred. Trial court properly awarded the FMV of shares- SRA (Stock Retirement Agr.)
purchase price, and gave the difference as damages for breach of fiduciary duties. (2) Courts
may look at the nature of employment of a shareholder in a closely held corporation to determine
the reasonable expectation by the employee-owner that his employment is not terminable at will.
Dad and brothers all planned on making life-time career out of business. Reasonable to believe
that Alfred did too. Statute allows for double recovery, as owner and as employee. (3) Carl and
Eugene both breached fiduciary duties and acted arbitrarily, vexatiously, and otherwise not in
good faith; the trial court thus has discretion to award attorneys fees.

Stuparich v. Harbor Furniture Mfg., Inc 83 Cal.App.4th 1268 (2000)

Facts: Harbor Furniture is a furniture manufacturing business and also owns and operates
a mobile park. Stuparich and Tuttleton, sisters and each owners of 19.05% voting shares and
33.33% non-voting shares of Harbor Furniture. Malcolm Tuttleton, Jr., their brother, bought
their dad’s voting stock, giving him 51.56% of voting shares and 33.33% of non-voting shares.
Stuparich and Tuttleton did not know about the sale of shares between their dad and
brother, and thought they together had voting control. They learned of the sale after
proposing a separation of the mobile park and furniture business due to the financial losses the
business was incurring each year. brother told them their meeting notice regarding the proposal
was defective. Stuparich and Tuttleton offered a buy out of their shares to Malcolm Jr, but he
refused. From 1984-1996, the sisters each received over $800k in dividends.
Hist: Sisters initially sued Harbor, Malcolm Jr, Sr, Jrs wife and son for involuntary
dissolution, declaratory relief, and damages for fraud, conspiracy, and negligence. The
individual defendants and all c/a other than that for dissolution were dismissed. Harbor moved
for summary judgment, and the trial court granted because the Ps could pursue a representative
on the BoD to protect their interests, and b/c they have consistently received dividends.
Issue: Whether the Ps raised a triable issue of material fact as to deem involuntary
dissolution of the corporation “reasonably necessary” to protect their rights or interests.
Held: No triable issue of material fact. Malcolm Jr. can outvote Ps, but the
distribution of shares from his father to him was not illegal. Even if the shares were
discounted as alleged, Malcolm Sr was privileged to sell his own shares to his son at
whatever price he chose. BJR. Ps are not entitled to substitute their own business judgment
for their brother’s with respect to the viability of the furniture operations. Liquidation is not
reasonably necessary to protect the rights or interests of the complaining shareholders.

§6 Transfer of Control

Frandsen v. Jenson-Sundquist Agency, Inc. 802 F.2d 941 (7th Cir. 1986)
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 Facts: Jensen-Sundquist was a holding company whose principal asset was a majority of
the stock of the First Bank of Grantsburg, and also owned a small insurance company. The sole
stockholder sold 52% of his stock in the holding company to his family (the majority bloc), 8%
to Frandsen, and the rest to other non-family members. The Stockholder Agreement had a
provision that the majority bloc would first offer its shares to the minority shareholders if it
decided to sell. (Right of first Refusal.) If the minority declined the offer, then the Agreement
provided that the majority bloc would offer to buy the minority’s shares at the same price it sold
its shares. (Take-me along Clause- Purpose is to share the control premium).
Deal 1: In 1984, the president on Jenson began discussions with First Wisconsin Corporation
over the acquisition of Jenson’s principal property, the First Bank of Grantsburg. They agreed
that First Wisconsin would buy Jenson for cash, merge First Bank of Grantsburg into a
subsidiary of First Wisconsin, and each Jenson shareholder would receive $62/share= $88/share
of the bank. Jensen asked each minority shareholder to waive his rights in the transaction,
advising each that they had no rights other than to receive the $62/share. Each signed or was
expected to sign except Frandsen. Frandsen refused to sign and announced that he was
exercising his right of first refusal and would buy the majority’s bloc at $62/share.
Deal 2: So Jenson and First Wisconsin restructured the deal. First Wisconsin agreed to purchase
all Jenson shares at $88/share, Jenson would liquidate, and the stockholders would end up with
the cash and the insurance company. This was completed over Frandsen’s protest.
Hist: Frandsen sued the majority bloc for breach of the stockholder agreement. The
district judge granted summary judgment for the defendants and Frandsen appealed.
Issue: Was the merger a breach of the stockholder agreement?
Held: No. The stockholder agreement only gave Frandsen the right of first refusal if the
majority stockholders wanted to sell only their stock, not sell the company. Frandsen’s right of
first refusal was bypassed when the majority bloc found someone to buy not just its shares, but
the whole company. The district court properly dismissed Frandsen’s claims.
Questions: Assume there is a Possible Clause #3: Should the family
negotiate a merger of the firm into another firm, Frandsen shall have the
right to enjoin the merger and buy the family’s shares at the effective price
of the merger. Which clause is best for the following motives? Motive 1:
To force the majority to share a “control premium” with him. (Clause 2
would apply).

Motive 2: To avoid dealing with a majority shareholder that he didn’t

know or didn’t know. (Clause 1 and 2).

Motive 3: Want to acquire FGB without getting into a bidding war with
another potential bidder. (Cl. 1 is consistent, but doesn’t get him all the way
there.) Is the proposed merger an offer to sell under the definition of the
RFR? Posner says No.

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Zetlin v. Hanson Holdings, Inc. 48 N.Y.2d 684 (1979)
Facts: Defendants owned 44.4% of Gable’s shares; Zetlin owned 2%. Ds sold shares to
Flintkote Co. for a premium price of $15/share, when the market price was $7.38/share. Zetlin
contends that minority stockholders are entitled to an opportunity to share equally in any
premium paid for a controlling interest in the corporation.
Rule: “Absent looting of corporate assets, conversion of a corporate opportunity, fraud
or other acts of bad faith, a controlling stockholder is free to sell, and a purchaser is free to buy,
that controlling interest at a premium price….”
Issue: Are minority shareholders entitled to share equally in any premiums paid for a
controlling interest in a corporation?
Held: No. This proposed rule is contrary to existing law and would require that a
controlling interest be transferred only by means of an offer to all stockholders (a tender offer).

Perlman v. Feldman, 219 F.2d 173 (2d Cir. 1955)

Facts: Feldman was the dominant shareholder, chairman of the BoD, and president of
Newport, a corporation that operated steel mills. Feldman sold his controlling interest in the
corporation to Wilport Company during a market shortage because of the Korean War. The
selling price was $20/share, although the market price was $12, and book value $17.03/share.
Hist: Perlman initiated a derivative action to compel an accounting for, and restitution of
Feldman’s gains from the sale of his controlling interest to Wilport Company.
Issue: Did Feldman, the majority shareholder, breach his fiduciary duties to Perlman, a
minority shareholder, when he sold his interest in the corporation at a higher price than market
value due to the shortage of steel?
Held: Yes. A fiduciary may not appropriate to himself the value of an unusually large
premium during a market shortage. Feldman personally gained from a situation that would have
many corporate advantages such as building up patronage and continuing to use the “Feldmann
plan.”
Dissent: Feldman was not proved to be under any fiduciary duty as a stockholder not to
sell the stock he controlled. By selling his stock, he acts on his own behalf. The lower court
found that Feldman had no reason to know or reason to believe that Wilport Company intended
to exercise the power of management to the detriment of the corporation, so his privilege to sell
was not terminated.

Essex Universal Corporation v. Yates, 305 F.2d 572 (2d 1962)

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 Facts: Yates was a shareholder and president of Republic Pictures, Inc., which operated a
film studio. He contracted to sell his interest to Essex at 8/share, when market price was 6/share.
The contract called for a transfer of 28% voting shares and the resignation of a majority of
Republic’s board, to be filled by Essex. A disagreement as to the value of the shares caused
Yates to back out of the deal.
Hist: Essex sued. Yates moved for summary judgment, arguing that the clause calling
for immediate transfer of control was illegal per se and voided the K. Essex appealed the
judgment.
Issue: May a sale of a controlling interest in a corporation include immediate transfer of
control?
Held: Yes. Control of a corporation may not be sold without the sale of sufficient share
to transfer that control. There is no reason why a transfer of control should not be assignable
upon sale of a block of stock. Transfer of control is inevitable in such a situation. Immediate
transfer of control will not void a sale of a controlling block of stock. Reversed.
Concurrence: (Clark): Summary judgment was improper, but this should be remanded
for trial with great discretion to the district court.
Concurrence; (Friendly): Paragraph 6 of the K violates corporate democracy. It allows
the removal and replacement of directors without any say of the minority shareholders. This
should be illegal, but cannot be applied retrospectively and cannot void the transaction.

Chapter 7 Mergers, Acquisitions, and Takeovers

§1 Mergers and Acquisitions
A. The De Facto Merger Doctrine

Farris v. Glen Alden Corporation, 393 Pa. 427 (1958)

Facts: List, a holding company, purchased 38.5% of the outstanding stock of Glen
Alden, a mining and manufacture corporation, and placed three of its directors on the Glen Alden
board. The two corporations entered into a “reorganization agreement” under which Glen Alden
was to purchase the assets of List and take over List’s liabilities. List shareholders would receive
negative stock in Glen Alden, and List would be dissolved. Notice of this agreement was sent to
the shareholders of Glen Alden, who approved the agreement at their annual meeting. Farris, a
shareholder of Glen Alden, filed this suit to enjoin performance of the agreement on the ground
that the notice to the shareholders of the proposed agreement did not conform to the statutory
requirements for a proposed merger. Glen Alden defended on the basis that the form of the
transaction was a sale of assets rather than a merger so the merger statute was inapplicable.

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 Issue: Do ‘reorganization agreements” which are de facto mergers, require conformance
by the corporations to the merger statutes?
Held: Yes. To decide whether a transaction is in fact a merger or only a share of assets,
a court must look not to the formalities of the agreement but to its practical effect. Under PA
law, a shareholder of a corp which is planning to merge has a right to dissent and to get paid fair
value for his shares, but has no such rights if his corporation is merely purchasing the assets of
another corp. A transaction is a de facto merger, and these rights be granted to dissenting
shareholders, if the agreement will so change the corporate character that to refuse to
allow to shareholder to dissent will, in effect, force him to give up his shares in one corp
and accept shares in an entirely different corporation. If this agreement is performed, Farris
will become a shareholder in a larger corporation which is engaged in an entirely different type
of business. The new corp will have a majority of directors appointed by List, Farris will have a
smaller percentage of ownership because of the shares issued to the List shareholders, and the
market value of his shares will decrease. This, then, is a de facto merger and Glen Alden must
follow the statutory merger requirements even though the transaction is in the form of a purchase
of List’s assets. Also, even if this were a purchase of assets, the reality of the agreement is that
List is acquiring Glen Alden, despite the form which states that Glen Alden is acquiring List, and
under PA law shareholders of a purchased corp also have a statutory right to dissent. Therefore,
even if this were not a de facto merger, Farris still has a right to dissent. Affirmed.

*Analysis: The rationale of the appraisal right is that the shareholder purchased the shares of a
specific corporation, and to force him to exchange his stock in the corporation he chose for stock
in an entirely different corporation is to deprive him of his property.

De Facto Merger: When a trans so fundamentally changes the nature of the

business as in effect to cause the shareholder to give up his shares in one co
and against his will accept share in a diff bus. Main Reason: Financial loss.

Hariton v. Arco Elecronics, Inc., 188 A.2d 123 (Del. Sup. Ct. 1963)
Facts: Arco Electronics and Loral Electronics Corporation entered into a Reorganization
Agreement and Plan. Per the Agreement, Arco would sell all assets to Loral. Arco would
receive, in exchange, 283k shares of Loral. Arco would dissolve and distribute the acquired
shares to its stockholders upon its liquidation. The Plan was approved at the annual stockholder
meeting, and the parties consummated the transaction.
Hist: Hariton sued to enjoin the consummation of the Plan on the grounds that it was
illegal because Arco did not call the transaction a merger, when it was a de facto merger not just
a sale of assets. Arco moved for summary judgment and dismissal of the complaint. The Vice
Chancellor granted the motion and Hariton appealed.

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 Issue: Is a sale of assets that results in a de facto merger legal?
Held: Yes. A sale of assets involving dissolution of the selling corporation and
distribution of the shares to its shareholders is legal. The statutes controlling mergers and those
controlling asset sales are independent of each other. If an asset sale meets the legal
requirements of such a sale, the fact that it might be a de facto merger should not invalidate it
any more than an otherwise legal merger should be invalidated because it is a de facto asset sale.
To hold otherwise would be to create unnecessary uncertainty in litigation.

B. Freeze-Out Mergers
Weinberger v. UOP, Inc. 457 A.2d 701 (Del. Sup. 1983)
Facts: The Signal Companies acquired a majority interest in UOP through market
purchases and a tender offer. Signal later decided to acquire all shares of UOP. Two directors of
both corporations conducted a feasibility study and determined that a share price of up to $24
would be a beneficial deal to Signal. Signal announced to minority shareholders in UOP that it
was offering $21/share to acquire all shares in UOP. At the annual shareholder meeting of UOP,
a majority of the minority shareholders approved the sale, which resulted in a forced sale of all
shares.
Hist: Weinberger, a minority shareholder who had voted against the sale, filed an action
seeking to enjoin the merger. The chancery court held the merger valid. Weinberger appealed.
Issue: Is a freeze-out merger approved without full disclosure of share value valid?
Held: No. For a freeze-out merger to be valid, it must be fair. Fairness means fair
dealing and fair price. There was no fair dealing because the directors who conducted the
feasibility study used UOP information for the sole benefit of Signal without full disclosure of
the findings. Minority stockholders were denied the information that $24/share would have been
a good investment for Signal. This would have meant over $17m for the minority. Had they
known this, they would not have voted in favor of a cash-out at $21/share. The merger was
unfair, and must be voided. The remedy upon remand shall be a liberal appraisal determining
fair value after taking into account all relevant factors.

Issues Addressed (Five ideas of a Freeze-out merger: 1) Business Purpose,

2) Exclusivity of appraisal, 3) Burden of Proof when a freeze-out merger is
challenged, 4) Requirement of entire fairness as between the dominant
shareholder and the minority, and 5) Valuation in appraisal.

Coggins v. New England Patriots Football Club, Inc. 397 Mass. 525 (1986)

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 Facts: Sullivan purchased an AFL franchise and then incorporated the American League
Professional Football Team of Boston, Inc. He contributed his AFL franchise, and with 9 other
investors contributing $25k, each of the ten investors received 10k of voting common stock of
the corporation. The corporation then sold 120k shares of nonvoting common stock to the public
at $5/share. Sullivan increased his voting stock to 23718 shares and acquired 5499 shares of
nonvoting stock, but was ousted from the presidency and from operating control of the
corporation. The next year he obtained ownership of all 100k voting shares; he then voted out
the other directors and replaced them, and resumed presidency. To acquire the shares, Sullivan
had taken out loans under the condition that he would reorganize the Patriots so that the income
of the corporation could be devoted to the payment of the personal loans. So Sullivan organized
a new corporation to merge with the Old Patriots to extinguish the voting stock of the Old
Patriots, nonvoting shares of the Old Patriots would be cashed out at $15/share, and then change
the name of the New Patriots back to the Old Patriots. Sullivan’s voting shares from the Old
Patriots were exchanged for 100% of the New Patriots stock. Sullivan, as the entire voting class,
approved the merger. The merger was also approved by the class of nonvoting stockholders.
Hist: Coggins, who voted against the merger, commenced a class action suit on behalf
those stockholders who believed the transaction was unfair and illegal. The trial judge ruled in
favor of Coggins, but determined that the merger should not be undone and that Coggins was
entitled to rescissory damages. The judge ordered further hearings to determine the amount of
damages.
Held: The trial judge properly found that the offered price for nonvoting shares was
inadequate after he considered the totality of the circumstances. The result of a freeze-out
merger is the elimination of public ownership of the corporation. The burden is on the defendant
to prove that the merger was for a legitimate business purpose. If the court is satisfied that the
merger was for a legitimate business purpose, it must then consider the totality of the
circumstances to determine if the transaction was fair. The trial court did not err when it found
that “the Ds have failed to demonstrate that the merger served any valid corporate objective
unrelated to the personal interests of the majority shareholders” (Sullivan!). Since there was no
legitimate business purpose for the merger, the court need not consider fairness. The remedy to
Coggins is rescissory damages based on the present value of the Patriots. The merger took place
ten years ago, so rescission of the merger is impossible, but damages will be assessed according
to what the stockholders would have if the merger were rescinded.

Rabkin v. Philip A. Hunt Chemical Corporation, 498 A.2d 1099 (Del. 1985)
Facts: Olin Corp. agreed to purchase a majority interest in Hunt. The K provided that
any further purchases of stock within the next year would be made for $25/share. Olin waited
for that year to end before discussing the possible acquisition of the Hunt minority stock. The
merger was approved at $20/share to the minority, despite the filing of class actions on behalf of
minority shareholders who sought to enjoin the proposed merger. The proxy statement was
issued, however there was no requirement of approval by a majority if the minority shareholders
for the merger.

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 Hist: Rabkin sued on the grounds that the price offered was grossly inadequate b/c Olin
unfairly avoided the one year commitment of 25/share within the Olin-Hunt stock purchase
agreement. Hunt moved to dismiss which was granted for failure to state a claim upon which
relief can be granted. The Vice Chancellor’s reasoning was that absent claims of fraud or
deception a minority shareholder’s rights in a cash-out merger were limited to an appraisal.
Issue: Did the trial court err in dismissing the claims on the ground that absent deception
the sole remedy is an appraisal, i.e., improperly interpret Weinberger?
Held: yes. Appraisal is appropriate in many cases, but it is not the only remedy. In
cases of fraud, self-dealing, manipulation, and the like, any remedy that will make the
aggrieved shareholder whole may be considered. In the context of a cash-out merger, timing,
structure, negotiation, and disclosure are all factors to be taken into account in ruling upon the
fairness of the transaction. The allegation here is that Olin mgmt knew that it was going to
acquire Hunt and delayed the merger to avoid the K provision requiring Olin to pay more per
share than it wanted to. This allegation is sufficient to withstand a motion to dismiss. Reversed
and remanded. If appraisal rights granted, the new corporation pays for the
appraisal.

C. De Facto Non-Merger
Rauch v. RCA Corporation, 861 F.2d 29 (2d Cir. 1988)
Facts: General Electric Company, a majority shareholder of RCA, merged RCA into
itself. Shareholders of preferred stock were paid $40/share. Rauch challenged the merger on the
grounds that the articles of incorporation of RCA contained a provision that Preferred Stock, if
redeemed, was to be paid $100/share. He argued that the merger had the same effect as
redemption. The district court dismissed the complaint b/c it concluded that the transaction was
a merger in accordance with DE General Corp Law.
Issue; Does a cash-out merger that is legal trigger any right to the shareholders with
respect to share redemption?
Held: No. RCA accomplished its merger by converting its stock to cash, which is
perfectly legal under DE law. Although this could have been accomplished by redemption, RCA
chose not to do so, and that is ok. If Rauch has claimed that the 40/share price was unfair, then
he may obtain an appraisal, but does not allege unfairness in the merger transaction. Affirmed.

Equal dignity with respect to structure over form.

D. LLC Mergers
VGS, Inc. v. Castiel, 2000 WL 1277372 (Del. Ch.)
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 Facts: Castiel formed Virtual Geosatellite LLC to pursue an FCC license to build a
satellite system to increase outer space real estate. The first two members were Holdings and
Ellipso, companies controlled by Castiel. Sahagen Satellite later became the third member.
Holdings received 65.46% of the LLC’s total equite, Ellipso received 11.54%, and Sahagen
Satellite received 25%. Castiel named himself and Quinn to the Bd of Mgrs, and Sahagen named
himself. Castiel and Sahagen began disagreeing about how the LLC should be managed and
operated, so Sahagen convinced Quinn that they needed to oust Castiel from leadership. Without
Castiel’s consent, Sahagen and Quinn merged the LLC into VGS, Inc, a DE corporation. They
named themselves and another man as the BoD. Sahagen executed a promissory note of $10m
plus interest to VGS for 2m shares of VGS Preferred Stock. 1.2m shares of common stock were
issued to Holdings, 230k to Ellipso, and 500k to Sahagen Satellite. This caused Holdings and
Ellipso’s combined ownership to drop from a 75% controlling interest in the LLC to a 37.5%
interest in VGS. Sahagen Satellite went from owning 25% of the LLC to 62.5% of VGS.
Issue: Do managers of a LLC owe to one another a duty of loyalty to act in good faith?
Held: Yes. Provisions of the LLC agreement allowed the Bd of Mgmt to act by majority
vote. The LLC statute did not require notice to Castiel before Sahagen and Quinn could act by
written consent, and no provision of the LLC agreement modified the statute. However, they
knew that Castiel would have removed Quinn from the Bd and blocked the planned merger had
he known. The state legislature never meant for the LLC statute to deprive “clandestinely and
surreptitiously” a third manager representing the majority interest in the LLC of an opportunity
to protect that interest by taking action that the third manager’s member would surely have
opposed if he had knowledge of it. The statute only allows action without notice only by a
constant or fixed majority. Sahagen and Quinn owed Castiel a duty of loyalty, and their capacity
of managers does not entitle them the protection of the BJR. The merger is invalid and is
ordered rescinded.

§2 Takeovers
A. Introduction
Cheff v. Mathes, 41 Del. Ch. 494 (1964)
Facts: Holland Furnace Co. was a furnace company that’s shares were held by several
family members and a holding company owned by the same individuals. Maremount, the
president of Motor Products, began buying shares of Holland. He proposed a merger, which
Holland rejected. Then he began purchasing many more of Holland’s shares. He demanded to
be placed on the BoD, but was not. Holland heard that Maremount had a history of looting
companies he acquired, so Holland decided to repurchase the shares that Maremount had
acquired. The agreed price was higher than the prevailing mkt price. Mathes, a shareholder of
Holland, filed a derivative action alleging that the directors of Holland effected the sale solely to
preserve their positions. The Chancellor agreed and entered a judgment awarding damages
against some of the directors.

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 Issue: May corporate fiduciaries use corporate funds to perpetuate their control of the
corporation?
Held: No. Corporate funds must be used for the good of the corporation. However, the
repurchase of corporate shares using corporate funds was not self-dealing. The Maremount
takeover was perceived as a threat to Holland, and this was a matter of business judgment. There
is no justification for holding the directors personally responsible. Reversed and remanded.
The primary purpose of using these takeover defense measurements
cannot be to perpetuate control.

B. Development
Unocal Corporation v. Mesa Petroleum Co., 493 A.2d 946 (1985)
Facts: Unocal was faced with a hostile tender offer by Mesa Petroleum Co. The tender
offer was of a “two-tier” structure such that the shareholders first tendering their stock obtained
much greater value than those who tendered theirs later in the offer. The purpose of the plan was
to motivate the shareholders to sell their shares lest they find themselves in the second tier of the
offering. Following consultations with financial professionals, the BoD of Unocal approved a
defensive tactic where Unocal would issue an exchange offer for its own stock, at an amount
higher than that offered by Mesa. Mesa was specifically excluded from the offer.
Hist: Mesa then filed an action seeking to enjoin Unocal’s selective exchange offer. The
Chancery Court issued a temp restraining order halting the proposed offer, which it extended into
an injunction. Unocal appealed.
Issue: Is a selective tender offer effected to thwart a takeover in itself invalid?
Discriminate self-tender offers bad?
Held: No. The Board’s actions must be measured by the BJR. Acts of the directors to
defeat a takeover must be shown to have been done in good faith and b/c the takeover would
danger the corporation. Defensive measures must be reasonable in relation to the threat posed.
Unocal directors concluded that the Mesa offer price was very low and Mesa was a known
greenmailer. Unocal’s selective exchange offer was reasonable in relation to the threat posed.
Unless, as shown by a preponderance of the evidence that the directors’ acts breached a fiduciary
duty such as fraud, lack of good faith, being uninformed, etc, the Court will not substitute its
judgment for that of the Board. Reversed. Unocal Rule: The BJR is not automatically applied
to defensive tactics. The court must look at the reasonableness of the tactic employed and
determine that the Board lacked self-interest. Courts find two-tiers coercive because
of the prisoner’s dilemma. Greenmailing: Greenmail or greenmailing is
the practice of purchasing enough shares in a firm to threaten a takeover
and thereby forcing the target firm to buy those shares back at a premium in
order to suspend the takeover. Any time a bond is issued that is graded as
an untrustworthy investment, it’s called a junk bond. Its riskier b/c the

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change of default is greater. In the 80s high interest rate b/c riskier, so
people would place bets on default then cash in.

Std of review: BJR? No. Why not? The “omnipresent specter that a board
may be acting primarily in its own interests.” Primary purpose? Relevant,
but subtly different too.

Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. Sup. Ct. 1985)
Facts: Pantry Pride offered to purchase Revlon at $45/share, but Revlon’s Board rejected
the offer. As part of a defensive strategy, Revlon’s board adopted a plan that would exchange
shareholders’ shares for bonds. Pantry Pride tried to make more tender offers, but all were
rejected. The board then announced a leveraged buyout by Forstmann at $57.25/share. The deal
included a lockup provision that would have made any acquisition of Revlon by another
unprofitable. Forstmann agreed to support the value of the notes. Pantry Pride filed an action
seeking to enjoin the agreement between Revlon and Forstmann. The Chancery Court ordered,
and Revlon appealed.
Issue; Are lockups and other defensive measures permitted where their adoption is
untainted by director interest or other breaches of fiduciary duty?
Held: Yes. Revlon directors did breach fiduciary duties though. The Board’s main
responsibility is to the shareholders. Here, it was clear that Revlon was going to be taken over,
so the Directors duty is to obtain a maximum sales price. Revlon ended the bidding for the
corporation by preventing a higher share price. The deal with Forstmann favored the noteholders
but was to the detriment of the shareholders. The transaction with Forstmann is invalid.
Affirmed. Revlon Rule: When it is clear that a target is going to be sold, the directors
become little more than auctioneers. Long-term corporate interests are no longer considered.
Flipover Poison pill: allows stockholders to buy acquirers shares at a
discounted price in the event of a merger. A strategy used by corporations
to discourage hostile takeovers. With a poison pill, the target company
attempts to make its stock less attractive to the acquirer. There are two
types of poison pills: 1. A "flip-in" allows existing shareholders (except the
acquirer) to buy more shares at a discount. 2. A "flip-over" allows
stockholders to buy the acquirer's shares at a discounted price after the
merger.

Court says you only have to look at shareholders. Once you become this
auctioneer, must look at best price only.

Investopedia explains Poison Pill

1. By purchasing more shares cheaply (flip-in), investors get instant profits

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and, more importantly, they dilute the shares held by the acquirer. This
makes the takeover attempt more difficult and more expensive.
2. An example of a flip-over is when shareholders gain the right to purchase
the stock of the acquirer on a two-for-one basis in any subsequent merger.

Lock-up agreement gives exclusive rights to the White Knight. DE S. Ct.

struck down the lock-up.

When the Board puts the company up for sale, they have a duty to maximize the
company’s value by selling to the highest bidder. The lock-up ended the bidding prematurely.
Distinguish between lockups that draw a bidder in and lockups that end an active auction.

Paramount Communications, Inc. v. Time Incorporated, 571 A.2d 1140 (Del. 1989)

PROCEDURAL POSTURE: Plaintiff shareholders appealed a judgment from the

Chancery Court, New Castle (Delaware), which denied their application to preliminarily enjoin
defendant corporation from concluding a merger.

OVERVIEW: Paramount filed suit against Time seeking a preliminary injunction to halt
defendant's offering of shares in preparation of a merger with Warner. The lower court denied
plaintiffs' motion on the grounds that defendant did not breach the business judgment rule in
making a tender offer. On appeal, plaintiffs asserted that defendant's tender offer triggered
Revlon duties, requiring Time to maximize shareholder value before the merger. The state
supreme court affirmed the lower court, holding that defendant reasonably responded to a
competing offer in a reasonable and proportionate manner. Further, defendant's response in
creating a merger would not place the transaction in violation of the business judgment rule
where plaintiffs' alleged a corporate threat solely centered on inadequate stock value.

OUTCOME: The state supreme court affirmed the lower court's dismissal of plaintiffs'
request for a preliminary injunction on the ground that defendant's decision to initiate a merger
was made in a reasonable and proportionate fashion.
*The court rejected the Revlon argument because there was no substantial evidence to conclude
that Time’s board made the dissolution or break-up of Time inevitable due to its negotiations
(including a lock-up agreement and no shop clause) with Warner. The court used the Unocal
analysis and found that 1) Time’s Board used proper business judgment to determine that
Paramount’s offer posed a threat to corporate policy and effectiveness and 2) the response was
reasonable in relation to the threat perceived.

Paramount Communications Inc. v. QVC Network, Inc. 637 A.2d 34 (Del. 1994)

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 Facts: Paramount began negotiating a possible merger with Viacom, but the
corporations could not agree on the merger price and the terms of the stock option granted to
Viacom. In the mean time, QVC expressed its interest in Paramount. Paramount and Viacom
resumed negotiations and later the Paramount Board approved a merger agreement with Viacom.
The Agreement has a no-shop provision, Termination Fee provision, and Stock Option
Agreement. The Stock Option Agreement contained a Note Feature (Viacom could pay with a
note rather than cash) and a Put Feature (Viacom could elect to require Paramount the difference
between the purchase price and market value of Paramount’s stock in cash). Paramount and
Viacom announced their proposed merger, and then QVC proposed a merger to acquire
Paramount. QVC publicly announced a tender offer of Paramount’s outstanding shares and filed
suit due to the slow pace of the merger discussions. Within hours, Viacom began discussing a
revised transaction with Paramount due to QVC’s hostile bid. The Paramount Board approved
an Amended Merger Agreement with Viacom including a provision for a tender offer by
Viacom and the power of Paramount’s Board to terminate the Amended Merger Agreement if it
withdrew its recommendation or recommended a competing transaction. The defensive
measures of the original Agreement were not eliminated or modified. Viacom and QVC both
commenced tender offers and began a bidding war . Paramount Board determined that the QVC
offer was not in the best interests of the stockholders.
Hist: A preliminary injunction in favor of QVC was ordered. Paramount appealed.
Held: Courts must undergo enhanced judicial scrutiny in cases of a sale or change of
control because once control has shifted, minority shareholders lose the power to influence
corporate direction and must rely on the fiduciary duties owed to them by the directors and the
majority shareholders. Directors must focus solely on securing the transaction that offers the
best value reasonably available to shareholders by analyzing the entire situation and comparing
alternatives. When a corporation undertakes a transaction which will cause: (a) a change in
corporate control; or (b) a break-up of the corporate entity, the directors’ obligation is to
seek the best value reasonably available to the stockholders. The Paramount directors were
required to evaluate the transaction with Viacom and determine if the results were reasonable
and in the best interest of the stockholders. The contractual provisions are invalid because they
prevent the directors from carrying out their fiduciary duties under DE law. The Paramount
Board breached its fiduciary duties by not analyzing the consequences of the transaction with
Viacom and not modifying or eliminating the defensive measures of the Agreement.

Omnicare, Inc. v. NCS Healthcare, Inc. 818 A.2d 914 (Del. 2003)
Facts: NCS was in a lot of debt and was going to enter a transaction with Omnicare
whereby NCS would sell its assets in bankruptcy. NCS began to improve though and decided to
look into different transactions so the shareholders would get something. Genesis and Omnicare
both began negotiating with NCS. The Board and the Independent Committee both approved the
Genesis proposal. Omnicare sued to enjoin. NCS Board got a waiver from Genesis, looked at
the Omnicare deal and concluded it was better. Impossible for Genesis to reject the bid b/c the
merger agreement required a Genesis stockholder vote for any change or modification, Omnicare
had irrevocably committed itself.
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