Professional Documents
Culture Documents
AGENCY
A. Master/servant agency relationship: Principal is responsible for acts of the agent.
1. Legal Standard (Restatement §1): Agency is a relationship that results from:
1. The manifestation of consent by P to A that A shall act
a. On P’s behalf, and
b. Subject to P’s control; and
c. A’s consent to so act
2. Distinguish agent from gratuitous bailee (borrow car for own use).
B. **Agency implication**: A way to hold someone else responsible for someone's actions.
C. Principal-Agent relationship creates mutual duties:
1. A must put P's interests ahead of her own; P must honor all obligations that arise b/t A and 3rd parties in
contract or tort.
2. A is bound by duty of loyalty to P (can't compete directly w/ P; misappropriate P's profits, property, or business
opps.; can't breach P's confidences).
E. Coase, Nature of the Firm
1. Firm = ongoing relationship (command entity) – Transaction costs push you into a long-term
relationship in the form of a firm (rather than just allowing market to make production decisions).
2. Difference b/t firm and market is control. Comes down to best way to foster a productive relationship.
F. PRINCIPAL'S LIABILITY IN CONTRACT:
1. Restatement §144: A principal "is subject to liability upon contracts made by an agent acting w/in his
authority if made in proper form and w/ the understanding that the principal is a party."
1. Cargill: Debtor/creditor relationship was turned into control (agency) relationship.
2. 4 TYPES OF AUTHORITY:
1. Actual Express Authority (AEA)
2. Actual Implied Authority (AIA)
3. Apparent Authority (AA)
4. Inherent Authority (IA)
3. Principal is always responsible regardless of what type of authority there is.
4. ACTUAL AUTHORITY: Requires a "manifestation of consent" from P to A.
1. ACTUAL EXPRESS AUTHORITY (AEA): P tells A to do x. A does x. P is liable for consequences (to
T) of x.
a. T can enforce the contract against P, not just A, regardless of whether T knows A is acting for
P.
2. ACTUAL IMPLIED AUTHORITY (AIA): P actually intended A to possess authority and includes such
powers as are practically necessary to carry out her duties. KEY: signal P to A.
a. AIA: P tells A to do x, but in order to carry out x, A takes other (not explicitly stated) actions
(y) in order to do x. P is bound to T for y. Rationale? Checking back...
5. APPARENT AUTHORITY (AA): Not actual authority. Not intended by the principal to delegate to the agent.
The authority the agent is held out by the principal as possessing. Seems like the agent has this type of
authority. Matter of appearances on which 3rd parties come to rely. KEY: signal received by T.
1. Rationale: Gives P incentive to take care - will carefully avoid having 3rd parties misled.
a. Wrinkle: P may signal T through A. If P authorizes A to make such statements, then P will
be liable to T under AA for statements made by A. Lind and Ampex...
2. Absent knowledge on the part of 3rd parties to the contrary, an agent has AA to do those things which
are usual and proper to the conduct of the business he is employed to conduct (Ampex).
3. AA can exist even where no agency relationship b/t P and person who appears to be A.
4. Mill St. Church v. Hogan: Both AIA and AA were present here - Bill has implied authority to hire Sam
b/c of past church actions, and Sam relied on Bill's representation.
5. Lind v. Schenley: Kaufman had AA b/c someone else in company told Lind to look to Kaufman for
compensation. Lind relied upon idea that Kaufman had authority to set his salary.
6. Ampex: Kays accepts K for Ampex - does he have the authority to do so?
a. Ampex has a rule for all employees that only some of them can sign (K managers). No actual
authority b/c Ampex has a rule Kays is aware of...principal did not intend to be bound in this
case.
b. Court accepts AA - Past dealings led Joyce to believe Ampex meant to be bound.
c. Company failed to protect itself by K. Seems in the ordinary course of business that salesmen
should be able to bind their principals.
6. INHERENT AUTHORITY (IA): P is responsible for some acts of A which, while unauthorized, are close to that
which A is authorized to do.
1. Inherent authority is UNINTENDED.
2. Restaters' catch-all category.
2. Principle of IA comes from idea that the agent possesses a special power to affect the legal rights of
the principal purely by virtue of the existence of an agency relationship.
3. Watteau v. Fenwick - Undisclosed Principal/IA case
a. IA b/c no basis for any other kind of authority (no actual; no AA b/c principal wasn’t known and
3rd party couldn’t rely).
b. To establish IA: Inference on the basis of the ordinary course of business. Might normally
expect barkeepers to stock the pub with these items.
c. Restatement §161: "A general agent for a disclosed or partially disclosed principal subjects
his principal to liability for acts done on his account which usually accompany or are incidental
to transactions which the agent is authorized to conduct if, although they are forbidden by the
principal, the other party reasonably believes that the agent is authorized to do them
and has no notice that he is not so authorized."
d. Here, secret limiting instructions on the ordinary course of business.
e. Policy - Commentary to Restatement §161: Efficient business transactions. "...3rd persons
should not be required to scrutinize the mandates of permanent or semi-permanent agents
who do no more than is usually done by agents in similar positions."
G. RATIFICATION
1. "The affirmance by a person of a prior act which did not bind him but which was done or professedly done on
his account." (Restatement (2d) §82).
2. After A acts w/o authority of any kind, P can still be bound if she ratifies the K.
3. “Requires 'acceptance of the results of the act with an intent to ratify, and with full knowledge of all the material
circumstances.'" Botticello, CB p. 38.
1. The affirmation can be express or implied.
2. BUT P must know or have reason to know all material facts.
H. ESTOPPEL
1. No authority, but if principal does something wrong, estopped (prevented) from denying the person acted for
them. (Hoddeson: Furniture store shouldn't have allowed conman access to their floor).
2. Elements:
1. Acts or omissions by the principal, either intentional or negligent, which create an appearance
of authority in the purported agent.
2. 3rd party reasonably and in GF acts in reliance on such appearance of authority.
3. 3rd party changed her position and in GF acts in reliance upon the appearance of authority.
I. PARTIALLY DISCLOSED PRINCIPAL
1. A is NOT liable to T if P is fully disclosed (identified to T), BUT A may be liable on the K if P is only partially
disclosed (i.e., not identified, see Rstmt 2d §4). Atlantic Salmon.
1. Under some circumstances, A may be made liable to P - e.g. violation of limiting instructions, breach of
duty, etc. See, e.g. Rstmt 2d §§ 160, 383, 399, 400.
2. If A wants to avoid liability, he must reveal not only (1) that he is acting on behalf of P but also (2) the
identity of P. T has no obligation to ask.
J. LIABILITY OF PRINCIPAL TO 3RD PARTIES IN TORT
1. VICARIOUS LIABILITY: "A master is subject to liability for torts of his servants committed while acting w/in the
scope of their employment." - Rstmt. §219(1).
2. 2 questions should start your analysis of tort liability in agency context:
1. Is there an AGENCY RELATIONSHIP between P and A?
2. Is A P's SERVANT or INDEPENDENT CONTRACTOR?
3. Doctrinal Distinction - *MASTER-SERVANT VS. INDEPENDENT CONTRACTOR RELATIONSHIP*
1. Master is liable for torts of its servants.
2. Servant (or "Employee")?
a. S has agreed (1) to work on behalf of M and (2) subject to M's physical control (control over
process as well as result).
b. Humble Oil: Control over day-to-day operational activities; ct. finds M-S relationship.
3. Independent Contractor?
a. Not subject to physical control - i.e. P controls what, not how.
b. Hoover & Holiday Inns: No control over day-to-day operations; no M/S relationship.
4. Test - control of day-to-day operations. Is this sufficient?
a. Hard to find control - proxy? (e.g., risk-bearing (Cargill)).
b. Policy: Makes sense to have legal liability turn on question of control. Trying to find the least
cost avoider, which is the person in control.
4. Franchise Relationships - Miller v. McDonald's Corp.
1. Is McDonald's liable? Need master-servant relationship - control. 2 prongs:
a. Traditional means of finding control: Control over day-to-day operations.
b. Reliance argument: Customer relied on the relationship (one where there is complete control
by principal); had no reason to believe this McD's wasn't controlled by corp.
2. Default rule: You have to provide notice to plaintiff; there was no notice to P.
3. McDonald's should make clear in franchise agreement leaving all control to franchisee.
5. Negligent Act - Bushey v. US
2. Court rejects motive test (purpose of employment relationship test). Foreseeability embraced (scope of
relationship test) - foreseeable that crew members get drunk on shore leave
3. Court says if he burned down the bar (even though foreseeable) wouldn't be Navy's problem. But, tort
happened on the dock. There is a relationship aspect.
4. Test is rooted in foreseeability but no bright lines - Foreseeability + some type of relationship.
6. Intentional Torts: To make P liable for A’s actions, plaintiff must show "employee's assault was in response to
conduct which was presently interfering with employee's ability to perform his duties successfully." (Manning v.
Grimsley)
1. For intentional torts, relationship must be closer b/t acts and incitement - rooted in employer/ employee
relationship.
7. Conoco: Court focuses on disclaimer - language doesn't establish that Conoco has control over day-to-day
operations and can't find M/S relationship (a statutory offense treated like intentional tort here).
1. Courts often disregard the legal form of the relationship and instead place liability where the
principal behaves like an owner.
a. Are they a residual risk bearer or more like a licensor of IP?
2. Scope of Employment Argument – 5 Factors:
a. Time, place, and purpose of the act.
b. Similarity to acts S is authorized to perform.
c. Whether act is commonly performed by S’s.
d. Extent of departure from normal methods.
e. Whether M could reasonably expect act would be performed.
8. Independent Contractors: Liability for IC's act generally stops at IC UNLESS...
1. P retains control (i.e., really a disguised M/S relationship).
2. P engages an incompetent IC.
3. The activity is hazardous, "nuisance per se." (Majestic v. Toti)
K. FIDUCIARY DUTY IN AGENCY
1. "Secret profits rule" (Regem p. 81): "If a servant takes advantage of his service and violates his duty of
honesty and good faith to make a profit for himself...he is accountable for it to his master."
1. Court held no fiduciary relationship, not acting in course of employment but get the money b/c servant
of the Crown.
2. Pp. 82-83: Hypos - *Differentiate mere relationship from personal aspect* (ex/ Gen. writes book - army
doesn't get profits b/c he did something extra to entitle himself to money).
3. How does the secret profits rule allocate a burden?
1. Allocates the burden to employee to tell the employer: More than just a duty of disclosure; gives the
employer a veto over actions taken by the employee.
2. Why give the employer the veto?
a. Control position
b. Cost of completeness
2. Fiduciary rules are default rules that can be changed/bargained over in an employment K.
4. Breach of FD
1. General Automotive v. Singer: "Under his FD to Automotive Singer he was bound to the exercise of
the utmost GF and loyalty so that he did not act adversely to the interests of Automotive by serving or
acquiring any private interest of his own."
2. Duty to "exercise GF by disclosing to Automotive all the facts regarding this matter."
a. Same as Regem: Disclosure (very similar to no secret profits).
b. Ct gives GA a ROFR - makes Singer turn down all outside offers (prob. bad rule).
5. Town & Country - "Grabbing & Leaving"
1. Problem: Client list was developed in a very specific way.
2. If you can't ever leave w/ clients, burdens employer/employee relationship - limits incentive of
employee to invest in relationship. But if no protection of client list, the employer has no incentive to
invest in list.
3. Ct. says they violated/stole a trade secret - IP theory to the case. Decides case based on FD.
4. R2d 396: When these duties end.
6. Review - AGENT'S FIDUCIARY DUTIES:
1. Care (R2d 379)
2. Loyalty
3. Kickbacks (profits arising from M-S relationship given back to P - R2d 388)
4. Secret profits
a. From transactions w/ principal (R2d 389)
b. Use of position (Reading)
5. Usurping business opportunities from principal (Singer)
6. "Grabbing and Leaving" (Town & Country)
II. PARTNERSHIP
A. UPA § 6(1): **A partnership is an association of 2 or more persons to carry on as co-owners of a business for
profit.**
B. Requires an AGREEMENT.
1. "Partnership results from contract, express or implied." (Martin v. Peyton).
2. No written agreement necessary to form a partnership
1. UPA § 6(1) association of 2+ implies agreement.
3. Share of profits is prima facie evidence of a partnership.
C. Fenwick: No partnership - Fenwick had control and management, no sharing in losses, etc.
1. Co-Ownership - Look for: Residual risk-bearing and control.
D. Partners vs. Lenders - be careful of distinction b/t partners and debtor/creditor (a loan given w/o control,
sharing of profits, etc.)
1. UPA § 15: Partners are personally liable for the obligations of the partnership (J&S for torts, breaches of
FD; jointly for K’s). Partnership = Full personal liability for debts of the partnership.
2. UPA § 40: Loans by partners to the partnership are subordinated to the loans of creditors other than partners.
3. Martin v. Peyton: P wants to find partnership to make PPF jointly liable. Ct. concludes no partnership:
1. These are normal precautions a lender would take.
2. PPF has no legal right to control Hall - no M/S relationship.
a. Compare to Cargill - creditors had control (agency relationship), so liable.
E. PARTNERSHIP BY ESTOPPEL: Representation/holding out by the alleged partnership to the 3rd part on which
the 3rd party relied.
1. Young v. Jones: No partnership in fact and no partnership by estoppel. No evidence that Ps relied on any act
or statement by any PW-US partner which indicated existence of a partnership w/ the Bahamian partnership.
2. How would you avoid partnership by estoppel? Disclaimer.
F. FIDUCIARY OBLIGATIONS OF PARTNERS
1. "Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of finest
loyalty....Not honesty alone, but the punctilio of an honor the most sensitive..." (Meinhard v. Salmon)
1. Is disclosure enough? Does Salmon have to disclose AND share all profit opportunities?
2. Not clear what the parties would have agreed to; also not clear if disclosure is all that is required, or if
FD requires disclosure PLUS sharing.
3. Does RUPA 404(b)(1) solve the problem? § 404: General Standards of Partner's Conduct:
a. The only FD’s as partner owes to the partnership and the other partners are the duty of loyalty
and the duty of care set forth in subsections (a) and (b).
2. Contract terms can alter the terms of fiduciary duty.
1. Fiduciary duties are limited (Bane: Rights were contractual so no breach of FD).
3. Grabbing and Leaving
1. Meehan v. Shaughnessy: Ds breached FD by unfairly acquiring from clients and referring attys.'
consent to withdraw cases to new firm.
a. A partner has a duty to render on demand true and full info of all things affecting the
partnership to any partner (Ds failed to tell firm on demand; prepared to remove clients
during period of secrecy; used position of trust and confidence to disadvantage of original
partnership).
b. Don’t read case to say you can never take clients away from your former law firm.
i. Fiduciaries may plan to compete w/ the entity to which they owe allegiance, provided
they don’t otherwise act in violation of their FDs.
i. Problem can be solved by contract.
G. EXPULSION - How to get rid of your partners.
1. Lawlis v. Kightlinger & Gray: Lawlis agreed to the expulsion clause, so the firm can fire him.
1. There is a limit of ability to alter FD contractually - Ct. reads expulsion clause w/ background of good
faith, but good faith is somewhat narrow. Main point of case: Limits of what you can and cannot
alter by contract.
H. PARTNERSHIP PROPERTY
1. Property rights:
1. Rights in specific partnership property;
2. Interest in the partnership and;
3. Right to participate in management.
2. No personal interest in any specific property or asset of the partnership, so conveyance of partnership
property held in the name of the partnership is made in the name of the partnership and not as a conveyance of
the individual interests of the partners.
3. § 203 RUPA (1996). Partnership is separate from the partners.
I. PARTNERSHIP CAPITAL
1. Partner owns initial capital contribution.
1. This goes into a Capital Account:
a. Running balance reflecting each partner's ownership equity. See UPA (1997) § 401(a).
b. Allocation of profits increases capital account.
c. Allocation of losses decreases capital account.
d. Taking a "draw" (distribution) decreases capital account.
2. Default Rule on profits: Profits are divided equally (pro rata) among partners.
1. Doesn't change even if one partner contributes more of the initial capital.
2. Can only be changed by contract.
3. Default Rule on losses: Losses follow profits. Can be changed by K. Also, if partners alter the profit rule,
the loss rule will automatically change as well.
4. Partner cannot transfer her interests in the partnership unless all the remaining partners agree or partnership
agreement permits it.
J. RIGHTS OF PARTNERS IN MANAGEMENT
1. 3 Default Rules (can be altered in partnership agreements):
1. UPA (1914) § 9(1): "Every partner is an agent of the partnership for the purpose of its business, and
the act of every partner...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."
a. Nabisco: Act of 1 partner binds partnership.
b. Exception - no actual authority and the 3rd party knows
2. UPA § 18(e): "All partners have equal rights in the management and conduct of the...business."
3. UPA § 18(h): "Any difference arising as to ordinary matters connected w/ the partnership business
may be decided by a majority of the partners; but no act in contravention of any agreement b/t the
partners may be done rightfully w/o the consent of all the partners."
a. In 2 person partnership, 1 person is not a majority. Summers: No reimbursement for P b/c
majority (both partners) didn't agree to hire 3rd man.
2. Nabisco and Summers...
1. Cases hinged on what is an ordinary matter of the business.
2. Who is suing whom? In 1st case, injured party is Nabisco (3rd party).
a. UPA § 9: You can bind the partnership to 3rd parties for usual business of the firm.
b. In 2nd case, partners are suing each other. It's what is chargeable to the partnership by the
partners.
3. UPA 18b: Partnership must indemnify every partner for purchases, etc. made in ordinary and proper
conduct of the business.
4. Ct. places burden on the party that wants something out of the ordinary; changing custom.
3. A joint venture b/t 2 corps. is a form of partnership (co-adventurers in a business for profit).
4. Partners are free to make any agreement that suits them (Day v. Sidley & Austin: P bound himself to K;
breach of FD claim fails. No court has recognized a FD to disclose this type of info (changes in internal
structure of the firm). No financial gain for Ds and remaining partners didn't acquire any more power as a result
of alleged withholding of info).
K. DURATION & DISSOLUTION
1. AT WILL VS. TERM PARTNERSHIP
1. At will = right to dissolve (UPA § 31 (1)(d)). Can be dissolved at any time.
a. Default rule: Partnerships are terminable at will.
2. Term = no right (but still power) to dissolve. But can't use power wrongfully (UPA § 31(2)).
2. "There always exists the power, as opposed to the right, of dissolution." (Collins v.Lewis).
1. Dissolution by act of one or more partners (e.g. UPA (1914) § 31).
2. Dissolution by operation of law (e.g. UPA (1914) § 31(4)).
3. Dissolution by court order (e.g. UPA (1914) § 32 (1)(a)).
3. Wrongful Dissolution
1. Can occur when a partner tries to dissolve term partnership w/o the right.
2. Owen v. Cohen: Ct. implies term on basis of the loan. Important b/c implication of a term into a
partnership makes the difference in having someone held liable for wrongful dissolution. But ct. orders
dissolution, saving Owen consequences of wrongful dissolution in spite of implying term.
4. Dissolution - Legal consequences: Remain partners but the business is put into dissolution.
1. Not the same as going out of business.
2. Simply the "change in relationship of the partners caused by any partner ceasing to be
associated in the carrying on" of the firm's business. UPA (1914) § 29.
3. Not termination. Partnership continues until "winding up" - i.e. the process of shutting down post-
dissolution.
4. After discharging partnership obligations, profits and losses are divided among the partners.
5. See also UPA §§ 31-32 (triggers of dissolution), 33-37 (effects of dissolution on partnership rights).
5. Winding up at Dissolution
1. In some circumstances (i.e. where dissolution is caused by the death of a partner), the winding up will
be accomplished by the partners who are still available to do so.
2. If this is not feasible, or if there is disagreement, a court may order a "sale."
a. Court has discretion as to the appointment of a receiver and as to how the sale is to be
accomplished (e.g. auction, use of a broker, or some other method).
b. Bid rights at winding up: The partners may bid for the assets of the partnership, including its
goodwill (i.e. piecemeal or as a going concern).
6. Judicial dissolution - available if:
1. (1) No reasonable expectation of profit, and
2. (2) The other partner's fault. (Collins v. Lewis - Ct. doesn't order dissolution b/c his fault - responsible
for ongoing capital contributions to partnership).
3. How else can you get out of partnership?
a. Sell interests to someone else. Problem: still have to fund the other guy's money.
c. Foreclose on the loan (wouldn't work in Collins b/c partnership agreement said had to keep on
funding it).
7. Partners may agree to continue in a business until a certain sum of money is earned or one or more partners
recoup their investments, or until certain debts or paid, or until certain property can be disposed of on favorable
terms. This can even be implied, but there must be evidence of the implied term. (Page v. Page - ct. doesn't
imply term on basis of hopes of profit).
1. Courts will only imply a term when a specific undertaking with a finite amount of time.
2. Distinguish Page from Meinhard v. Salmon. Here the partnership is at will. In Salmon, renewal of lease
occurred during partnership. Here, an opportunity might happen but hasn’t happened yet. Both
brothers are aware of it. But in Salmon, other party didn’t know (disclosure issue). Salmon was about
giving partner opportunity to compete.
L. THE CONSEQUENCES OF DISSOLUTION
1. Prentiss v. Sheffel: Partnership-at-will existed which was dissolved by a freeze-out or exclusion of D from the
management and affairs of the partnership.
1. UPA 18(e): Absent an agreement in the contrary, all partnerships share equally in management. Ct.
instead looks at difference in voting powers - only had 15% so low ability to influence management.
2. Pav-Saver Corporation v. Vasso
1. Dale, idea guy, decides to dissolve partnership.
2. Holding: Wrongful dissolution b/c it's in contravention of the partnership agreement (which has a
permanent term). Rights in wrongful dissolution are liquidated damages and rights to continue the
business contained in the UPA (UPA 38(2) (a) & (b)).
3. Did the partners want it to be permanent? Probably not. But it’s how P and court read agreement.
M. THE SHARING OF LOSSES
1. Default rule: Losses follow profits.
2. Kovacik v. Reed: Ct. tries to fashion new default rule: If one party contributes only services (and other party
contributes only capital), neither party is liable to the other for contribution for any loss sustained.
3. UPA rejects the Kovacik Rule. See UPA 401(b)(1996) commentary. Might seem unfair, but partners should
foresee the application of the default rule may bring about unusual results and take advantage of their power to
vary by agreement the allocation of capital losses.
N. BASIC RULE ABOUT PARTNERSHIPS
1. Implication of being in a partnership: Full personal liability for the acts of your partners and for the
obligation of the partnership.
2. If people have a lot of foresight, can organize a limited partnership and file correct papers in Sec. of State's
office and achieve limited liability for the limited partners in the partnership. Limited partners in LP is supposed
to be a passive activity. Sort of investment partners - just put in capital while GP takes control of management.
3. How can you achieve limited liability for everyone? Make a corp. act as the GP. Then general partnership has
full limited liability for all SHs.
V. PROBLEMS OF CONTROL
A. VOTING CONTROL - SH Meetings and Election of Board of Directors
1. DGCL 211(b): Annual SH meeting for election of directors - required.
1. Very few SHs attend, but SHs have to elect the board of directors. So election occurs through proxy.
2. DGCL 211(d): Special meetings may be called by board of directors.
3. Proxy Voting
1. SH appoints a proxy (aka proxy agent) to vote his/her shares at the meeting.
2. Appointment effected by means of a proxy card.
3. Most important part of proxy voting: Proxy Contests - 1 set of directors running against another set of
directors - incumbents vs. insurgents.
4. Proxy contests are expensive - have to send out proxy card and proxy statement - statement is filed w/
SEC and must be sent to every SH.
B. PROXY CONTESTS
1. Reimbursement of expenses: RULES (Levin and Rosenfeld):
1. The corp. may not reimburse either party unless the dispute concerns questions of policy.
a. Personal matter can almost always be twisted into a policy matter (just like SH maximization
norm is weak constraint on directors otherwise protected by BJR).
2. The corp. may reimburse only reasonable and proper expenses.
3. The corp. may reimburse incumbents whether they win or lose.
4. The firm will reimburse insurgents only if they win, and only if SHs ratify the payment.
5. BJR seems to be animating principle in deciding whether they can be reimbursed. Presumption that
directors acting in best interests of SHs - supported here unless there is fraud, self-interest.
b. SH approval b/c obvious self-interest.
2. Proxy contests often about control. 2 ways to take over a company:
1. Buy entire company's shares - gives you right to appoint the directors yourself.
2. Win the votes.
a. Cheaper to win a proxy contest than buy a company, but rewards aren't the same. Rewards
only equal to existing ownership stake and if you win the votes you won't get all of the
improvement - if you buy the shares get 100% of the marginal improvement.
3. SEC Proxy Rules
1. Proxies regulated by SEC b/c proxy documents are disclosures to SHs.
2. Securities Exchange Act §14(a) - gives SEC broad discretion to draft laws and makes proxy
voting a federal matter as much as SEC wants it to be.
a. 14a-3: Incumbent directors must provide annual report before soliciting proxies for annual
meeting.
b. 14a-7: In a proxy contest, incumbent management must either mail the insurgent's proxy
materials for it or provide insurgents w/ the SH list.
c. Anyone who "solicits" a proxy must provide a written proxy statement BEFORE soliciting the
proxy.
i. Solicitation is broad.
ii. Bottom line - if you are soliciting proxies there must be a proxy statement and must
be provided to SEC - will be basis for fraud allegations.
d. Proxy fraud: Solicitation that is false or misleading w/ respect to any material fact, or that
omits a material fact necessary to make statements in the solicitation not false or misleading
(14a-9).
C. SHAREHOLDER PROPOSALS
1. Common SH Proposals - relate to how the corp. could be governed better:
1. To remove of poison pills;
2. To require annual election of all directors;
3. To require that directors hold a specified minimum amount of corp. shares;
4. To prevent the same person from being both CEO and chair of the board;
2. SH proposals not always about corporate governance. Sometimes about gaining publicity on an issue.
3. Requirements for SHs to get proposals into company's proxy materials? (1) 500 word limit (can't use internet),
(2) SHs have to have $2K or 1% for one year, (3) send someone to the meeting.
4. Bases on which companies can keep SH proposals out - 14a-8
1. Not "a proper subject for action" by SHs - basically forcing board to do something. Get around
limitation by framing it as a request/proposal/suggestion. Then the board can use BJ to say yes or no -
like normal corp. structure where boards make decisions based on BJ.
2. Illegal.
3. Violates proxy rules.
4. Personal grievance or benefit.
5. Relevance
a. Proposal must relate to operations which account for more than 5% of company's total assets;
and for less than 5% of its net earnings, must be otherwise significantly related.
b. Lovenheim v. Iroquois: Goose proposal. Fight on basis of relevance exception. Ct. says
"otherwise significantly related" can be matters of moral or economic significance. Wins.
6. Matter beyond power of firm to effectuate.
7. Relates to firm's "ordinary business operations" - SHs can’t have a say in that.
8. Submitted in the past w/o winning much support.
5. Dole: Proposal that Dole study the impact of national health care reform proposals (to gain publicity).
1. Dole tried to exclude it on relevance test on grounds that it:
a. Involved matters w/ only an insignificant financial relation to the company (14a-8i5).
i. Court says health care imposes large financial burden on company, so good enough.
Applied 5% test correctly?
b. Involved matters beyond Dole's power to effectuate (14a-8i6).
i. Only asks company to study effect, not to change national policy.
c. Involved ordinary business matters (14a-8i7).
i. Court says health care a matter of great social concern so goes beyond company's
own health care issues. Court allows proposal.
6. Austin v. ConEd : Proposal: Non-binding resolution (non-binding is just a suggestion so ok). Company argues
personal grievance/not ordinary business matter. Court says it's an employment compensation dispute, which
is an ordinary business matter.
D. SHAREHOLDER INSPECTION RIGHTS
1. DGCL 220(b): Any SH...shall...have the right to inspect and to make copies and extract from (1) the
corp.'s stock ledger, a list of its SH, and its other books and records...
1. Plus a limited right w/r/t subsidiary records.
2. DGCL 220(b):
1. SH must make a written demand setting forth a "proper purpose."
2. A "proper purpose" is one "reasonably related to such person's interest as a SH."
a. Crane: Tender offer (potential change of ownership) is related to business of company.
b. Pillsbury v. Honeywell: Wanting to change corp.'s policy as to dropping bombs over Vietnam
during war is a personal/ideological reason - not a basis for discovery of books and records (if
interested in economic well-being of company, maybe).
3. DGCL 220(c):
1. If SH only seeks access to SH list, burden is on corp. to show SH doing so for improper reason.
2. If SH seeks access to other corp. records, burden on SH to prove requisite proper purpose.
4. Purposes:
1. Proper:
a. Investigate alleged corp. mismanagement (“tools at hand”).
b. Collecting info relevant to valuing shares.
c. Communicating w/ fellow SHs in connection w/ a planned proxy contest.
2. Improper:
a. Attempting to discover proprietary business info for the benefit of a competitor.
b. Secure prospects for personal business.
c. Institute strike suits.
5. Sadler v. NCR: Ct. decides to use NY law b/c "access to SH lists is a recognized exception to the internal
affairs doctrine." Under DE law don't have to produce NOBO list, but under NY law they do.
E. CONTROL IN CLOSELY-HELD CORPS.
1. Courts generally deferential to SHs in voting for directors, but reluctant to allow SHs to agree about who they
will appoint as officers.
1. Reflects BJR - Board appoints officers. Board supposed to represent SHs' interests. SHs' interests
supposed to represent all people. SHs have less of an ability to constrain appointment of officers.
2. Vote pooling agreements are valid (Ringling Brothers Circus).
3. Directors acting as SHs: "Directors may not by agreements entered into as SHs abrogate their independent
judgment..." (McQuade v. Stoneham) Directors were acting as SHs AND as directors, and directors owe FDs
to all SHs (while SHs only owe duties to e/o). As a SH, you can make an agreement in your own self-interest
but you can't restrict your decisions as a director b/c owe a FD to everybody.
4. Clark v. Dodge: Ct. doesn't accept McQuade argument b/c directors and SHs have same interests. 2 SHs;
agreement is b/t the 2 of them. No 3rd party to protect - no public policy preventing them from agreeing this
way. Also, Dodge is complying w/ his FDs in connection w/ the K and just has to show unfaithful, etc.
5. These cases all involve a small amount of people in a relatively small corp. Question is: How, as owners, do we
see a return on our investment? Either get a regular salary or a dividend.
6. How could McQuade and Clark have gotten what they wanted (cash flow and job) w/o risking these lawsuits
over contractual invalidity?
1. Separate voting agreement (as SHs), which maybe all it can do is get you a board seat.
2. Employment K (b/t individual and the corp.), to get you all that other stuff.
3. See pp. 615-16.
4. See also Galler v. Galler, p. 618, (agreements among SHs to appoint specific directors is enforceable
if signed by all SHs).
5. In closely-held corps., these types of agreements are necessary b/c rarely are people willing to invest
money in small businesses w/o any contractual right to a return. Don't want to leave all the control up
to someone else - want a way of protecting your right to a return on investment.
7. Closely held corps. with no agreement about allocating rights:
1. In general, in a closely held or publicly held corp., you have no right as an investor to a job or a
dividend. So why invest unless you get a special type of agreement like in the last few cases?
8. Where no agreement in closely held corp., a case rests on FD grounds. "SHs in the close corp. owe one
another substantially the same FD in the operation of the enterprise that partners owe to one another."
(Wilkes - 3 guys can't freeze out 4th and offer to buy him back at too low of price).
1. May not act out of avarice, expediency or self-interest in derogation of their DOL to other SHs and to
the corp.
2. This clashes w/ conception of what SHs are in business for - have right of selfish ownership.
9. Wilkes 2-Part Test - When SHs act to a disadvantage to the other SHs in a close corp.:
1. (1) Control group (majority SHs) must show legitimate business purpose for the action.
a. Special rule for closely-held corps. where the acts of a majority group disadvantage minority
group. Majority group has burden of justifying their actions - complete opposite of BJR.
2. (2) Disadvantaged minority may rebut by showing there is an alternative course of action less
harmful to the minority.
3. Test doesn't mean someone is always entitled to a job. Read it narrowly - all it means is you cannot be
unfair. Almost turns it into a for-cause job instead of at-will. But that isn't the default employment rule -
changes the relationship as a result of it being a close corp.
4. To avoid litigation, draft employment agreement for at-will termination (w/ buyout provision).
3. What is a close corp.?
1. Small number of SHs;
2. No ready market for the corporate stock; and
3. Substantial majority SH participation in the management, direction and operations of the corp.
4. Hard to get money out of a closely-held corp. b/c no secondary trading market paying out dividends.
4. Ingle v. Glamore : Unlike Wilkes, a SH agreement - at-will employee w/ buyback right. Right to buyout was in
agreement so can't sue over unfair buyout price.
1. Read Wilkes narrowly. He was suing to get money out of corp., while Ingle suing to keep himself in the
corp. Impt. distinction.
2. Wilkes doesn't change basic employment principle - it is still at-will. Ingle entered into an employment
relationship w/ expectation that it's at-will, so can be fired at any time. In a closely-held corp., you can't
abuse the majority SH position.
5. Position of a minority SH in a close corp.:
2. No right to demand dividends; No right to a job.
3. The controlling SHs can work for the corp. and pay themselves generous (but not excessive) salaries.
a. If the controlling SHs do work for the corp. and treat themselves generously, value of minority
shares will likely be worth less than they would be if the corp. were sold as a going concern
and they received their pro rata share of the proceeds.
b. Moreover, they will have difficulty selling their shares at any price - they are locked in.
6. Sugarman v. Sugarman - Minority SHs sue. Claims:
1. Excessive compensation (deriv).
2. Freeze out (direct claim). Based on 3 wrongs by Leonard:
a. Paid himself a big salary.
i. Wrong? High standard to show and ct. looking at it like should be deriv. claim.
b. Didn't pay out dividends or salaries to minority SHs.
i. Don't necessarily have rights to a job or a dividend (Ingle). Itself not a problem.
c. Offered to buy out the minority at a low price.
i. No requirement to even buy out the minority.
3. Looking at each one individually, doesn't look like anything wrong. Ct. puts the 3 of them together and
gets evidence of a plan or device (Freeze out).
4. After this case, what does a freeze out mean? Looking for some sort of plan where they are cutting off
cash flow interest with some sort of intent (lack of good faith) to act unfairly towards minority.
7. Smith: 1 of 4 investors causes firm to incur AET (tax). 80% requirement gave control to each of 4 SHs
(requires unanimous vote and gives each veto right). Ct. holds breach of FD under Wilkes (applies not just to
minority SHs but to anyone who controls firm).
1. Look at them as directors - did anyone breach their DOC? Maybe - Wolfson could have avoided tax
assessment by paying dividends. But the other 3 did too then. If all 3 breached a FD, seems wrong for
court to only hold 1 liable.
8. Review of all 4 cases - What did the Ds do wrong?
1. Wilkes: Cut off Wilkes' salary and offered him a low price for his shares.
2. Ingle: Nothing. The allegation was that Glamore improperly bought out Ingle and the dissent agreed,
but the majority did not.
3. Sugarman: Sugarman paid himself too high a salary, didn't pay dividends, and offered the Ps a low
price for their shares.
4. Smith: Blocked the payment of dividends and failed to produce a sound plan for the investment of
retained earnings.
5. Look for unfairness. Close corp. freeze-out rule has something to do w/ unfairness. Default rule: Don't
have a right to a job or dividend as a SH in a corp. But if these 4 cases are a way to try to tweak or find
a gray area in the rule, should we change the default rule?
9. What planning techniques might have avoided litigation?
1. Wilkes: A buy-sell agreement, employment Ks, or a SH agreement.
2. Ingle: Spell out the understanding more clearly.
3. Sugarman: Buy-sell agreement.
4. Smith: Wolfson created a deadlock. How to solve a deadlock problem? Arbitration in case of impasse,
dissolution in case of impasse, or a buy-sell agreement.
5. These only apply in context of close corp. b/c of absence of secondary market for shares - no other
way for minority SHs to get the value out of their shares.
F. TRANSFER OF CONTROL
1. Frandsen v. Jensen-Sundquist: Jensens entered into a SH agreement w/ SHs they sold to.
1. 2 provisions:
a. ROFR: Prevents minority SHs from being bought out at an inadequate price.
b. Bring-Alone Rights: If majority sells their shares, they have to buy out the minority shares.
Prevents minority from becoming part of another unknown majority.
2. Rule of case : In a transfer of control of a company, the ROFRs to buy shares at the offer price are to
be interpreted narrowly. There was never an offer w/in the scope of the SH agreement; P’s ROFR was
never triggered. Acquiring bank never interested in becoming a majority SH, just wanted to acquire the
bank. A sale of stock was never contemplated.
2. Zetlin v. Hanson Holdings, Inc.
1. 44.4% owner Sylvestri. Company is diffusely held, so a large ownership stake can essentially count as
a controlling stake b/c the others aren't voting their shares. Sylvestri sells shares at control premium.
2. Court: "absent looting of corp. assets, conversion of a corp. opportunity, fraud, or other acts of bad
faith, a controlling SH is free to sell, and a purchaser is free to buy, that controlling interest at a
premium price."
3. Perlman v. Feldmann: Breach of FD b/c majority takes something from rest of SHs (basic DOL).
1. Feldmanns buy majority SHs shares at a high premium.
2. Court says breach of FD - abuse to SHs. Feldmanns got paid for change from ethical market price to
black market price and then sold shares for black market price. Decision could have been made by
corp. but if it changed the way its resource decisions were made it would have changed value of entire
company - here only changes value of Feldmann's stake.
4. Basic Rules re: Transfers of Control:
1. Controlling SHs generally do not have to share control premia w/ minority SHs..
2. But if circumstances suggest an ABUSE of the minority in the transaction, then courts may
step in and order that the control premium be shared.
a. Abuse is not well defined.
b. Clear examples: a non-pro rata wealth transfer of something in which the minority
normally would get to share (Perlman), a sale to a looter, the sale of an office.
5. You CANNOT sell your corporate office (Essex v. Yates: K caused majority of current board to resign and
replaced w/ Essex nominees).
VI. TAKEOVERS
A. Pattern: Overture by outside player and response by board.
B. Cheff v. Mathes
1. Threat of liquidation or substantial alteration of business practices by Maremont.
1. Why liquidate? Here, good option for takeover b/c assets for themselves might be worth more than
they are now w/ current business strategies (board of directors).
2. Board starts doing a buyback of shares on the market - guarantees the management favorable vote for those
shares. Also pays Greenmail - targeted share buyback - buy Maremont's shares at a premium.
1. Harms company (SHs);
a. Makes takeover offer go away, so company strategy is never changed.
b. Depletes corp. treasury of money SHs would normally have access to.
3. Can the company do this? Yes. Standard:
1. BJR? Not quite - a little stricter (but not as strict as conflict of interest).
2. In takeover context, a change of where the burden is allocated. Normally, BJR Ps have burden (and
BJR presumes directors acted in good faith). Instead, the board of directors must show:
a. Reasonable grounds to believe a threat to corporate policy and effectiveness existed.
3. Standard for showing it: Good faith and reasonable investigation.
4. Good faith what? Business purpose, not entrenchment (keeping themselves in office).
a. Established as long as entrenchment is not "sole or primary motive."
1. Not hard burden to meet - just state another motive. Not far from BJR after all.
C. Unocal
1. Tender offer: Offer to buy SHs' shares (enough to give acquirer at least 51%). Bypasses the board and
appeals directly to SHs. Powerful tool for an acquirer.
2. Pickins tries to take over Unocal w/ a two-tier "front loaded" cash tender. Already owns 13%, so front end offer
to buy 37% at $54; back end, takeout merger for junk bonds "worth" $54.
3. Unocal's response: Exclusionary self-tender for 49% of its stock at $72, w/ "Mesa Purchase Condition" - Unocal
tender offer only kicks in after 49% of its SHs tendered into $54 Mesa offer - never happens.
1. Remove Mesa Purchase Condition, and this leaves the exclusionary offer - only SHs other than Mesa
can tender into the Unocal offer.
4. Unocal board rationales
1. Substantive Coercion: The consideration is "grossly inadequate." (?? More than market price).
2. Structural Coercion: Back end junk bond consideration would coerce SHs into tendering in front end.
(Really? $54=$54, plus credible commitment of SEC filings).
2. Not obvious, but if you do the math you get a structurally coercive tender offer.
5. Can Unocal engage in an exclusionary self tender offer to defend itself from Mesa's structurally coercive 2-tier
tender offer? Yes, but a different standard.
6. The Unocal Standard - Applies ONLY to a board’s unilateral defensive conduct in response to a perceived
threat of director self-interest in context of takeover defense. 2-part test:
1. Reasonable perception of threat of harm to SHs;
a. Board has the burden - must show reasonable grounds for believing a danger to corp. policy
and effectiveness existed b/c of another person's stock ownership.
1. Examples: inadequacy of price offered; nature and timing of offer; questions of
illegality; impact on other "constituencies" w/in the organization; risk of
nonconsummation; quality of the securities being offered in the exchange.
1. But, weird, b/c board of directors owes duty to shareholders.
2. How can the board meet the burden of showing reasonable threat? "By showing good
faith and reasonable investigation..."
1. "Such proof is materially enhanced by the approval of a board comprised of
a majority of outside independent directors who have acted in accordance w/
the foregoing standards."
2. But good faith and reasonable investigation were the "tests" in Kors, Cheff,
and Johnson, so just show a purpose other than entrenchment and show
you had some meetings??
3. Later cases under Unocal never overturn defenses on threat grounds. Only
(rarely) proportionality grounds.
2. Element of balance/proportionality: Reasonableness in relation to threat posed.
7. Ct. is giving us an element of heightened scrutiny (after Unocal, the space of judicial authority is broadened in
context of takeover actions).
8. But every question in Unocal is answered in favor of the board's directors.
9. Unocal rarely results in overturning defensive devices. Outside of a Revlon context, Unocal doesn't grant a lot
of restraint on boards of directors.
1. Preemptive, prophylactic tactics also considered defensive conduct subject to Unocal standard, like
staggered boards and poison pills.
2. Unocal does not apply to a board’s rejection of a merger offer.
D. Policy question: To what extent should board be able to defend themselves from takeovers?
1. Defensive Thesis: Supports judicial deference to board's defensive tactics (see Unocal, FN 11 @ 776).
Argument that defending themselves is better for the long-term.
2. Passivity Thesis: Easterbrook/Fischell: Boards should do nothing b/c when they do something, they thwart the
disciplinary effect of the market.
3. Auctioneer Thesis: Bebchuk: Defensive devices might be ok, but only insofar as they raise the price of the
takeover. Tries to keep disciplinary effect going but allow board to act defensively to raise prices.
1. Debate: Assuming SHs are diversified, is it necessarily good on the whole to bid up the price (premium
paid to target SH just comes from acquiring SH)?
E. Defensive Devices
1. Unocal rule: Exclusionary self-tenders are ok. SEC overturns that narrow rule w/ 14d-10.
2. Rule 14d-10: The "All Holders Rule - Exclusionary self-tenders are no longer ok:
1. (a) No bidder shall make a tender offer unless:
a. The tender offer is open to all security holders of the class of securities subject to the tender
offer (meaning, no exclusion);
b. The consideration paid to any SH pursuant to tender offer is highest consideration paid to any
other SH during such tender offer (knocks out 2-tier device).
3. Other defensive devices
1. Crown Jewel Lock-Ups (Revlon): Promise to sell vital assets of company (crown jewel) to a single
bidder, regardless of price.
2. White Knights: Rather than selling to hostile bidder, write binding merger agreement to sell company
to someone you like. Can preserve structure of company or allow you to keep job.
3. Pac Man: Borrow a lot of money and buy the bidder.
4. Golden Parachutes: Gives top level managers a huge severance package. Idea - raises price of
takeover; but double effect – diff. from other devices b/c makes acquisition attractive to incumbent
managers.
5. Poison Pills: Most impt. takeover defense. Type of security issued by board to all of its current SHs.
Security contains rights:
a. To buy 1/100th of new class of preferred share (designed to mimic economically 1 share of
common, but purchase price set very high, so no one will ever exercise the right).
b. A right to buy common shares at steep discount, if triggering event occurs.
1. Triggering event:
1. Market purchase/"creeping acquisition."
2. Squeeze-out mergers - the Flip Over.
2. Bidder of company is excluded from purchase right, so effect is dilution of value of
acquirer's stake. As result of dilution, no acquirer ever buys up the stake.
c. So effective that no modern poison pill has ever been triggered. Perfect defense against
tender offers acquisitions.
d. Poison pills are issued as a warrant/new class of securities. Board of directors has this
exclusive power, not SHs. So board can do this w/o SH approval - this is critically impt.
1. Boards can create a poison pill overnight.
1. Poison pills accepted by DE under Unocal standard.
1. Conclusion - every company essentially has a poison pill.
h. Board can also cancel unilaterally the poison pill and allow the acquisition to occur (board can
create w/o SH approval b/c they are securities and boards have power to issue securities). So
poison pill essentially creates a board veto power. Tender offer avoids board and appeals
straight to SHs, but w/ poison pill can't appeal directly to SHs – must get approval from board.
i. How to work around poison pill? Launch proxy fight contingent upon new board redeeming
poison pill, so if it succeeds, replace board and new directors will redeem poison pill. To get
around this?
6. Staggered Boards: Board is staggered into 3 classes. Each has 3 year term - effect is that can't get
control of one board in one election - have to wait 2 meeting cycles/years. Bidder won't promise to hold
bid open for 2 years - too much risk. So combo of poison pill and staggered boards = complete
takeover defense.
a. Staggered boards have to be adopted by board in charter amendment and approved by SHs,
but poison pill available to every corp.
b. Raise entrenchment concerns.
F. Revlon
1. Perelman approaches Bergerac about acquiring Revlon for $45/share. Bergerac turns it down b/c too low.
2. Revlon adopts poison pill - "Note Purchase Rights Plan" to buy time.
1. Every offer on corp. will be conditional on that poison pill.
2. Pantry Pride makes a hostile offer, conditioned upon redemption of NPRP.
3. Revlon buyback - Management brings in Forstmann Little (White Knight), who will buy the company for
management and allow company to run it.
4. PP comes back and says it will beat any Forstmann offer.
5. Revlon agrees to deal w/ Forstmann, supposedly on grounds that financing more secure. Agree to:
1. Cancellation fee;
2. No-Shop; and
3. A "crown jewel" lock up.
6. SHs sue - Breach of FD - DOL owed to all SHs (all these takeover cases are about DOL).
1. If sold to PP, SHs would get more money. Board instead chooses FL b/c better for their note-holders
(a diff. constituency in the corp.).
a. Note holders are fixed claimants w/ guarantees, and SHs are residual claimants, which is why
FDs come in to fill the gap.
7. "The directors' role changed from defenders of the corp...to auctioneers charged w/ getting the best
price for the SHs at a sale of the company."
8. Revlon duties are different. Unocal - can act for other constituencies. SH wealth maximization usually a weak
constraint. Here, directors' discretion changes and are held to a higher standard where have to get best price
for SHs. Does this happen every time there is an offer for sale of company?
9. "Revlon duties": When a buyout becomes inevitable (when the board authorizes management to look for a
buyer) the duty to the board changes from preservation of company as corp. entity to maximization of
company's value at sale for SHs’ benefit. When a company is going to get sold, board no longer has discretion
to pay attention to anything other than SH wealth maximization.
1. This is impt. b/c everything we have learned so much has SHWM as a weak background norm.
2. When are Revlon duties triggered?
G. Paramount v. Time
1. T-W merger: Time creates Merger Sub; Warner merges w/ Merger Sub to become subsidiary of Time.
2. DGCL 251(c): SHs of merging companies get to vote on merger. Under DE law, in triangular merger, SHs that
get to vote are essentially just the target SHs b/c they merge. Target company itself rarely merges - instead
creates subsidiary that merges w/ acquiring company. Only Warner SHs can vote under DE law.
3. But as a result of NYSE rule, Time SHs get to vote too (b/c issuing Time shares as consideration).
4. Before this, Paramount comes along, offering cash at huge premium on Time's shares to purchase Time, but
Time board rejects offer.
5. Risk for Time if accept Paramount offer: a no-vote. B/c of NYSE rule, Time board has to send proxy card to all
Time SHs. SHs likely to vote no on T-W transaction b/c would make much more on Paramount transaction.
6. So Time restructures the transaction. Instead, a cash tender offer for Warner shares. Time SHs cut out of the
loop b/c Time is not voting (don't get 251(c) right to vote) and b/c cash, no NYSE rule. Prevents Time SHs from
having opportunity to refuse the transaction.
7. Paramount continues to raise price, and Time board keeps saying no - wants to preserve Time culture.
8. Paramount - 2 claims:
1. The Unocal claim:
a. Paramount's offer was an all shares cash tender offer - i.e. not 2-tiered or otherwise
structurally coercive - so not a legally cognizable threat; and
b. Even if there was a cognizable threat, the restructured deal was not a proportional response
(it took away all SHs' rights).
c. Ct's response - Low price alone is a threat regardless of whether it’s coercive (broad view).
Board can save the SHs from themselves. 1st prong of Unocal means very little. 2nd prong -
Ct. says Time just continuing w/ their plans. Poor reasoning - have restructured transaction.
d. Unocal analysis not a problem - board allowed to do what it was doing before (sounds like
BJR).
2. The Revlon analysis:
b. If Revlon view prevails, Time SHs win, not Time board. Revlon = more ct. stringency.
c. Chancery Ct. says Revlon is not triggered. Question is whether change of control is
contemplated - must look at specific circumstances surrounding transaction.
1. Ct. says either a cash deal or a stock for stock deal where a controlled person exists
after the transaction is a change of control. But ct. says this doesn’t occur here, b/c
both Time and Warner diffusely held.
d. Supreme Ct.: Revlon duties come into play only when:
1. Cash transaction where there is a breakup.
2. Decision to deviate from long-term strategy and seeking alternative transaction
involving breakup.
e. T-W fits neither category. Ct. says the T-W merger is ok b/c Revlon duties don't apply b/c no
change of control found in this way.
H. Revlon duties: Loosely, strict SWM, but how the board complies is up to the board
1. What triggers Revlon? A Change of Control: (1) A cash or bust up deal; (2) A deal that causes a diffusely
held company to come under the control of an individual or group (QVC).
I. Paramount v. QVC
2. Paramount (Davis); Viacom (Redstone); QVC (Diller).
3. Deal b/t Paramount and Viacom. But QVC comes along and tries to buy company.
4. Question in this and all cases: Does the target in the merger have to deal with the other suitor (prospective
acquirer), or can they go ahead w/ pre-existing plans?
1. Does the transaction involve a change of control or not?
a. If Revlon applies, there must be a process that shows SHWM has been observed.
b. We are under Revlon. Tweak of definition of change of control. B/c they are selling to a corp.
w/ a controlling SH, the sale results in a change as if a single person is buying.
c. TW: Time SHs go from being Time SHs to TW SHs. There, not considered a change of
control. Were still voting SHs.
d. Here, Paramount SHs go from being Paramount SHs to Viacom/Paramount SHs. But it
matters b/c new company would be controlled by Redstone.
1. Following the transaction, there would be a Controlling SH w/ voting power to elect
directors, cause break-up of the corp., merge it w/ another company, cash-out the
public SHs, amend COI, sell all or substantially all of the corp. assets, etc.
2. Proposed sale of control would provide new controlling SH w/ power to alter
Paramount's vision of long-term strategic alliance w/ Viacom.
3. Once control has shifted, current Paramount SHs will have no leverage in the future
to demand another control premium, b/c have no control rights.
b. Change of Control in QVC: When a majority of a corp.'s voting shares are acquired by a
single person or entity, or by a cohesive group acting together, there is a significant diminution
in the voting power of those who thereby become minority SHs.
5. Who has control in a diffusely held corp.? The Board. The board has the authority to use anti-takeover devices
w/o SH approval. Board has a veto over that transaction, so control is vested in management.
1. Minority SHs - control is really limited to voting board of directors.
2. So why not look at change of control w/ respect to management?
J. A note on appraisal rights...
1.Remember: A 51% SH can force the 49% minority to accept a merger (b/c her 51% stake will carry the day in
approving it). Includes the right to choose the consideration.
2. Does that mean they can pay a penny? No. The minority SHs may have appraisal rights. DGCL 262.
3. Appraisal
1. Gives SHs who dissent from the merger the right to have the fair value of their shares
determined and paid to them in cash.
2. Availability of Appraisal: DE Law
a. DGCL 262(b)(1): Appraisal rights shall not be available for targets whose stock is listed on an
exchange or where the target has more than 2,000 record SHs.
1. But 262(b)(2) then gives those target SHs back appraisal rights if the consideration
paid in the merger is anything other than stock (i.e. cash).
b. Available in sale of all or substantially all of Target's assets? No.
3. Exercising Appraisal Rights
a. DGCL 262(a) requires that dissenting SHs:
1. Hold onto their shares continuously through the effective date of the merger;
2. Perfect their appraisal rights per 262(d) by sending written notice to the corp., prior to
the SH vote, that she intends to exercise her appraisal rights (inot sufficient to merely
vote against the merger at the meeting);
3. Neither vote in favor of nor consent in writing to the merger.
VII. CORPORATE DEBT
A. Classes of Securities
1. Equity: Common stock and Preferred stock (common stock w/ more fixed rights).
2. Debt
1. Bonds: Secured long-term
a. Bond Indenture: A contract in which corp. agrees not to engage in specific conduct that
would increase the bondholder's risk.
b. Key players:
1. Issuer
2. Lead underwriter
3. Indenture trustee
c. Bond Indenture: Key Provisions
1. Statement of events of default.
1. If a default occurs, the bondholders are entitled to accelerate the maturity of
the bonds: they become immediately due and payable.
2. Duration:
1. Call provisions.
3. Control/Protection - Restrictive Covenants...
1. No change in nature of business or board w/o consent - an extreme
provision.
a. Rare in bond indentures! Less rare in bank loan agreements.
2. Limit dividends.
3. Specify financial ratios (e.g., current assets to current liabilities).
2. Debentures: Unsecured long-term
3. Notes: Short term
B. Sharon Steel v. Chase Manhattan Bank
1. UV Industries issued a series of 5 notes and debentures under similar indentures.
2. UV had 3 lines of business, incl. Mueller Brass.
3. Plan of liquidation. Fight b/t prospective buyer of Mueller Brass and Chase (debt indenture trustee) about
whether debt of indentures have to be paid off or whether they can be redeemed at face value.
1. Sharon Steel wants to assume the debt of the debentures - b/c market value was less than face value
b/c issued at a time when interest rates were lower. Price of a bond/debenture falls when the price of
an interest rate rises.
2. Interests:
1. Of Trustee: Wants bonds to be paid off at full face amount - b/c that gets the most for the
bond/debenture holders.
a. Trustee is fiduciary to bondholders.
2. Of Sharon: Assume debt.
2. Of UV board (not in case): Looking out for interests of UV SH's. Conflict b/t UV debt-holders and
equity-holders. Board should want Sharon to assume debt b/c more money for SHs.
3. What was the (legal) issue?
1. The interpretation of the successor obligor clause in the covenant on consolidations.
a. Provided that in the case of a merger or sale of all or substantially all of the assets of a corp.,
the surviving corp. assumes the issuer's debt.
b. In the case of a liquidation of the issuer, on the other hand, the debt must be paid off at the
face amount (plus call premium).
2. Sharon argues clause 1 applies to Sharon's benefit, which provides for assumption of debt. Trustee
argues not substantially all the assets sold b/c essentially only 1/3 of assets were sold.
4. Interpretation of "boilerplate" provisions of indenture are matter of law for judge, not fact-finding for jury.
5. What principles does Judge Winter announce for interpreting boilerplate?
1. "Consistency and uniformity"...
2. Explicitly rejects the "literalist approach" – instead chooses interpretation of the purpose of
successor obligor clauses – to protect lenders.
a. Idea behind clause is to keep track of what the assets are.
3. "We hold, therefore, that boilerplate successor obligor clauses do not permit assignment of the public
debt to another party in the course of a liquidation unless 'all or substantially all' of the assets of
the company at the time the plan of liquidation is determined upon are transferred to a single
purchaser."
C. Layers of financing...all has to do w/ liquidation and who gets paid 1st - the "liquidity waterfall."
1. Senior secured debt
2. Subordinated secured debt
3. Subordinated unsecured debt
4. Equity
D. Met Life
1. Equity cushion: A relationship b/t debt and equity.
1. The remaining residual, taking into account fixed claims.
2. A proxy for risk.
a. LESS EQUITY CUSHION = GREATER DEFAULT RISK.
b. Means less likely for those at bottom to get money b/c those at top can call a default.
3. Shrinking equity cushion...
a. Reductions in the value of the business (reducing value of the residual).
b. Increasing the amount of debt (increasing fixed claims).
2. RJR Pre-LBO Debt
1. Indenture included 2 relevant provisions:
a. Negative pledge clause:
1. No senior debt; no security interests in assets.
2. Allowed unsecured debt; did not mandate a debt-to-equity ratio; did not mandate
subordination.
b. Successor obligor provision in M&A clause.
1. Allows mergers conditioned on successor firm assuming debt obligations.
2. Neither are triggered, but argue it's implied.
3. Implying good faith into the bargain...
1. Content and effect of implied covenant of good faith? Court willing to accept this.
2. Only duty of good faith is to fulfill the express terms of the contract that you agreed to - narrow
meaning of good faith here.
a. This implied covenant of good faith is NOT a FD.
b. Corps. do NOT have FDs to their bondholders - their only duties are contractual.
3. No new terms of contract to be implied.
4. Ct. won't imply covenant (would prevent incurrence of new debt to facilitate the LBO).
a. They could have contracted for this term.
4. How do covenants find their way into indentures?
1. Bond issuances are repeat transactions.
2. Underwriters have incentives to demand indenture terms that produce saleable bonds.
3. Pricing mechanisms and diversification.