BUSINESS ORGS NOTES

Chapter 1 Agency

Section 1. Who is an Agent?

Gorton v. Doty
Woman loans car to football coach (Garst) to drive team. Wreck occurs, and injured party sues
Doty (owner of car). Court finds that jury could conceive that coach was acting as agent and that
owner was principal b/c no “loan language existed. Court reasons that relationship of principal
and agent does not have to involve business, does not have to involve a contract, does not have to
involve compensation.

Dissent: Was woman doing favor (she had no interest in the affair) and appellees argument
biased jury b/c of “insurance” coverage

Definitions:
Agency: “The relationship which results from the manifestation of consent by one person to
another that the other shall act on his behalf and subject to his control, and consent by the other
so to act.”

Principal: Individual responsible for the actions of his agent.

Rule Today
§ 1.01 Agency Defined
“Agency is the fiduciary relationship that arises when one person (a "principal")
manifests assent to another person (an "agent") that the agent shall act on the principal's
behalf and subject to the principal's control, and the agent manifests assent or otherwise
consents so to act.”

§ 1.02 Parties' Labeling And Popular Usage Not Controlling

An agency relationship arises only when the elements stated in § 1.01 are present.
Whether a relationship is characterized as agency in an agreement between parties or in the
context of industry or popular usage is not controlling

§ 1.03 Manifestation
A person manifests assent or intention through written or spoken words or other conduct.

See § 1.04: Terminology

Gay Jensen Farms Co. v. Cargill, Inc.

Cargill is trying to fuck the small farmer (not pay debt owed). Warren (agent of Cargill)
defaulted on contracts with 86 farmers. 9 factors that indicate Cargill’s control over its agent
Warren. (Warren was 3.6 million in debt and owed the farmers 2 million (class action)).

Definition: “Agency is the fiduciary relationship that results from the manifestation of consent
by one person to another that the other shall act on his behalf and subject to his control, and
consent by the other so to act.”

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 “In order to create an agent there must be an agreement, but not necessarily a contract between
the parties . . . . An agreement may result in the creation of an agency relationship although the
parties did not call it an agency and did not intend the legal consequences of the relation to
follow. The existence of the agency may be proved by circumstantial evidence: principal must be
shown to have consented to the agency since one cannot be the agent of another except by
consent of the latter.”

Section 2. Liability of Principal to Third Parties in Contract

A. THE AGENT’S AUTHORITY

Mill Street Church of Christ v. Hogan

Bill Hogan hires bro Sam to help finish paint job (history of doing this for church), parties did
discuss Bill hiring a partner. Workers comp claim filed by Sam.

Issue: Did Bill have the implied authority to hire Sam?

Implied authority: “Actual authority circumstantially proven which the principal actually
intended the agent to possess and includes such powers as are practically necessary to carry out
the duties actually delegated

Apparent Authority: Authority the agent is held out by the principal as possessing. Matter of
appearances on which third parties come to rely

Test for implied authority: It must be determined whether the agent reasonably believes because
of present or past conduct of the principal that the principal wishes him to act in a certain way or
to have certain authority. 3 Am.Jur.2d, Agency § 75. The nature of the task or job may be another
factor to consider. Implied authority may be necessary in order to implement the express
authority. 3 Am.Jur.2d, Agency § 75, supra. The existence of prior similar practices is one of the
most important factors. Specific conduct by the principal in the past permitting the agent to
exercise similar powers is crucial.

Dweck v. Nassar
Toy deal gone bad. Dweck was operating competing business out of the office. Shiboleth’s
settlement authority is the only issue the court must decide (was not attorney of power, but acted
as agent).

Three types of agent authority:

1. Actual authority express authority granted orally or in writing
2. Implied Authority to do what is practically necessary
3. Apparent Authority Such power as principal holds his agent our as possessing or permits
him to exercise under such circumstances as to preclude denial of its existence

1. Nassar said Shiboleth was his agent

2. 20 yr. relationship b/ween Shiboleth and Nassar (plus told him to settle
3. Damned by his own tongue again

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Three-Seventy Leasing Corporation v. Ampex Corporation
No written K b/ween 370 and Ampex, but Court finds that confirmation of delivery dates is
sufficient to illustrate meeting of the minds b/ween Kays, agent of Ampex, and 370. Kays had
sufficient apparent authority to bind the principal. Certainly reasonable to believe that salesman
has the ability to bind his employer to sell.

“Apparent authority only exists when a third party reasonably believes the actor has authority to
act on behalf of the principal and that belief is traceable to the principal’s manifestations.”

Watteau v. Fenwick
P brings case to recover price of goods delivered at Victoria Hotel over course of years. Humble
transferred business to defendants but stayed on as manager and license remained in Humble’s
name and was printed on the door. Under the terms of the ∆’s and Humble’s agreement, he did
not have authority to buy any goods except bottled ales and minerals. All other goods were t obe
purchased by the ∆’s. Action brought to recover losses incurred by P’s when they provided
Humble with cigars, Bovril, and other articles. P gave credit to Humble alone and had never
heard of the other ∆’s.

Reasoning: P can only recover from the ∆’s (principal) if Humble’s acts were within the scope of
his agency. Where one has been held out as agent, there is contract with principal by estoppel.
Was acquiring of goods supplied within the reasonable scope of the agent’s authority?

Rule: The Principal is liable for all acts of the agent which are within the authority usually
confided to an agent of that character, not-withstanding limitations, as between the principal and
the agent, put upon that authority.

Today’s Rule

§ 2.06 Liability Of Undisclosed Principal

(1) An undisclosed principal is subject to liability to a third party who is justifiably induced to
make a detrimental change in position by an agent acting on the principal's behalf and without
actual authority if the principal, having notice of the agent's conduct and that it might induce
others to change their positions, did not take reasonable steps to notify them of the facts.

(2) An undisclosed principal may not rely on instructions given an agent that qualify or reduce
the agent's authority to less than the authority a third party would reasonably believe the agent to
have under the same circumstances if the principal had been disclosed.

B. RATIFICATION
Botticello v. Stefanovicz, 177 Conn. 22 (1979) (Dumb Buyer Case)
Facts: ∆’s (Mary and Walter) owned property as tenants in common (Farm situated in towns of
Colchester and Lebanon). Bottic. Made offer to buy farm for 75k, Mary said she would never
sell for that amount. Ultimately, P and Walter agreed upon 85,000 lease with option to purchase.
Agreement signed by Walter and Bottic. P never requests his attorney to do title search. Walter
never stated he was acting on Mary’s behalf. So, P enters land for lease and exercises option to

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purchase. ∆’s refused to honor the option to purchase and this action was commenced. Trial
court found that Walter acted as Mary’s agent.

Issue: Was Walter Mary’s agent?

Reasoning: Three elements must be satisfied to show agency: (1) manifestation by the principal
that the agent will act for him; (2) acceptance by the agent of the undertaking; (3) an
understanding between the parties that the principal will be in control of the undertaking.
“Marital status, in and of itself, cannot prove the agency relationship.” Facts wholly insufficient
to support agency relationship. Walter had never signed any documents for Mary before, and
she repeatedly rejected the sale (not apparent she ever agreed with it.

2nd Arg. P argues that b/c Mary ratified the agreement by receiving and accepting payments
from Botticelli.

Ratification is defined as “the affirmance by a person of a prior act which did not bind him but
which was done or professedly done on his account.” Ratification requires “acceptance of the
results of the act with an intent to ratify, and with full knowledge of all the material
consequences.”

Reasoning: Record does not indicate an intent by Mary to ratify, nor does it show that she had
knowledge of the material circumstances. P fails to satisfy all elements.

Botticello is free to pursue action against Walter, but not Mary’s ½ interest in he property.

C. ESTOPPEL
Hoddeson v. Koos Bros. (1957) (Furniture Con Artist Case)
Ms. Hoddeson gets played when buying furniture. She gives money to “salesman” and he
allegedly handed her receipt. Furniture was never delivered and defendant had no record of the
transaction. Hoddeson and her mother were unable to positively ID the salesman and the only
salesman that the women believed resembled the con was on vacation that week. P must prove
that agent had express, implied, or apparent authority. None present, was not employed by
principal (created by the principal’s manifestations). Estoppel proprietor’s duty of care and
precaution for customers extends beyond the removel of banana peels from the aisles. P should
get new trial on theory of agency by estoppel (that proprietor has duty to protect the consumer
from illegitimate agents conning people out of dough)

§ 2.05 Estoppel To Deny Existence Of Agency Relationship

A person who has not made a manifestation that an actor has authority as an agent and who is not
otherwise liable as a party to a transaction purportedly done by the actor on that person's account
is subject to liability to a third party who justifiably is induced to make a detrimental change in
position because the transaction is believed to be on the person's account, if
(1) the person intentionally or carelessly caused such belief, or
(2) having notice of such belief and that it might induce others to change their positions, the
person did not take reasonable steps to notify them of the facts.

§ 2.01 Actual Authority

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 An agent acts with actual authority when, at the time of taking action that has legal
consequences for the principal, the agent reasonably believes, in accordance with the principal's
manifestations to the agent, that the principal wishes the agent so to act.

§ 2.03 Apparent Authority

Apparent authority is the power held by an agent or other actor to affect a principal's legal
relations with third parties when a third party reasonably believes the actor has authority to act
on behalf of the principal and that belief is traceable to the principal's manifestations.

§ 3.01 Creation of Actual Authority

Actual authority, as defined in § 2.01 is created by the principal’s manifestation to an
agent that, as reasonable understood by the agent, expresses the principal’s assent that the agent
take action on the principal’s behalf.”

§ 3.02 Formal Requirements

If the law requires a writing of record signed by the principal to evidence an agent’s
authority to bind a principal to a contract or other transaction, the principal is not bound in the
absence of such a writing or record. A principal may be estopped to assert the lack of suc ha
writing or record when a third party has been induced to make a detrimental change in position
by the reasonable belief that an agent has authority to bind the principal that is traceable to a
manifestation made by the principal.

§ 3.03 Creation of Apparent Authority

Created by person’s manifestation that another has authority to act with legal
consequences for the person who makes manifestation, when a third party reasonable believes
the actor to be authorized and the belief is traceable to the manifestation.

D. AGENTS LIABILITY ON THE CONTRACT

Atlantic Salmon A/S v. Curran (1992) (Partially disclosed principal case)
∆ began doing business with the plaintiffs Salmoner and Atlantic Salmon “A/S”. ∆ always dealt
with A/S as a representative of the Boston International Seafood Exchange. Salmon purchased
by ∆ was sold to other wholesalers. ∆’s checks to P were labeled Boston Intern and signed by the
∆, wire transfers also went to Boston International, ∆ gave P’s business cards saying he was
“marketing director” for Boston Intern. At all relevant times, no such Massachussetts corporation
existed. Appears ∆ did have marketing business under different name “Marketing Designs Inc”
that was conducting business under the name of the Boston Seafood Exchange. Salmoner owed
101k and Atlantic 153k for salmon sold to Boston International. ∆ did not inform P of
“Marketing Designs Inc.” At trial and on appeal, ∆ argued that he was acting as agent of
Marketing Designs when he incurred the debt which the P’s seek to recover from him
individually.

Reasoning: If the other party to a transaction has notice that the agent is or may be acting for a
principal but has no notice of the principal’s identity, the principal for whom the agent is acting
is a partially disclosed principal.” “Unless otherwise agreed, a person purporting to make a
contract with another for a partially disclosed principal is a party to the contract.”

 To avoid liability, agent must disclose the identity of his principal. Defendant did not satisfy
this obligation. Actual knowledge is the test (not constructive knowledge), no hardship in this

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rule, as agent always has the power to relieve himself of liability by fully disclosing his
principal’s name and contracting only in the latter’s name.

Section 3. Liability of Principal to Third Parties In Tort

A. Servant Versus Independent Contractor

 Respondeat Superior 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

Humble Oil & Refining Co. v. Martin

Car rolls off of mechanics lot (oops, who forgot to put the brake in) and hits Mr. MArtin
and his two daughters. At lower court, Humble Oil and Refining and Mrs. Love (owner of
automobile), found liable for the injuries sustained. Each petitioner seeks indemnity from the
other. Humble argues not liable b/c station was operated by independent contractor (W.V.
Schneider) and thus not liable for contractor, and his agents, negligence. Court finds master
servant relationship (facts not conclusive against master-servant relationship). Provisions of K
evince master-servant relationship. Schneider required to “make reports and perform other
duties in connection with the operation of said station that may be required of him from time to
time by Company.” Humble had to pay ¾ of most expensive operating costs. (No business
discretion in Schneider). Humble provided all important station location equipment, and paid
operating costs. Hours of operation controlled by Humble. Court distinguishes Texas Company
v. Wheat on the facts.

Hoover v. Sun Oil Co.

Fire at gas station operated by James Barone. Fire started at plaintiff’s car where it was
being filled and was allegedly caused by an employee of Barone’s, a Mr. Smilyk. Plaintiff
brought suit against Smilyk, Barone, and Sun Oil Company. Sun moved for s.j. on theory that
Barone is independent agent and thus Sun has no liability. Sun owned most of the equipment.
General rental agreement b/ween Sun and Barone. Was dealer’s agreement by which Barone
was to purchase oil from Sun. Barone was permitted to sell competitive products, but did so
only in few minor areas. Had to sell Sunoco products under that label and separately from
others. Sunoco sign in front, advertised as Sunoco and employees wore Sunoco uniforms.
Attended “Sun” school. Weekly visits from Sunoco rep. But, Barone was under no obligation to
follow the Rep’s advice. Barone alone assumed all of the monetary risk. Plaintiff’s argue that
Sun controlled the day to day operations and thus is responsible for the negligent acts (or that
there is at least jury question on this issue). Facts make it clear that Barone was independent
contractor. Lease contract and dealer’s agreement fail to establish any relationship other than
landlord-tenant, and independent contractor.

Murphy v. Holiday Inns., Inc. (Premises Liability Case)

Slip and fall case. Water leaking from AC unit allegedly was dangerous condition that
caused plaintiff’s injury. ∆ filed motion for s.j. arguing that it had no relationship with regard to
operation of the premises. (Only licensing agreement). S.J. granted by trial court, on grounds that
∆ did not own premises. Appeal follows: argument that there was principal-agent or master-
servant relationship. Court notes definition of agency and that you cannot contract agency away.
“The critical test is the nature and extent of the control agreed upon.” Plaintiff points to 8 facts

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that it believes supports a finding of an agency relationship. (This is franchising) “The fact that
an agreement is a franchise contract does not insulate the contracting parties from an agency
relationship. If a franchise K so regulates the activities of the franchisee as to vest the franchisor
with control within the definition of agency, the agency relationship arises even though the
parties expressly deny it. Betsy Len retained the right to profit and bore the risk of loss. Court
concludes that franchise agreement did not give the defendant control or right to control the
methods or details of doing the work. ∆ was given no power to control Betsy Len’s current
business expenditures, fix customer rates, or demand a share of the profits. Most all management
controls were retained by Betsy-Len.

B. Tort Liability and Apparent Agency

Miller v. McDonald’s Corp.

P bit into a heart-shaped sapphire stone while eating a Big Mac and suffered injuries.
Trial court granted summary judgment to ∆ on theory that it did not own or operate restaurant.
Reversed. 3k owned and operated the business under License Agreement w/t McDonald’s. 3k
had to use “only those methods of food handling and preparation that ∆ may designate from time
to time. Agreement provided that 3k was not agent of McDonald’s (can’t K out of agency).
Based upon outwards representations, P was under the impression that McD’s owned the
restaurant. # of courts have applied the control test. “If, in practical effect, the franchise
agreements goes beyond the stage of setting standards, and allocates to the franchisor the right to
exercise control over the daily operations of the franshise, an agency relationship exists.”
Court finds that a jury could find that McD’s controlled enough aspects to be liable. As to
apparent agency: Crucial issues are whether the putative principal held the third party out as an
agent and whether the plaintiff relied on that holding out.” Thus, in present case, there is issue of
fact about whether defendant held 3k out as its agent.

C. Scope of Employment

Ira S. Bushey & Sons, Inc. v. United States

Drunk sailor opens drylocks, owner of dock sues and is awarded compensation.
Seamaster Lane, who had been drinking, returned from shore leave, turned wheels 20 or so
times, admits to doing it. When ship falls off drydock, damages drydock wall. Govt. acts
plaintiff’s claim on ground that Lane’s acts were not within the scope of his employment.
“Conduct of a servant is within the scope of employment if, but only if, it is actuated, at least in
part, by a purpose to serve the master.” Court believes it would be going to far to find such
relationship here. Lower courts finding will not lead to a more efficient allocation of resources.
More intensive screening of employees is highly questionable (lower court’s argument). Better
served to place locks on valves than impose an overly burdensome screening process upon ship
owners. This court will not expand the doctrine of respondeat superior (policy analysis not
sufficient to justify expanse of liability). Cannot impose burden on employer to prepare for
uncompensable risks. Court does not agree with Nelson test.

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Proper Test: “The employer should be held to expect risks, to the public also, which arise ‘out of
and in the course of’ his employment of labor.” (Moving beyond the Nelson Rule) Although
Lane’s exact action was unforeseen, it is immaterial.

“The risk that seamen going and coming from the Tamaroa might cause damage to the drydock
is enough to make it fair that the enterprise bear the loss.

Judge Friendly acknowledged that no purpose to serve the master could be found in this case

Note Case: Clover v. Snowbird Ski Resort

Ski instructor, skiing recklessly, injures patron. S.J. granted to ∆’s. S.C. reversed, held that
reasonable jury could find that Zulliger was acting within the scope of his employment when he
injured P.

Manning v. Grimsley
P injured at bball game by wild patch. Sues pitcher and owner. Directed verdict for
plaintiffs at trial. Orioles and Red Sox game. Spectators were heckling Grimsley, so he
eventually threw a ball that traveled through the wire mesh and hit the spectator. P is appealing
battery count. Court finds that, viewing facts in the light most favorable to the plaintiff, a
reasonable jury could infer that (1) Grimsley intended to throw the ball in the direction of the
hecklers, (2) he intended to cause them imminent apprehension of being hit, (3) Did so to better
warm up. So, directed verdict was in err. Also have battery count against Orioles, “Where a
plaintiff seeks to recover damages from an employer for injuries resulting from an employer’s
assault . . . what must be shown is that the employee’s assault was in response to the plaintiff’s
conduct which was presently interfering with the employer’s ability to perform his duties.”

D. Statutory Claims

Arguello v. Conoco, Inc.

Racial discrimination case, allegedly occurred while purchasing gasoline and other
services. Appellants challenge granting of S.J. to Conoco. Arguello discriminated against
(employee says he wont take her ID when she tries to use it to validate her credit card). Tried to
re-enter store to find employee’s name and found doors locked. Employee not fired, although she
was reprimanded for her behavior. Smith transferred for safety reasons. 2nd incident: Conoco
salesmen would not serve three minorities and said “We don’t have to serve you, etc..”
Policeman summoned and they are served. 3rd incident: Conoco rep won’t provide tp to
Mexican family. “you Mexicans need to go back to Mexico.” Conoco granted s.j.

Agency Relationship Plain language of Patro Marketing Agreement defines relationship as

independent contractor. Conoco has no participation in the daily operations of the branded stores
nor that Conoco, Inc., participates in making personnel decisions.

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Scope of Employment Factors to consider when determining if an employee’s acts are within
the scope of his employment (1) the time, place and purpose of the act (2) its similarity to acts
which the servant is authorized to perform (3) whether the act is commonly performed by
servants (4) the extent of departure from normal methods (5) whether the master would
reasonable expect such act to be performed. (only looking at Smith’s behavior towards Arguello
and Govea)

Court rejects the presumption that because Smith behaved in an unacceptable manner that she
was obviously outside the scope of her employment. S.J. should not have been granted.

E. Liability For Torts of Independent Contractors

Majestic Realty Associates, Inc. v. Toti Contracting Co.

P’s seek compensation for damage to Majestic’s building and to Bohen’s goods. Toti
allegedly damaged properties while demolishing certain properties owned by the Authority.
Bohen’s conducted dry goods business in basement of property owned by Majestic. Authority
demolishes several buildings (through Toti) to build parking garage. Toti used wrecking ball in
demo work. Due to careless work, 15 by 40 foot section of wall fell on Majestic’s roof, causing a
25 by 40 foot break thereon. Bohen’s employee asked Toti’s crane operator what happened and
he said “I goofed.” Trial Court recognized that work violated code, but found that Authority, not
having exercised control over the manner and method or means of performing the demo
operation, could not be held liable for negligent acts of independent contractor. Exceptions to
rule that one not liable for work of independent contractor (1) where landowner retains control of
the manner and means of the doing of the work which is the subject of the k (2) where he
engages an incompetent contractor (3) where activity contracted for is nuisance per se. Court
notes that “nuisance per se” issue is not clear in the law; however, liability is absolute where the
work is ultra-hazardous

Section 4. Fiduciary Obligation of Agents

A. Duties During Agency

Reading v. Regem
Plaintiff was sergeant in Royal Medical Army Corps, stationed in Cairo. P was making
money somehow (drugs, gun smuggling ??), money paid to him by man for escorting package
through Cairo so that it would not be inspected by the police. Ultimately gets paid 20,000 pounds
for transporting lorries across Cairo. P argues that these monies are his and should be returned to
him by the Crown. Crown’s theory is that P was taking bribes while acting as agent of the
Crown. Servant must account for his profits if he was unjustly enriched while serving as servant.
P was violating his duty, and money must be paid over to the master. A servant may, during his
master’s time, in breach of his contract, do other things to make money for himself, such as
gambling, but he is entitled to keep that money for himself.

Rest § 8.02

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 “An agent has a duty not to acquire a material benefit from a third party in connection with
transactions conducted or other actions taken on behalf of the principal or otherwise through the
agent’s use of the agent’s position.”

Rest § 8.05
“An agent has a duty (1) not to use property of the principal for the agent’s own purposes
or those of a third party . . . . .”

General Automotive Manufacturing Co. v. Singer

P sued Singer seeking to recover secret profits received while he was an employee. Jury
found ∆ liable for $64,088. Plaintiff was machine shop jobbing business (5 employees). ∆ is
machinist-consultant and manufacturer’s representative. ∆ has special skill set which no other
employees of General Auto have. Stipution in k that Singer will “devote his entire tie, skill, labor
and attention to said employment, during the term of his employment, and not to engage in any
other business or vocation of a permanent nature during the term of his employment, and to
observe working hours for 5 ½ days.” P arguing ∆ violated this fiduciary duty. Lower court
found that activities of ∆ were carried on in secret and were carried on in secret and without
knowledge of the plaintiff. App. Court finds that this conclusion is not against the great weight
and clear preponderance of the evidence. However, Singer did act in best interest of the business,
he even bore risk of loss in some areas (made parts to held business at own cost that did not sell).
In effect, Singer behaved as a broker by contracting out work that Auto. could not complete to
another shop and taking a cut of the proceeds. Was this operation violative of his fiduciary duty?
∆ argues he only turned orders away when they could not be completed by General Auto. “By
failing to disclose all the facts relating to the orders from Husco and by receiving secret profits
from these orders, Singer violated his fiduciary duty to act solely for the benefit of Automotive.
Therefore, he is liable.

B. Duties During and After Termination of Agency: Herein of “Grabbing and Leaving”

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

Action brought for injuction and damages against appellants on theory of unfair
competition. Injunction bars them from engaging in same business as P, from soliciting its
customers, and for an accounting and damages. House and home cleaning enterprise (“Mass
production business plan”). Appellate division reversed lower court’s dismissal of the case
(lower court said services were not unique, but were age old procedures) on theory that ∆’s
conspired during their course of employment to overtake P’s business. Court finds that “only
trade secret which could be involved in this business is plaintiff’s list of customers.” P’s
customers were the only one ∆’s solicited. Solicited total of about 35 clients (give or take), so
plaintiff is entitled to enjoin defendants from further solicitation of its customers.

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CHAPTER 2. PARTNERSHIPS
Section 1. What is a Partnership? And who are Partners?

A. Partners Compared with Employers

Fenwick v. Unemployment Compensation Commission

Is Arline Cheshire an employee or a partner? Purpose of case is to determine the status of the
respondent (was he required to may unemployment compensation funds). Fenwick opened
beauty shop and employed Cheshire as cashier and reception clerk. Cheshire requested a raise
and the K noted in the text was entered into b/ween the parties. Commission held that agreement
was nothing more than employee relationship, whereas Supreme Court held that the parties were
partners. So, is there a partnership present between Cheshire and Fenwick? Court says no.
Looks @ Elements
1. Did the parties intend to form a partnership? Have k, but court says that was mere agreement
between employer and employee b/c Fenwick did not want to lose her help
2. Right to share in profits Existed in this case
3. Obligation to share in losses Not present

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4. Ownership and control of the partnership property and business Fenwick owned all property
and reserved control
5. Community of power in administration Fenwick exclusively controlled business
6. Language in agreement Although parties call themselves partners, Chesire not granted
partner rights
7. Conduct of the parties towards third parties Generally did not hold themselves out as
partners except to avoid paying into the unemployment commission fund
8. Rights of parties on dissolution All rights go to Fenwick

UPA defines a partnership as “two or more persons who carry on as co-owners of a business for
profit.”

B. Partners Compared with Lenders

Martin v. Peyton
Plaintiff was creditor, trying to collect from whoever they can, defendants claimed that they were
creditors also, not partners. P argues that ∆’s intended to from partnership when they loaned
money to K.N. & K. Issue: Did ∆’s so associate themselves with the firm as to carry on as co-
owners as a business for profit. Mr. Hall and Mr. Peyton are friends, unwise speculations break
the firm, so get mo money from Peyton, Perkins, and Freeman. Parties were invited to become
partners, but adamantly refused this proposition. Respondents were to loan KK 2.5 mill and to
receive some of the firm’s speculative securities and were to may them profits. Respondents
were also given option to join the firm. Respondents called “trustees,” loaned securities were not
to be mingled with others, trustees were to be informed of all transactions, and they get proceeds
from sales. Hall was directly managing company until all securities were returned to the
respondents. (Properly safeguarding their loan).

C. Partnership Versus Contract

Southex Exhibitions, Inc., v. Rhode Island Builders Association, Inc.

Court affirms earlier finding that no partnership agreement existed. Southex acquired
SEM’s interest under the 1974 agreement. RIBA, dissatisfied with Southex’s performance,
entered into another service contract with another producer, Yoffee Exposition Services. Southex
commenced suit alleging that RIBA breached fiduciary duties of its partnership with Southex, by
its wrongful dissolution of the partnership. In determining whether a partnership exists, part
ownership does not signify a partnership, the receipt of share of profits is prima facie evidence
that partnership exists, but no such inference is drawn if profits were received in payment as
debt, as wages of an employee, as annuity. Southex must demonstrate to the court ruling is not
rationally supported by the record evidence: cannot do this.
1. 1974 agreement is entitled “agreement,” not partnership agreement
2. Agreement was for fixed term
3. SEM advanced all monies and indemnified RIBA for show related losses as well (parties not
sharing proportionally in the losses)
4. SEM was responsible for the lion’s share of management decisions
5. Southex did not represent partnership to third parties (did business under its own name)
6. Was no mutual ownership of property

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7. SEM disclaimed any ownership interest in the home shows in 1974

Southex also argues that RIBA expressly agreed to share profits in 1974, thus there is prima facie
evidence of a partnership. Reasoning: Profit sharing not determinative of partnership. Also no
intent here to form partnership. Also argue that b/c agreements uses term “partners,” they must
be.

D. Partnership by Estoppel

Young v. Jones
P’s invested half million bucks in bank and it magically disappeared. Other ∆’s allegedly
sent money from South Carolina bank to SAFIG (swiss fund). Letterhead identified SAFIG firm
as Price Waterhouse and audit letters also bore PW trademark. P’s assert that PW symbol granted
credence to the financial statement such that P’s were induced to invest to their detriment. P’s
contend that PW Bahamas and PW US are partners, or that they are operating as partners by
estoppel. Counsel for plaintiffs admits that he has found nothing which establishes that the 2
entities are partners in fact. Thus, court finds that there is no partnership in fact.
Estoppel Argument “A person who represents himself, or permits another to represent 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 representation is made who
has, on the faith of the representation, given credit to the actual or apparent partnership.”
Plaintiff’s argue that if PW’s are partners by estoppel, they are jointly and several liable for
losses. Plaintiff argues partnership by estoppel on theory that PW promotes its image as a global
organization and that it is common knowledge that PW operates around the world. P’s offer
brochure that describes PW as one of the world’s largest and most respected organizations.
Brochure says that entity is global. No evidence that P’s relied on brochure when making
investment, nor do they point to anything in brochure that says PW entities are liable for another
branches acts. Reading the statute narrowly, no credit was given by P’s to partnership
relationship, thus arg fails. No evidence that PW-US indicated existence of such partnership.

See UPA (1997) § 103, 201(a), 202, 401

Section 2. The Fiduciary Obligations of Partners

A. Introduction

Meinhard v. Salmon (Judge Cardozo—Destroyed Privity in McPhaerson v. Buick)

Ms. Gerry leased hotel to ∆ Walter J. Salmon. 20 yr. lease, lessee undertook to change
hotel to office space at cost of 200k. Salmon was operating in joint venture with Meinhard,
Meinhard was to pay salmon half of moneys requisite to reconstruct, alter, manage, and operate
the property. Salmon was to pay to Meinhard 40% of net profits for first 5 years and 50%
thereafter. Each party bore risk of loss. However, Salmon was to have sole power to manage,
lease, and operate the building. Business struggled at first, but later profits became great (rich
return). Near end of lease, Elbridge Gerry acquired the reversionary interest. Gerry approached
Salmon with less than 4 months of lease to run, and Salmon leased property under name of
Midpoint Realty Company under new terms. Salmon had not told Meinhard anything about the
new lease. P suing to establish his interest in the new lease. Eventually he gets ½ interest in the
property. ∆’s appealing this finding.

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 Court finds that to the eye of the observer, Salmon held the lease in his own right.
Salmon appropriated to himself in secrecy and silence. The trouble about his conduct is that he
excluded his partner from any chance to compete. Court finds that he was under a duty to
concede this chance. Court does find that Salmon was a managing coadventurer. (Key fact is that
here the subject-matter of the new lease was an extension and enlargement of the existing lease).
Court finds that an extra share should be granted to Salmon to preserve his expected dominion
over the property. So court breaks shares in half, with one extra share going to Salmon.

Dissent: Takes different view of the joint venture. Characterizes it as ending at a set time. Was
no intent to continue venture beyond the end of first lease. Thus, there was nothing unfair in Mr.
Salmon’s conduct.

B. Opting out of Fiduciary Duties

Perretta v. Prometheus Development Company, Inc.

Prometheus was organized to manage 2 large apartment complexes in Cali. PDC is
owned by DNS Trust, a trust controlled by Sanford Diller (who is also PDC’s sole director,
President and CFO. Plaintiffs were limited partners and represent a class of partners. In 2000,
Diller and his daughter offer to buy out all limited partners for cash in a merger transaction.
Proxy statement sent to limited partners notifying them of his proposition, in statement it noted
that PDC’s interests were adverse to those of the limited partners unaffiliated with PDC. At a
vote, 50.7% of partners voted to approve the merger. An absolute majority was needed to
approve the merger. (Not exactly clear what happened during voting)
P’s allege that the merger constituted a self-dealing transaction which violated PDC’s
duty of loyalty by setting an unfairly low price. Issue is whether partnership or other partners
were harmed by the transaction b/c “partnership is a fiduciary relationship and partners may not
take advantage for themselves at the expense of the partnership. “Thus a partner who seeks a
business advantage over another partner bears the burden of showing complete good faith and
fairness to the other.” One way to solve this issue is to look at ratification. If partners properly
ratified transaction, any claim against partner for violation of the duty of loyalty is extinguished.
Court finds that majority vote (ratification) was unjust b/c only 46% of the unaffiliated units
voted yes to the merger. However, since Cali law allows a partnership agreement to vary
ratifications, we must look at whether the terms were manifestly unreasonable.
In determining reasonableness, court looks at precedent but finds it unconvincing. Cali
statutes in related areas of law support the idea that interested partners votes should not be
counted in ratification votes. (Example: Action for rescission of merger). Also looks at
corporation ratification statute which mandates that interested directors are not entitled to vote.
Moreover, allowing an interested party to participate in a ratification election is contrary to
sound policy. B/c only 46% of outstanding units voted yes, not valid ratification and ∆ must
prove acted in complete good faith and fairness to all partners.

C. Grabbing and Leaving

Meehan v. Shaughnessy
Plaintiffs, Meehan and Boyle, were partners at law firm. After terminating their
relationship with the firm, they brought this action to collect money they felt they were owed
under former partnership agreement and to obtain declaration as to how much $$ they owed ∆’s

14
for work done on old cases done at their firm which transferred with them to their new firm. ∆’s
counterclaimed alleging that M and B violated their fiduciary duties, the partnership agreement,
and tortuous interference with their business. (Stole client theory). ∆’s also filed third party claim
against other associates of their law firm who joined MBC.
Superior court judge awards M and B $$ owed to them under p-ship agreement, and that
under quantum meruit theory Parker Coutler is entitled to reasonable value of work completed.
Case ultimately remanded on theory that the judge erred in finding that M and B acted properly
in acquiring consent to move cases to MBC.
M and B were big hitters in the firm with excellent reputations. B was actually in charge
of the plaintiff’s department. M’s interest was 6% and B’s was 4.8%. Prior to leaving, start
talking to employees of P,C,D, and W. Offer Cohen position as partner and show her potential
earnings, etc… All talk was kept confidential. 3 ultimately left firm, only giving 30 days notice
instead of the required 3 months. Cohen went with them b/c she enjoyed working with M and B.
(Left on Dec. 31st 1984). After leaving, B offers position to Schafer and tells him to manage
work so he brings big cases over (also told him to keep convos confidential). Late summer of
1984, M asked Black and Fitzgerald to become associates at MBC. After getting assurance from
key client that he would transfer work to MBC, Black offers to join firm.
Towards end of November, B prepares form letters to be sent to clients to get them to
transfer over. (Schafer prepared similar letters). Boyle, Schafer, and Meehan ended up removing
142 of 350 total contingent cases to MBC. In each case, the client signed an authorization of
removal. Schafer subsequently removed his practice from MBC’s.
Court agrees with P’s proposition that ∆ unfairly acquired clients. Rejects other
arguments. “A partner has a duty to render true and full information of all things affecting the
partnership to any partner.” M denied to his partners 3 times that he had made any plans for
leaving the firm. Look back to facts. B also had already transferred clients before he made firm
aware that he was taking them. Court also finds ethical breach b/c M and B’s letter was unfairly
prejudicial.

D. Expulsion

Lawlis v. Kightlinger & Gray (was at will employment k)

Lawlis was partner at K&G for number of years without interruption until 1982. Lawlis
becomes alcoholic and did not disclose his condition until 1983. Upon telling financial
committee, firm set forth certain conditions in writing that Lawlis had to follow or he would be
terminated. Lawlis breached conditions once, but was given second chance. He has not
consumed alcohol since leaving therapy in 1984. As his units were reduced due to his alcohol
problem, upon recovery, Lawlis requested that his participation be increased from 60 to 90.
On Oct. 23, 1986, Wampler told Lawlis that he was effectively fired. Lawlis terminated
at year end meeting but he is allowed to retain his status for insurance benefits. Lawlis filed suit
for breach of contract. From entry of an adverse judgment, Lawlis appeals.
Claim 1. Partnership was wrongfully terminated prior to vote on Oct. 23, 1986 when
Wanpler told him he was about to get revoked. Court finds that facts do not support such a
finding. He remained on the payroll, his name was on the letterhead, etc.. Thus, court concludes
that Lawlis was expelled in accordance with the partnership agreement on Feb. 23, 1987 when
the partners voted to expel him.

Claim 2. Lawlis’s expulsion contravened the agreement’s implied duty of good faith and fair
dealing b.c he was expelled for the predatory purpose of increasing the firm’s lawyer to partner

15
ration. Indiana Uniform Partnership Act requires that when a partner is involuntarily expelled,
his expulsion must have been done in good faith. Lawlis believes bad faith rests in the firms 5
year plan, to increase partner revenue by eliminating weak partners. Court finds no predatory
purpose, in fact firm went to great lengths to take care of Lawlis during his struggle with
alcoholism. Moreover, record shows us that firm didn’t just fire him, it kept him on at its expense
in an attempt to ease his transition to a new job.

Claim 3. Expelling of him was constructively fraudulent b/c firm breached fiduciary duty of
good faith and fair dealing in partnership relationship. Court finds not even relevant to the case at
bar.

Section 3. Partnership Property

Putnam v. Shoaf
Dispute of sale of partnership interest. Frog Jump Gin was not profitable business. Shaofs
assume all partnership obligations. Putnam conveyed her interest to the Shoafs that she had
acquired via her husbands death. Charlton’s own other ½ interest in the Gin. Bookkepper wasw
embezzling funds, sued by Shoafs and recovery is 68,000 (judgment). Lawsuit is about who gets
$$$ Shoafs or Mrs. Putnam’s estate. B/c Mrs. Putnam intended to convey her partnership
interest, the Shoafs take the proceeds of the judgment. Court makes good point which is what
would she say if business had further losses.

Section 4. Raising Additional Capital

Do Problem Late

Section 5. The Rights of Parties in Management

 Section 18(e) of the UPA provides that in the absence of an agreement to the contrary, “all
partners have equal rights in the management and conduct of the partnership business
 Section 18(h) provides that any difference arising as to ordinary business matters connected
with the partnership business may be decided by a majority of the partners

National Biscuit Company v. Stroud

Stroud and Freeman enter into general partnership to sell groceries. No purchasing
restrictions. Stroud told P he would not be personally responsible for bread sold to ∆. At the
request of Freeman, bread continued to be delivered. Suing to recover 171.04. “What either
person does with a third person is binding on the partnership” and “every partner is agent of the
partnership for the purposes of its business, and the act of every partner, including the execution
in the partnership name of any instrument, for apparently carrying on in the usual way of

16
business of the partnership of which he is a member binds the partnership, unless the partner so
acting has in fact no authority to act for the partnership in the particular matter, and the person
with whom he is dealing has knowledge of the fact that he has no such authority. Stroud could
not restrict Freeman’s buying power. Thus partnership and Stroud liable for the $$$. (Stroud had
assumed liabilities after the partnership dissolved.

Summers v. Dooley
Parties were partners in trash-collecting business. Dooley gets hurt, so hires someone at
his own expense to fulfill his obligations. Summers wishes to hire more help, but Dooley refuses.
Summers hires man anyway. Dooley refused to pay for the new employee out of the partnership
fund. Summers suing to recover $11,000 he paid in out of pocket expenses to the “employee.”
Summers granted only partial relief, thus he is appealing. P arguing ratification b/c ∆ retained
benefits conferred upon him by the hiring of the third party. (estoppel theory). Rule: “Any
difference arising as to ordinary matters connected with the partnership business may be decided
by a majority of the partners.” B/c there was no majority and Dooley vehemently opposed hiring,
no $$$.

Day v. Sidley & Austin

P resigned as senior partner at lawfirm that merged. Was senior underwriting partner at
old law firm, S & A (good American btw), as senior partner he was entitled to % of profits and
got to vote on certain matters specified in the partnership agreement. Merger discussed, P
initially approves of it. All partners at S & A executed final agreement. Decide to merge new
firm into new building. P objects to this, but move still made. P resigns b/c changes were
intolerable. P’s allegations.

1. Fraud “No S & A employee would be worse off.” P thought this meant that he would
remain as the sole chairman of the Washington office. (that he would control where the office is).
P’s position contravenes partnership agreement which embodies the intent of the parties. If he
wanted it, he should have asked for it in the agreement. Also, no estoppel type argument b/c no
reason to believe changes wouldn’t be made when power is vested in the executive committee.

2. Breach of Fiduciary Duty Argues that partners breached their fiduciary duty by negotiating
with other firm without consulting with all partners on the executive committee. Rule: “”The
essence of a breach of fiduciary duty between partners is that one partner has advantaged himself
at the expense of the firm. The basic fiduciary duties are 1. A partner must account for any profit
acquired in a manner injurious to the interests of the partnership, such as commissions or
purchases on the sale of partnership property 2. A partner cannot without the consent of the other
partners, acquire for himself a partnership asset, nor may be divert to his own use a partnership
opportunity; and 3. he must not compete with the partnership within the scope of the business.

Courts finds no cause of action (partner dealing with bruised ego), terms of k provide for
management to rest in the executive committee (he assumed risk when he joined the partnership)

See UPA § 601

Section 6. Partnership Dissolution

A. The Right to Dissolve

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Owen v. Cohen
Action brought for dissolution of partnership (sale of assets). Bowling lane partnership.
No express ending period. P advanced 7k to partnership as a loan. Differences lead to this action.
Debt was never repaid. Trial court found that partnership dissolvable b/c ∆ breached partnership
agreement and acted as if p-ship did not exist.
Issue: Does the evidence warrant a decree of dissolution of the partnership? Extraneous
factual evidence that ∆ was not acting in good faith. However, ∆ still argues differences were
petty. U.P.A. § 32 Can get dissolution if “partner has been guilty of such conduct as tends to
affect prejudicially the carrying on of the business (b) if partner willfully breaches the
partnership agreement. (c) if dissolution is equitable. P gets dissolution based upon the facts. ∆
also argues P shouldn’t get 7k from the assets b/c he said he would take them from profits. On
principles of equity the court rejected this argument.

UPA § 801(5)
Partnership is dissolved “on application by a partner, by a judicial decree that: (i) the
economic purpose of the partnership is likely to be reasonably frustrated; (ii) another partner has
engaged in conduct relating to the partnership business that makes it not reasonably practicable
to carry on the business in partnership with that partner; or (iii) it is not otherwise reasonably
practicable to carry on the partnership business in conformity with the partnership agreement.

Collins v. Lewis (Tough Case)

P owns 50% partnership interest in L-C cafeteria. Seeks dissolution. Trial court denied all
relief sought. Parties did not get good partnership k in writing. Roughly speaking, Collins to give
all funds and Lewis to run the café until Collins gets $$$ invested back. Initially Collins willing
to give 300k, but ends up investing 600k (pissed him off). Claims ∆ took him on this deal.
Business loses money (expenses greatly exceeded intake). Collins says it was due to extravagant
management. Files suit once this occurred.
Jury findings prevail, Collins should have kept shelling out dough in hope of profit. This
is based on the initial agreement b/ween the 2 partners. Affirms the jury findings. Also have loan
issue. Court finds that “there is testimony in the record to the effect that Collins, as a director and
stockholder in the Dallas Bank had induced the bank to make demand for payment in order to
effect foreclosure.” Court finds that Lewis met his obligation (repaying $$ for the first year).

Page v. Page
Parties (brothers) are partners in linen business. P appealing from judgment that granted
partnership to be for term rather than at will. Oral partnership agreement. Each party invested
43k. First 8 years, corporation is bust, losing roughly 62k. Major creditor is owned by the P. 47k
note. Partnership does appear to be making money now, but P still seeks dissolution. UPA
provides that a partnership may be dissolved “by the express will of any partner when ne definite
term or particular undertaking is specified. ∆ believes was term, specifically however long it took
to make money. (Argues that this partnership was like former partnership the parties had entered
into).
However, ∆ admits that this partnership is different from previous partnerships. Was no
specified term here, was also no discussion of what would happen if company lost $$$. ∆
explicitly arguing that b/c there was an alleged understanding that all debts would be paid out of
profits, such an expectation is sufficient to create a partnership for term under prior case law.

18
Court finds that precedent does establish that partners may impliedly agree to continue in
business until certain sum of $$ is earned.
Court finds that ∆ failed to prove any facts from which an agreement can be implied. ∆
also claims bad faith, but court finds that there is nothing in record that supports this finding. So,
b/c it is at will partnership, unless the ∆ can prove that P acted in bad faith, partnership can be
legally dissolved.

B. The Consequences of Dissolution

Prentiss v. Sheffel
Should 2 partners be able to purchase the partnership assets at a judicially supervised
dissolution sale? (when third partner exists) Court finds purchase is proper under these facts.
Partnership operated a Shopping Center in Phoenix. Dissolution was sought on grounds that third
partner failed in this partnership duties (didn’t pay debts, etc.). ∆ claimed he had been wrongfully
excluded from the partnership.
Key findings of fact by the jury: ∆ owned only 15% of business, No written partnership
agreement, constant disagreements b/ween the partner, ∆ didn’t make payments b/c of his poor
economic position, there was a freeze out by other partners.
Trial court found that partnership at will existed, ordered sale. Two partners bought
business. ∆ fundamental argument is that he was wrongfully excluded. Record does not support
this contention. Moreover, it appears that ∆’s interest was helped by the partners purchase b/c
they run up the bid at auction. ∆ could have purchased property.

Rule: Is no precedent that prohibits a partner from bidding at a judicial sale of the partnership
assets.

Pav-Saver Corporation v. Vasso Corporation

Dissolution of Pav-Saver corporation, Harry Dale is the majority shareholder. Vasso
owned by an attorney, Harry S. Meersman. Dale and Meersman formed partnership in 1974 to
sell Pav-Saver machines. Meersman was to provide the $$, and Dale the patents and trademarks.
Construing terms of the partnership agreement. 1976, partnership is dissolved and replaced with
identical one b/ween PSC and Vasso.
Until 1981, PSC thrived. Economic downturn, PSC seeks to dissolve p-ship in 1983 in
accord with paragraph 11 of the partnership agreement. In response, Meersman ousted Dale and
took control of the business. So, Dale sued for damages and for return of its patent and
trademarks. Trial court found that PSC had wrongfully terminated the k, thus Vasso gets patents
and trademarks and PSC must pay liquidated damages.
Both parties appealed, PSC takes issue with the court’s failure to return its patents and
trademarks. PSC also argues that ld’s are a penalty. Vasso seeks immediate payment of the ld’s.
Court’s findings: Partnership was permanent, PSC unilaterally terminated the partnership.
Vasso wished to continue business which he has the right to do under UPA § 38(2)(b). Thus, the
right to possess the partnership property and continue in business upon a wrongful termination
must be derived from and is controlled by the statute. To continue business pursuant to the
statutorily granted right, had to have trademarks and patents.

19
Dissent—Text of the agreement concerning return of the patents and trademarks must be
enforced, because express terms of the p-ship agreement deal with the status of patents they must
be returned in accord with the language of the k. No precedent suggests otherwise.

C. The Sharing of Losses

Kovacik v. Reed
P in home-remodeling business. Asks ∆ to be his job superintendent and estimator. They
are to share profits 50-50, but ∆ was not asked to bear any of the losses (never discussed it).
Venture ends up losing money, P demands that ∆ contribute to the amounts that the P had
advanced beyond the income he received. ∆ refused to pay arguing that he never bore the risk of
loss.
P brought action to recover ½ of the losses from the ∆. Trial court found that ∆ was liable
for 4,340$$. “It is the general rule that in the absence of an agreement to the contrary the law
presumes that partners and joint adventurers intended to participate equally in the profits and
losses of the common enterprise.” However, differing from other cases in which this rule was
applied, where one party provided all of the capital, neither party is liable to the other for
contribution for any losses sustained. Rationale is that where one contributes money and other
services, then in event of loss each would lose his capital. (equitable decision). Judgment
reversed.

Note: Text of the UPA explicitly rejects the reasoning of this decision

D. Buyout Agreements

G&S Investments v. Belman

Lawsuit arising out of death of one partner (a Mr. Nordale). Issues: Whether the
surviving general partner, G&S Investments, is entitled to continue the partnership after the
death of Nordale, and how the value of Nardale’s interest in the partnership is to be computed.
Partnership was formed to receive ownership of 62 unit apartment building, general
partners were G&S investments (51 percent) and Nordale (25.5%). Remaining interest owned by
limited partners Jones and Chapin. 1979, Nordale began using cocaine, became an addicted ass
hole and his actions included not going to work, being generally agitated with his partners,
making threats to partners, etc..). Nordale lived in the complex and this led to the following
problems. 1. He sexually solicited an underage female tenant of the complex, refused to pay rent
on the apartment, and he scared tenants with his attitude.
Nordale also insisted upon raising rent (bad business decision) and turning apartments
into condos. In light of these facts, by 1981, Gibson and Smith had come to the conclusion that
Nordale was incapable of making rational business decisions and that they should seek
dissolution of the partnership so that they could but out Nordale’s interest.

20
 After filing of complaint seeking dissolution, Nordale died. After death, appellees file
supplemental complaint invoking their right to continue the business and acquire Nordale’s
interest under Article 19 of the Articles of Limited Partnership.
Appellant contends that the filing of the original complaint was an effective dissolution
of the partnership.Appelle’s contend that the wrongful conduct of Nordale in contravention of
the partnership agreement permitted the court to find that the appellees should carry on the
business. UPA § 32 (1914). Also is precedent that the mere filing of a complaint is not a
dissolution of the partnership.
Article 19 of the Articles of Partnership

CHAPTER 3. THE NATURE OF THE CORPORATION

Section 1. Promoters and the Corporate Entity

Promoter A term of art referring to 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. v. Camcraft, Inc.

P alleging breach of contract, failure to furnish a ship, ∆ claiming that P was not
corporation at time k entered into, thus no breach. At trial, ∆’s motion to dismiss granted,
reversed on appeal.
Dec. 6th, 1978 “letter of agreement” entered into b/ween parties, P was to purchase 156
ft. boat from ∆ for 1.35 million bucks. Agreement signed by both parties and authority was given
to start acquiring materials to build the ship. Vessel construction contract ultimately entered into
on May 30, 1979, b/ween the parties with preamble containing statement that P was corporation
organized by virtue of Texas laws. Subsequently, P writes to ∆ and informs him that his
organization was now incorporated in the British West Indies. (Was clause in k that referred to
Shipping Act of 1916 Owner warrants American citizenship). Told ∆ that the move was
completed to make the vessel’s use in foreign waters more economical. Mr. Bowman, president
of Camcraft, signed written acceptance of this amendment to the initial k. ∆ then defaulted on its
obligation to build the ship.
Trial judge’s reasoning is that there were not two parties b/c one was not incorporated,
thus no k was created. Bring 4 arguments on appeal, first one taken up by the court is estoppel.
Should the defendant be estopped from asserting the plaintiff’s lack of corporate capacity at the
time the Vessel Construction Contract was executed after dealing with the plaintiff as a
corporation? Rule: “Where a party has contracted with a corporation, and is sued upon the k,
neither is permitted to deny the existence, or the legal validity of such corporation. To hold
otherwise would be contrary to the plainest principles of reason and of good faith, and involve a
mockery of justice.”
Hence, must build ship. (Cannot avoid liability b/c vessel appreciated beyond value of
contract price).

Section 2. The Corporation Entity and Limited Liability

Limited Liability

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MBCA § 6.22(b): “Unless otherwise provided in the articles of incorporation, a shareholder of a
corporation is not personally liable for the acts or debts of the corporation except that he may
become personally liable by reason of his own acts or conduct.”

Walkovsky v. Carlton
P alleges he was injured when he was run down by taxicab owned by ∆. (negligence
case). Carlton is claimed to be stockholder in 10 corporations, each of which has 2 cabs, and all
carry minimum liability insurance (10,000k). Although seemingly independent of each other,
corporations are alleged to be run as one regarding finances, supplies, repairs, employees, and
garaging. Essentially argues corporate structure is an attempt to defraud members of the general
public.
Law does permit incorporation of business to escape personal liability; however, there are
limits. The courts will “pierce the corporate veil” to prevent fraud or achieve equity. In
determining whether liability should extend to assets beyond the corporation, governed by rules
of agency. Whenever anyone uses control of the corporation to further his own rather than the
corporation’s business, liable by respondeat superior.
P alleges two theories of liability. 1. Corporation is fragment of larger corporate combine
which actually conducts business. 2. Corporation is ‘dummy’ for its individual stockholders who
are carrying on business only for personal gains. No allegations that ∆ was conducting business
in his individual capacity. In first instance, only a larger corporate entity would be financially
responsible.
Reading the complaint liberally in P’s favor, it does not believe that cause of action can
be stated against ∆ Carlton. No allegations that he was conducting entire business in his
individual capacity. Corporate form cannot be disregarded merely to get P the damages he seeks,
nor can Carlton be personally liable b/c of infinite regress argument. If insurance coverage is
insufficient, this is matter for the Legislature to handle. Not impossible for plaintiff to state cause
of action, he merely didn’t do it here. Complaint is barren of any sufficiently particularized
statements that Carlton and his associates are doing business in their individual capacities.

How does “piercing” the corporate veil work?

Enterprise liability- Roping in other corporations

PCV- Only looking at shareholders of smaller corp. (Carlton’s 10 cab unit), here P would only be
able to recover from Carlton

Dissent: ∆ Carlton was principal shareholder and organizer of ∆ corporation which owned the
taxicab. Corporations intentionally undercapitalized intentionally to avoid liability. Under these
facts, shareholders should all be held individually liable to the plaintiff. Equity requires this
finding. Cannot have general public injured then give them a grossly unjust compensation for
their injuries suffered. Statute should not be given merit. Holds that corporations organized with
capital insufficient to meet liabilities which hare certain to arise in the ordinary course of the
corporation’s business may be held personally responsible for such liabilities.

Notes:

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Pg. 194
#1 Tell incorporators to not mix personal funds with business funds. Other factors to
consider: undercapitalization, disregard for corporate formalities (failure to shareholder
meetings, failure to hold board meetings, failure to keep minutes of said meetings, failure
to keep separate books, failure to issue stock, failure to appoint a board, failure to adopt
charter or by-laws.

As to enterprise liability: make sure clients keep separate books for each corp, separately
insured, no-comingling of funds

Sea-Land Services, Inc., v. Pepper Source

Jamaican Sweet Peppers case. Appellee, ocean carrier, shipped peppers on behalf of
Pepper Source (PS). PS then stiffed SL on the freight bill. SL files suit and gets judgment, but PS
is nowhere to be found, had been dissolved for failure to pay the annual state franchise tax in
1987. Apparently, even had it not been dissolved, PS had no assets.
1988, SL files this suit in an attempt to pierce PS’s corporate veil. File suit against Gerald
Marchese and five businesses he owns in attempt to do so. Seeks to render Marchese personally
liable and then reverse pierce Marchese’s other corporations. Thus SL alleges that corporations
are alter egos of each other and that they are also alter egos of Marchese. SL amended complaint
to also include Tie-Net, unlike the other corps, Tie-Ne is only 1/2 owned by Marchese.
SL was granted s.j., effectively piercing the corporate veil. Marchese appeals from this
finding. Facts: Marchese runs all of these corporations out of the same, single office, with the
same phone line, the same expense accounts, Corporations also borrow money from eachother
and he borrows money interest free from the corporations. Marchese pays alimony and child
support from the bank accounts of these corporations. Tie-Net is treated the same as all other
businesses, even though it is co-owned. Court agrees that the shared control/unity of interest part
of the Van Dorn test is satisfied.
Sea-land must also show that honoring the separate corporate existence of the ∆’s would
sanction fraud or promote injustice. SL argues that honoring ∆s separate identities would
promote injustice. (had argued fraud, but abandoned this argument). Court undertakes its own
review of Illinois cases to determine how the promote justice feature of the veil-piercing inquiry
has been interpreted. Standard: “Some element of unfairness, something akin to fraud or
deception of the existence of a compelling public interest must be present in order to disregard
the corporate fiction.” After a case by case analysis of what constitutes injustice, the court finds
that SL has yet to come forth with evidence akin to the wrongs found in Illinois cases that have
pierced the corporate veil. Its unsatisfied judgment was not enough to pierce the veil as an
injustice. Court proposes what SL must prove: unjust enrichment or attempt to defraud.

Fraud is crucial part of PCV analysis!!!

Is it enough that the creditor will be unable to collect the full amount owed unless the court
pierces the veil? Hell no, then any P would be able to collect. Something more is required, fraud
or something along these lines.

Back to Walkovsky
Was there fraud or other injustice on the facts of Walkovsky? Dissent thinks so. Maybe a
weak case for unjust enrichment if Carlton deliberately siphoned assets out of the corporation to
avoid liability to victims of his taxi drivers.

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PCV “One commentator has compared it to lightning, freakish and rare.”

Ways to avoid Piercing the Corporate Veil

• Respect corporate formalities
• Keep corporate minutes
• Don’t mingle corporate funds and personal funds
• Do not use the corporation to commit fraud

Take away point #2

• Don’t confuse PCV and enterprise liability
• Enterprise liability is simply an extension of agency law (when one corporation can be liable
for the wrongs of another where the 1st corporation decides how the 2nd corporation does its
business)
• PCV- different theory entirely (unity of interest, fraud and injustice)

Take away point #3 (19 Factors for WV for PCV, Laya v. Erin Homes, 352 S.E.2d 93 (1986)

Roman Catholic Archbishop of San Francisco v. Sheffield

Sheffield agrees to purchase St. Bernard from Fr. Bernard Cretton of the monestary of St.
Augustine, the monk in charge of the monestary, for 175$, payable in 20$ installments. Dog was
to be shipped from Geneva to LA and Sheffield was to pay 125$ shipping. Sheffield paid 60$
total towards dog but did not receive it. Writes monestary asking for refund or for the dog.
Sheffield told dog won’t be shipped until he pays entire purchase price and 60 extra dollars for
priest’s trip to Geneva.
P sues essentially the entire Roman Catholic Church alleging that there exists “a unity of
interest and ownership b/ween all and each of the ∆’s and that all ∆’s are alter ego’s of
eachother. Archibiship of San Fran claims that he is distinct legal entity and that he never had
any dealings with Sheffield or the Canons of Regular St. Augustine. (or done any business with
them). P’s claim is essentially that “the Roman Catholic church, governed by the pope through
the Code of Canon Law, Roman congregations, and other ecclesiastical organs, is but one
worldwide entity; not a composite of entirely separate entities as claimed by Walsh.
P does not contend that the Archbishop was involved in the transaction b/ween him and
the monastery, his action against Archbishop is based upon the alter ego doctrine. Requirements
for applying the alter ego principle are: “it must be made to appear that the corporation is not
only influenced and governed by that person, but that there is such unity of interest and
ownership that the individuality, or separateness, of such person and corporation ceased, and the
facts are such that an adherence to the fiction of the separate existence of the corporation would,
under the particular circumstances, sanction a fraud or promote injustice.
Court finds that complaint and affidavits fail to prove that Archbishop is an alter ego of
the Canons Regular of St. Augustine, pope may be, but he is not. Moreover, failure to pierce the
corporate veil will not lead to inequities. The purpose of the doctrine is not to protect every
unsatisfied creditor, bud to protect him where bad faith makes it inequitable.

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In Re Silicone Gel Breast Implants Products Liability Litigation
∆, sole shareholder of Medical Engineering Corporation, filed motion for summary
judgment. Bristol (∆) asserts that the evidence is insufficient to pierce the corporate veil.

Facts: MEC, incorporated in Wisconsin, produces breast implants. In 1982, Bristol purchases all
of MEC’s stock for 28$ a share. Bristol proceeds to acquire two more breast implant companies,
uses funds from Bristol account to pay for businesses. Due diligence review which indicated
potential hazards and possible liability was conducted jointly by MEC and Bristol. MEC’s board
of directors consists of Bristol’s VP, another Bristol exec, and MEC’s president. Several former
MEC presidents did not recall that MEC had board of directors. Bristol had control.
MEC reported to Bristol frequently, but neither MEC nor Bristol employees recall any orders or
recommendations upon reviewing the reports. MEC submitted budgets for approval by Bristol.
Cash received by Bristol transferred to account maintained by Bristol. Interest earned on account
credited to Bristol. Bristol controlled employment policies and wages. Bristol’s corporate devp.
groups and scientists aided MEC in developments. Bristol audited MEC once or twice a year.
Bristol’s public affairs development prepared question and answer scripts for MEC employees
for use in responding to questions about breast implant safety. Bristol’s name also used to
advertise the implants.

Two claims by P’s

Corporate Control Claims

“When a corporation is so controlled as to be the alter ego or mere instrumentality of its
stockholder, the corporate from may be disregarded in the interest of justice. List of factors to be
considered on page 208. Summary judgment not appropriate b/c many of these factors could be
proven at trial. ∆ contends that finding of fraud is necessary to pierce corporate veil. Tort and
contract distinction. “In actions based on contract, the creditor has willingly transacted business
with the subsidiary although it could have insisted on assurances that would make the parent also
responsible. In tort, however, the injured party had no such choice; the limitations on corporate
liability were, from its standpoint, fortuitous and non-consensual. (No fraud must be proven).
However, fraud may be provable here given that Bristol permitted label to be on packages to
gain trust of physicians and public and that hid funds.

Direct Liability Claims

Negligent undertaking: by allowing its name to be placed on the breast implant packages and
product inserts, Bristol held itself out as supporting the product. Hence, no s.j..
State statute that “one who undertakes, gratuitously or for consideration, to render services to
another which he should recognize as necessary for the protection of a third person or his things,
is subject to liability to the third person for physical harm resulting from his failure to exercise
reasonable care to perform his undertakings.”

Derivative Litigation
• Corporations can sue or be sued

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• Rule at law: Lawsuit must be filed by the corporation or it cannot be filed at all
• A derivative suit is a suit in equity against a corporation to compel it to sue a 3rd party
• Classic example: shareholder sue corporation to force it to sue firm’s manager for fraud
• Derivate suit is also the primary method for shareholders to enforce fiduciary duties*****
under MBC 7.46 –corporation must reimburse plaintiff for attorney’s fees if they prevail
• Considered two suits in one
• All benefits from suit go to corporation

Direct v. Derivative Suit

• Law suit is direct if alleges a direct harm to the shareholder
• It is derivative if it alleges a loss to the shareholder that comes from a loss to the corporation
• Direct- brought by the shareholder in his of her name, cause of action belonging to the
shareholder in his or her individual capacity, arises from injury directly to shareholder
• Derivative- brought by a shareholder on corporation’s behalf, cause of action belongs to the
corporation as an entity, arises out of an injury done to the corporation as an entity

Traditional Test
1. Who suffered the most direct injury? If corporation, suit is derivative

2. To whom did ∆’s duty run? If corporation, suit is derivative

Why are suits in equity and not in law

• At law, the shareholder cannot sue wrongdoers because the theory of the corporation was that
the wrong was to the corporation, not to the shareholder
• In equity, the court is free to fashion a remedy to prevent injustice

Pros and Cons of Derivative Suits

1. Micro-management
2. Attorneys seeking out clients to get $$$ for themselves (strike suits)
3. No real benefit conferred to shareholder
4. S.C. called it ‘remedy born of stockholder helplessness’

Plaintiff-side Incentives
• Any recovery goes to corporate treasury
• Lawyer is real party in interest (corp must pay fees if there is substantial non-monetary
victory)

∆ side incentives
• Strike Suits- settle to go away
• Meritorious suits against insider defendants: Indemnification
• MBCA 7.41(2) “the named plaintiff must be a fair and adequate representation of the
corporation’s interest”
• MBCA 7.45 requires judicial approval of all settlements

Frigidaire Sales Corp. v. Union Properties

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 Frigid seeking review of Court of appeals decision which held that 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.
Frigid entered in to k with commercial investors LLP. Leonard Mannon and Raleigh
Baxter were limited partners of Commercial and are also directors of Union Properties (the only
general partner of commercial). Leonard and Raleigh, through their day to day control of Union,
exercised day to day control of Commercial.
Frigid’s sole contention is that ∆ should incur general liability for the limited
partnership’s obligations because they exercised day-to-day control and management of
Commercial. ∆’s argue that Commercial was controlled by Union, a separate legal entity, and not
by respondents in their individual capacities.
B/c statutes allow limited partnership’s to be formed, they are ok. Moreover, Frigid was
never led to believe that parties acted in any capacity other than their corporate capacities. Parties
in fact stipulated that respondents never acted in any direct, personal capacity. Rule: “When the
shareholders of a corporation, who are also the corporation’s officers and diretors,
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. In the eyes of the law, it was Union Properties,
as a separate corporate entity, which entered into the k with petitioner and controlled the limited
partnership.

Section 3. Shareholder Derivative Actions

A. Introduction

Cohen v. Beneficial Industrial Loan Corp.

P brought derivative action alleging mismanagement and fraud over a period of 18 years.
One of 16,000 stockholders, he owned 100 of corps 2 million shares. His holdings never
exceeded 9,000. Dealing with N.J. statute: general effect is to make a plaintiff having so small an
interest liable for the reasonable expenses and attorney’s fees of the defense if he fails to make
good his complaint and to entitle the corporation to indemnity before the case can be prosecuted.
Petitioners deny the validity of this statute under the Federal Constitution. Courts goes
through brief history of derivative suits: were originally suits of equity and then proceeds to
describe how these suits were uses as strike suits to foster quick settlements. Court concludes
that the state has plenary power over this type of legislation because it has the ability to impose
standards of responsibility, liability, and accountability on the shareholders bringing the suit.
As to the EP claim: (b/c person who owns 5% or $50,000 in market value treated
differently) court is unable to say that a classification for these purposes, based upon the
percentage or market value of the stock alleged to be injured by the wrongs, is an
unconstitutional one. (Has legitimate purpose: prevent strike suits).

Applicability in Federal Court

Cohen also argues that N.J. statute is n/a because provisions of rule are procedural rather
than substantive issues of law. Court finds that this statute is not procedural, with it our without it
the main action takes the same course. Statute prescribes a procedure by which the liability is
insured by entitling the corporate ∆ to a bond of indemnity before the outlay is incurred.

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Eisenberg v. Flying Tiger Line, Inc.
P brought action to enjoin the effectuation of a plan of reorganization and merger. Was
statute that required security to be deposited in sum of 35k. P did not comply, and consequently
his action was dismissed. B/c the court finds that P’s cause of action is personal and not
derivative within the meaning of § 627 the court reverses the dismissal.
P alleges that series of corporate maneuvers were intended to dilute his voting rights.
Specifically, P alleges that Flying Tiger organized a wholly owned Delaware subsidiary, FTC,
then another, FTL, by which only FTL would survive post merger. 2/3 of stockholders approved
merger at the stockholder’s meeting. Effect of the merger is that business operations are now
confided to a wholly owned subsidiary of a holding company whose stockholders are the former
stockholders of Flying Tiger. Flying Tiger contends that restructuring was undertaken to get tax
benefits and diversify the business without interference from the Civil Aeronautics Board. Only
required to decide whether Eisenberg should have been required to post security for costs as a
condition to prosecuting his action.
Court refers to Cohen, then proceeds. “If the gravamen of the complaint is injury to the
corporation the suit is derivative, but if the injury is one to the plaintiff as a stockholder and to
him individually and not to the corporation, the suit is individual in nature and may take the form
of a representative class action.” Court believes that this case is border-line hence rule is not very
helpful.
Court proceeds to characterize E’s claim as “reorganization has deprived him and fellow
stockholders of their right to vote on the operating company affairs and that this right in no sense
ever belonged to Flying Tiger itself. FT argues that the stockholders, if harmed at all, can only be
remedied if defunct corp. is revived.
Distinguishing b/ween derivative and non-derivative actions, court notes previous errs by
court, then proceed to Lazar as precedent that when a stockholder sought to force directors to call
a stockholder’s meeting, the court held that security for costs could not be required where a
plaintiff “does not challenge acts of the management on behalf of the corporation. He challenges
the right of the present management to exclude him and other stockholders from proper
participation in the affairs of the corporation. He claims that the ∆’s are interfering with the
plaintiff’s rights and privileges as stockholders. (Court believes that in substance this is similar
to what E challenges here).
So, court distinguishes this case from Gordon, and reverses decision. Eisenberg had also
won a previous decision on similar grounds.

To make derivative argument, would have to argue that there is corporate inefficiency, biggest
problem with this case is that Eisenberg suffered no financial harm, his voting rights were only
affected right. Two consequences if this were found to be derivative suit: (1) He would have had
to post security and he would have been required to make a demand pre-suit.

Delaware’s Alternative
• In Tooley the S.C. adopted a two pronged standard
• Who suffered the alleged harm, the corporation of the suing stockholder individually?
• Who would receive benefit of any recovery or other remedy, the corporation or the
stockholder, individually?

Need to get definition of representative cause of action-

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B. The Requirement of Demand on the Directors

Grimes v. Donald
Grimes appealing from court’s granting of 12(b)(6) to his detriment. Grimes seeks
declaration of the invalidity of the Agreements b/ween Donald and the Company. Alleges that
the board has breached its fiduciary duties by abdicating its authority, failing to exercise due
care, and by committing waste. Company is Delaware corporation, headquartered in Texas.
Company designs, manufactures, markets, and services telecommunication systems.
Employment agreement provides that Donald “shall be responsible for the general
management of the affairs of the company . . .” and that Donald shall report to the board.
Agreement terminates on Donald’s 75th b-day or upon his death, for just cause, or without cause.
Grimes gets to decide if he was fired for cause, so gets to decide if he gets money. Upon
termination, Donald is entitled to benefits. (Great benefits upon termination). Grimes alleged that
Donald’s stock benefits may equal 66 million.
G alleges that he wrote to the Board and demanded that they abrogate the agreements and
they responded very officially.

Distinction b/ween direct and derivative claims

• The distinction depends upon the nature of the wrong alleged and the relief, if any, which
could result of plaintiff were to prevail.
• In determining whether a shareholders claim is derivative or direct, the issue must turn solely
on the following questions (1) who suffered the alleged harm, the corporation or the suing
stockholders, individually; and (2) who would receive the benefit of any recovery or other
remedy, the corporation or the stockholders individually.

Analysis of Grimes’ Abdication Claim

Grimes claims that the potentially severe financial penalties which the Company would
incur in the event that the Board attempts to interfere in Donald’s management of the Company
will inhibit and deter the Board from exercising its duties under Section 141(a). Rule: A court
cannot give legal sanction to agreements which have the effect of removing from directors in a
very substantial way their duty to use their own best judgment on management matters. Finds
that “in a world of scarcity, a decision to do one thing will commit a board to a certain course of
action and make it costly and difficult to change course and do another. This is an inevitable fact
of life and is not an abdication of directorial duty.” Court wants to leave such decisions to boards
of businesses. (it is not the courts place to step in and say what the value of an employee is).

The Demand Requirement of Derivative Suits

• “A stockholder filing a derivative suit must allege either that the board rejected his pre-suit
demand that the board assert the corporation’s claim or allege with particularity why the
stockholder was justified in not having made the effort to obtain board action.”

• Reasons for alleging that demand would be futile (1) a majority of the board has a material
financial or familial interest; (2) a majority of the board is incapable of acting independently
for some other reason such as domination or control: or (3) the underlying transaction is not
the product of a valid exercise of business judgment
• Court says that one of these factors is sufficient to excuse demand

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• Demand requirement serves salutary purpose. First, demand requirement invokes a species of
alternative dispute resolution procedure which might avoid litigation altogether. (2nd), if
litigation is beneficial, the corporation can control the proceedings, (3) if demand is excused
or wrongfully refused, the stockholder will normally control the proceedings.

• Given these findings, the court believes that the reasonable doubt standard gives the court
sufficient “keys to the courthouse” in an appropriate case where the claim is not based on
mere suspicions

B. Wrongful Refusal Distinguished From Excusal

• A stockholder who makes a demand is entitled to know promptly what action the board has
taken in response to the demand

• The stockholder does not, by making a demand, waive the right to claim that demand was
been wrongfully refused

• If there is reason to doubt that the board acted independently or with due care in responding to
the demand, the stockholder may have the basis ex post to claim wrongful refusal

Application to the current case

Grimes assertions that board was biased are conclusive. “Such conclusory, ipse
dixit, assertions are inconsistent with the requirements of chancery rule 23.1 . . . The
complaint fails 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.

DEMAND
• If a shareholder has a beef against the corporation, why not provide a day in court (without a
demand)?
• Since 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 corporation to take over the cause of action
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.
• MBCA does not have a futility provision/exception
• Under WV law, we follow the idea of a written demand, then must wait for 90 days before
filing suit
• Third, where a demand is made, the plaintiff 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 plaintiff invariably loses
• And, where demand is required (or made) the plaintiff is not entitled to discovery
• This means that well-advised plaintiffs in Delaware almost never make a demand, so the issue
becomes whether demand is excused or futile

Marx v. Akers

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 Shareholder derivative action against IBM and IBM’s Board of Directors without first
demanding that the board initiate a lawsuit. Amended complaint alleges that the board wasted
corporate assets by awarding excessive compensation to IBM’s executives and outside directors.
Issue raised is did the Appellate Division abuse its discretion when it dismissed P’s complaint for
failure to make a demand.
NY Law requires P to set forth with particularity the efforts of the P to secure the
initiation of such action by the board or by the reasons for not making such effort. Purposes of
demand are to (1) relieve courts from deciding matters of internal corporate governance by
providing corporate directors with opportunities to correct alleged abuses, (2) provide corporate
boards with reasonable protection from harassment by litigation on matters clearly within the
discretion of directors, and (3) discourage ‘strike suits.’
Delaware approach: once director interest has been established, the business judgment
rule becomes inapplicable and the demand excused without further inquiry. Look to procedural
and substantive due care to determine if board acted appropriately.
Universal Demand approach: Demand required in all cases, and derivative suit must
proceed w/in 90 days of the demand unless the demand is rejected earlier.

NY’s approach to Demand Futility

 In NY, a demand would be futile if a complaint alleges with particularity that (1) a majority
of the directors are interested in the transaction, or (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.
 Court cites Barr decision as stating that demand can be excused because of self-dealing, or
self-interest in a transaction
 Barr complaint also alleged with specificity that the directors were guilty of a breach of their
duties of due care and diligence to the corporation
 Barr reflects the statutory requirement that the complaint shall set forth with particularity the
reasons for not making such effort

Rule
“Demand is excused b/c of futility when a complaint alleges with particularity that a majority of
the board of directors is interested in the challenged transaction. Director interest may either be
self-interest in the transaction at issue, or a loss of independence because a director with no
direct interest in a transaction is ‘controlled’ by a self interested director. Also, demand is
excused because of futility when a complaint alleges with particularity that the board of directors
did not fully inform themselves about the challenged transaction to the extent reasonably
appropriate under the circumstances and third, demand is excused because if futility when a
complaint alleges with particularity that the challenged transaction was so egregious on its face
that it could not have been the product of sound business judgment of the directors.

Application:
Pleading in this case is largely insufficient. Majority of board members not implicated.
However, demand was excused as to P’s allegations that compensation set for outside directors
was excessive b/c person receiving benefit is always interested in this transaction, but b/c court
does not find corporate waste, motion to dismiss affirmed in its entirety.

Section 4. The Role and Purposes of Corporation

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A.P. Smith Mfg. Co. v. Barlow
Company manufactures and sells valves, fire hydrants, and special equipment. Company
has contributed regularly to local charities and on occasion to Upsala College. 1951, board of
directors decides that it was in the corporation’s best interest to join with others in the 1951
annual giving to Princeton and thus appropriated $1,500 to be transferred to Princeton. When this
act was questioned by stockholders the corporation instituted a declaratory judgment action to
get a ruling.
O’brien, president, testifies that he though investment was sound: furthers self-interest in
having free flow of properly trained individuals. Olds, former chairmen of U.S. Steel, testifies
that companies have self interest in investing in employees of tomorrow. Dodds, president of
Princeton, testifies to the same effect.
P’s raise two arguments: (1) the plaintiff’s certificate of incorporation does not expressly
authorize the contribution and under common-law principles the company does not possess any
implied or incidental power to make it, and (2) the N.J. statutes which expressly authorize the
contribution may not constitutionally be applied to the plaintiff, a corporation created long before
their enactment.
Old rule is that “those who managed the corporation could not disburse any corporate
funds for philanthropic or other worthy public causes unless the expenditure would benefit the
corporation.” 20th century has presented different climate for businesses, thus many
contributions have been upheld moving to new rule. B/c most of our countries wealth is now
in corporate hands, they must continue the tradition of good will giving. “Modern conditions
require that corporations acknowledge and discharge social as well as private responsibilities as
members of the communities within which they operate.
As to the statutory argument: 50 years prior to the incorporation of A.P. Smith, the
Legislature provided that “every corporate charter shall be subject to alteration, suspension, and
repeal, in the discretion of the Legislature.” Hence court applies settled rule 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 b/ween the corporation and its
stockholders and between stockholders inter se.” So public policy allows charitable gifts made in
good faith to be given, must be some benefit somewhere to the corporation. (Distinguishing
Zabriskie).

 Must make sure that CEO’s are not giving money to pet charities
Dodge v. Ford Motor Co. (Key Case)
Ford Motor Co. incorporated in 1903 with investment of $150,000. Amount invested
rapidly increases and profits soar. 1916, Henry Ford, who owns 58% of the common shares,
announced that in the future no special dividends will be paid. Rather, money will be re-invested
in the business, ex. to build an iron ore smelting plant.
Dodge brothers owned 10% of the common shares, were not members of the board of
directors and were not employed by the company. When Dodge bros hear of Ford’s new plan,
they offer to sell their interest to him for 35 million. He refuses, then the Dodge brothers sued,
attacking both the dividend policy and Ford’s proposed plans to expand the company’s
manufacturing facilities. They prevailed in lower court.
P’s claim: the proposed expansion of the business ought to be enjoined because inimical
to the best interests of the company and its shareholders, and upon the further claim that in any
event the withholding of the special dividend asked for by the plaintiffs is arbitrary action of the
directors requiring judicial interference. Rule applied: “The directors of a corporation, and they

32
alone, have the power to declare a dividend of the earnings of the corporation, and to determine
its amount. Courts of equity will not interfere in the management of the directors unless it is
clearly apparent that they are guilty of fraud or misappropriation of the corporate funds, or refuse
to declare a dividend when the corporation has a surplus of net profits which it can, without
detriment to its business, divide among its stockholders, and when a refusal to do so would
amount to such an abuse of discretion as would constitute a fraud, a breach of that good faith
which they are bound to exercise towards its stockholders.”
Considering only the monetary facts, a refusal to declare and pay further dividends
appears to be not an exercise of discretion on the part of the directors, but an arbitrary refusal to
do what the circumstances required to be done. Such facts call upon the directors to justify their
action, or failure or refusal to act. Offered justification: It is out policy to annually reduce the
selling price of cars while keeping up or improving quality. Want to efficiently increase output.
Court finds that in short, the plan will immediately produce a less profitable business.
Thus it appears that the immediate effect is to diminish the value of shares and the returns to
shareholders. Indeed, it appears that certain sentiments, “philanthropic and altruistic, creditable
to Mr. Ford, had large influence in determining the policy the be pursued by the Ford Motor
Company. (appears that Mr. Ford wishes to share profits with the public to the detriment of
shareholders).
Specifically, his counsel suggests that “although a manufacturing corporation cannot
engage in humanitarian works as its principal business, the fact that it is organized for profit does
not prevent the existence of implied powers to carry on with humanitarian motives such
charitable works as are incidental to the main business of the corporation.” Court rejects this
notion and decisively states that this case is distinguishable from all cases cited by Ford’s
attorney and that “a business corporation is organized and carried on primarily for the profit of
the stockholders. The power of the directors are to be employed for that end, and does not extend
to a change in the end itself, to the reduction of profits, or to the non-distribution of profits
among stockholders in order to devote them to other purposes.
However, court is not persuaded that it should interfere with Ford’s management b/c
selling price of products could be increased at any time, hence the court defers management of
the company to its board of directors.

Court requires payment of dividends but allows smelting plant to go forward

 Most cited case for point of law that shareholder profit maximization is the purpose of the
corporation: Dicta “A business is organized and carried on primarily for the profit of the
stockholders. The powers of the directors are to be employed for that end.” Pg. 274

Purpose of the Corporation Take Away Points

• Although profit maximization is the general principle, courts will give a lot of deference to
corporations. However, even under this model sometimes a corporation will reach its “outer
limits.”
• Common Issues
• (a) When can a corporation contribute to a public charity?
• (b) When must a corporation issue dividends?
• (c) To what extent can a controlling person use a corporation to indulge his or her whims?

Shlensky v. Wrigley
Stockholders’ derivative suit against the directors for negligence and mismanagement. P
is minority stockholder of Chicago Cubs. P alleges that since night baseball was first played in

33
1935 19 of the 20 major league teams have scheduled night games. P alleges that every other
member of the majors, other than the Cubs, scheduled substantially all of its home games in 1966
at night allegedly to maximize attendance thereby maximizing revenue and income.
Cubs, from 1961 to 1965 sustained operating losses from its baseball operations. P
attributes losses to poor attendance at Cubs home games. Concludes that Cubs will continue to
sustain losses until night games are scheduled. Compares Cubs to White Sox to prove his point.
P further claims that funds for installing lights can be readily obtained through financing and that
the cost of installation would be far more than offset by increased revenues and increased
attendance. Also alleges that ∆ hasn’t installed lights b/c of his personal belief that baseball is a
day-time sport. P also charges that board of directors have acquiesced in the policy laid down by
Wrigley with full knowledge that P’s act are wholly unrelated to the business interests of the
corporation.
Issue: Does P’s complaint state cause of action?
“The directors are chosen to pass upon such questions and their judgment unless shown
to be tainted with fraud is accepted as final. The judgment of the directors of corporations enjoys
the benefit of a presumption that it was formed in good faith and was designed to promote the
best interests of the corporation they serve.”
P tries to cite Ford case as giving him a cause of action, but court makes it clear that the
Dodge court made it clear that there must be fraud or a breach of good faith which directors are
bound to exercise toward the stockholders in order to justify the courts entering into the internal
affairs of corporations. (Court says this was made clear when the court refused to interfere with
the director’s decision to expand business).
Court not convinced that Wrigley acting with improper motives. It is not shown that night
games enhanced profits of the other 19 teams, nor is it adequately shown that the benefits would
outweigh the costs of installing lights. Additionally, it also appears that factors other than
attendance affect the net earnings and losses.
Moreove, P did no show that failure to follow the example of other major league teams in
scheduling night games constituted negligence. P made no allegation that other teams night
games were profitable nor must a director follow the lead of the other corporations in the field
even if the director is losing money. “Courts may not decide these questions in the absence of a
clear showing of dereliction of duty on the part of the specific directors and mere failure to
‘follow the crowd’ is not such dereliction.”

CHAPTER 4. THE LIMITED LIABILITY COMPANY

General Notes
• In LLC, investors are called ‘member’
• LLC may be managed by all its member or by managers who may or may not be members
• Investors in LLC are taxed, like partners, only once on its profits, as those profits are earned.
Moreover, the investors in an LLC can take account, on their individual tax returns, for any
losses of the LLC as those losses are incurred
• LLC’s first created in Wyoming, didn’t take off until the 1990’s
• Created as a vehicle for ownership of real estate and development of oil, gas and other
mineral rights
• IRS’s initial position was that LLC’s should not be treated as partnerships
• 1988, IRS ruled that LLC cold qualify for partnership-like tax advantages

Funding

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• Members usually contribute capital
• Contribution may be cash, property, services rendered, a promissory note, or other obligation
to contribute cash, property, or to perform services

Liability
• Members stand to lose capital contributions, but their personal assets are not subject to
attachment

Tax Consequences
• Income passes through to members
• LLC does not pay taxes

Advantages of Pass Through Taxation vis-à-vis Corporate Taxation

• Profits are not subject to double taxation
• Losses flow through to owners
• Capital gains flow through to owners and retain their tax attributes (is no penalty tax for
accumulating profits within the entity)
• There are fewer negative consequences to transfers of assets between the entity and owners

Formation
• File article of organization in the designated State office: required and optional contents set
forth in ULLCA § 203
• Other formation tasks
○ Choose and register name
○ Designate office and agent for service of process
○ Draft operating agreement- basic contract governing the affairs of a LLC and
stating the various rights and duties of the members
○ Need annual report
Member’s Interest
• Financial Interest- a right to distribution and liquidation participation
• Management rights

Financial Interests
• Profit and Loss Sharing
○ Absent contrary agreement, most statutes allocate profits and losses on the basis
of the value of all members’ contributions
○ Compare partnership law’s equal division
○ Withdrawal- Members may withdraw and demand payment of his/her interest
upon giving the notice specified in the statute or the LLC’s operating agreement

Management Rights
• Absent contrary agreement, each member has equal rights in the management of an LLC,
ULLCA § 404(a)(1)
○ Most matters decided by majority vote, ULLCA 404(a)(2)
○ Significant matters decided by majority vote, ULLCA § 404(a)(2)

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 ○ Can make LLC manager managed, must stipulate in k, ULLCA § 404(b), can be
structured as a board of directors, a CEO, or both and must be specified in articles
of incorporation

Assignment of LLC Interest

○ Unless otherwise provided in the LLC’s operating agreement, a member may assign his
financial interest in the LLC: See ULLCA §501-503

Fiduciary Duties
○ Manager-managed LLC’s  the managers of a manager-managed LLC have a duty of
care and loyalty. Usually, members or a manager-managed LLC have no duties to the
LLC or its members by virtue of being members
○ Member-Managed LLC’s All members have a duty of care and loyalty
○ Derivative Actions Member may bring an action on behalf of the LLC to recover a
judgment in its favor if the members with authority to bring the action refuse to do so

Liabilities
○ No member or manager of a limited liability company is obligated personally for any
debt, obligation, or liability of the limited liability company by reason of being a member
or acting as a manager of the limited liability company

Section 1. Formation

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

Issue: Are members of LLC excused from personal liability on a k where the other party to k did
not have notice that the members were negotiating on behalf of a LLC at the time the k was
made?
March 1995, Clark (∆) contacted Westec about possibility of hiring Westec to perform
some engineering work in connection with Taco Cabana project. In discussion, Clark gives
Westec rep a business card that included Lanham’s (Clark’s associate) address, the card also had
the initials P.I.I.. After further negotiations, parties reach agreement concerning Taco Shack.
Westec never received signed k, but did receive oral authorization from Clark to begin work.
Westec completed work and sent 9,183 dollar bill to Lanham and no payments were made.
At trial, company admitted liability for the amount owed Westec. Trial court finds for P,
district court reverses holding that filing of the articles of incorporation serve as constructive
notice of a company’s status as a limited liability company. [The ability to avoid two levels of
income taxation is an especially attractive feature of organization as a LLC].
Court return to agency law b/c sued ∆ under theory of agency. Under common law of
agency “an agent is liable on a k entered on behalf of a principal of the principal is not fully
disclosed.” “If both the existence and identity of the agent’s principal are fully disclosed to the
other party, the agent does not become a party to any contract which he negotiates. . . . But where
the principal is partially disclosed, it is usually inferred that the agent is a party to the k.”
Given this accepted law, Westec did not know that Clark was acting on Preferred Income
Investors behalf when he entered into k. Letters P.I.I. were not sufficient to inform P of this.
However, court proceeds to examine LLC act to ensure that the Act does not pre-empt the
partially disclosed principal doctrine.
Court not persuaded that the statute means that a third party who deals with the agent of a
limited liability company always has constructive notice of the existence of the agent’s principal.

36
Court believes that such a reading exaggerates the plain meaning of the statute and that the broad
interpretation urged by the ∆ would be an invitation to fraud because “it would leave the agent of
a limited liability company free to mislead third parties into the belief that the agent would bear
personal financial responsibility under any k when, in fact, recovery would be limited to the
assets of the LLC.
“The missing link between the limited disclosure made by Clark and the protection of the
notice statute was the failure to state that P.I.I. the Company stood for Preferred Income
Investors, LLC.

Section 2. The Operating Agreement

Elf Atochem North America, Inc. v. Jaffari

P, a Pennsylvania corporation, manufactures and distributed solvent based maskants to
the aerospace and aviation industries. ∆ had developed an innovative, environmentally friendly
alternative to the solvent=based maskants that dominate the market.
Mid 90’s Elf approached Jaffari and sought to invest in his product and assisting in its
marketing. Elf and Jaffari agree to undertake joint venture using LLC as the vehicle. Malek LLC
formed . Next, Elf, Jaffarie and Malek Inc., entered into series of agreements providing for the
governance and operation of the joint venture. Elf and Malek entered into exclusive
distributorship agreement. Agreement provided that Jaffari would be the manager of Malek LLC.
Under agreement, Elf provided 1 million in exchange for a 30% interest in Malek LLC. Malek
contributed its rights to the maskant in exchange for $$. Agreement also has arbitration clause
and contains a forum selection clause conferring jurisdiction to California.
Elf sues Malek alleging that “Jaffari breached his fiduciary duty to Malek LLC, pushed
Malek to the brink of insolvency by withdrawing funds for personal use, interfered with business
opportunities, failed to make disclosures to Elf, and threatened to make poor quality maskant and
to violate EPA regulations. Also alleged breach of K, tortuous interference with prospective
business relations and fraud.
Purpose of the LLC (Delaware Act) is to provide members with broad discretion in
drafting the Agreement and to furnish default provisions when the members’ agreement is silent.
§ 18-1101(b) of the Act provides that “it is the policy of the Act to give the maximum effect to
the principle of freedom of contract and to the enforceability of limited liability company
agreements.” Commentators observe that “only where the agreement is inconsistent wit
mandatory statutory provisions will the members’ agreement be invalidated.”
As to the arbitration and forum clause (P appealing lower court finding that they govern
this suit), the arbitration provisions fosters the Delaware policy favoring alternate dispute
resolution mechanisms, including arbitration. Elf also claims that because Malek LLC is not a
party to the agreement, the derivative claims are not governed by the arbitration and forum
selection clauses. Court says members are real parties in interest, and LLC is thus simply vehicle.
Elf also argues that the court erred in failing to classify the claims against Malek LLC as
derivative. Court finds Elf contracted away its right to bring such an action in Delaware and
agreed instead to dispute resolution in California.
Elf also claims that Delaware laws require the Court of Chancery to grant subject matter
jurisdiction. Again, contracted away these rights and moreover there is public policy in favor of
arbitration. Cannot avoid arbitration agreements!!!

Section 3. Piercing the “LLC” Veil

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Kaycee Land and Livestock v. Flahive
Wyoming asked to decide if the piercing the corporate veil doctrine should or should not
be applied to LLC’s particularly when there are no accusations of fraud. Court said that in some
instances the veil should be able to be pierced. Question becomes what factors you use to pierce
the corporate veil of an LLC in comparison to a corporation. “Certainly the various factors which
would justify piercing an LLC veil would not be identical to the corporate situation for the
obvious reason that many of the organizational formalities applicable to corporations do not
apply to LLCs.
Steps you take in piercing the veil analysis:
1. Look to statute (Some statutes will say that you use corporate law standards, also look to the
jurisdictions common law)
§ 303 of the ULLCA, it appears, tells us that failure to observe corporate formalities is
not an adequate basis for piercing the veil (essentially, you can k around these formalities)

10/6 Notes
Exam: Three or Four parts
1. Policy question is based upon what we have done to this point
2. Will be issue spotting question
3. Will be drafting issue

-500 Words or less summary of writing workshop is worth

-If draft best or worst 1st sentence for novel, get 1 class extra credit point
Problem
• There is tension b/ween allowing directors decisions making autonomy and holding them
accountable for their misdeeds
• Solution? Business judgment rule—courts will not second guess the business judgment of the
directors (except in limited circumstances)

Section 4. Fiduciary Obligation

McConnell v. Hunt Sport Enterprises

Columbus Hockey Limited LLC formed for the purpose of getting NHL team in
Columbus. CHL needed arena, no public financing provided, NIE decides might be profitable to
build arena and lease it to CHL. Dimon McPherson, representing NIE, talks to Hunt about
getting lease in writing, but Hunt objects to terms. Later, McConnell, who said that he was
representing CHL, said that he would agree to the lease. June 4, 1994, NHL franchise expansion
committee advised of McConnell’s commitment and recommended that NHL team be placed in
Columbus.
CHL investors meet, Hunt and his allies state that they still believe terms of lease are
unacceptable. Mcconnell and his allies signed lease on their own accord. NHL expansion group
recommended that Columbus franchise be awarded to McConnell’s group. McConnell’s group
files action seeking declaratory judgment that they have right to establish franchise. 1997, NHL
board of governors awarded franchise to McConnell.
Court looks to the terms of k to determine if they are ambiguous or unambiguous. “The
test for determining whether a term is ambiguous is that common words in a written contract will

38
be given their ordinary meaning unless manifest absurdity results or unless some other meaning
is clearly evidenced from the face or overall content of the contract.” [Court concludes that this k
is plain and unambiguous].
Clause in k that says members shall not be prohibited or restricted in engaging or owning
an interest in any other business venture of any nature, including competitive businesses.

Fiduciary Relationship “A relationship in which special confidence and trust is reposed in the
integrity and fidelity of another, and there is a resulting position of superiority or influence
acquired by virtue of this special trust.”

Key fact: “Was no duty not to compete under the k”  case further exposes freedom of k
as fundamental principle of the LLC

Tortious Interference Claim “the tort of interference with a business relationship occurs when
a person, without a privilege to do so, induces or otherwise purposely causes a third person not to
enter into or continue a business relationship with another
• McConnell only stated that he would accept franchise if Hunt did not take it, hence no
interference
• Further, appellant breached terms of CHL’s k when he filed this action, he did not get
approval.
• Thus, evidence showed appellant engaged in willful misconduct in filing this action @ issue
b/c he did not have the authority to file any such action

Notes 10/08

ULLCA v. Minnesota Act

• § 303. Liability of Members and Managers . . . . . A member or manager is not personally
liable for a debt, obligation, or liability of the company solely by reason of being or acting as
a member or manager
• Minn. Stat § 322B.303(2) “Case law that states the conditions and circumstances under which
the corporate veil of a corporation may be pierced under Minnesota law also applies to limited
liability companies
○ Minnesota law requires application of the corporate law standard which is “courts
will pierce the corporate veil if (1) an entity ignores the corporate formalities and
acts as the alter ego or instrumentality of a shareholder and (2) the liability
limitations of the corporate form results in injustice or is fundamentally unfair.”
○ Under 303(b) the failure of an LLC to observe the usual company formalities is
not significant to pierce the veil

 Take away points on LLCs & Veil Piercing

○ Standard for determining whether piercing an LLCs veil is permissible varies wildly
among jurisdictions
○ Some state statutes specifically prohibit it
○ Other state statutes specifically permit it (Minnesota)
○ Many states do not discuss it
○ In ULLCA jurisdictions courts focus on the fraud or potential injustice

 Fiduciary Obligation Absent Agreement to the Contrary

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 ○ ULLCA § 409(b)
○ (b)(1) duty “to account to the company … for … any property, profit, or benefit, . . .
derived from a use my a member

 Effect of Operating Agreemtn

○ Contracting our of fiduciary dutes
○ Partnership law: Singer v. Singer, contract may limit but not eliminate duty of
loyalty (UPA § 103(b)(3)
○ Limited partnership law: Contract did not trump fiduciary duty
○ LLC law: McConnell v. Hunt—“ an operating agreement of a limited liability
company may, in essence, limit or define the scope of the fiduciary duties
imposed upon its members.”

 LLC Statutory Provision

○ Delaware Code tit. 6, §18-1101(c)(2): fiduciary duties and liabilities may be expanded or
restricted by provisions in an LLC agreement
○ ULLCA § 103(b)(2): operating agreement may not “eliminate the duty of loyalty but may
“identify specific types or categories of activities that do not violate the duty of loyalty, if
not manifestly unreasonable
○ Was McConnell v. Hunt agreement manifestly unreasonable? Court said no, another
example of freedom of K in LLCs. Differnet from
 Dissociation v. Dissolution
○ Dissociation:
○ Withdrawal or expulsion must of a member UCLA § 601

○ Dissolution § 801

 Dissociated member’s interest must be purchased by the LLC (ULLCA 701)

○ Judicial proceeding available
○ See also UCLA 603

Events of Dissolution
○ By operation of law:
○ Upon happening of any event specified in LLC operating agreement
○ Vote of members
○ Unlawful to carry on business
○ Upon court order: economic purpose frustrated, misconduct by members

 Consequences of Dissolution Without Following Procedures

○ See New Horizons Supply Cooperative v. Hack

Extra Credit- What model does West Virginia follow?

Must determine what is immutable and what is not immutable b/c can k around in-immutable
rules
○ Fiduciary duty is considered immutable

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 ○ But in LLCs can’t you k away?
○ We will get to these rules, could be critical on final b/c she could give us k then ask how
it will be interpreted, etc..

Chapter 5. The Duties of Officers, Directors, and Other Insiders

Section 1. The Obligations of Control: Duty of Care

Kamin v. American Express Company
Stockholder derivative action, ∆’s file motion to dismiss. P’s sued seeking declaration
that a certain dividend in kind is a waste of corporate assets, directing ∆’s not to proceed with the
distribution, or, in the alternative, for monetary damages. Complaint specifically alleges that the
BOD declared a special dividend to all stockholders of record to distribute worthless shares of
stock for tax benefits to the company. Such a sale, they allege, would result in tax savings of 8
million, which would not be available in the case of the distribution of DLJ shares to
stockholders. Also alleged that plaintiffs made a demand and that the demand was rejected.
Court only dealing w/t request for declaratory judgment b/c stocks were distributed
(injunctive issue moot). No claim of fraud or self-dealing in the complaint, and no contention
that there was any bad faith or oppressive conduct. Court finds that question of whether or not
dividend is distributed is to be made exclusively by the BOD b/c it is a matter of business
judgment. [“Courts will not interfere with such discretion unless it be first made to appear that
the directors have acted or are about to act in bad faith for a dishonest purpose.”]
“A complaint which alleges merely that some course of action other than that pursued by
the BOD would have been more advantageous gives rise to no cognizable cause of action.
Directors room is the place for business decisions to be handled. Also no statutory claim b/c P is
essentially saying that they do not agree with the decision and such a claim is not actionable.
Court also notes that this case is not case where pleadings are merely inartful. Business decision
was soundly made to keep stock value high, and claim that earnings may have been overstated
(CEO’s awarded more dough than they should get) is highly speculative. Furthermore, plaintiff
must show clear case for a court to intrude into the sphere of the BOD.
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• MBCA § 6.40: “A BOD may authorize and the corporation may make distributions to its
shareholders.”
• MBCA § 1.40(6)
• At the hear of the business judgment rule—courts will not impose liability for dumb decisions
(here, BOD thought that there would have been serious effect on market value of the stock if
they had acted differently)

Study by Andrew Ballard

• ¾ of corporations would knowingly sacrifice shareholder values to meet earnings
expectations
• Additionally, financial executives are focused on short-term results and are willing to sacrifice
long-term value to achieve them

Strong Abstention Version

• “Complaint which alleges merely that some course of action other than that pursued by the
BOD would have been more advantageous gives rise to no cognizable cause of action.”

Question to Ponder in Decision

• Self interest?? Four of twenty four board members held stock in the corporation.

Smith v. Van Gorkom

Class action brought by shareholders of the ∆, Trans Union Corporation, against BOD.
Lower court grants judgment for BOD. Trans Union was publicly traded company in the railcar
leasing business. Company had difficulty generating sufficient taxable income investment tax
credits. Gorkem meets with BOD to discuss improvements, talks include discussions of sale of
Trans Union to a company with a larger taxable income. Study done to determine if buy-out will
benefit company.
Romans again brings up discussion of leveraged buy out at another meeting: however no
price discussed with the council. Merely ran figures at 50 and 60 dollars a share to get rough
estimate of the benefits. At this meeting Van Gorkem states that he would take $55 per share for
his personal shares. (75,000 shares). Van Gorkem meets with takeover specialist, Jay Pritzker,
and assembles a proposed per share price for sale of the company and a financing structure by
which to accomplish the sale. VG did so without consulting his board or any members of senior
management, except one: Carl Peterson. VG asks Peterson to do calculations on sale at $55
although the record is devoid of any evidence that $55 represented the per share intrinsic value of
the stock.
VG calculates firm to be worth 690 million, after figures ran by Peterson, VG frustrated
but decides to go ahead and meet with Pritzker, the takeover specialist. VG reviews calculations
with Pritzker, initially, no deal made, but on September 15th Pritzker informs VG that he is
making moves. Pritzker says he will take 1 million shares at $38. He requires the BOD to act on
his decision no later than Sunday evening. September 19, VG calls a special meeting, reaction to
his proposal was completely negative. No member of management, except Cheldberg and
Peterson, supported the takeover.
VG began meeting with a 20 minute presentation, copies of the presentation were
delivered to late for study before or during the meeting. Outlines terms of the agreement as
follows: Pritzker woulf pay $55 for all outstanding shares, VG felt this price was fair and that
stockholders should be able to accept or reject the offer. Directors approve VG’s presentation

42
and representation based on their limited knowledge. Board later claimed to have attached two
conditions to the acceptance: (1) that Trans Union reserved the right to accept any better offer
that was made during the market test period; (2) that Trans Union could share proprietary info
with other bidders. (Board actually did not reserve the right to solicit alternate offers). No
directors read the agreement prior to signing it and delivering it to Pritzker.
Within 10 days of public announcement, dissent arose among senior management over
the merger. Agreement altered in attempt to retain senior staff. Other suitors list interest, on
February 10th, stockholders approved merger. 69.9% voted in favor of the merger, 7.25% voted
against merger, and 22.85% did not vote.

II. Business Judgment Rule—“Is a presumption that in making a business decision, the
directors of a corporation acted on an informal basis, in good faith and in the honest belief that
the action taken was in the best interests of the company.” “Thus the party attacking a board
decision must rebut the presumption that its business judgment was an informed one.” “The
determination of whether a business judgment is an informed one turns on whether the directors
have informed themselves prior to making a business decision, of all material information
reasonably available to them.” “There is no protection for directors who have made an
unintelligent or unadvised judgment.”
Analysis—Did the directors reach an informed decision on September 20th and if not, did the
actions taken subsequent to September 20th cure any deficiencies stemming from their earlier
decision?
As to September 20th, directors did not reach informed decision. No directors had
knowledge of the merger, except few, no members of senior management present, only saw 20
minute oral presentation prior to vote, no one read agreement, no “report” presented to the board
which justifies protecting their decision. VG’s presentation not a report because he lacked a
substantive understanding of what he was discussing. Furthermore, BOD did not correctly
calculate the intrinsic value of the stock. No formal evaluation done to value the enterprise,
Board thereby failed to find that VG had simply recommended price to Pritzker.
Post September 20 market test—Facts do not support finding that BOD made informed
business decision because no evidence that an auction was in fact permitted to occur or that
agreement was amended to even give Trans Union the opportunity to auction to the highest
bidder. Additionally, Board’s collective experience and sophistication is insufficient basis for
finding that it reached an informed decision.

B. Was the BOD’s conduct post September 20th grossly negligent? Was action sufficient to cure
board’s earlier derelictions?
Rather than reviewing the amendments, the Board approved them sight unseen and
adjourned, giving VG unfettered power to execute them. Because of the level of ignorance
among board members, the Court finds that the BOD breached its fiduciary duty to the
stockholders by failing to make an informed decision and also by failing to disclose all
information that a reasonable stockholder would consider in making a decision whether to
approve the offer.

Legal Rule Emerging: No protection for uninformed decision . . . burden of proof is on party
attacking the decision. What must that party prove: “gross negligence by directors who failed to
inform themselves of ‘all material information reasonably available to them’

Dissent: BOD was simply using its experience to make an informed decision, no negligence.

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Business Judgment Rule does not indemnify you from liability if you do not look at your options
when making a decision!!!! Must look to all factors when making business decision!!!!

Business judgment rule post Van Gorkom

A standard of liability—Directors may be held liable for gross negligence in failing to make an
informed decision

Rule of abstention—Will court review substance of BOD decision? No, court will examine
decision-making process to determine the extent to which BOD made an informed decision

Market test-defense—IF price was too low you would know because many offers would come
in, court rejected this defense b/c time period too short, all proprietary interests were not
provided

Gross negligence standard met b/c no evidence presented that $55 represented the intrinsic value
of the corporation

Delaware Corp. Law § 141(e)—Delaware officers are allowed to defend their behavior based
upon reliance on reports presented to them. BOD in this case could not use this defense b/c there
were no sufficient reports. “Absent sufficient evidence of any deliberative process, liability may
be imposed.”

Note on Cinema Inc., v. Technicolor Inc.,

Same type situation as above, but “no harm no foul” mentality and CEO had done
thorough job researching. Court distinguishes from VG on these grounds.

Francis v. United Jersey Bank

P and B are reinsurance brokers. “Reinsurance is the process by which an insurance
company that has agreed to insure a risk assigns all or a portion of that risk to another company,
along with a share of the premium.” Broker acts as intermediary between the companies, and in
doing so he receives funds from ceding companies and is obligated to pay these funds over to the
re-insurers. Lillian Pritchard inherited a 48% interest in P and B from her husband. She was the
largest single shareholder and a director. Remaining shares were owned by her sons who also
acted as directors. Charles Jr. dominated the management after death of his father. Both sons
w/drew large sums of money from the corporation in the form of “loans.” By bankruptcy, loans
were over 12 million. Loans were taken from clients funds. After discovery of thievery, Mrs. P
died, current suit is by trustee in b-ruptcy against her estate to recover funds.
Mrs. P knew nothing of the corporate affairs. Although her husband warned her that
Charles would “take the shirt off my back” she still did not pay attention to her duties as director
or to the business affairs. After husband’s death, she became bed-ridden and drank heavily. Her
physical condition deteriorated until she died. Trial court found she was competent to act and
held her to it.
Individual liability rarely imposed upon corporate director, determination of the liability
of Mrs. Pritchard requires findings that she had a duty to the clients of P & B, that she breached
the duty and that her breach was a proximate cause of their losses.

44
 Court notes that directors cannot set up as a defense lack of knowledge needed to
exercise the requisite degree of care. “If one feels that he has not had sufficient business
experience to qualify him to perform the duties of a director, he should either acquire the
knowledge by inquiry, or refuse to act.” Directors are also obligated to keep informed about
businesses activities. [Cannot shut your eyes upon corporate misconduct]. Directors shold
regularly review the financial statements of the corporation. Also, upon discovery of illegal
course of action, director has duty of further inquiry. “Shareholders have a right to expect that
directors will exercise reasonable supervision and control over the policies and practices of a
corporation.
Could finds that P&B resembles a bank, accordingly, the court classifies Mrs. P’s
obligation as similar to those of a director of a bank to its depositors. Hence, her conduct is
inexcusable b/c she entirely failed to take not of bank statements, and had she heeded the
accounts she would have realized that her sons were stealing money. Thus, she breached her
duties of basic knowledge and supervision.
So, crux of the case is whether she is the proximate cause of the loss? There are two
significant reasons for holding her liable. 1. She did not resign until just before the bankruptcy.
Consequently, there is no factual basis for the speculation that the losses would have occurred
even if she had objected and resigned. 2. the nature of the reinsurance business distinguishes it
from most other commercial activities in that reinsurance brokers are encumbered by fiduciary
duties owed to third parties. Hence, court finds that wrongdoing of her sons should not excuse
breach of her duties. Her failure to act was a contributing factor to the ponzi scheme.

Notes 10/13

Two Ways of Thinking About the Business Judgment Rule

1. As a standard of liability no liability for negligence, only liability for fraud, illegal conduct,
or self-dealing

2. As an abstention doctrine Courts will not review BOD decisions unless a finding of fraud,
illegality, or self-dealing is made

• Courts rarely specify what way they are thinking about the rule
• Bainbridge believes that the standard of liability concept means that it is far more likely that
the claim will survive until summary judgment—can have substantial impact on settlement
value of the case
• For purposes of the exam, should state both, but it will not effect analysis if we do not know
both

Section 2. Duty of Loyalty

A. Directors and Managers

Recap: The Duty of Care

• Historically the Duty of Care imposed personal liability on directors of a corporation when
they acted negligently

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• It is not generally understood that the standard of liability for a duty of care action in most
jurisdictions is one of gross negligence or reckless disregard
• What is corporate waste?
○ “A transaction that is so one sided that no business person of ordinary, sound
judgment could conclude that the corporation has received adequate
consideration.”
○ “Irrationality is the outer limit of the business judgment rule. Irrationality may be
the functional equivalent of the waste test or it may tend to show that the decision
is not made in good faith.”
The Duty of Loyalty
• Two Types of Conflicted Transactions
• 1) Direct- the Director is selling something directly to the firm (like real estate)
• 2) Indirect- The person or entity in which the director has an interest is dealing with the firm
• Generally the second type of transaction creates the greater problem: more difficult for people
to notice the conflict in the first place, can lead you down the slippery slope as the director’s
interest becomes more attenuated. Was it in fact a conflict?

Duty of Care Duty of Loyalty

Imposes liability under negligence principles
BJRule is intrinsically intertwined
Implicates decisions made by whole board
Harm required (See Cinerama Inc.)
Proper remedy: Damages
Imposes liability for self dealing
BFJ doesn’t preclude judicial review
Usually involves misconduct of one director
Harm not necessary
Proper Remedy: Rescission

History of duty of loyalty

• Early Common Law: conflicted interest transaction were voidable by the regardless of
whether they were fair or whether they had been approved by the board or by the shareholders
• Modern Rule: Interested Director Statutes DGCL § 144
• DCGL § 144 (a) No contract or transaction b/ween a corporation and 1 or more of its directors
or officers, or between a corporation and any other corporation, partnership, association, or
other organization in which 1 or more . . . . . . .

Issues with the Duty of Loyalty

• 1) Approval of Conflicted Interest Transactions by a Majority of Disinterested Board
Members (Benihana)
• 2) Ratification if Disinterested Shareholders of Board Action (Fliegler)
• 3) Fairness Absent Valid Approval by Shareholders or Ratification by Board (Fliegler)

§ 144(a)(3)
• Hallmark of a fair transaction?
• Within the range of terms that parties bargaining at arms-length might reach
• E.G. Bayer
○ Nothing to show that some other soprano would have enhanced program
○ No suggestion that present show’s cost disproportionate
○ Her compensation was in conformity with similarly situated singers
Defects in disclosure highly relevant!!

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Special Issues with D of L: Corporate Opportunities
○ Definition: When a director takes an opportunity that rightfully belonged to the
corporation
○ Is bring the opportunity informally to the corporation enough? Broz v. Cellular

Bayer v. Beran
Court notes business judgment rule, noting that even the business judgment rule yields to
the rule of undivided loyalty. Thus transactions as may tend to produce a conflict between self-
interest and fiduciary obligation, are, when challenged, 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 are voided. Burden is on the director not only to prove the good faith
of the transaction but also to show the inherent fairness from the viewpoint of the corporation
and those interested therein.
Negligent advertising cause of action. Alleges that they were negligent in selecting the
type of advertising, further claimed that radio advertising was for the benefit of Miss Tennyson,
one of the singers on the program, who is the wife of the president and a director of the
company. Money allegedly given to “furnish a vehicle” for her talents.
Court notes that had the wife of the president not been involved, advertising cause of
action could have been disposed of summarily. Company had previously considered radio
advertising, but had not done it b/c wanted its product strictly to be referred to as Celanese, not
Rayon or Rayon Celanese. Business had option to multiply current advertising or go into radio
advertising.
Towards end of 1941, informally decide to resort to radio advertising, decide to go on air
with dignified program of fine music. Radio plan was not adopted at the spur of the moment or at
the whim of the directors. They acted after studies reported to them made by the advertising
department. Maximum obligation not > 250,000 b/c could cancel contract after 13 weeks. Given
these facts, expenditure was not negligent or reckless, rather, the advertising bore a relationship
to the total amount of net sales and to the company’s earnings.
Dr. Dreyfus owns 135,000 shares. His wife is the singer. Wife gave suggestions to
advertising company about what music should be played, she also was an artist. She received
$500 night for her services. Court believes claim far-fetched that company incur large
expenditures so that she can gain measly 24k. However, whenever appoint close family member
such appointment must be given close judicial scrutiny. However, court believes evidence fails
to satisfy that the program was designed to subsidize wife’s career. She was paid comparable to
other artists. She received no undue prominence, no special build-up.
P also argues that failure of board to act collectively voids advertising agreement. Court
says this flaw is not fatal. Court doesn’t buy it, says that the same informal practice followed in
this transaction has been the customary procedure of the directors in acting on corporate projects
of equal and greater magnitude. All members were available for consultation. All board members
ratified agreement!! Rule: “Because the k is fair, it is valid even though disinterested directors
have not formally ratified it.

Benihana of Tokyo, Inc. v. Benihana, Inc.

Aoki owned 100% of the stock until 1998 when, because of felony insider trading
charges, he transferred his stock to the Benihana Protective Trust. Trustees were three of his six

47
children. Before transaction at issue, BOT owner 50.9 of the common stock and 2% of the Class
A stock.
August 2003, kids upset to learn that Aoki changed will to give control of BOT to his
wife upon his death. Joel Schwartz, Benihana’s president and CEO was also concerned about this
change. Jan 9, 2004, Schwartz and others meet and discuss the appropriate course of action for
Benihana’s remodeling. Full boards meets on Jan. 29.2004 and Joseph proposes that company
issue convertible preferred stock to get the funds needed for the construction and renovation plan
and also to put the company in a better situation to obtain financing from Wachovia.
Joseph gives directors book marked “Confidential” that contained analysis of the
proposed stock issuance. Terms: Issue 20 mill in preferred stock, convertible into common stock,
along with other terms. Meet again in February 2004 and discuss the options. Shortly after this
meeting, becomes known that BFC Financial Corporation interest in buying the stock. Joseph
contacts BFC. During negotiations following terms emerge: $20 mill payable in two tranches of
$10 mill each, BFC immediately obtains one seat on the board, and one additional seat if
Benihana fails to pay dividends for 2 consecutive quarters, BFC obtained preemptive rights on
new voting securities, 5% dividend and right to redeem preferred stock after 10 years.
April 22, 2004 Abdo sends memo to Dornbush, Schwartz and Joseph with these terms.
Next board meeting, May 6, 2004, entire board notified of BFC’s interest. Board votes and
approves the transaction (didn’t know Abdo negotiated agreement, but did know that he was
principal of BFC). May 18, 2004, public announcement. Two days later, Aoki’s counsel sends
letter asking board to abandon transaction and pursue more favorable alternative. Letter
questions director’s conflicts, dilutive effect of the stock issuance, and the legality of the entire
agreement. Board again approves transaction on belief that it was fair.
Benihana received three alternative financing proposals the following two weeks and an
independent committee examined all alternatives and found them to all be inferior to the
previous deal. BFC and Benihana execute agreement on June 8, 2004, so BOT files this action
against all of Benihana’s directors except Kevin Aoki alleging breaches of fiduciary duties, and
against BFC alleging that it aided and abetted in the breach of fiduciary violations.

Analysis:
Directors understood that Abdo represented BFC in the transaction, thus no conflict.
Second, Abdo did not breach fiduciary duty b/c he did not reveal confidential information, nor
did he control the negotiations. Also, trial court was correct in finding that purpose of agreement
was not to dilute BOT’s voting power b/c deal was made to secure the best financing options for
Construction and Renovation of restaurants.

Broz v. Cellular Information Systems

Broz is sole stockholder/pres of RFBC, Broz is also member of BOD of CIS. RFCB has
FCC license which entitles it to provide cellular services to a portion of rural Michigan. April of
1994, Mackinac sough to divest itself of Michigan-2, area right next to Michigan-4. Daniels,
broker, included RFBC as likely candidate for Michigan-2. May 1994, Rhodes, representative of
Daniels, contacted Broz and talked about RFBC’s possible acquisition of Michigan-2.
Michigan-2 not offered to CIS, likely not offered b/c Daniels felt CIS was financially
inadequate. June 13,1994, Broz spoke with CIS’ CEO, Triebick, concerning his interest in
acquiring Michigan-2. Triebick and another CIS director, Bloch, both inform Broz that CIS had
neither the wherewithal or the inclination to purchase Michigan-2. Broz contacted Bloch at this
time to also have him, Bloch, represent RFBC in its dealings with Mackinac.

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 June 28, 1994, six CIS directors agree to sell all their shares to Pri-Cellular, date pushed
back. August 6, and September 21, 1994, Broz submitted written offers to Mackinac for purchase
of Michigan-2. During this time period, Pri-Cellular also began negotiations with Mackinac to
purchase Michigan-2. Pri-Cellular’s Interest disclosed to CIS’s CEO, Tribick. Late September
2004, Pricellular had option to purchase Michigan-2 for 6.7 million. However, Broz steals del by
paying more than 500,000 over the asking price and asset purchase agreement executed by
Mackinac and RFBC.
Issue is Broz’s duty to CIS. CIS was not in financial stance to buy Michigan-2. CIS had
no interest or expectancy in the Michigan-2 opportunity. Broz breached no duty but should have
further protected himself by presenting a proposal to CIS.

Rule: Doctrine of Corporate Opportunity: “If there is presented to a corporate officer or director
a business opportunity which the corporation is financially able to undertake, is, from its 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 himself.

Four relevant Considerations when considering Corporate Opportunity Doctrine

○ 1. Is the corporation financially able to take the opportunity?
○ 2. Is the opportunity in the corporation’s line of business?
○ 3. Does the corporation have in interest or expectancy in the opportunity?
○ 4. Does a director create a conflict b/ween his self-interest and that of the corporation by
taking the opportunity?

In Re Ebay Shareholder Litigation

Derivative actions. Plaintiffs allege that Goldman Sachs bribed certain eBay insiders,
using the currency of highly profitable investment opportunities—opportunities that should have
been offered to, or provided for the benefit of, Ebay, rather than the favored insiders. Suing
because Goldman provided certain individuals IPO stocks that they flipped and made money on.
Court finds than an action can be sustained against the insider ∆’s because no one can seriously
argue that the ∆’s conduct did not place them in a conflicting position with their duties to the
corporation and moreover they were acting as agents and thus any consideration they received
must be transferred to the corporation if they were accepting the consideration as an inducement
to maintaining the business relationship with EBAY. In Ebay the court predominantly looked at
question #2 in finding that the shareholders were not given the opportunity.

C. DOMINANT SHAREHOLDERS

Sinclair Oil. Corp v. Levien

Court finds that by reason of Sinclair’s domination, it is cleat that Sinclair owed Sinven a
fiduciary duty. B/c of duty, its relationship w/t Sinven must meet the test of intrinsic fairness.
“The standard of intrinsic fairness involves both a high degree of fairness and a shift in the
burden of proof. Under this standard the burden is on Sinclair to prove, subject to careful judicial
scrutiny, that its transactions with Sinven were objectively fair.”
Sinclair argues that business judgment rule should be applied and thus that its decision
should not be second guessed. Court disagrees, finds that when the situation involves a parent

49
and a subsidiary, with the parent receiving a benefit to the exclusion and at the expense of the
subsidiary, the intrinsic fairness test should apply. However, court finds that intrinsic fairness
standard will be applied only when the fiduciary duty is accompanied by self-dealing (the
satiation when a parent is on both sides of a transaction with a subsidiary). “Self-dealing occurs
when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such
a way that the parent receives something from the subsidiary to the exclusion of, and detriment
to, the minority stockholders of the subsidiary.”
Facts: P’s contend that Sinclair forced Sinven to pay out such excessive dividends that
the industrial development of Sinven was prevent, and that it became in reality a corporation in
dissolution. From 1960 to 1966, Sinven paid out 108 mill in dividends. (More than it made in
profits). P claims that dividends resulted from an improper motive, Sinclair’s need for cash.
Court must determine whether dividend payments were self-dealing. Court finds that Sinclair
received nothing to the exclusion of Sinven’s minority shareholders, thus no self-dealing
occurred. Further, P proved no business opportunities which came to Sinven independently and
which Sinclair seized, thus business judgment is the best principle to be applied and the court
will not interfere with the BOD.

Breach of k Claim: Sinclair made Sinclair Internation Oil Company to deal with Sinven. Court
finds that this was clearly self-dealing. Sinclair received products produced by Sinven and
minority shareholders of Sinven were not able to share in receipt of these products. Court finds
that k was breached as to time of payments and the amounts purchased (had set time and
minimum #). Under the intrinsic fairness standard, Sinclair must prove that its causing Sinven
not to enforce the k was fair to the minority shareholders if Sinven. Court finds that Sinclair has
failed to meet this burden.

Zahn v. Transamerica Corporation

P asserts that Transamerica caused Axton-Fisher to redeem its class A stock at $80.80 per
share on July 1, 1943, instead of permitting Class A stockholders to participate in the assets on
liquidation of their company in June 1944. Alleges that stockholders would have received $240
per share instead of $80.80.
Were three types of stock: preferred, Class A, and Class B. Upon liquidation, preferred
stock got $105 and class A was entitled to share with Class B in the stock distribution, but Class
A stock was entitled to receive twice as much per share as the Class B Stock. (More stock
descriptions, pg. 362).
May 16, 1941, Transamerica purchased 80,160 shares of Axton-Fisher’s Class B
common stock, about 71.5% of Class B stock and about 46.7% of total voting stocks. Acquired
even more stock Transmerica had control of and dominated the management, directorate,
financial policies, business and affairs of Axton Fisher since May 16, 1941. Fall of 1942, AF
possessed as principal asset leaf tobacco that had risen to the value of 20 mill. Complaint thus
alleges that Transamerica, knowing of value of this tobacco, conceived a plan to get $$$ by
redeeming Class A stock at the price of $60 per share plus accrued dividends and thereafter, the
redemption of Class A stock being completed, to liquidate Axton Fisher. Complaint further
alleges that in pursuit of this end, AF called stock at $60, selling large part of tobacco to Phillip
Morris, thereafter liquidated AF, paid of the preferred stock and pocketed the balance of the
proceeds.
Rule: “Directors may not declare or withhold the declaration of dividends of the purpose of
personal profit or, by analogy, take any corporation action for such a purpose.”

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D. RATIFICATION

Fliegler v. Lawrence
Shareholder derivative action brought on behalf of Agnu Mines. November 1969, John
Lawrence, then president of Agua, acquired certain antimony properties valued at 60k. Lawrence
offered to transfer the properties to Agua, but BOD and he agreed that corporation’s financial
status would not permit acquisition and development of the properties at this time. SO, decided
to transfer properties to USAC, a closely held corporation, where capital necessary for the
development could be raised through the sale of USAC stock; it was also decided to grant Ague
long-term option to acquire USAC if properties proved to be valuable.
Jan. 1970, option agreement executed. Agua to deliver 80k shares of its restricted
investment stock for all USAC stock. BOD of Agua ratifies this agreement. Subsequently, P sued
to recover 800k shares and for an accounting. (Interest given to USAC as consideration). Court
believes that the agreement is instrinsically fair, Agua received properties of value, with the
potential to earn cash it needed to undertake further exploration, thus was fair price to pay to
USAC.

In re Wheelabrator Technologies Inc. Shareholders Litigation

WTI and Waste Management are intertwined businesses. Reached an agreement whereby
Waste Management bought 22% of WTI Stock and elected 4 of its own directors to serve on
WTI’s board. 1990, Waste and WTI negotiated 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. Ratified by BOD and shareholders.
P’s first allege that ∆’s breached duty of disclosure because proxy statement issued in
connection w/t merger was misleading. P’s argue that WTI board deliberated only three hours
before approving the merger and recommending to WTI shareholders. Court finds this argument
false: 1. Had investment bankers at meeting, 2. proxy statement was detailed, 3. Waste and WTI
had close business relationship over previous years.
Duty of Care Claim: P’s conceded that WTI shareholder vote was fully informed thus,
based on principle of Smith v. VG, cannot now say that board acted w/out due care in prepping
proxy statement. No breach.
Duty of Loyalty: Review standard applicable to this case is business judgment b/c no
proof that Waste had controlling interest in WTI.

The Obligation of Good Faith

○ Should good faith be considered as a Separate Duty?
○ Up until recently although the language of good faith was discussed throughout Delaware
jurisprudence, the idea had not been analyzed or defined as a separate prong
○ Then in 1993…. “A shareholder plaintiff challenging a board decisions has the burden at
the outset to rebut the rule’s presumption. To rebut the rule, a shareholder P assumes the
burden or providing evidence that directors, in reaching their challenged decision,
breached any one of the triads of their fiduciary duty-good faith- loyalty or due care.

In Re Walt Disney

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 ○ Court defined as good faith as encompassing “all actions required by a true faithfulness
and devotion to the interest of the corporation and its shareholders. A failure to act may
be shown, for instance, where a fiduciary intentionally acts with a purpose other than that
of advancing the best interests of the corporation, where the fiduciary acts with the intent
to violate applicable positive law or where the fiduciary intentionally fails to act in the
face of a known duty to act, demonstrating conscious disregard for his duties.”

What about that triad?

Stone v. Ritter (396)—2006

○ According to the court in Ritter, the court’s earlier statement regarding the triad was a
colloquialism. The court stated “the obligation to act in good faith does not establish an
independent fiduciary duty that stands on the same footing as the duty of care and
loyalty.” The court went on to say: “The fiduciary duty of loyalty is not limited to cases
involving a financial or other cognizable fiduciary conflict of interest. It also
encompasses cases where the fiduciary fails to act in good faith… ‘A director cannot act
loyally towards the corporation unless she acts in the good faith belief that her actions are
in the corporation’s best interests.

What is the point of having a B of D?

○ Is it for them to take affirmative steps on certain measures?
○ To supervise the process?
○ Directors are not supposed to know everything on a day to day basis. Instead, directors
are supposed to have a rudimentary knowledge of the firm’s business, keep abreast of
firm activities, engage in a general monitoring of the firm’s affairs, attend B of D
meetings and review financial statements.
○ In Re Caremerk, Court stated that the B of D had the obligation to take affirmative
compliance measures (if someone out of whack, get em back in line).

What would an adequate compliance program include?

○ Policy manual
○ Training of employees
○ Compliance audits
○ Sanctions for violation
○ Provisions for self-reporting of violations to regulators
Not certain who determines compliancy!!!

Egregious Board Decisions

○ In Caremark, court limits liability for egregious decisions. When can directors be held
liable for egregious decisions?
○ Only when directors acted in bad faith or followed an irrational decision-making
process
○ No objective review of substance of decision

Take Away Point- Enter Good Faith

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1. Courts often refer to the business judgment rule as ‘a presumption’ that the directors or
officers of a corporation acted on an informed basis, in good faith, and in the honest belief that
the action taken was in the best interests of the company

2. DGCL § 141(e) “A member of the BOD or a member of any committee designated by the
BOD, shall be fully protected in relying in good faith upon specified documents and person.”
3. DGCL § 102(b)(7)
4. DCGL § 145(a) and (b) only authorize indemnification of a director or officer who “acted in
good faith.”

GROSS NEGLIGENCE IS NOT THE SAME AS BAD FAITH!!!

Good Faith an Independent Duty

○ No—“although good faith may be described colloquially as part of a triad of fiduciary
duties that include the duties of case and loyalty, the obligation to act in good faith does
not establish an independent fiduciary duty that stands on the same footing as the duties
of care and loyalty. Only the latter two duties, where violated, may directly result in
liability, whereas a failure to act in good faith may do so, but indirectly.”
○ But so what? Acts taken in bad faith breach the duty of loyalty.

In re The Walt Disney Co. Derivative Litigation

PROCEDURAL POSTURE: Appellant shareholders brought derivative actions on behalf of

appellee corporation against appellees, the corporation's former president and directors who
served at the time of the events complained of. The Court of Chancery of the State of Delaware,
in and for New Castle County, ruled in favor of appellees, finding that the director defendants
did not breach their fiduciary duties or commit waste. Appellants challenged that judgment.

OVERVIEW: The shareholders claimed that a decision to approve the president's employment
agreement and a decision to terminate him on a non-fault basis resulted from various breaches of
fiduciary duty by the president and the corporate directors. The supreme court disagreed. No
reasonably prudent fiduciary in the president's position would have unilaterally called a board
meeting to force the corporation's chief executive officer to reconsider his termination and the
terms thereof, with that reconsideration for the benefit of shareholders and potentially to the
president's detriment. The decisions to approve the president's employment agreement, to hire
him as president, and then to terminate him on a no-fault basis were protected business
judgments, made without any violations of fiduciary duty. Having so concluded, it was
unnecessary to reach the shareholders' contention that the directors were required to prove that
the payment of severance was entirely fair. Because the shareholders failed to show that the
approval of the no-fault termination terms of the employment agreement was not a rational
business decision, their corporate waste claim failed.

OUTCOME: The judgment was affirmed.

Section 3. Disclosure and Fairness

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Purposes of Securities Laws
• Full Disclosure (33 Act)
○ Make sure that investors have all the information they need to make informed
decisions
• Prevention of fraud (34 Act)
○ Most other countries, insider trading is not illegal, viewed as the benefit given to
those who do all the work

What is a security? Statutory definition provided in § 2(1) of the Securities Act. First, a list of
rather specific instruments, including stock, bonds, and notes, are securities. Second, is the
general catch all phrase, “any instrument commonly known as a security.” Courts have also used
catch all phrase as an out to hold that an instrument shall not be held as a security for purposes of
the securities laws if the context otherwise requires

Note: Where the most malpractice claims are filed against attorneys, good law for P’s to use b/c
easy venue and not as stringent a requirement as fraud.

Robinson v. Glynn (4th Cir. 2003)

Robinson alleges that Glynn committed securities fraud when he sold him a partial
interest in GeoPhone. Lower Court found that Robinson’s interest was not security, higher court
affirmed.
Geophone was an LLC, Glynn was the company’s majority shareholder. Glynn trying to
raise capital, so recruits Robinson for $$$. After seeing Glynn’s business plan, Robinson loans 1
million to Glynn to perform field testing. Robinson goes so far as to pledge 25 mill if CAMA
and Geophone technology work together. 1995, Field test conducted, CAMA techno not used,
but Glynn tells Robinson test was a success.
Consistent with his letter of intent, Robinson and Glynn exercised agreement to purchase
membership interest in Geophone. So Robinson puts in his 25 mill. Pursuant to this agreement,
Robinson received 33,333 of Geophone’s 133,333 shares. On back of shares, restrictive legend
referred to certificates as shares and securities. Also stated certificates were exempt from
registration under the Securities Act and that they could not be transferred without proper
registration. Agreement also defined roles of parties in Geophone’s development. Robinson got
to appoint 2 board members and was the company treasurer.
1998, Robinson allegedly learned that CAMA technology had never been implemented in
Geophone system. So files suit claiming violation of the Securities and Exchange Act.
Robinson’s claim—his membership interest in Geophone qualifies as an investment
contract or stock under the Securities Acts. Court first defines investment contract “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.” Court has relaxed this
standard though, what matters more than the form is the economic reality that the investment
represents. Question is whether an investor is left unable to exercise meaningful control over his
investment.
Robinson was by no means a passive investor. In short, Robinson carefully negotiated for
a level of control ‘antithetical to the notion of member passivity’ required to find an investment
contract under the federal securities laws. Robinson argues that his lack of techno knowledge
prevented him from participating. Court doesn’t buy it, could’ve brought in outside help and
moreover, record does not reflect lack of technological understanding.

54
 Robinson also argues that language in APMIG, ARGOA, and on the back of the
certificates evinces that he and Glenn considered the interests as securities. “It is the economic
reality of a particular investment, rather than the label attached to it, that ultimately determines
whether it falls within the reach of the securities laws. Economic reality in this case is that
Robinson was not passive investor.
Robinson also claims that his investment was stock, court says that securities law applies
when an instrument is both called ‘stock’ and bears stock’s usual characteristics; court however
does not find that Robinson’s interest was denominated stock by the parties or had the usual
characteristics of stock.
Characteristics associated w/t common stock: 1. The right to receive dividends contingent
upon apportionment of profits, 2. negotiability, 3. ability to be pledged or hypothecated, 4. voting
rights in proportion to shares owned, 5. capacity to appreciate in value.

Robinson received 100% of profits to certain extent

Robinson’s interest not freely negotiable, could only transfer interest if he first offered other
members opportunity to purchase
Conclusively, from the beginning, Robinson’s interest was viewed as a membership interest, not
as stock, looks to language of agreements in finding this

LLC BOSS!!

Securities Act § 2(a)(1): “Theterm ‘security’ means any note, stock, … bond, debenture, …
investment contract… or, in general, any instrument commonly known as a security.
Howe Factors: Is there (1) investment of money, (2) in a common enterprise, (3) with an
expectation of profit, (4) from the efforts of others [only analysis for investment contract]
[analyze all four factors to determine if investment contract is a security, if elements satisfied,
then the investment qualifies as a security]
On exam, must run through the elements, court here primarily focused on the efforts on
the fourth element

A stock is always a security!! (If it is in fact a stock)

Real estate can be a security: For that matter, any investment can be a security so long as it meets
the Howe factors

B. The Registration Process [Once you have security, most of the time you are required to
register it]

Three basic rules:

1. Security may not be offered through the mails or by use of other means of interstate commerce
unless a registration statement has been filed with the SEC
2. Securities may not be sold until the registration statement has become effective
3. The prospectus must be delivered to the purchaser before a sale

Two types of general exceptions

1. Those based on the nature of the transaction
2. Those based on the type of security

Doran v. Petroleum Management Corp.

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 Petro contacts four individuals and discusses participating in partnership, all but plaintiff
declined. Broker, Phillip Kendrick, advises Doran of opportunity to become a special participant
in Petro. Petro informed Doran that 2 of 4 wells had already been completed. Doran agreed to
participate in partnership, agrees to contribute 125 k to partnership.
During 1970 and 1971, wells deliberately overproduced in violation of Wyoming Oil and
Gas Conservation Commission allowances, updates sent to Doran. As consequence, well shut
down for 338 days. After re-opening in 1972, wells yield small profits. After wells closed, Mid-
Continent note upon which Doran was primarily liable went into default. Mid-C obtains state
court judgment against Doran for 50k plus attorneys fees and interest. October 1972, Doran files
this suit seeking damages for breach of k, rescission of the k based on violation of the Securities
Acts, and a judgment declaring Petro liable for the state judgment obtained by Mid-C.
P contends violation b/c defendant failed to register with any federal or regulatory body.
∆ raises defense that the relevant transactions came within the exemption from registration found
in §4 (2) 15 U.S.C. § 77d(2). Specifically, they contend that the offering of securities was not a
public offering. Four factors court considers: Number of offerees and their relationship to each
other and the issuer, number of units offered, size of the offering, manner of the offering.
Court notes SEC decision holding that “the applicability of §4(2) should turn on whether
the particular class of persons affected need the protection of the Act. An offering to those who
are shown to be able to fend for themselves is a transaction “not involving any public offering.”
Therefore follows that the exemption question turns on the knowledge of the offerees.
Prior to examining the main issue (first factor) court notes that the ∆’s may have
demonstrated the existence of the latter three factors, small number of units offered, modest
financial stakes, personal contract free of public advertising or intermediaries. However, first
factor is most important and not going to grant exemption!! (Number of offerees and their
relationship to the issuer)
“More offerees, the more likelihood that the offering is public.” Only eight parties
offered (???) chance to invest in partnership, court notes that this total would be consistent with
finding that offering was private. Court also finds that Doran was experienced investor. Court
says that nevertheless, high degree of business of business sophistication does not bring offering
within the private placement exemption. Court says that their must be sufficient basis of accurate
information upon which the sophisticated investor may exercise his skills. For an investor to be
invested with exemptive status he must have the required data for judgment
So ∆’s must show that all offerees had available information a registration statement
would have afforded a prospective investor in a public offering. Such a showing is necessary to
gain the exemption and is to be weighed along with the sophistication and number of the
offerees, the number of the units offered, and the size and manner of the offering.
On remand, court must consider that the ‘availability’ of information means either
disclosure of or effective access to the relevant information. Case remanded to determine if the
offeree knew or had a realistic opportunity to learn facts essential to make an investment
judgment.

Private placement exemption (probably largest exemption fro msecurities). Look to four factors
in determining if exempt status is present. Look @ (1) number of offerees and relationship to
issuer, (2) Number of units offered (3) size of the offer (3) manner of the otter
Should also look at offerees’ knowledge and sophistication and offerees’ access to information
(Information generally provided through private placement memorandum)

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Take away: private placement test is where you should look first in determining if a security is
exempt from registration

Important Civil Liabilities under Securities Law

1933 Act § 11, § 12(a)(1), §12(a)(2)
Implied private rights of action—1934 Act § 10(b) and SEC Rule 10(b)(5)

10(b)(5) is the biggest weapon in your arsenal if P’s attorney

Section 11 Elements
• Liability arises if the registration statement is materially misleading
• Liability flows to the issuer
• Liability flows to others who sign it (directors, experts, and underwriters)
• No defense for issuer
• Due-diligence defense available for others

Two Variables for § 11 Liability

• Variable #1—What part of the Registration Statement is at issue?
○ Parts prepared by certified experts
○ Everything else
○
• Variable #2—Which group is at issue?
○ The experts
○ Everyone else

Liability Under These Two Variables

• Under §(a)(4), the experts are not liable for misstatements in the non-expertised part of the
document
• Under §(B)(3)(a), with respect to the non-expertised portions, the non-experts must show that,
after reasonable investigation, they had reasonable grounds to believe, and did believe, that
the statements were true
• Under § (b)(3)(b), roughly the same test applies to the liability of the experts with respect to
the expertised portion
• Under §(b)(3)(C), with respect to the expertised portions, the non-eexperts must show that
they had no reason to believe, and did not believe, that the statements were misleading

Other Issues Under § 11

• In addition, note that § 11(c) gives, as a test for reasonable investigation and reasonable
belief, the level of case that a prudent person would exercise if his or her own money were at
stake. Section 11(e) then specifies the damages recoverable (roughly, the difference b/ween
the original price of the security and its present price). It adds that the ∆may reduce those
damages by showing that part of the damages resulted, not from the misstatements in the
document, but rather from other causes

Escott v. Barchris Construction Corp.

Action brought under § 11 of the Securities Act, allege that registration statement with
respect to debentures, filed with the SEC, contained material false statements and material

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omission. 3 categories of ∆’s, persons who signed the registration statement, underwriters
(salesman, sued b/c they make representations to the public and b/c they review registration
statements), and BarChris’ auditors.
Issues: Did the registration statement contain false statements of fact, or did it omit to
state facts which should have been state in order to prevent it from being misleading? If so, were
fact which were falsely stated or omitted ‘material’ within the meaning of the Act; (3) if so, have
∆’s established their affirmative defenses?

Factual B-Ground Barchris primarily constructed bowling facilities, 1960 Barchris installed
approximately 3% of all lanes built in the U.S.. B/c Barchris was compelled to expend
considerable sums in defraying the cost of construction, before it received re-imbursement, BC
in constant need of cash to finance its operations. December 1959, BC sells 560,000 shares of
stock to the public at 3$ per share.
BC having trouble collecting from its customers and industry was overbuilt. 1962, this
becomes painfully obvious. May of 1962, BC tries to raise more money, October 29, 1962,
bankruptcy filed by BC.

Analysis
Materiality
“The term material, when used to qualify a requirement for the furnishing of
information as to any subject, limits the information required to those matters as to which an
average prudent investor ought reasonably be informed before purchasing the security
registered.”
Based upon this standard, the Court finds that many of the misstatements and omission in
the prospectus were material. Ex. Overstatement of sales and gross profits for the first quarter
overstatement of orders on hand and the failure to disclose true facts with respect to officers’
loans, customers’ delinquencies, application of proceeds and the prospective operation of several
alleys.
However, court notes that minor errors in 1960 may not have had material impact on
willingness to invest, this may not be misrepresentations. However, court finds that on all of the
evidence, there were material misrepresentations in the balance sheet.

Due Diligence Defense

“Standard of reasonableness shall be that required or a prudent man in the management of
his own property.” All ∆’s (except issuer, b/c he cannot claim this defense), plead these
affirmative defenses.

Vitolo and Pugliese (Not expertised)

• Men of limited education, not hard to believe that prospectus was hard for them to read. More
construction foreman than businessman. But “whether the prospectus was hard to read or not
is irrelevant. 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”
• Record indicates that they were not a naïve as they claim: must of known of cash shortage

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• Court thus finds that that they have not proved their due diligence ∆ b/c they could not have
believed that registration statement was wholly true

Kircher (Not expertised)

• Treasurer of BC
• Prepared registration statement, he understood prospectus
• Argues that he had never dealt with registration statement before, and that he thus relied on
others to guide him
• Court finds that knowing the facts, kircher had reason to believe that the expertised portion of
the prospectus was in part incorrect.. cannot rely on others

Birnbaum
• In House Counsel
• Signed later amendments to the prospectus
• However, he did not participate in management
• Court finds it probable that he did not know of many of the inadequacies of the prospectus
• In any case, he made no investigation, should have known that under the statute he was
required to make reasonable investigation of the truth of all the statements in the unexpertised
portion of the document which he signed
• Having failed to make such an investigation, breached due diligence

Auslander
• Outside director
• As to the 1960 figures, Auslander believed them to be correct b/c he had confidence in Peat,
Marwick. No reasonable ground to believe otherwise.
• B/c director on the eve of the financing: court says that § 11 imposes liability upon a director
no matter how new he is, presumed to know responsibility when he becomes a director. Not
established due diligence b/c didn’t investigate!!

Grant
• Prepared registration statements and assured its accuracy
• After making all due allowances for the fact that BC’s officers misled him, 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.

Peat, Marwick (Expert)

Class Notes

(Court somewhat establishes sliding scale of liability)

If accountant or counsel reviews the registration instrument as a whole, that is not, in and of
itself, enough to make the document expertised, in some cases its not even enough to show that
they prepared it. Essentially, to be expertised, court must show that instrument prepared was
within the expertise of the individual. In the end, the court found that those statements that were
particularly audited were expertised.

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Basic Inc. v. Levinson
During 1977 and 1978, Basic made three public statements denying that it was engaged
in merger negotiations (when it was with Combustion). Dec 18, 1978, Basic asks stock exchange
to suspend trading in its shares and issues release stating that it had been approached by another
company concerning a merger. December 19, merger goes through, Combustion pays $46 per
share.
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. Asserts that Basic issued
three misleading or false public statements and thereby were in violation of § 10(b) of the
Securities act. 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. District
Court found for ∆’s.
Court of appeals reversed D.C.’s summary judgment (found basic’s statements that no
negotiations were taking place and that it knew of no corporate developments to account for
heavy trading activity were misleading). Circuit split, court of appeals joined # of other circuits
in adopting “fraud on the market theory” to create a reasonable presumption that respondents
relied on petitioner’s material misrepresentations. Court granted cert. to solve circuit split.
Court notes that private cause of action does exist under § 10(b) and 10b-5. Notes
materiality standard (“an omitted fact is material if there is a substantial likelihood that a
reasonable shareholder would consider it important in deciding how to vote.” And “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 information made available.
Court notes that materiality standard difficult to apply in this case given the speculative
nature of merger agreements (it is difficult to ascertain whether the reasonable investor would
have considered the omitted information significant at the time).
Basic argues for Third Circuit test: “preliminary merger discussions do not become
material until ‘agreement in principle’ as to the price and structure of the transaction has been
reached b/ween the would be mergers. By definition then, information concerning any
wrongdoing could be withheld or misrepresented until agreement. Justification for this argument
are as follows: investors need not worry about this speculative risk (could foster false optimism),
protect confidentiality of merger talks, and brightline test when disclosure must be made.
Courts find first justification baseless: calling investors stupid. SEC promotes disclosure.
And investor should know. (prevent bidding war is justification offered but court finds argument
unconvincing). As to last justification, ease of application alone is not excuse for ignoring
purposes of Securities Act and Congress’ policy decision. Court thus finds no valid justification
for artificially excluding from the definition of materiality, information concerning merger
discussions.
Court then looks to 2nd Circuit to give meaning to speculative materiality (merger info).
Finds that “Under such circumstances, materiality will depend at any given time upon a
balancing of both the indicated probability that the event will occur and the anticipated
magnitude of the event in light of the totality of the company activity.” Court ultimately states
that whether merger discussions in any case are “material” depends on the facts. Factfinder must
look to indicia of interest in the transaction at the highest corporate levels. Need to consider such
facts as the size of the two corporate entities and of the potential premiums over market value.
After noting this, court then turns to the ‘fraud on the market theory.’ “The fraud on the
market theory is based on the hypothesis that, in an open an developed securities market, the

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price of a company’s stock is determined by the available material information regarding the
company and its business . . . misleading statements will therefore defraud purchasers of stick
even if the purchasers do not directly rely on the misstatements . . . . The causal connection
between the ∆’s fraud and the plaintiff’s purchase of stock in such a case is no less significant
than in a case of direct reliance on misrepresentations.” Court below applied rebuttable
presumption of reliance (was this correct?).
Court believes presumption correct for three reasons: two of which are common sense
and probability. Impractical to require all P’s to show that they relied on market price when
almost all consumers rely on market price b/c most publicly available info is reflected in the
market price.

Elements of 10b-5 Action

Two Types of Causation in 10b-5

Transaction Causation—Closely related to reliance (links fraud closely to sale or purchase)

But for the fraud, plaintiff would not have invested

Loss Causation -- akin to proximate cause, fraud caused the loss

SEC’s theory is that any type of fraud is detriment to the investor and thus SEC does not have to
prove these elements (only matters in private suits)

Presumption of Causation
• Where reliance is presumed, courts will also assume transaction causation
○ Omissions
○ Fraud on the market

• Loss Causation not Presumed

○ How would Basic plaintiffs prove loss causation on remand?

• Scienter
○ Intent to defraud
○ Reckless Disregard of falsity of statement
○ Somewhere above negligence, but not specific intent

• Required in private party litigation: Ernst & Ernst v. Hochfelder

• Required in SEC actions: Aaron v. SEC

Section 5. Inside Information

Evolution of State Common Law

• 1933—insider trading ok, was minority rule which evolved into 10b-5 (“where director seeks
out shareholder, transaction will be closely scrutinized)

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Goodwin v. Agassiz
P sues director and president of Cliff Mining Company, P contends that they had certain
knowledge, material as to the value of stock, which the plaintiff did not have. Knowledge was
that geologist had formulated a theory as to the possible existence of copper deposits in one of
the company’s properties. Previously, in 1925, Cliff has started mining operations which proved
unsuccessful and thus quit in 1926. ∆’s discussed geologist’s theory and feeling that it had merit
and thus should give it a try.
∆’s agreed that before they started tests, options should be obtained by another copper
company of which they were officers on land adjacent to the copper belt. So, options secured
(court notes that ∆’s thought if theory successful the price of stock would soar).
P learns of closing of mines and immediately sells his shares. P did not know that the
purchase was made for the ∆’s and they did not know that his stock was being sought for them.
P’s contention is essentially that this purchase constituted actionable wrong for which he should
be re-imbursed. Rule: “Directors cannot rightly be allowed to indulge with impunity in practices
which do violence to prevailing standards of upright business men. Therefore, where a director
personally seeks a stockholder for the purpose of buying his shares without making disclosure of
material facts within his peculiar knowledge and not within the reach of the stockholder, the
transaction will be closely scrutinized and relief may be granted in appropriate instances.
Court proceeds to say that facts show no fraud or conspiracy, annual report did not cover
time when theory was promoted (moreover, theory was only an expectation, not a reality). Court
concludes that ∆’s had not duty to disclose before trading and are therefore not liable (Insider
trading under state law still follows this pattern). Rationale: Duty runs to the corporation, not the
shareholders

Rule 10b-5: Need to insert rule

Penalties
• Range from administrative hearings against ∆’s under SEC’s direct regulation
• Equitable Relief in civil case: injunctions, disgorgement of profits
• Criminal Indictment pursuant to INSA: up o 20 years jail, 5 million fine and 25.5 million in
damages for corporate ∆’s per count
• Private suits—rare

Option Contracts
• A call option gives the owner the right, but not the obligation, to but a specified by a number
of shares at a specified price
○ A put option gives the owner the right, but not the obligation, to sell a specified
number of shares at a specified price

The price paid the purchase an option is call the option premium

Legal Rule Re insider trading

Where an insider has material nonpublic information the insider must either disclose such
info before trading or abstain from trading until the information has been disclosed

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 Rationale for rule, the rule is based in policy on the justifiable expectation of the
securities marketplace that all investors trading on impersonal exchanges have relatively

Property Rights Analysis

The rationale for prohibiting insider trading is precisely the same as that for prohibiting
patent infringement of theft of trade secrets
--Protecting the economic incentive to produce socially valuable information

Securities and Exchange Commission v. Texas Gulf Sulphur Co

Synopsis of Rule of Law. Insiders cannot act on material information (information that a
reasonable man would deem important to the value of the stock) until the information is
reasonably, publicly disseminated.

Facts. Defendants were officers, employees or were closely tied to employees of Texas Gulf.
Texas Gulf, utilizing a geological survey, was conducting mining exploration in Canada. One
area, called Kidd 55, was deemed promising by the survey, and a hole was drilled with the
resulting core analyzed. The analysis showed that the minerals present in the area were
extremely rich in minerals. Several other samples verified the findings. Defendants did not
disclose the results of the analysis to outsiders, including other officers of Texas Gulf.
Defendants did proceed to purchase shares and calls once they knew about the results. The
trading activity and sample drilling did prompt rumors in the industry of a significant find by
Texas Gulf, and on April 12, 1964 Defendants sent out a misleading press release to calm the
speculation. The press release misrepresented the actual results of the samples. Defendants
decided to announce the results on April 15, although the news did not reach the public until
April 16. Defendants still traded between April 12 and the announcement. Defendants claimed
that the information was not material to the value of the company and therefore did not feel
obligated to publicly disclose the information. They also argued that any trading after they
released the news at midnight of April 16 was legitimate because technically the news was
disseminated to the public.

Issue. The issue is whether Defendants utilized material inside information when they purchase
shares and calls of Texas Gulf stock.

Held. The Defendants withheld information that was material to shareholders and therefore were
acting on insider information when they purchased their shares and calls on Texas Gulf stock.
The court looked at the conduct of Defendants as evidence that the information was material:
they purchased a great deal of shares in Texas Gulf, they deliberately kept the information from
others, and the timing of their purchases occurred during the period that they exclusively held the
information. It did not matter that there was still an element of uncertainty in the eventual
mineral mining, but the key element was whether a reasonable person would believe that the
information would be relevant to the price of the stock. Further, Defendants should not act upon
the information until the information is disseminated to the point that the public would have had
a reasonable opportunity to act on it.

Discussion. The court has moved away from Goodwin v. Agassiz where the emphasis was
placed on whether a plaintiff suffered any damages and was directly wronged by a defendant

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insider. Now the test is whether defendants have an advantage over anyone without the
information.

Dirks v. Securities & Exchange Commission

Facts: An insider that worked for Equity Funding of America told Petitioner that the company
was overstating their assets and that Petitioner, who was an officer that provided investment
analysis for a broker-dealer firm, should investigate the fraud. Petitioner interviewed other
employees who corroborated the fraudulent allegations. Petitioner contacted a bureau chief at
The Wall Street Journal and offered his findings for the purpose of exposing the fraud. The
bureau chief, fearing a libel suit, declined to pursue it. During this time, Petitioner told investors
and clients about the fraud, and they reacted by selling their stake in the company. When the
stock was being heavily traded and dipped from $26 to $15, the New York Stock Exchange
halted trading and Respondent, The Securities and Exchange Commission, investigated and
found fraud. Respondents then filed suit against Petitioner for violations of Section:10(b) of the
Securities and Exchange Act of 1934 for using the insider inf
ormation and perhaps receive commissions from those clients. The trial court and appellate court
agreed with Respondent, reasoning that anytime a tippee knowingly has inside information that
they should publicly disclose it or refrain from acting upon it.

Analysis:
To establish Rule 10b-5 violation, must show (i) the existence of a relationship affording
access to inside information intended to be available only for a corporate purpose, (ii) the
unfairness of allowing a corporate insider to take advantage of that information by trading
without disclosure. Chiarella, the court held that “a duty to disclose under 10(b) does not arise
from the mere possession of nonpublic market information. Such a duty rather arises from the
existence of a fiduciary relationship.
But, not all breaches of fiduciary duty come within the ambit of Rule 10b-5, there must also be
manipulation or deception. Thus court states that an “insider will be liable under 10b for inside
trading only where he fails to disclose material nonpublic information before trading on it and
thus makes ‘secret profits.’
Tippeee issue difficult b/c not fiduciary, agent, or person trusted by the public in securities
transactions. SEC argues that tippee assumes fiduciary position when the tippee knowingly
transmits info to someone who will probably trade on the basis thereof. Court asserts that this
position could have an inhibiting influence on the role of market analysts, which the SEC itself
notes is necessary to the preservation of a healthy market. Common for analysts to ferret out info
and act upon it. However, court believes that the need for ban on some tippee trading is clear.
Cannot merely let insiders give info to outsider for purpose of exploiting info for their personal
gain. Thus, “a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on
material nonpublic information only when the insider has breached his fiduciary duty to the
shareholders by disclosing the information to the tippee and the tippee knows or should know
that there has been a breach.
So how do we determine if insider’s tip constituted breach of the insider’s fiduciary duty?
“The test is whether the insider personally will benefit, directly or indirectly from his disclosure.
Absent some personal gain, there has been no breach of duty to stockholders. And absent breach
by the insider, there is no derivative breach.”

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 So, no actionable violation by Dirks, no gain by Secrest, Dirks had no relationship with Equity
Funding.

Holding: Re Tipping
○ In general, 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 the fiduciary duty
○ A tippee therefore can be held liable only when:
○ The tipper breached a fiduciary duty by disclosing information to the tippee
○ The tippee knows or has reason to know of the breach of duty

U.S. v. O’Hagan
Respondent was a partner in a law firm, Dorsey & Whitney, which was representing a
company that was potentially tendering an offer for common stock of the Pillsbury Company.
Respondent was not personally involved in the representation, but he was aware of the
transaction enough to know that if he purchased Pillsbury securities now that they would
increase in value once the offer went through. Respondent was going to use the profits from this
transaction to replace money that he embezzled from the firm and its clients. After the offer went
through, he made a $4.3 million profit. The SEC investigated Respondent’s transactions and
claimed he violated Section:10(b) and Section:14(e) for misappropriating confidential
information. A jury convicted Respondent.
There are two issues regarding Section:10(b) and Section:14(e).
The first issue is whether Respondent violated Section:10(b) and Rule 10b-5 when he
misappropriated nonpublic information to personally benefit through the trading of securities.
The second issue is whether Rule 14e-3(a) exceeds the SEC’s rule-making authority as granted
by the Securities and Exchange Act.
Respondent did violate Section:10(b) and Rule 10b-5 because all of the element of the
rule were met. Respondent did use deceit in connection with the purchase of securities. He did
not disclose to the firm or the client that he was using the nonpublic information, and his use of it
was at the expense of the client. He did not necessarily have to deceive the seller in order to
violate the Rule. As a matter of public policy, it would not make sense to limit the scope of the
Act to only prohibit certain kinds of activities that endanger a fair market.
Rule 14e-3(a) did not exceed the SEC’s rule-making authority. Again, the purpose of the Act is
to provide safeguards to ensure that the market is operating fairly and that investors can rely on
the market. Rule 14e-3(a) does not require a demonstration of a breach of duty in order to find a
party liable for violations of the Act. There will be instances where justice would deem this
appropriate, such as in this case.
Held: The misappropriation theory is a valid basis on which to impose insider trading liability.
“A fiduciary’s undisclosed use of information 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.

Rule 14e-3
Prohibits insider trading during a tender offer and thus supplements Rule 10b-5
--One substantial steps towards a tender offer taken, Rule 14e-3(a) prohibits
anyone except the bidder, who possesses material, nonpublic information about the offer
from trading in the target’s securities

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 --14e-3(d) prohibits anyone connected with the tender offer from tipping material,
nonpublic information about it

Rule 14e-3 is not premised on breach of a fiduciary duty

Section 6. Short Swing Profits

• Section 16(a)—“Every person who is more directly or indirectly the beneficial owner of more
than 10 per centum of any lass of any equity security . . . or who is a director or an officer of
the issuer of such security . . . within ten days after the close of each calendar month . . . shall
file with the Commission . . . a statement indicating his ownership at the close of the calendar
month and such changes in his ownership as have occurred during such calendar month.

• Form 3—Insider must file no later than the effective date of the registration statement, or, if
the issuer is already registered, within ten days of becoming an officer, director, or beneficial
owner
• Form 4—Changes in ownership must be reported w/in 2 business days.
• Form 5—For those who forgot
• People often monitor the forms to determine how a company is doing (are insiders loading up
on shares or off-loading shares)—theory is that nobody knows better about the company than
the insiders

• Section 16(b) “any profit realized by such beneficial owner, director, or officer, from any
purchase and sale, or any sale and purchase, of any equity security of such issuer . . . within
any period of less than six months . . . shall inure to and be recoverable by the issuer

• Highlights
○ §16 only applies to officers, directors, or shareholders with more than 10% stock
○ Smaller group of insiders than under Rule 10b-5
○ No tipping liability, no misappropriation liability, no constructive insiders
○ Officer: SEC definition includes president, CFO, chief accounting officers, VPs
of principal business units and any person with significant ‘policymaking
function’
○ Only applies to companies who must register under the 1934 act
○ In contrast, Rule 10b-5 applies to all issuers
○ §16B applies whether the sale follows the purchase or vice cersa
○ Hence, shares are fungible, if the trader sells 10 shares of stock and buys back 10
different shares of stock in the same company at a cheaper price, he or she is still
liable
○ But the sale and purchase must occur with six months of each other (being paid in
stock is not considered a purchase)
○ Recovery

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  Any recovery goes to the company
 Shareholders can sue derivatively, and a shareholder’s lawyer can get a
contingent fee out of any recovery or settlement
 Courts interpret the statute to maximize the gains the company recovers
 If officer at time of sale or at buying time, still liable to corporation

 If you are an officer at time of sale or purchase you are liable

 “The statute shall not be construed to cover any …

On Final, need to be able to analyze issue

under 10b-5 and under 16b

Reliance Electric Co. v. Emerson Electric Co.

§ 16(b) of Securities and Exchange Act of 1934 provides “that a corporation may recover
for itself the profits realized by an owner of more than 10% of its shares from a purchase and
sale of its stock within any six-month period, provided that the owner held > 10% both at the
time of the purchase and sale.
In this case, respondent, owner of 13.2% of the corporation’s shares, disposed of his
entire earnings in two sales, both within six months of purchase. First sale reduced respondents
holding to 9.96% and the second disposed of the remainder of the sales. Issue is whether the
profits derived from the second sale are recoverable by the corporation under 16(b).

Specific Facts: Respondent bought 13.2% of Dodge’s shares for the purpose of taking over
Dodge. Dodge shareholders decided to merge with Petitioner instead. Respondent had little use
for maintaining 13.2% of the ownership of a competitor, and therefore decided to sell the shares.
Under Section:16(b), a party that owns more than 10% of the shares of a company will have to
forfeit any profits of a sale of the stock to the parent company if the sale is within 6 months of
the purchase. The shares at issue were worth more due to the merger, so the profits were a
considerable amount. Respondent’s attorney recommended that the company sell just enough
shares to get under a 10% ownership, and then make a second sale of the remaining shares to
avoid liability. The district court held that Respondent was liable for the profits on both sales
because the split of the sale was done solely for the purpose of avoiding the Section:16(b)
liability. The Appellate court reversed the decision regarding the second sale
because the intent of the selling party should not matter as long as they are following the statute.

Analysis: Court looks to the objective standards imposed by the rule and applies them literally to
read that one can structure sales to their benefit or sale past the 6 month period to avoid losing
profits under Rule 16(b)

Synopsis of Rule of Law. A company can split its sale of shares into more than one part to
reduce their holdings under the statutory minimum percentage of shares (10%) to reduce their
liability under Section:16(b)

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Foremost-McKesson Inc. v. Provident Securities Company
Respondent (Provident) was a holding company that sought to liquidate its assets for its
members. Respondent agreed to sell assets to Petitioner in return for cash and convertible
debentures for Petitioner stock. The debentures were immediately convertible to Petitioner’s
stock, and the total value was greater than 10% of Petitioner’s stock. Because it was greater than
10%, Respondent was a beneficial owner of Petitioner under Section: 16(b) of the Securities
Exchange Act. The shares were converted and distributed to the members of the Respondent
holding company. Respondent, realizing that the value of their ownership in Petitioner made
them a beneficial owner, sought a declaratory judgment to affirm that they would not be liable
for profits realized on the shares.
Issue: The issue is whether Respondent’s immediate conversion and sale of debentures
received by Petitioner made them liable under Section: 16(b) to return any profits to Petitioner.

Held: The Respondent was a beneficial owner under Section: 16(b), but they fall under the
exemption which states that the section “shall not be construed to cover any transaction where
such beneficial owner was not such both at the time of the purchase and sale, or the sale and
purchase, of the security involved. Court also believes that this finding justified by distinction
Congress made b/ween directors/officers and stockholders. “Trading by mere stockholders
viewed as being subject to abuse only when the size of their holdings afforded potential for
access to corporate information.”

Notes on § 16(b)
• 10% of any stock, even if you don’t own 10% of company’s total stock, significant to give
rise to an action under 16(b)
• In calculating damages, courts match the lowest price purchased and the highest priced sales

Chapter 6. Problems of Control

Section 1. Proxy Fights

Intro
• Shareholders may appoint an agent to attend the meeting and vote on their behalf, that agent is
the shareholder’s proxy-holder
• Proxy fights result when an insurgent group tries to oust incumbent managers by soliciting
proxy cards and electing its own representatives to the board
• Shareholders transferring right to vote to certain delegates
• Can give to broker or similar figure or management officials can solicit proxies

Voting at annual (or special) meetings

• Most matters require a majority of shares present at a meeting at which there is a quorum
• MBCA § 7.25(c): A matter is approved if votes cast in favor > votes cast against
○ Some matters that require majority vote of the total outstanding shares, these
include mergers and amendments to the charter

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• Generally speaking, election of board members only requires plurality of those represented at
meeting
• Regulations at Issue: Rule 14a-4, Rule 14a-8 (talks about things the corporation can exclude
from proxy solicitations), and Rule 14a-9 (talks about misrepresentations in a proxy
solicitation)
• Rule 14a-4 (General Proxy Card Requirements)—must identify each matter to be voted on,
may give discretionary authority to vote in the proxies discretion on other matter that may
come before the meeting, for, against, or abstain boxes are required for each matter other than
election of directors, for and withhold boxes for election of directors, proxies may be revoked
of more than one is given, must sign and date
• Fraud under 14a-9, must relate somehow to the issue being voted on, § 14a prohibits
misrepresentations or omissions of a material fact in proxy statements

Who Can Sue??

• SEC
• U.S. Justice Department
• Private cause of action for shareholders
• The company itself

A. STRATEGIC USE OF PROXIES

Levin v. Metro-Goldwyn-Mayer, Inc.

Action filed by 6 substantial shareholders, one of whom is Philip Levin (a director of
MGM). Conflict arises from conflict for corporate control b/ween Levin group and the present
management, the “O’brien group. Each group actively solicited proxies for annual shareholder
meeting in hope of taking control.
P’s complain of the method, manner, and means employed by ∆’s in soliciting proxies.
Allege that ∆’s have wrongfully committed MGM to pay for the services of specially retained
attorneys, a public relations firm and proxy soliciting organizations, and have improperly used
the offices and employees of MGM in proxy solicitation and the good-will and business contacts
of MGM to secure support for the present management.

Issue: The issue is whether directors of a company can use company resources to solicit proxies
for an upcoming vote for directors.

Held: The United States District Court for the Southern District of New York held that Plaintiffs
were not entitled to an injunction. There was no indication that there was fraud or corruption on
behalf of Defendants. There also is no statute prohibiting the solicitation practice and the amount
MGM spent was limited.

Discussion. The court, absent a statute or regulation stating otherwise, will not restrict the
directors of a company from spending the company’s money on proxy solicitation when full
disclosure made to the stockholder of expenses incurred in order to solicit proxies

Take away points—If unhappy with management, start proxy fight n begin to solicit proxies.
Can get shareholder info from company and revolt. If insurgent group want to do this, they pay
for it (ridiculously expensive which is why it rarely happens). As long as funds reasonable,

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corporation itself will bear the brunt of costs if current BOD solicits proxies. [Theory behind
payment is that BOD is in best position to control business]

Is inherent COI, b/c you get to use someone else’s money to insure that you retain your job

Is there another system that could address both of these concerns and tensions?
B. REIMBURSEMENT OF COSTS

Rosenfeld v. Fairchild Engine & Airplane Corp.

The old board of directors and the new board spent over $120,000 each in soliciting
proxies for a shareholder vote for new directors. After the new board won, they authorized
Fairchild to reimburse the old board for most of their expenses, and they voted to have Fairchild
reimburse their own expenses. Plaintiff did not allege any fraudulent behavior, and agreed that
the expenses were reasonable, but nonetheless not legal.
Issue: The issue is whether directors can use the company treasury to fund the solicitation
of proxies.
Reasoning: The Court of Appeals of New York held that when there is a good faith
dispute concerning a significant policy, the directors should be able to use corporate resources to
fund proxy solicitations to ensure that the upcoming vote receives the attention that it is due. In a
situation such as the case at bar, the expenses were reasonable and did go to a reasonable dispute
between two factions.
Dissent. The dissent believed that the burden should be on Defendants to prove that their
expenses were legitimate.
Concurrence. The concurring opinion believed the holding was correct, but only because
Plaintiff failed top offer proof that the expenses were illegitimate. The concurring opinion
believed that there possibly could have been expenses in this case that solicited proxies for the
benefit of only one side, and they did not want to allow a system where one side can solicit
solely for their benefit on the company’s dime.

C. PRIVATE ACTIONS FOR PROXY RULE VIOLATIONS

J.I. Case Co. v. Borak

Respondent held 2,000 shares of Petitioner company. Petitioner released a misleading
proxy statement concerning an upcoming merger. Respondent was unsuccessful in gaining an
injunction to prevent a merger based upon the proxy statement, and therefore sued for a
rescission of the merger and damages due to the misleading statement. Respondent cited Section:
27 for jurisdiction to file a Section: 14(a) claim. Petitioner asserts that Congress did not expressly
provide a private right of action under Section: 14(a), and that the merger could only be
dissolved based upon a fraudulent or non-beneficial claim. The District court dismissed the case,
but the Appellate allowed the action to go forward.
Issue: The issue is whether Section: 27 allows a private party to bring a Section: 14(a) action.
Discussion. Similarly to the cases regarding inside information, the Court looks at the
overall purpose of the Securities Act [Cites Congressional language] to determine which
outcome will best serve the purpose. In this case, allowing private parties the right to bring an
action best supports the purpose of protecting investors. Also, Congress intended on providing
methods of redress to prevent deceptive practices of corporate officers. The Securities &
Exchange Commission do not have the resources to thoroughly investigate each of the 2,000
proxy statements it receives annually, and it would be counterintuitive to rely solely on the

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Commission’s findings. The language of the Act does not prohibit private actions, but instead
implies the right.

Mills v. Electric Auto-Lite Co.

Expansion of Borak, issue here is “what causal relationship must be shown b/ween such a
statement and the merger to establish a cause of action based on the violation of the Act.

Held: A material misrepresentation or omission is enough to establish a cause of action. The

United States Supreme Court declined to follow the Appellate court’s “fairness of the merger”
test because it basically removed the shareholders from the voting process. A company could
release an extremely false proxy statement and justify it as long as they could demonstrate that
the merger was fair. The Court noted that misleading material in a solicitation is in itself a
violation of Section: 14(a). In this case, Petitioner has established facts, namely that shareholders
may have been materially affected by the recommendation of an interested board of directors,
which would allow for a cause of action.

“Where there has been a finding of materiality, a shareholder has made a sufficient showing of
causal relationship b/ween the violation and the injury for which he seeks redress if, as here, he
proves that the proxy solicitation itself, rather than the particular defect in the solicitation
materials, was an essential link in the accomplishment of the transaction.”

Modern definition
Omitted fact is material “if these is a substantial likelihood that a reasonable shareholder would
consider it important in deciding how to vote.”

Seinfeld v. Bartz
Defendants (Cisco) wanted to increase the amount of stock options offered to outside
directors when they join and what they would receive annually. Defendants, in their proxy
statement, listed the retainer fee for each director as $32,000. Plaintiff contends that if the
options were valued under the Black-Scholes option valuation method, the compensation for
each outside director would be valued at $369,500 at the issuance of the options and over $1
million at the date of the proxy statement. Plaintiff also argues that Defendants did not disclose
the adverse tax consequences for the company. Defendant argues that there is neither a statutory
basis for disclosing the tax consequences nor a requirement for the Black-Scholes value of the
options.
Synopsis of Rule of Law. An omitted or misleading fact is only material, for the purposes of
determining whether a proxy statement violates Section: 14(a), if it was likely to have a
substantial effect on a reasonable shareholder’s decision for voting.
Issue. The issue is whether the non-disclosure of the option value under the Black-
Scholes method, or the tax consequences of the options, were material omissions under Section:
14(a) of the Securities Exchange Act.

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 Held. The non-disclosure of the information sought by Plaintiff was not material for the
purpose of Section: 14(a), and therefore the action is dismissed. There is no statutory or common
law requirement to provide the option value under the calculate Black-Scholes value. And there
was no requirement to disclose any negative tax consequences. Defendants did not give any false
information regarding either issue, and the missing information would not materially affect the
shareholder’s decision for voting. The case offers an example of information that would not be
material to the shareholder’s voting decision. This was not a case where shareholders were
inquiring into the tax status and were misled; it was a matter of placing a burden on directors of
requiring only enough to ensure that shareholders have all material information.

Materiality discussion:
“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 fact in question would cause a reasonable shareholder to
change his or 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.”

See fnote 7

Whats the best way to bring a fraud action? 10b-5

Elements of Action
• Causation
• Materiality (Could pass materiality and fail causation)
• Scienter (State of mind)—most courts say that negligence suffices
• Reliance?
○ As with Rule 10b-5, presumed where dealing with omission

Remedies
• Injunction
• Damages
• Rescission

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D. Shareholder Proposals

Rule 14a-8
• Also known as the town meeting rule
• Allows qualifying shareholders to put a proposal before their fellow shareholders
○ And have proxies solicited in favor of them in the company’s proxy statement
○ Expense thus borne by the company

Who Are Proponents?

• Hedge and private equity funds
• Pension funds
• Individual Activists

Responses to Proposals
• Attempt to exclude on procedural or substantive grounds
• Must have specific reason to exclude that is valid under Rule 14a-8
• Include w/t opposing statement
• Negotiate with proponent [wide range of possible compromises]
• Adopt proposal as submitted

Exclusions under Rule 14a-8

• Procedural Standards
○ Proponent does not meet ownership/format guidelines
○ Proposal not timely
○ Issuer must provide proponent w/t opportunity to cure most errors w/in 14 days
after submission

• Substantive Reasons
○ Improper under law of issuer’s domicile
○ Person grievance/special interest
○ Management functions

Process for Excluding a Proposal

• Management files notice of intent to exclude with the SEC
• Accompanied by an opinion of counsel if any of the stated reasons rely on legal issues
• Under rule 14a-8(f), management must notify the shareholder-proponent of remediable
deficiencies in the proposal and provide an opportunity for them to be cured
• A copy of the firm’s notice and statement must also be sent to the proponent who may (but
need not) reply

Timing Issues
• Proposal must be submitted at least 120 days before proposal statement is to be issued

SEC Response
Staff Level Action
• Staff determines can be excluded: Issue a no-action letter

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• Staff determine should be included: Notify the issuer of possible enforcement action if the
proposal is excluded
• Immediate position: proposal not includible in present form, but can be cured

Eligibility: Timing
• The proposal must be submitted to the corporation at least 120 days before the date on which
proxy materials were mailed for the previous year’s annual shareholder’s meeting
• 14a-8(b)(1): Proponent must have owned at least 1% or $2000 (whichever is less) of the
issuer’s securities for at least one year prior to the date on which the proposal is submitted

Eligibility: Submitting Proposals

• 14a-8(c): Only one proposal per corporation per year (no limit on how many companies a
proponent can submit proposals to)
• 14a-8(h): If the proponent fails to show up at the meeting to present the proposal in person,
the proponent will be ineligible to use the rule for the following two years

Eligibility: Repeat Proposals

• Per Rule 14a-8(i)(12) a proposal can be excluded if it was submitted
○ 1. once during the preceding 5 years and got less than 3% of the vote
○ 2. twice in the preceding 5 years and got less than

Substantive Grounds For Exclusion

• Not otherwise significant
• Rule 14a-8(i)(5)

Lovenheim v. Iroquois Brands, Ltd.

Plaintiff wanted to insert a proposal in proxy statement to determine whether a supplier of
pate, in which he held stock, de fois gras force-fed the geese in order to enlarge the livers and to
determine whether a better method was available to feed geese. The pate represented less than .
05 percent of Defendants sales, and the product operated at a loss. Therefore Defendants wanted
to omit the proposal. Defendants believed that only a proposal related to economic purposes are
required to be accepted per Rule 14a-8(i)(5) [were excepted], and that the 5% threshold was not
exceeded. Plaintiff argued that material social issues that were relevant to the business would not
fit under the Rule’s exception.
So, must interpret the exception. Court finds that less than .05 percent of company’s
assets are related to pate. Nevertheless, P contends that his proposal is “significantly related to
the issuer’s business. So P argues that Rule 14a-8 does not permit omission when the proposal
has ethical or social significance.
Court considers history of the shareholder proposal rule in determining the rule’s proper
interpretation. Committee stated in 1976 that it did not believe the exception should hinge solely
on economic factors. Thus the committee required inclusion of social settings. 1983
amendment’s purpose was to make test more objective. Thus, court finds that “the meaning of
significantly related” is not limited to economical significance. So, P gets his case.

Exception: “If the proposal relates to operations which account for less than 5 percent of the
issuer’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net
earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related

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to the issuer’s business, an issuer of security ‘may omit a proposal and any statement in support
thereof from its proxy statement

AFSCME v. AIG, Inc.

P is one of countries largest public service employee unions. Holds 26,965 shares of AIG.
Dec. 1, 2004, AFSCME submits to AIG for inclusion in the company’s proxy statement a
shareholder proposal that, if adopted, would amend the AIG bylaws to require the Company,
under certain circumstances, to publish the names of the shareholder-nominated candidates for
director positions together with any candidates nominated by AIG’s board of directors. AIG
sought input from the SEC to see if they could exclude the statement under the election exclusion
on the basis that it “relates to an election.” SEC says can exclude in no-action letter. After AIG
excludes the proposal from the company’s proxy statement, AFSCME brings suit in US District
Court seeking to compel inclusion.
Rule 14a-8(i)(8), provides that a corporation may exclude a shareholder proposal “if the
proposal relates to an election for membership on the company’s board of directors or analogous
governing body.” Issue: is whether a shareholder proposal ‘relates to an election’ if it seeks to
amend the corporate bylaws to establish a procedure by which certain shareholders are entitled to
include in the corporate proxy materials their nominees for the BOD.
AMSCFE claims that exception applies narrowly in that the relates to language is
intended to relate to proposals that address particular elections, instead of simply elections
generally. Court finds that language is ambiguous and thus does not justify either interpretation
as argued by the adversaries.
So, b/c of ambiguity, court looks to any interpretations made by the SEC. Court finds two
statement by the SEC on point. 1976 statement clearly reflects view that the election exclusion is
limited to shareholder proposals used to oppose solicitations dealing with an identified board seat
in an upcoming elections and rejects the somewhat broader interpretation that the election
exclusion applies to shareholder proposals that would institute procedures making such election
contests more likely. 1990 statement, SEC first signaled change, be deeming excludable
proposals that might result in contested elections.
Court says it would normally defer to SEC, but no reason to here b/c no justification has
been offered for the new approach. And, SEC has “duty to explain its departure from prior
norms.” Accordingly, court defers to the 1976 Statement which represents the narrow
interpretation.

Sec added this language to the Rule “or a procedure for such nomination or election” (See pg.
555 of text), so the rule now governs the aforementioned instance

E. Shareholder Inspection Rights and Intro Note

• Battles for shareholder list are fought under state law
• Often, if trying to overthrow BOD, need this info to get big shareholders in your corner
• But company does not have to give info unless there is legal ground (confidentiality issues)

Crane Co. v. Anaconda Co.

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 Crane announced a plan to purchase up to five million shares of Anaconda’s stock by
exchanging $100 million in subordinated debentures. Anaconda managers did not approve of the
exchange. A consent order was issued as a result of litigation between the parties that limited
Crane to 5 million shares. Crane requested a list of shareholders from Appellant before they
owned any shares and again after they owned over 2 million shares. Both times Appellant
refused. Respondent’s second request was accompanied by an affidavit that it wanted to inspect
its stock book only for the benefit of Crane’s shareholders. Appellant offered to include the
Respondent prospectus in a mailing to shareholders. Anaconda, who now owned 11% of
Respondent stock, petitioned to inspect Respondent stockholder information, claiming that their
request conformed to Section 1315 of the Business Corporation Law because the inspection was
for no other business than for the business of Crane. Crane argued that the inspection would have
to be for the proper purpose from the perspective of the company and not the shareholder.
Appellate division granted Crane’s request (concluded that matter was one of general
interest to Anaconda’s shareholders).
Issue: Is whether a qualified stockholder may inspect the corporation’s stock register to
ascertain the identity of fellow stockholders for the avowed purpose of informing them directly
of its exchange offer and soliciting tenders of stock. Rule: “A shareholder should be granted
access to the shareholder list unless it is sought for a purpose inimical to the corporation or its
stockholders.
The court held that it was in the shareholders’ best interests to allow Respondent to
inspect the stock register in order to identify shareholders who they can then notify of relevant
offers for their stock. Section 1315 of the statute requires a written demand along with an
affidavit that the inspection will be for a proper purpose, which Respondent did in this case (the
proper purpose being the tender offer). Once Respondent met the statutory requirements, the
burden is on Appellant to prove an improper purpose. The Appellant did not meet their burden.
The proper purpose is determined from a shareholder’s perspective rather than the
corporation. The ability to identify other shareholders is rooted in common law where the
identification of other shareholders was important in understanding the factors that affected a
business.

Shareholder Inspections Rights

• Policy Concerns
○ Shareholders have a legitimate interest in using the proxy system to hold the
board accountable
○ Nobody wants a junk mail distributor to get this info

Delaware Statute
• Section 222(b):Shareholder must set forth proper purpose for info, and proper purpose is one
reasonably related to such person’s interest as a stockholder. If shareholder only seeks access
to the shareholder list, burden on the corporation to show that shareholder doing so for an
improper reason
• Section 220(c): If shareholder seeks access to other corporate records, burden of production
on shareholder to prove requisite proper purpose

State ex. re. Pillsbury v. Honeywell, Inc.

Pillsbury was part of an anti-war group that decided to target Honeywell, Inc., for their
manufacturing of weaponry that would be used in the Vietnam War. Pillsbury decided to
purchase shares (for the purpose of this suit, he only owned one share) of Honeywell for the

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purpose of requesting corporate documents, as a shareholder, in order to identify other
Honeywell shareholders in order to inform them of Honeywell’s involvement. Pillsbury made
two formal demands for the records that were both denied. Pillsbury then filed a writ of
mandamus, and he explained his reasons for the inspection. The trial court agreed with
Honeywell in finding that there was no proper purpose related to his interest as a stockholder.
Held. The court held that Petitioner’s purpose was not proper. The proper purpose has to
pertain to investment purposes rather than just simply whenever a stockholder has any grievance
with a company’s management. The court will not allow an absolute right of inspection.
Discussion. The court is concerned that allowing an inspection by simply being able to be
identified as a shareholder puts an enormous burden on corporations, which can have thousands
of shareholders at any given point, to maintain their corporate records.

Synopsis of Rule of Law. A shareholder can only demand corporate investor identification
information when the purpose is related to investment concerns traditionally associated with
shareholder concerns.

Sadler v. NCR Corporation

Plaintiffs were a couple, William and Barbara Sadler, who worked with another Plaintiff,
American Telephone & Telegraph (AT&T), to receive Defendant’s corporate records regarding
shareholder identity. Plaintiffs also requested a NOBO list. AT&T worked with the Sadlers
because the Sadlers were shareholders that satisfied all of the requirements of section 1315(a) of
the New York Business Corporation Law that allow a request of the information, namely that it
had to be from someone who held Defendant stock for longer than six months. AT&T agreed to
indemnify the Sadlers for any costs incurred in the request, and in return AT&T effectively
controlled the entire request. Defendant argued that the arrangement with AT&T made the
Sadlers ineligible to request the information, and that the requirement of a Maryland corporation
to abide by a New York statute violates the Commerce Clause of the United States Constitution.
The court held that the statute will be read on its face without the incorporation of agency
law principles. As long as the requirements of the section are met, and there is no bad faith on
the part of the Plaintiffs, then the request for the corporate records should be granted. These
elements were met by Plaintiffs. Further, the request for the NOBO list is not unduly
burdensome. Upholding the New York Statute does not violate the Commerce Clause because
the New York Statute is not inconsistent with the Maryland statute even though the New York
statute compels the records disclosure while Maryland’s law only allows for the disclosure with
no mandatory requirements. Court also notes that other courts (other jurisdictions) have not
compelled companies to produce NOBO lists. But court ultimately says that it is not too
burdensome to require company to formulate and then delivery list to P.

--NY law amended post judgment and now provides that “the corporation shall not be
required to obtain information about beneficial owners not in its possession.”
CEDE list- List kept by brokers that tells on whose behalf they purchase stock
NOBO list- Non-objecting Beneficial Owners..basically shareholders who have purchased stocks
through brokers and banks and do not object to their personal info being shared

What is internal affairs doctrine?

Corporate governance issues controlled by law of state of incorporation

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Section 2. Shareholder Voting Control

Stroh v. Blackhawk Holding Corp.

PROCEDURAL POSTURE: Appellants shareholders sought recovery from appellee
corporation alleging that the Class B shares of stock it issued were invalid because their principal
attribute consisted solely of the right to vote. The shareholders were granted a summary
judgment on their claim, but the Appellate Court of the Third District (Illinois) reversed and
remanded on the grounds that the shares of stock were valid. The shareholders sought review.

OVERVIEW: The shareholders claimed that the term proprietary in the definition of shares in
the Business Corporation Act, specifically Ill. Rev. Stat. ch. 32, para. 157.14 (1969), meant a
property right and that the shares must represent some economic interest in the property or assets
of the corporation. The corporation claimed that the word proprietary did not necessarily denote
economic or asset rights. The court agreed with the corporation's construction of ch. 32, para.
157.14. The court held that the word proprietary meant that the rights conferred by the ownership
of stock could consist of one or more of the rights to participate in the control of the corporation,
but did not require that the shares possess an economic interest in the corporation. The court
found that Ill Const. art. XI, 3 required only that the right to vote be proportionate to the
number of shares owned and did not require shares to be an investment in a corporation. The
court concluded that a shareholder could be deprived of an economic interest in the corporation
but could not be deprived of his voice in management. Thus, the court held that the Class B
shares were valid shares of stock in the corporation.

OUTCOME: The court affirmed the judgment of the appellate court and remanded the cause to
the circuit court with directions to vacate its decree entered in this cause finding the Class B
shares of the corporation to be invalid.

Close Corporations

Galler v. Galler
• “a close corporation is one in which the stock is held in a few hands, or in a few families, and
wherein it is not at all, or only rarely, dealt in by buying or selling” (I.E. no secondary market
for shares)

Contrasting Close and Public Corporation Shareholders

• Public corporation shareholders—usually own small % of shares as part of diversified
portfolio, interested in share price, have little influence on B of D or management, if
dissatisfied typically follow ‘wall street rule’ and sell shares
• Close Corporation Shareholders—Often undiversified, interest in the company’s performance
and dividends, minority shareholders may have little influence on B of D or management,
personality conflicts can lead to deadlock or oppression

Locked in and Frozen Out

• Locked in as shareholders—close corporations often restrict share transfers, even if no formal
restrictions there is no secondary market for the shares

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• Risk of being frozen out of decision-making and compensation—minority shareholders may
have no control over company’s activities, may be denied compensation if denied
employment

**On exam, how would you draft merger or close corporations A of I so that
problems do not arise**

Solutions
• Voting Trusts
• Shareholder Agreements
○ Agreements relating to election of the B of D
○ Agreements relating to limitation on the board’s discretion

Voting Trust
• Agreement among shareholders under which all of the shares owned by the parties are
transferred to a trustee, who becomes the nominal, record owner of the shares
○ Trustee votes the shares in accordance with the provisions of the trust agreement,
if any, and is responsible for distributing any dividends to the beneficial owners of
the shares

• Advantages—no possibility of shareholder deadlock, since everybody puts their shares in the
trust and trustee votes
• Disadvantages—loss of control, duration (most states limit to 10 years), still possible for
board to oppress

Voting Trust Requirement

• Per DGCL § 218, a copy of the trust document must be filed with corporation’s registered
Delaware office
• Voting Trust could not exceed 10 years
• Courts reluctant to re-characterize an agreement as a trust

Section 4. Abuse of Control

Wilkes v. Springside Nursing Home, Inc. (Corporation being treated as partnership)

Plaintiff was locally renowned for his profitable real estate dealings, and in 1951 when
Defendants heard about Plaintiff’s option to purchase a particular building, they agreed to partner
with Plaintiff on developing a business venture around that option. The parties agreed to allow
each to receive money from the corporation as long as they actively participated in running the
business. The parties then agreed to open a nursing home at the location, and by 1952 the profit
from the business was large enough for them to each draw a salary from the business. One of the
Defendants wanted to purchase part of the property for his own business use, and Plaintiff forced
a higher price for the property than what was expected. This created bad feelings between the
partners until finally, in 1967, Plaintiff notified the other shareholders that he wanted to sell his
share. A month later, but prior to the sale of his shares, Defendants voted to terminate Plaintiff
from his position and took away his stipend (despite the fact that another owner at that point
received a stipend while having no day-to-day responsibilities). Defendants argued that they had
the power, under the corporate by-laws, to set salaries and positions.

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 Issue: The issue is whether Defendants violated a fiduciary duty when they removed
Plaintiff from his position after a falling-out between the parties.
Held. Shareholders have a duty of loyalty to other shareholders in a close corporation,
and in this case the duty owed to Plaintiff by Defendants was violated. Therefore Plaintiff is
entitled to lost wages. In close corporations, a minority shareholder can be easily frozen out
(depriving the minority of a position in the company) by the majority since there is not a readily
available market for their shares. Although this is traditionally an issue of management, the test
for close corporations, should be whether the management decision that severely frustrates a
minority owner has a legitimate business purpose. In the case at issue, Defendants’ decision
would assure that Plaintiff would never receive a return on the investment while offering no
justification.
Discussion. The court is reversing a prior line of thought that management decisions are
not within the scope of review of the courts. The court notes at the negative effects that the prior
line of reasoning had wrought, such as the freezing out or the oppression of minority
shareholders.

Synopsis of Rule of Law. Shareholders in a close corporation owe each other a duty of
acting in good faith, and they are in breach of their duty when they terminate another
shareholder’s salaried position, when the shareholder was competent in that position, in an
attempt to gain leverage against that shareholder.

Idea that majority shareholders have duty to minority counterparts is very novel given what we
have experienced so far, however, this is just exception that courts have carved out for closely
held corporations
 Does this decision blur the lines b/ween a corporation and a partnership?
 Rule, to some degree, undercuts the business judgment rule (assert case as majority
shareholders taking advantage of minority shareholders)
What mitigates the business judgment rule?
Duty of Care
Duty of Loyalty (shown by proving conflict of interest, self-dealing)

Ingle v. Glamore Motor Sales, Inc.

Ingle was hired as a sales manager by Defendant owner, James Glamore, in 1964 after
Glamore rebuffed his offer to buy an equity share into the company. In 1966, Plaintiff entered a
shareholders agreement with Glamore that provided 22 of 100 shares to Plaintiff with a provision
that allowed Glamore to buy back the shares if Plaintiff was terminated for any reason. In 1982,
another shareholders agreement allowed Plaintiff to buy another 22 of 60 shares, and that
agreement also contained buyback language. In 1983, a shareholders meeting voted out Plaintiff
from his position at Defendant company, and Defendants bought Plaintiff’s shares for $96,000.
Plaintiff brought this suit, claiming that as a minority shareholder in a close corporation he was
owed a fiduciary duty by Defendants to keep him in his employment as long as he was
competent in his duties. Defendants argued, absent an employment agreement, Plaintiff was an
at-will employee who would be adequately compensated
with the buyback provision.
Issue. The issue is whether Ingle, minority shareholder, is owed a fiduciary duty by the
majority to keep Plaintiff in his position at Defendant company.
Held. Defendants do not owe Plaintiff a duty to keep Plaintiff indefinitely as an employee
as a result of his minority shareholder status. Traditionally, an employee is an at-will employee if

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he does not have an employment agreement that gives a duration for the employment. This
situation does not change when an employee attains shareholder status, especially when there is a
provision in the shareholder agreement that allows the majority shareholder to buy back
Plaintiff’s share if he is terminated for any reason. Plaintiff never asserted that the buyback
amount was unfair, and therefore he suffered no harm.
Discussion. The majority allowed Plaintiff to, in a sense, agree to give up any rights he
had as a minority shareholder when he agreed to purchasing shares with a termination buyback
provision. The distinguishing feature in this case compared to Wilkes v. Springside Nursing
Home, Inc. is that in this case the plaintiff was an employee before he was a shareholder, and
here the court uses that timing to justify his at-will employment status.
Dissent. The dissent argues that the majority gives the minority shareholder in a close
corporation no rights at all when they enforce the at-will principle over the rights as a minority
shareholder. This leads to a minority shareholder having no redress for any egregious behavior
by the majority shareholders. In this case, that includes a $96,000 buyback on a $75,000
investment made at least 15 years ago, a period of time wherein Plaintiff sometimes advanced his
own funds to help the business.

Synopsis of Rule of Law. Absent an employment contract, an employee is an at-will employee

when his shareholder agreement provides a buyback provision of his shares if they are
terminated for any reason.

How do you reconcile this decision w/t Wilkes? Wilkes talks about legitimate business purpose,
is this legitimate business reason?? Hell no, just squeezing someone out for your benefit (or for
the benefit of your sons), court frames the question differently to effectively freeze out the non-
familial interest in the company

Brodie v. Jordan (Cites Zimmerman Case)

P’s husband (Walter Brodie) was one of founding members of “Malden”, a
Massachusetts corporation that produced metal objects and ball bearings. Jordan was employee
of the company and was responsible for the day to day operations of the company.
1984, Walter, Barbuto, and Jordan each own 1/3 of the shares of the company and all
served as directors. 1988, Walter no longer involved in companies day to day operations. Walter
begins to disagree w/t management decisions and requests company purchase his shares, requests
denied.
Jordan receives salary from company for running day to day operations, has use of
company vehicle and participates in company profit sharing company. Barbuto receives business
benefits. Walter received no money from the corporation since 1995. Walter dies 1997, at this
time Jordan is president and director of Malden. P inherited husband’s 1/3 interest. She attends
shareholders meeting and asks to be made director, request refused, she also asks for valuation of
her stock, request also refused. 1998, she files suit alleging that ∆’s failed to provide her w/t
various financial and operational info. ∆’s had failed to hold shareholder meeting for 5 years.
Discussion: Malden is close held corporation and stockholders in such corporation “owe
one another substantially the same fiduciary duty in the operation of the enterprise that partners
owe to one another. Duty violated if shareholders “freeze out” the minority. Def. of freeze out on
pg. 620. Common theme is that “majority frustrates the minority’s reasonable expectations of
benefit from their ownership of shares. Lower court correctly found that she was frozen out.
Issue on appeal: Was she entitled to a forced buyout of her shares by the majority?
Zimmerman case: “proper remedy is to restore the minority shareholder as nearly as possible to

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the position she would have been in had there been no wrongdoing.” Lower court ordered other
shareholders to purchase her stock and erred in doing so, b/c such a remedy placed her in a
significantly better position than she would have enjoyed. On remand, her reasonable
expectations of ownership should be determined, money damages may be awarded if necessary,
or injunctive relief may be granted.

Smith v. Atlantic Properties

Wolfson offered the three Plaintiffs, Paul T. Smith et al., to go in equal shares in the
purchase and development of some real estate. The partners formed Atlantic Properties with each
party becoming a 25% shareholder, and Atlantic then bought the property in 1951. The corporate
by-laws provided that any proposals had to be approved by at least 80% of the directors,
meaning that in real terms for the group of four there would need to be a unanimous vote. The
corporation was profitable every year through 1969 but dividends were only paid in 1964 and
1970. Because so much of the value of the company was in cash, the Internal Revenue Service
assessed penalty taxes in seven different years for the accumulation of the money. Wolfson was
the lone dissenter for the voting for dividends, and his vote was enough to defeat the proposals
under the 80% plan in the by-laws. Wolfson maintained that he wanted the money for
improvements to the property, and Plaintiffs asserted that he w
anted to avoid his own personal tax issues. Plaintiffs then sought damages from Defendants for
dividends, damages due to the tax penalties and legal expenses, and also asked to remove
Wolfson as a director. The lower court agreed with Plaintiffs that dividends should be issued and
that Defendants were liable for the tax penalty amounts.
Issue: The issue is whether Wolfson owes Plaintiffs the same fiduciary duty a majority
would owe a minority shareholder.
Held. The court held that the determining factor for the fiduciary duty owed is whether a
party would be considered a controlling party. Because Wolfson was the controlling party in that
he alone prevented the dividend payouts despite no real business justification, the court affirms
that a fair dividend should be declared. Wolfson was unreasonable and did not demonstrate
utmost good faith and loyalty to the business.
Discussion. The court had no problem with the by-law provision that allowed for a
minority to veto dividends, but rather in the manner in which he utilized his powers to
unreasonably prevent the allowance dividends in the face of tax penalties.
Synopsis of Rule of Law. Minority shareholders (who exercise excessive power) owe
majority shareholders a fiduciary duty in the same manner that majority owners owe minority
shareholders, and therefore the majority can seek judicial intervention for decisions that are
unjustifiable for the corporation’s interests.

Can this case be reconciled with Wilkes? Legitimate Business Purpose was not promoted by
Wolfson’s decision, (Wilkes was freeze-out case) and this was deadlock case, this case is taking
the idea of corporate duties (majority shareholders owe fiduciary duty) and diluting them b/c
minority shareholders now have fiduciary duty to the majority. Other issue is that in this case
Wolfson did this at the expense of the others,

**On exam, is corporation closely held or is it publicly traded, if closely held hard to tell
the outcome, if publicly traded  Business judgment rule***

Jordan v. Duff and Phelps (Very matter of fact written opinion) (10b-5 Fraud action)

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 Plaintiff was a securities analyst for Defendant. Due to a falling-out between his wife and
mother, Plaintiff believed that it would best to relocate. Because Defendant could not use his
services except in the office he was currently in, Plaintiff landed a job with another company in
late 1983. While he was employed with Defendant, Plaintiff bought 188 (out of 20,100) shares at
book value and could have bought 62 more shares if he wanted them. Per the agreement, Plaintiff
was to receive book value of the shares upon the termination of his employment, and the book
value would be determined as the value of the prior December 31st. Plaintiff stayed with the
company an extra period of time in order to get the book value for December 31, 1983 instead of
1982. He received a check for $23,225, but before he cashed it he noticed that Defendant had
been in merger talks with another company (talks that took place before Plaintiff’s resignation)
that would have put the shares he was eligible for at a value of $452,000, plus be entitled to
another $194,000 in “earn-out” money.
Plaintiff wanted his stock back, but Defendant refused. Plaintiff brought this action,
arguing that if he had information concerning the merger that he would have altered his plans
and staid with the company. (First merger essentially cancelled by Fed, but firm’s management
ultimately purchases stock). Defendant argued that they were under no obligation to disclose
information, especially in this case where there was no agreement as to the price and structure of
the merger. Defendant also argued that it was moot to give him the stock back after he resigned
because the share agreement provided that Plaintiff had to sell his shares back after he resigned.
Issue: The issue is whether Defendant had a duty to disclose to Plaintiff, and employee
minority shareholder, talks of a possible merger.
Held. The court held that Defendant was obligated, under a fiduciary duty to close
corporation shareholders, to disclose the talks of a possible merger that would greatly affect the
share price. Although in publicly traded companies there is no duty to disclose confidential
merger talks because it would be impractical and injurious to shareholders, close corporations do
not have to worry about the same issues because there is no third party market. At the same time,
other shareholders in close corporations have no resources other than the shareholders that are
participating in the merger talks to find out about the value of the stock. Plaintiff did not forfeit
his ability to use that information by resigning. Therefore the court declined to dismiss the case
and remanded it back for a jury trial.
Dissent. The dissent argues that Plaintiff’s status as an at-will employee does not allow
him a right to change his mind about his resignation. Not only did the shareholding agreement
not confer any rights, but it provided for the ability to buy back the shares if the employee is
terminated. (Same rationale as Ingle)
Discussion. The dissent views this case as the majority did so in Ingle v. Glamore Auto
Sales, Inc., which is to view the issue as an employee right first and a shareholder right second.
In both cases a shareholder provision allowed the employer to buy back the shares at the point of
termination for any reason.

Synopsis of Rule of Law. A closely held corporation has a duty to disclose a potential
merger or buyout when attempting to buy shares from an unwary shareholder, even if the deal
has yet to reach an agreement as to price or structure of the deal.

If this is employee case—go away—you were at till employee and got fired
If this is shareholder case, then you deprived me of something material and I have action
under 10b-5

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 **On final, want to discuss both employment and shareholder aspects and how the
analysis of those issues impacts the decision**

How do we plan around these issues?

For instance, in Wilkes, given how the freeze-out happened, how could you have planned
around it?
Voting Trust—Can stipulate dividend payments, salary agreements
Employment Contract—Would not have likely worked b/c

What about Ingle? He was employee at-will (why he got hosed) so employment k would have
dramatically altered the court’s analysis (he could also have negotiated a better but-sell
agreement)

What about Brody? How could you have protected wife’s interest in property? A of I, all they
had to do was include her in meetings, could have put her on board

What about Wolfson? Subject matter of case is what they contracted for, P should have had
better attorney from onset informing them that minority shareholder was taking control of voting
rights

Section 5. Control, Duration, and Statutory Dissolution

Dissolution of Close Corporations

• Risk of oppression of minority interest by majority shareholders
• Limited by:
○ Imposition of expansive fiduciary duties
○ Relatively high costs of judicial enforcement
○ Often difficult to construct a remedy for breach of fiduciary duty
○ How much damages are someone entitled to when they are squeezed out of
employment with the close corporation?

• All states have provisions under which a shareholder may seek an involuntary dissolution of
the corporation
• Dissolution leads to a winding up and liquidation of the firm, followed by a distribution of
the firm’s remaining assets to creditors and then to shareholders

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Options for Dissolution
• 1. Only available when the board is deadlocked and the company cannot be managed
(Delaware Law)
• 2. Allow dissolution when the minority shareholder’s reasonable expectations have been
frustrated
• 3. Fraud, illegality, or Oppression
• 4. Some combination of the above (MBCA § 14.30)
• Some states require a threshold of shares to petition the court before oppression will be
allowed
• Courts will use broad equitable remedies to avoid the ‘extreme’ solution of dissolution
(Alaska Plastics)

Alaska Plastics, Inc. v. Coppock

Synopsis of Rule of Law. Absent a statutory right of appraisal, a shareholder is not entitled to an
equitable remedy wherein the corporation purchases their shares when the shareholder has issues
regarding the director’s allocation of company resources.

Facts. Patricia Muir divorced one of the three Appellant directors, and was given 150 shares (1/6
of the outstanding shares) in the divorce settlement. The directors did not notify, or did not notify
adequately, Appellee of four annual shareholder meetings. The directors collected a salary or
fees from the company, and they used company money to pay for their wives to attend business
meetings. The directors offered to purchase Appellee’s shares for $15,000, but Appellee hired an
attorney and accountant to assess the value of the shares. The accountant valued her shares
between $23 and 40 thousand, not including property owned by Appellant corporation. The
directors increased their offer at one point to $20,000. The directors agreed to buy another
company without first notifying Appellee (although she ratified that with a subsequent vote of
approval). After the initial company burned down without insurance, there was another offer by
one of the directors, acting individually, to buy her shares at $20,000. After Appellee filed an
action for an equitable remedy, the lower court ordered Appellants to purchase her shares for
$32,000 and to pay attorney fees and interest.

Issue. The issue is whether Appellee is entitled to equitable relief by forcing Appellants to
purchase her shares at a price determined by the lower court.

Held. The court held that there was no remedy available that Appellee could use to force the
close corporation to purchase her shares. The court listed four ways where this can happen but
none applied to Appellee: 1) provision in a by-law (not present here); 2) petition for involuntary
dissolution of corporation (the directors’ conduct was not so extreme as to warrant this remedy);
3) change in corporate structure such as a merger (Appellee approved the merger in this case);
and 4) statutory right of appraisal (not recognized by state law). Appellee may have a claim for
relief, but it should be through other means, such as forcing a dividend payment that compares to
the benefits the other shareholders receive.

Discussion. The court notes that typically the best relief that could be granted to a disgruntled
shareholder is to receive fair value for the shares and end their participation in a close
corporation. However, the court wants to limit this remedy to extreme cases, or at least judicially
recognized cases.

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Derivative Claim- No action b/c of business judgment rule. (Also, may have been poorly plead)

**Majority shareholders cannot derive a benefit at the expense of minority shareholders**

Dividends must be paid out equally, can’t simply pay dividend to majority shareholders and
ignore the minority**

**Often times, majority shareholders try and low ball minority shareholders, this is when file
action**

Grounds for Involuntary Dissolution: Director Deadlock (3 Conditions)

1. The directors must be evenly divided and therefore unable to make corporate decisions
2. The shareholders must be unable to resolve the deadlock
3. The deadlock must threaten irreparable injury to the corporation or prevent the business of the
corporation from being conducted to the advantage of the shareholders.
What does this mean? Business can no longer make profit to be dissolved
WTF? In Haley, still making a profit

Grounds for involuntary dissolution: Shareholder Deadlock

1. Shareholders must be evenly divided
2. Because of their division the shareholders must be unable to elect a board of directors for two
years running

What is oppression?
• Oppression is defined as conduct that substantially defeats a minority shareholder’s
reasonable expectation
• Reasonable expectation factors: 1. Were expectations reasonable under the circumstances, 2.
Were they known or should have been known by the majority, 3. Were they central to the
petitioner’s decision to join the venture
Buyout in Lieu of Dissolution
• If Ms. Muir could prove that she was oppressed, the statutory remedy would be a dissolution
and liquidation. But the court said it was reluctant to order a dissolution. Why would a court
be reluctant to grant the statutory dissolution remedy?
○ The court may believe the firm is worth more as a going concern than if it were to
be split up and sold off in pieces (Whole better than sum of its parts)
○ The share repurchase option creates such a market by effectively coercing the
majority into buying the minority’s shares, while also preserving the going
concern value of the firm

Is Buyout Necessary in Lieu of Dissolution Valid? **May be on exam** As Policy Question**

1. Necessary given the practical effect of dissolution order?
2. Appraisal any less drastic than dissolution? Usually just opening up books is less drastic
3. Liberal dissolution rights allow minority shareholders to threaten to dissolve the firm and
thereby potentially extort additional benefits from the firm or the other shareholders?
4. Is it appropriate for court to create a remedy when the legislature didn’t?

Haley v. Talcott
Haley seeks dissolution of Matt and Greg Real Estate. Haley and Talcott each owned
50%. Haley brings action by statute §18-802 which permits a court in Delaware “to decree

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dissolution of a limited liability company whenever it is not reasonably practicable to carry on
the business in conformity with a limited liability company agreement.”
Issue: Should dissolution be granted or is Haley limited to the contractually-provided exit
mechanism in the LLC agreement?

Facts: Talcott and Haley co-operate the Redfin Grill. Talcott solely owns the grill, Haley’s rights
are defined by a series of contracts, but the property is owned by Matt and Greg Real Estate.
Employment contract makes it clear that parties were operating business as a joint venture. Haley
was to receive ½ of profits from Redfin Grill once Talcott’s initial investment repaid. Haley was
also awarded ½ of any proceeds from the sale of the Redfin Grill. Employment k also limited
Talcott’s ability to remove Haley from his active role. (Court finds that employment k thus sets
up, for all practical purposes, a partnership). Talcott also granted Haley the right to participate in
an option to purchase the property where the Redfin Grill was located.
2001-2003, Redfin profitable. 2003, parties form Matt and Greg Real Estate to purchase
property, take out 720,000 loan and do so. Both Haley and Talcott signed personal guarantees for
the entire amount of the mortgage to secure the loan. Make payments, things looking good until
Mid-2003 when personal relationship deteriorates. Haley felt he would be provided direct stock
in corporation, personal conflict when wishes not granted, consequently, Talcott sends letter of
understanding to Haley purporting to accept his resignation and forbidding him to enter the
premises of the Redfin Grill.
Haley’s responds w/t letter rebuking Talcott’s resignation allegations, stating that he was
terminated w/out cause in breach of his k. Second letter by Haley proposes sale of the property
along w/t other measures. Status-quo remained b/c of 50/50 split in ownership rights. Absent
intervention by court, Haley stuck unless he chooses to avail himself to the exit mechanism in
the LLC Agreement.
Holding: Three requirements must be met for a court to order the dissolution
of an corporation: (1) The LLC must have two 50% stockholders; (2) those
stockholders must be engaged in a joint venture; and (3) they must be unable to
agree upon whether to discontinue the business or how to dispose of its assets.
Here, the court determined that all three requirements had been met, but not
dealing with corporation, dealing with LLC. So look to freedom of k, court found that
looking to freedom of k produced inequitable result in this case b/c both parties still
liable for debt incurred. The court required both parties to confer, and within four
weeks of this order they were to submit a plan for the dissolution of the LLC. This
plan was to include a procedure to sell the property owned by the LLC within a
commercially-reasonable time frame. The court further stated that either party was
permitted to bid on the property.
**Seems to contradict our earlier finding that a court will not dissolve business if the
business is making a profit, moreover, freedom to k w/in the LLC world is usually
upheld, so WTF**

Pedro v. Pedro
Alfred Pedro (Respondent) and Carl and Eugene Pedro (Appellants) were three brothers
with equal ownership in The Pedro Companies. The brothers entered into a stock retirement
agreement that allowed them to buy back shares of a deceased brother at 75% of net book value.
Several years afterward, Alfred, after noticing a discrepancy of $330,000 in the accounting
records, demanded an independent accountant to investigate. After the missing funds could not
be located by two accountants who were frustrated in their investigation by Carl and Eugene,
Carl and Eugene fired Alfred and took away all of his benefits. Respondent then brought this

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action, claiming Appellants breached their fiduciary duty owed to him, that he had a contract for
lifetime employment and that he suffered numerous injuries resulting from the termination.
Appellants responded that they did not breach a duty because the stock value did not diminish.

Issue. The issue is whether Appellants violated a fiduciary duty owed to Respondent by the
termination of Respondent and the subsequent buyout of his shares below market value.

Held. The court affirmed the trial court, holding that Appellants did breach their duty to
Respondent. The duty can be breached in more ways than just a diminishing of the stock value,
such as by terminating Respondent and forcing a share sale at the agreement’s stated price of
75% market value. There was also evidence that, in the facts surrounding the structure of this
close corporation, that there was an expectation of lifetime employment for the shareholders.
Looks to reasonable expectations of Alfred and ok’s finding given the broad power of the court.

Discussion. The facts of the case at issue demonstrated a compelling case for the appraisal and
sale of shares back to the corporation from a shareholder who was treated unfairly.

Stuparich v. Harbor Furniture Mfg., Inc.

Facts. Plaintiffs are two sisters who owned a majority of the non-voting shares and a
smaller percentage of voting shares of Harbor Furniture. Their brother, Malcolm, Jr., controlled
Harbor Furniture with his 51.56% voting share ownership. The shares were passed down by
family members to both parties. Harbor Furniture was comprised of two business ventures: a
furniture company which lost money, and a mobile home park which was lucrative. Malcolm, Jr.
actively participated in the business early on, and he was able to collect a majority of shares by
buying his father’s stock at a reduced rate. He collected a salary (as did his wife and son), but the
company paid dividends to the shareholders. Defendants sometimes neglected to keep Plaintiffs
informed of all business activities, and Plaintiffs never had an active role in running the
company. Plaintiffs at one point mistakenly believed that they had had a majority of voting
shares of the company, and they called for a vote to divide the two ventures. The vote was
refused, and Malcolm, Jr. repeatedly refused to buy out the Plaintiffs’ shares. The relationship
between the parties became strained to the point where Malcolm, Jr. physically injured one of the
Plaintiffs. Plaintiffs then brought this action to dissolve the company, arguing that they were
given no role in the company while Malcolm, Jr. has a vested interest in continuing the venture
(he draws a salary), and the relationships were strained beyond repair. The trial court sided with
Defendants and granted their summary judgment.

Issue. The issue is whether Plaintiffs raised triable issues of fact under § 1800(b)(5) that would
justify an involuntary dissolution of Harbor Furniture.

Held. Plaintiffs did not raise triable issues of fact to justify the dissolution, and therefore the
summary judgment in Defendants’ favor was proper. The involuntary dissolution of the company
is a severe remedy that a minority shareholder is not automatically entitled to. The threshold has
to be set high to justify a court to enact such a remedy. In this case, there was nothing illegal or
abusive in Malcolm, Jr.’s purchase (at a reduced rate) and control of a majority of the company
shares because Malcolm, Sr. is entitled to sell his shares at whatever value he desires. There was
not enough evidence presented by Plaintiffs to indicate that the furniture business was never
going to be profitable. There is also no right for a minority shareholder to force a majority

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shareholder to purchase their shares if they are dissatisfied.

Discussion. The court does not want to allow involuntary dissolution in cases where there is
simply a difference of opinion between the minority and the majority. The majority must engage
in conduct that puts the minority shareholder in a position where there is no other alternative.

Section 6. Transfers of Control

Context
• Controlling shareholder sells his or her block of stock to an outsider: receives substantial
premium over the market price, minority shareholder gets no premium
• Can the selling shareholder be held liable for failing to share the ‘control premium’ with the
minority?
• Control Premium “The amount an investor will pay to acquire control of a company,
typically an amount higher than the current market value of the company. An investor seeking
to acquire control of a company is highly motivated, and is typically willing to pay more, this
often comes into play when one company is trying to acquire another.

Source of Control Premium

• You own 51% of a very small public-held corporation, whose stock is currently trading in the
market for $5. An investor comes along and offers you $8 per share for your stock.
• Purpose—to gain control of the company (savvy takeover will insure that they get certain # of
shares to take majority before they agree to buy any shares)

Why is control valuable?

1. Control will generate non-pro rate benefits in the form of generous salaries, perks, etc.
2. Shares may be worth more in the hands of a new owner than in the hands of an incumbent,
because the incumbent is doing a bad job of managing the business

Frandsen v. Jense-Sundquist Agency, Inc.

Jensen-Sundquist was a holding company comprised of the First Bank of Grantsburg and
a small insurance company. In 1975, Walter Jensen owned all of the stock of Jensen-Sundquist,
but gave 52% to family and sold 8% to Plaintiff. Plaintiff also received a right of first refusal to
purchase the majority block of shares, and also had the right to have his shares purchased by the
majority if they were to be sold to a third party. In 1984, Jensen-Sundquist entered discussions
with First Wisconsin, wherein First Wisconsin would purchase Jensen-Sundquist for $62 per
share. Plaintiff refused to go along, and the agreement between Defendants was modified to
allow Jensen-Sundquist to treat the First Bank of Grantsburg as an asset that would be sold off to
First Wisconsin for $88 per share. Plaintiff protested, arguing that he had the right of first refusal
and that the only reason they avoided offering that right to Plaintiff was to make sure the
president of Jensen-Sundquist did not lose his job under Plaintiff.
Issue. The issue is whether Defendants breached or tortiously interfered with the
agreement between Plaintiff and Jensen-Sundquist that provided him with the right of first
refusal on the sale of the majority shares.
Held. The court held that the agreement was not breached because there was never a sale
of the majority’s shares to First Wisconsin. The court read the terms of the agreement literally to
include only what the agreement allowed for, which is the sale of the majority’s shares. And

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absent a breach of the agreement, or unfair competition, First Wisconsin can not be liable for
tortious interference.
Discussion. The narrow interpretation of the shareholder agreement, as Plaintiff notes,
offers Plaintiff very little rights since there are several ways to avoid the actual sale of the
majority’s shares while still allowing the significant assets to change hands.

The Shareholder Agreement: Take Me Along

1. Right of First Refusal
2. Take-me along clause: Done to establish share control premium

Possible Clause #3 Enjoin merger clause and buy family’s shares at the effective price of the
merger

What were Frandsen’s Motives in Negotiating the language?

--To force the majority to share a control premium with him
--to avoid dealing w/t a majority shareholder that he didn’t know or didn’t trust
--want to acquire FBG w/out getting into a bidding was w/t another potential bidder

Zetlin v. Hanson Holdings, Inc.

Synopsis of Rule of Law. Absent bad faith such as corporate looting of assets or a conversion of
a corporate opportunity, a party can purchase a controlling share of a corporation at a premium
price without extending a tender offer to all shareholders. Control premiums permissible!!!

Facts. Plaintiff owned 2% of Gable Industries, Inc. Defendants owned 44.4% of the outstanding
shares which they sold to Flintkote Co. for $15, giving Flintkote the controlling majority. The
open market value of the shares was $7.38 per share. Plaintiff brought this action, believing all of
the Gable shareholders were entitled to the premium paid by Flintkote.

Issue. The issue is whether Plaintiff is entitled to the premium share value that Flintkote paid to
Defendants for their controlling shares.

Held. The Court of Appeals of New York declined to adopt Plaintiff rule which would
effectively mandate that a purchaser give a tender offer to all shareholders when they are only
seeking a controlling interest in a corporation. The rule change should be provided by the
legislature and not the courts, but the current law has never held that such a policy should be in
place.

Discussion. The court realized that the rule advocated by Plaintiff would place a significant
burden on parties who are simply trying to get a majority interest in a company rather than
complete ownership.

Perlman v. Feldman
Facts. Plaintiffs and Defendants were shareholders in Newport Steel. Newport Steel
provided steel sheets typically to regional customers because their facilities were outdated. Due
to the Korean War, steel was at a premium and it turned Newport Steel into a more profitable
venture. Newport began updating their facilities, but a third party, Wilport Company, bought
Defendants’ shares in an effort to secure more steel output. The over-the-counter price for the

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shares was $12 and the book value was $17.03, but Wilport paid $20 per share to Defendants.
Plaintiffs sued to receive the same premium (attributable to the sale of corporate power) for their
shares, and the trial court denied their claims. The trial court ruled that the premium was an
inherent benefit of having a controlling ownership, and alternatively, the burden was on
Plaintiffs to prove the lesser value of the stock.
Issue. The issue is whether Plaintiffs are entitled to a share of the premium paid by
Wilport attributed to the sale of corporate power.
Held. Plaintiffs are entitled to a share of the premium paid to Defendant shareholders.
Feldmann was the president and dominant shareholder, and in both positions he owes a fiduciary
duty to minority shareholders not to let a personal interest override the interests of all the
shareholders. The burden is on the shareholder to prove that this is not the case. The court is not
holding that the dominant shareholder is not able to sell his shares, but in this case Feldmann did
not meet his duty in the sale of his shares. The court noted that there only had to be a possibility
that Defendants misappropriated a corporate opportunity and not an absolute certainty. The facts
demonstrate that there was a shortage of steel and Defendants took advantage of this to obtain a
market premium for their shares.
Dissent. The dissent does not argue that Feldmann owed Plaintiffs a fiduciary duty, but he
argues that Feldmann did not violate any duty here. As a majority shareholder, Feldmann is
entitled to sell his shares for the best price he can receive. There was no evidence that Wilport
was going to abuse their control or not act in the best interests of the other shareholders.
Discussion. The dissent takes the position provided in Zetlin v. Hanson Holdings, Inc.
which allows for a majority shareholder to get the best price for their shares without having to
account for any premium to the minority shareholders.

Synopsis of Rule of Law. A majority shareholder, particularly when they also are the president
and chairman of the board, who sells his shares to a third party who then obtains a controlling
interest, owes the minority shareholder their share of the premium paid by the third party for the
controlling interest.

Essex Universal Corporation v. Yates

Facts. Plaintiff offered to purchase between 566,223 shares at $8 per share ($2 more per
share than the market value) of Republic Pictures shares from Defendant. This represented
28.3% of the outstanding shares of Republic Pictures. Plaintiff was going to pay 37.5% of the
total price up front and pay the rest over 24 monthly payments, during which time Defendant
would hold on to the certificates as security. Defendant agreed that once Plaintiff closed on the
transaction that Defendant would have 8 of the 14 board members resign so Plaintiff could
replace them with their own members. When the parties met to close the deal, Defendant refused.
Plaintiff then brought this action for $2.7 million to recover the difference between their price
and what the shares were worth. Defendant argued that the agreement was invalid because it
called for terminating management.
Issue. The issue is whether the stock purchase agreement is invalid because it provided
for the termination of prior board members and subsequent control of management for Plaintiff.
Held. Chief Judge Lumbard held that the agreement is valid and does not violate public
policy. Plaintiff was receiving a sizable portion of the shares which would have eventually
entitled them to elect representatives to the board. The agreement only accelerated that process.
It was also acceptable for the majority shareholder to obtain a premium for selling the control of
the company in this case because, unlike Perlman v. Feldmann, there was no breach of a
fiduciary duty to minority shareholders. On remand, the burden would be on Defendant to prove

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that a voting block greater than Plaintiff’s size would have not approved of the deal.

Concurrence.Circuit Judge Clark agreed with the other judges to decline to grant a summary
judgment, but his reasoning was simply that not enough facts were available to determine the
legality of the transaction.
Circuit Judge Friendly voted to remand the case as well, but he declined to accept Chief Judge
Lumbard’s reasoning. Judge Friendly personally would void a contract that gave controlling
majority of management to a company that held less than fifty percent of the shares. But he
wanted the state of New York to be able to determine what policy they would follow on their
own.
Discussion. There was no majority consensus on whether a stock purchase agreement that gave
management control to the purchaser was valid, although two of the three judges did not rule it
out.

Planning Problem pg. 676

How should the parties allocate the voting interest of the firm?
50/50 b/ween sisters n Sally

How should the minority shareholders negotiate protection against opportunism?

Any potential problems w/t freeze outs?

Should Maria negotiate a buy-out agreement? If so, what should it look like?

CHAPTER 7. Mergers, Acquisitions, and Takeovers

Ways to re-organize
1. Statutory Merger
2. Asset Acquisition
3. Stock Acquisition
4. Proxy Contest

Each of these methods also implicate the relevant procedure:

1. Whether “target” board of director approval is necessary
2. Whether shareholders need to approve the transaction

Each of these different methods has various consequences in a number of major areas
1. Taxation- both to the shareholder and to the corporation
2. Level of shareholder protection
3. Liabilities to the new corporate entity
4. Rights of Dissenting Shareholders (appraisal rights)
5. Fiduciary Duty Implications for boards

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6. Implications under the federal securities laws

Legal Effect of a Statutory Merger

“When any merger … shall have become effective … for all purposes of the laws of this
state the separate existence of all the constituent corporations … except the one into which the
other … constituent corporations have been merged … shall cease.” See DGCL § 259(a)
“And the surviving corporation shall have all the rights, privileges, and … of the
company merged,
“By statute, all rights of creditors attack to the new company)

(Can negotiate so that the liabilities do not transfer over to the new company)

Merger v. Consolidation
Consolidation—two companies to join to form new entity
Merger—one company consumed by another

Merger v. Asset Sales (Not on final)

Merger—Takes effect when the Articles of Merger are filed w/t the requisite state official, hey
events thereupon take place by operation of law

Statutory Sale of Assets (More Complicated)—both corporations survive, but target is typically
liquidated

Tax Consequences of Asset Sale: Double Taxation of Asset Sales

1. Tax at the corporate level based on difference in the depreciated tax book value of the assets
sold and the sum of the purchase price and the liabilities assumed
2. Tax at the shareholder level, based on the difference b/ween the tax basis of the shareholder’s
stock and the liquidating distribution

Ease of Transferring Control

--When merger become effective, the separate existence of all corporate parties, with the
exception of the surviving corporation, comes to an end (In merger, title to all property owned by
each corporate party is automatically vested in the surviving corporation)

--In Asset Sale, the target company remains in existence at least for a little while after the asset
sale has been completed (documents of transfer must be prepared w/t respect to every asset sold
and those documents must be filed w/t every applicable agency)

--In Merger, surviving company succeeds to all liabilities of each corporate party

--In asset sale, the company purchasing the assets does not take the liabilities of the selling
company unless there has been a written assumption of liabilities

Ease of passing Consideration

--In merger, the consideration passes to non-dissenting shareholders
--In asset sale, distribute consideration as a dividend

Shareholder Voting and Appraisal in Standard Merger

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-Approval
--Both companies’ boards
--Both companies’ shareholders
-Appraisal
--Available to shareholders of both corporations

Shareholder Voting and Appraisal in Asset Sale

--Shareholders of company buying assets do not have to approve purchase (board of purchaser
must only approve)
--Also, no appraisal rights under Delaware law

Triangular Transactions
--subsidiary purchases another company for big companies benefit
--provides cost-minimizing advantages of an asset sale, while also providing the advantages of a
merger

Farris v. Glen Alden Corporation

Defendant is a coal-mining company wherein Plaintiff is a shareholder. In 1957 a second
company, List, purchased 38.5% of Defendant’s stock. List is a holding company that owns
interest in real estate, motion pictures, textile companies, but no coal companies until the 1957
stock purchase. The purchase allowed List to put three members on the board, and in 1958
Defendant entered an agreement with List to purchase List’s assets and liabilities in return for
Defendant stock. The name of the company would change, directors from both companies would
run the new company and List would be dissolved. A majority of the shareholders agreed to the
reorganization at a shareholders meeting. Plaintiff filed suit because the reorganization plan did
not conform to Pennsylvania Business Corporation Law that applied to the plan. Plaintiff argued
that the reorganization was a de facto merger, and as such the dissenting shareholders should
have been notified that they could claim fair value for their shares. Defendants argued that the
reorganization is considered a purchase of assets under the applicable statute.
Issue. The issue is whether the reorganization plan between Defendant and List operates
as a de facto merger.
Held. The court held that the plan was a de facto merger. Instead of looking at just the
nature of the corporate transaction, the court looked at the consequences. If the plan did go
through, Plaintiff would own shares in an entity that is very different than the original Defendant
corporation, and the directorship would be completely revamped. Plaintiff’s percent ownership
and the value of the shares themselves would be diminished by the transaction. Therefore
Defendant should have notified shareholders of their right to dissent and appraisal.
Discussion. Defendant acknowledged that if the transaction was considered a merger and
shareholders were given the right to dissent, then they would not have the resources to go
through with the plan. If it did go through, List shareholders would have received a significant
boost in share value.

PA recognizes de facto merger doctrine,

Hariton v. Arco Electronics, Inc.

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 Synopsis of Rule of Law. Asset sales statutes and merger statutes are independent of each
other, and a corporation complying with one or the other is complying with the law.
Facts. Defendant and Loral Electronics Corp., both electronic equipment companies,
entered into an agreement wherein Defendant would sell all of its assets to Loral in exchange for
shares in Loral. The agreement was approved by 80% of shareholders. Plaintiff did not
participate in the voting but later filed this action to prevent the transaction because it did not
comply with Delaware’s merger statute that required Defendant to notify shareholders of the
right to dissent and receive fair value for their shares upon dissent. Defendant countered that the
transaction complied with Delaware’s asset sale statute. The lower court, agreeing with
Defendant, dismissed the complaint.
Issue. The issue is whether the asset sale agreement between Defendant and Loral is invalid
because Defendant did not comply with Delaware’s merger statute.
Held. The Supreme Court of Delaware held that the agreement was valid because it
complied with Delaware’s statute regarding the sale of assets. The two statute provisions operate
independently, and an agreement is valid if it complies with one or the other.
Discussion. The holding is opposite of Farris v. Glen Alden Corporation which prevented
the same type of transaction, except it was a shareholder from the purchasing company that
brought the action. This case did not present the same lopsided effects that the Farris transaction
provided.

Under Delaware law, De Facto Merger not recognized, is structure as an asset sale, will treat as
an asset sale.

B. FREEZE-OUT MERGERS

Why eliminate the minority?

--Eliminate costs associated w/t being publicly held
--Eliminate fiduciary duties

Alternatives to Freeze Out

1. Liquidation- Minority shareholders receive pro rate distribution of the sales price

2. Stock split- Reverse stock split, e.g, 1 for 2,000 that greatly reduces the number of outstanding
shares

Weinberger v. UOP, Inc.

Issues Addressed
1. Business Purpose (“In order to determine fairness, there must be another purpose other than
simply eliminating the minority shareholder)
2. Exclusivity of appraisal
3. Burden of proof when freeze-out merger is challenged
4. Requirement of entire fairness as b/ween the dominant shareholder and the minority
Valuation in appraisal

Synopsis of Rule of Law. A majority shareholder owes a fiduciary duty to minority

shareholders to provide all relevant information that would pertain to a proposed cash-out
merger.
Facts. Signal sold off a subsidiary company for $420 million in cash and desired to turn

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around and reinvest the money. In 1975, Signal decided to purchase a majority stake in UOP.
Signal paid $21 per share (it was trading at around $14) to obtain 50.5% of UOP’s shares. In
1978, Signal still had a great deal of money left over, and with no other attractive investments
they decided to acquire all remaining shares of UOP. At this point, Signal had placed seven
directors, including the president and CEO James Crawford, on the 13-member board. Two
directors that served on both the board of Signal and of UOP, Charles Arledge and Andrew
Chitiea, performed a study using information obtained from UOP that determined it would be in
Signal’s interest to get the remaining shares of UOP stock for anything under $24 per share. The
Signal board decided to offer between $20-21. Signal discussed the proposal with Crawford, and
he thought the price was generous, provided that employees of UOP would have access to decent
benefits under Signal. He never suggested a price over $21. Crawford hired James Glanville to
render a fairness opinion despite the fact that Glanville’s firm also did work for Signal. Glanville
also had a short amount of time to prepare the opinion, and his number was the same as Signal’s.
The UOP board, using the fairness opinion as its guide but not the Arledge-Chitiea study, voted
unanimously to recommend the merger.

Issue. The issue is whether the majority shareholder breached their fiduciary duty to the minority
shareholders by withholding relevant information from non-Signal UOP directors and minority
shareholders.
Held. The Supreme Court of Delaware held that the shareholder vote was not an
informed vote and that Signal breached their duty as a majority shareholder to the minority
shareholders. Therefore the minority shareholders are entitled to a greater value (to be
determined by weighing all relevant factors such as the Arledge-Chitiea study value). The
evidence indicated a lack of fair dealing by the majority, such as withholding the Arledge-
Chitiea report from the UOP board and the shareholders. The only information the outside
directors of UOP had at their disposal was a hurried fairness opinion by an arguably interested
party. The board members that served with Signal and UOP breached their duty as UOP directors
as well by not providing Arledge-Chitiea study. They are not exempt from their duties because
the entities are a parent and a subsidiary.
Discussion. The court places the same burden on majority shareholders for mergers as
they would place on them for inside information. A majority shareholder can not gain in a
purchase by withholding information to a party whom they owe a fiduciary duty.

Coggins v. The Patriots

Facts. Defendant president, William Sullivan, Jr., bought the New England Patriots in
1959 for $25,000. Four months later, he had nine others buy into the team for $25,000 each, and
each of the ten owners was given 10,000 shares. Another four months later, 120,000 nonvoting
shares were issued for $5 each. In 1974 the other owners removed Sullivan from his presidency
but by November of 1975, after securing a personal loan for over $5 million, he owned all
100,000 voting shares (at $102 per share) and put in his own directors. The loan required
Sullivan to use the Defendant corporation’s profits and assets to repay the loan, but he could not
do this without complete ownership. Sullivan then created a second corporation, appointed the
same directors, and then voted to merge the two companies into the new one. The shareholders
of the old company would receive $15 per share. Plaintiff was a fan of the team and proudly
owned ten shares of the corporation. Plaintiff brought this action after he was forced to sell his
shares pursuant to a freeze-out merger initiated by directors who, he asserted, violated their

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fiduciary duties when they voted while holding directorships for both companies. Defendants
argued that each class of shares approved of the merger.
Issue. The issue is whether the freeze-out merger illegal.
Held. The court held that the merger was unfair and illegal, but since the merger was now
ten years old it should not be reversed. The controlling shareholder owed a fiduciary duty to the
minority shareholders, and the burden was on Sullivan to prove that the merger furthered the
goals of the corporation rather than just his own interests and is fair to Plaintiffs. Sullivan failed
to prove either point.
Discussion. The typical equitable remedy for an illegal merger such as the one at issue is
a rescission. However, the length of time between the merger and the holding made an appraisal
a better alternative.
Synopsis of Rule of Law. A controlling shareholder in a transaction between boards of
directors wherein he and others are common members has the burden to prove that the
transaction serves a legitimate purpose for the corporation and is fair to the minority
shareholders.

Definition of freeze out merger—“when the sole purpose of the merger is to freeze out
shareholders for individual benefit, have freeze out”

**Combined the business purpose test with a fundamental fairness test**

Burden or proving legitimate purpose and fairness is on the defendants in a freeze out merger

Holding—No legitimate corporate purpose was served by freezing out the minority nonvoting
shareholders. The merger was used merely to facilitate the repaying of indebtedness by Sullivan
individually

**Weinberger eliminates business purpose test, then Coggins re-institutes it** (Weinberger just
looked @ fairness) [Weinberger was Delaware case and this was Massachussets case]

Rabkin v. Philip A. Hunt Chemical Corporation

Plaintiffs brought this action against Defendants Hunt, Olin and several of their directors,
to enjoin a cash-out merger after Olin offered only $20 per share to the minority shareholders.
When Olin initially bought their 63.4% majority stake from Turner and Newall Industries, Inc.
for $25 per share, they agreed to a commitment to pay $25 per share if Olin purchased the
remaining shares within one year of their initial purchase. Throughout the year Olin directors
referred to an eventual cash-out merger of Hunt as if it were a near-certainty. After the year
lapsed, Olin directors had a banking firm render a fairness opinion on a $20 per share offer. Four
days later, without reviewing the one-year commitment, appraising Hunt’s assets or interviewing
Hunt management, the firm declared that the $20 price was fair. Olin’s finance committee
approved the merger, and Hunt’s outside directors hired Merrill Lynch to assess the offer. Merrill
Lynch assessed the value at $19 to $25 per share. The outside directors, after suggesting a higher
price, finally agree to support a $20 price. After the board approved, Olin assured it’s passing by
virtue of holding a majority of the shares. Plaintiffs then brought this action to enjoin the merger,
arguing that the price was unfair, that Defendants manipulated the timing of the merger to avoid
the one-year commitment and that Defendants were obligated as a result of their Securities filing
to pay the $25 price. The lower court held that, absent fraud, the only remedy for Plaintiffs was
appraisal. Plaintiffs do not want the appraisal value because it is likely lower than the $25 value

97
they believe they are entitled to per the agreement.
Issue. The issue is whether the facts alleged by Plaintiff would only support a remedy of
appraisal.
Held. The court held that the lower court’s interpretation of precedent was too narrow,
and Plaintiffs have pled facts that would allow a remedy outside of an appraisal. Plaintiffs’ facts
demonstrate unfair dealing by Defendants as majority shareholders to Plaintiff minority
shareholders, but Plaintiffs’ unique circumstances (they are trying to obtain a contracted-for
price rather than the appraised value) merit an alternative remedy.
Discussion. The court combines contract law with Corporate law as they recognize a
fiduciary duty for Defendants to not intentionally avoid a commitment made to minority
shareholders under the initial purchase contract.
Synopsis of Rule of Law. A party alleging unfair dealing should be allowed an alternative
remedy to appraisal if the circumstances would require such a result.

C. DE FACTO NON-MERGER

**Delaware courts look at form over substance**

Rauch v. RCA Corporation

Synopsis of Rule of Law. A conversion of shares to cash to complete a merger is legally
distinct from a redemption of shares and therefore redemption provisions or laws governing
redemption are inapplicable.
Facts. Plaintiff owned 250 preferred shares of RCA. Defendant General Electric
Company (”GE”) sought to acquire RCA, and set up a subsidiary, Gesub, Inc., to carry out the
acquisition. RCA and Gesub shares were converted to cash and Gesub then merged into RCA.
The terms of the merger priced Plaintiff’s stock at $40.00 per share. A provision in RCA’s
certificate of incorporation provided a $100 per share value if Plaintiff’s shares were ever
redeemed by RCA. Plaintiff’s argument is that the merger acts as an end-around to avoid paying
Plaintiff her $100 per share
Issue. The issue is whether the merger between Defendant corporations that resulted in a $40 per
share payout to Plaintiff was invalid because it violated the redemption provision of RCA’s
certificate of incorporation.
Held. The United States Court of Appeals for the Second Circuit held that the merger is
valid and therefore Plaintiff’s action is dismissed under the doctrine of independent legal
significance. The merger complied with Delaware’s merger statute, and Defendants had the right
to choose to merge rather than redeem shares. Delaware has given different corporate statutes
equal dignity which allows a company to pursue different avenues without having to worry about
violating other alternatives.
Discussion. The doctrine of independent legal significance simplifies the complexity of
corporate law because a corporation can be assured that as long as they satisfy the elements of
one provision then they will not have to worry about the large amount of other provisions that
could possibly be applicable to a transaction.

**Court gives effect to the form**

Appraisal Rights

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--All appraisal statutes give you appraisal rights in long-form mergers of closely held
corporations

DGCL 262(b)

Exercising Appraisal Rights: Dissenting shareholders required to

1. Hold onto shares continuously through the date of merger

Exclusivity of Appraisal
Weingerber held—relief for unfair mergers usually is limited to the appraisal remedy

In cases of fraud, misrepresentation, self-dealing, deliberate waste of corporate assets,

relief may be available outside appraisal

11/19/09: Notes (Didn’t Read For Class)

Hershey/Kraft hostile takeover of Cadbury Example (Study for final)

According to the article, Kraft began thinking about taking over Cadbury on September 7th. How
could Kraft do this?
1. Cash-tender offer to the shareholders of Cadbury
2. Stock-Cash Tender Offer (similar in nature to 1st b/c Kraft going to Cadbury shareholders)
3. Asset purchase or outright merger proposal (going to Cadbury’s directors n trying to make a
deal.

What are the advantages/disadvantages of going to management?

Efficiency, possible conflict of interest if going to board, if negotiate w/t management Kraft
doesn’t have to offer premium for stock (thus money not spent on deal will likely go to the
board),

So takeovers, in the most direct way, implicate notion of self interest of the board. Question
becomes: How do you analyze duty owed to shareholders in takeovers? If duty of care applies,
look to business judgment rule (directors decision will most likely prevail), if duty of loyalty
analysis almost all takeovers will be struck down (what are the 3 things courts look @: self
dealing,

Golden parachute—When company taken over in hostile takeover, has clause that affords him
(board member) great compensation for being fired

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The Approaches to Handling Takeover Defenses

Cheff v. Mathes
Synopsis of Rule of Law. Directors have the burden of proof that a buyback of shares by a
corporation in an attempt to remove a threat to the current corporate model is in the corporation’s
interests.

Facts. Defendants were directors of Holland, including the CEO. Holland manufactured furnaces
and air conditioners, and it directly hired its retail sales staff (a practice that the directors
believed was a key to Holland’s success). Holland performed well during 1946 to 1948, but sales
declined until 1956. In 1957 the company reorganized and cut some unprofitable stores and it
resulted in a healthier bottom line. At the same time, shares of Holland were being bought on the
open market by Arnold Maremont, which increased share price. Maremont was well-known for
taking over companies and then liquidating their assets. At the very least, Maremont contacted
the Holland CEO, P.T. Cheff, to inquire about a merger with his company and altering the sales
model to only sell to wholesalers. Cheff discussed this with other directors, and they agreed to
thwart Maremont’s attempts to buy Holland in order to keep Holland running in its current state.
Some directors agreed to personally buy the shares from Maremont if the board decided not to do
so, but the board voted to use Holland funds to purchase the shares at a premium price of $20 per
share (the net quick asset value was $14). Plaintiffs argued that the directors used Holland’s
funds to ensure that their positions with the company remained intact. The Vice-Chancellor of
the lower court agreed, and therefore upheld the suit against the defendants that had a vested
interest in the purchase as a result of their positions with the company.

Issue. The issue is whether the directors improperly agreed to purchase its own shares in order to
keep their positions with the company.

Held. The Supreme Court of Delaware agreed with the Vice-Chancellor that the burden of proof
was on the directors to prove that their conduct in purchasing the shares was proper, but the court
here believed that the facts alleged demonstrated that they acted properly. There was a legitimate
threat that Maremont would push to alter the sales strategy of Holland, which the directors
believed was an essential component to the company. There was also a legitimate concern that
they would lose quality personnel under Maremont’s control. The price paid was reasonable
considering that there is always a premium for buying a bulk parcel of shares. In hindsight the
decision may not have been the best, but the business judgment rule will not penalize honest
mistakes of judgment.

Discussion. The court notes that the burden of proof is somewhat analogous to the burden on
directors who use corporate money to fund proxy statements regarding policy questions wherein
there is the danger that a director will use the funds to perpetuate themselves in office.

**Takeaway point, primary purpose of using take-holder defenses cannot be simply to

perpetuate control, there must be a legitimate, good faith basis for the defense***

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Unocal Corporation v. Mesa Petroleum Co.
Synopsis of Rule of Law. Directors have a duty to protect the corporation from injury by third
parties and other shareholders, which grants directors the power to exclude some shareholders
from a stock repurchase.

Facts. Plaintiff was a corporation led by a well-known corporate raider. Plaintiff offered a two-
tier tender offer wherein the first tier would allow for shareholders to sell at $54 per share and
the second tier would be subsidized by securities that the court equated with “junk bonds”. The
threat therefore was that shareholders would rush to sell their shares for the first tier because they
did not want to be subject to the reduced value of the back-end value of the junk securities.
Defendant directors met to discuss their options and came up with an alternative that would have
Defendant corporation repurchase their own shares at $72 each. The Directors decided to exclude
Plaintiffs from the tender offer (discriminatory self-tender offer) because it was counterintuitive
to include the shareholder who initiated the conflict. The lower court held that Defendant could
not exclude a shareholder from a tender offer.

Issue. The issue is whether Defendant can exclude Plaintiff from participating in Defendant’s
self-tender.

Held. The court held that Defendant could exclude Plaintiff from its repurchase of its own
shares. The directors for Defendant corporation have a duty to protect the shareholders and the
corporations, and one of the harms that can befall a company is a takeover by a shareholder who
is offering an inadequate offer. The directors’ decision to prevent an offer such as the one at
issue should be subjected to an enhanced scrutiny since there is a natural conflict when the
directors are excluding a party from acquiring a majority control. In this case the directors met
the burden. There was evidence to support that the company was in reasonable danger: the
outside directors approved of their self-tender, the offer by Plaintiff included the junk bonds, the
value of each share was more than the proposed $54 per share, and Plaintiff was well-known as a
corporate raider.

Discussion. The burden of proof was on the directors to prove that there was a legitimate
business interest at stake to rebut the presumption of their conflicting interest in denying the
takeover. This was well-established, but the allowance by the court to allow the directors to deny
the plaintiff from participating in the resulting repurchase was new ground.

Why isn’t this business judgment rule B/c this is self-dealing (The omnipresent specter that a
board may be acting primarily in its own interests) … so then take up Cheff’s analysis and look
at primary purpose

Sp standard of review is conditional BJR “an enhanced duty which calls for judicial examination
at the threshold before the protections of the business judgment rule may be conferred.” [Burden
of proof goes on the directors]

The Unocal test

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1. Was the action w/in the power and authority of the board? (Does the statute authorize this
defense, and if it is okay, does the firm’s charter impose any restrictions on the use of this
defense?

2. Did the board have reasonable grounds for believing that a danger to corporate policy and
effectiveness existed? (Directors satisfy this burden bu showing good faith and reasonable
investigation)

3. Was the defense reasonable in relation to the threat posed?

Unocal left two critical questions

1. Which decisions get reviewed under which standards?
2. What content should we give the applicable standard in a given situation?

Revlon v. MacAndrews & Forbes Holdings Inc.

Synopsis of Rule of Law. When a takeover is inevitable, the directors’ duty is to achieve the best
price for the shareholder.

Facts. Pantry Pride’s CEO approached Revlon’s CEO and offered a $40-42 per share price for
Revlon, or $45 if it had to be a hostile takeover. The CEO’s had personal differences, and the
court noted this as a potential motivation for Revlon to turn elsewhere. Revlon’s directors met
and decided to adopt a poison pill plan and to repurchase five million of Revlon’s shares. Pantry
Pride countered with a $47.50 price which pushed Revlon to repurchase ten million shares with
senior subordinated notes. Pantry Pride continued to increase their bids, and Revlon decided to
seek another buyer in Forstmann. Revlon offered $56.25 with the promise to increase the bidding
further if another bidding topped that price. Instead, Revlon made an agreement to have
Forstmann pay $57.25 per share subject to certain restrictions such as a $25 million cancellation
fee for Forstmann and a no-shop provision. Plaintiffs, MacAndrews & Forbes Holdings, Inc.,
sought to enjoin the agreement because it was not in the best interests of the shareholders.
Defendants argued that they needed to also consider the best interests of the noteholders.

Issue. The issue is whether Revlon’s agreement with Forstmann should be enjoined because it is
not in the best interests of the shareholders.

Held. The Delaware Supreme Court affirmed the lower court’s decision to enjoin the agreement.
Revlon’s directors owed a fiduciary duty to the shareholders and the corporation, but once it was
evident that Revlon would be bought by a third party the directors had a duty solely to the
shareholders to get the best price for their shares. Any duty to the noteholders is outweighed by
the duty to shareholders. By preventing the auction between Pantry Pride and any other bidders,
the directors did not maximize the potential price for shareholders.

Discussion. The court held that the Unocal doctrine that outlined a director’s duty to the
corporation and the shareholder no longer extended to the corporation once it was determined
that the corporation would be sold

Poison pill--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

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 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.

See pg. 760 for summary of first 2 cases

Take away point Revlon

• When the board puts the company up for sale they have a duty to maximize the company’s
value by selling it to the highest bidder
• B/c the lockup ended the bidding prematurely, hence court draws distinction b/ween lock up
that draw a bidder in and lockups that end an active auction

No shop Agreements (What is the difference b/ween lockup and no-shop agreement?)

**Revlon analysis only kicks in if Cadbury views Hershey as a white knight**

Hershey is our white knight, determine if

For Tues (Last Class Hurrah!!!!!)

Stop Reading at 811

Start paramount

Brief Fact Summary. Plaintiffs, Paramount Communications, Inc. et al., sought to enjoin
Defendants, Time, Inc. et al., from moving forward with a tender offer for 51% of the shares of
Warner Communications, Inc. Paramount made its own bid to acquire control of Time.

Synopsis of Rule of Law. Directors are not required to favor a short-term shareholder profit over
an ongoing long-term corporate plan as long as there is a reasonable basis to maintain the
corporate plan.

Facts. Time decided to seek a merger or acquire a company to expand their enterprise. After
researching several options, Time decided to combine with Warner. Time was known for its record
of respectable journalism, and Warner was known for its entertainment programming. Time
wanted to partner with a company that would ensure that Time would be able to keep their
journalistic integrity post-merger. The plan called for Time’s president to serve as CEO while
Warner shareholders would own 62% of Time’s stock. Time was concerned that other parties may
consider this merger as a sale of Time, and therefore Time’s board enacted several defensive
tactics, such as a no-shop clause, that would make them unattractive to a third party. In response to
the merger talks, Paramount made a competing offer of $175 per share which was raised at one
point to $200. Time was concerned that the journalistic integrity would be in jeopardy under
Paramount’s ownership, and they believed that shareholder
s would not understand why Warner was a better suitor. Paramount then brought this action to

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prevent the Time-Warner merger, arguing that Time put itself up for sale and under the Revlon
holding the directors were required to act solely to maximize the shareholders’ profit. Plaintiffs
also argued that the merger failed the Unocal test because Time’s directors did not act in a
reasonable manner.

Issue. The issue is whether Time’s proposed merger acts as a sale of Time that would trigger a
Revlon analysis that would render the merger invalid.

Held. The Delaware Supreme Court affirmed the lower court’s holding in Defendant’s favor. The
court distinguished the Revlon decision as concerning a company that already was determined to
sell itself off to the highest bidder, and therefore the only duty owed at that point was to the
shareholders. In this case, Time only looked as if it were for sale as it moved forward on a long-
term expansion plan. Various facts, such as Time’s insistence on ensuring the journalistic
independence and it’s temporary holding of the CEO position, illustrated that the directors were
not simply selling off assets. Once it was determined that the directors’ decision passed the Revlon
test, the Unocal test was applied. The directors also passed the higher standard called for in Unocal
to directors who are rebuffing a potential buyer. The directors reasonably believed, after
researching several companies, that a merger with Warner made the most sense as far as future
opportunities and maintaining th
eir journalistic credibility.

Discussion. The court has now applied a dual Revlon/Unocal test to determine if the directors
acted reasonably. Once it is determined that a company is not simply putting itself up for sale, then
the courts will apply the Unocal standard.

Brief Fact Summary. Defendants, Paramount Communications, Inc. et al., are appealing an order
enjoining the merger agreement between Paramount and Viacom Inc. Plaintiffs, QVC Network
Inc. et al., sought to enjoin the agreement because the agreement’s defensive measures prohibited
QVC from competing for a merger.

Synopsis of Rule of Law. A merger agreement between a target company and an acquiring
company that restricts the target company’s directors from upholding their fiduciary duties owed to
their shareholders is invalid.

Facts. Paramount was looking for possible merger or acquisition targets in order to remain
competitive in their field. The CEO of Paramount had a meeting with the CEO of Viacom wherein
they discussed Paramount merging into Viacom. The discussions hit a dead end until QVC sought
to acquire Paramount. The discussions between QVC and Paramount were renewed, and the
parties entered a merger agreement that had several defensive measures to prevent other
companies, namely QVC, from bidding against Viacom. There was a no-shop provision that
prevented Paramount from soliciting other bidders; a termination fee provision that paid Viacom
$100 million if they were eventually outbid; and a stock option provision that allowed Viacom to
purchase 19.9% of Paramount’s shares at $69.14 per share. The stock option provision also
allowed Viacom to pay for the stock in subordinated notes or Viacom could elect to get a cash
payout for the difference between the option price and market price. The st
ock option was significant because Paramount’s shares rose sharply and would have led at one

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point to a $500 million payout to Viacom if the merger fell through. QVC started bidding against
Viacom’s offer which forced Viacom to renegotiate with Paramount to raise their offer

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