CORPORATION

PROF WELLS
I AGENCY LAW
 Generally – an agent is any person authorized to act on behalf of another. The law of
agency governs the interactions among principles, agents, and the third parties with
whom agents deal on behalf of principals.
1 CREATING AN AGENCY RELATIONSHIP
A RST 3rd A § 1.01 – Fiduciary relation which results 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 or otherwise so
consents to act
B QUESTIONS THAT MUST RESOLVED WHEN FACED WITH A FACT PATERN IN
WHICH ONE PERSON IS ACTING ON BEHALF OF ANOTHER (i and ii)
i Does a principal/agent relationship exist? (see RST 3rd A § 1.01)
a Factors to look at: 1. What did the parties say; 2. What did they do; 3. How did they
act; 4. Their course of dealing over time
b Note – even SILENCE can be used to demonstrate a party’s consent; compensation
is not essential to this equation
c NOTE 2 – Just answering this question ALONE does not suffice to finish the
analysis
ii Do the main players (P, A, 3rd party) now owe any duties to one another
a There are some basic issues that arise out of this relationship:
(i) A has certain duties and obligations to the P
(ii) The P has certain duties and obligations to the A
(iii) The P is responsible for tortuous acts committed by the A that falls w/in the
scope of the agency
(iv) The A has the ability to enter into binding agreements on the P’s behalf, as long
as the agreement may be traced to the P’s authority
iii Essence is when someone asks another to do something for them:
a Principal, Agent, 3rd Party PA3d
(i) P asks A to do something and A interacts with 3rd party  commits tort or K
breach
(ii) Inward looking v. Outward looking Consequences:
(a) INWARD – There are inward looking consequences to the agency
relationship which relate to the relationship b/w the P and A and are governed
by the Ks b/w the parties and by the law of FDs
(b) OUTWARD - These relate to the relationship among the P, the A, and a 3rd
party which are governed by the various principles of attribution
1. E.g. A hit 3rd with car and P is now liable
i. Someone is trying to get to both the A and the P
iv 3 Factors in determining whether an agency relationship exists: (from Cyberheat)
a (1) The principal’s RIGHT TO CONTROL the alleged agent
b (2) Alleged agent’s DUTY TO ACT primarily for the benefit of P
c (3) Alleged agent’s POWER TO ALTER the legal relations of the P
d NOTE – These factors provide guidance, but they are neither exclusive nor
conclusive considerations
e CYBERHEAT – Porn site as P didn’t have enough control over illegally spamming
affiliate to be liable. Porn site told them not to break the law
(i) RULE – In some situations, the law of agency renders a P liable for the agent’s
torts. The creation of an agency relationship ultimately turns on the PARTIE’S
 INTENTIONS. Court’s go through the 3 FACTOR TEST (above) in determining
whether the relationship exists.
2 FIDUCIARY DUTIES
 Generally, when one person takes responsibility for acting on behalf of another, that
responsibility carries with it certain duties beyond the mere completion of the task
involved.
A DUTIES IMPOSED – RST 3RD A 8.01-8.05
i LOYALTY – A must acts loyally for the P’s benefit in all matters connected with the
agency (i.e. put P’s interests ahead of your own)
ii TO NOT ACQUIRE MATERIAL BENEFITS ARISING OUT OF AGENCY – A may NOT
acquire a material benefit from a 3rd party in connection with transactions or actions
taken on behalf of P or otherwise through the agent’s position
iii TO NOT ACT AS AN ADVERSE PARTY – A may not act as an adverse party to the P
in a transaction connected with the agency relationship
iv NOT TO COMPETE – duty not to compete with the P in any matter within the cope of
the P in a transaction connected w/the agency relationship
a NOTE – this prohibition does not extend beyond the END OF AGENCY
RELATIONSHIP and does not prohibit and agent’s preparing to compete,
following the end of the agency relationship, provided the conduct is not
otherwise wrongful
v TO NOT USE P’S PROPERTY OR INFO – agent may not use property of the P for his
own purposes or for the purpose of a 3rd party; A can’t do this without P’s confidential
info either,
B NOTE – An A’s FD of loyalty ends the day the agency relationship ends. The only
exceptions are where there are 1) NON COMPETE AGREEMENTS (which must be
reasonable in scope and time) and 2) for attorney’s to their former clients
C FOOD LYON – 2 news reporters get hired (by misrepresenting themselves) by PF in order
to expose their bad practices (nasty practices with their meats). Food Lyon got mad and
sue
i ANALYSIS – EE breaches his DOL when 1) EE act in a way inconsistent with
promoting the best interest of ER when employed or 2) when EE deliberately acquires
an interest adverse to ER.
a Previous Cases – Disloyal conducts by EE are tortuous when:
(i) An EE competes directly with ER (either on her own or as an agent of a rival C)
(ii) The EE misappropriates her ER’s profits, property, or business opportunities
(iii) The EE breaches her ER’s confidence
b Applies to FOOD LYON – the 2 reporters were not fake EEs of Food Lyon. They
were actually hired. When you get hired, you owe a DOL to your ER. This is made
as a CL cause of action under NC and SC.
(i) Here the court puts forward a novel theory: the EEs were disloyal b/c, as EEs of
2 organizations, their duties to one ER were “diametrically opposed” to that of the
other.
(ii) You do NOT breach DOL simply by having 2 jobs, but when the INTENT to act
against the interests of the second ER for the benefit of the 1st ER exists, then
there is disloyalty
ii NOTE – draw from this that FDs are flexible and very fuzzy
D DEFAULT V. MANDATORY RULES – C and Agency law gives you rules that you have to
follow (like DOL). It CAN be contracted around or negotiated. The body of agency law is a
set of rules provided for us UNLESS we agree otherwise
i Default – These are rules that exist if there was no contract in place to change them.
ii Mandatory – These CANNOT be negotiated; these are imposed upon all parties (i.e.
Criminal laws)
 iii POLICY – Economic Justification – it is more efficient that you DON’T have to negotiate
everything otherwise people would be reluctant to hire others and Ks would be very long
E NON-COMPETE CLAUSES – are used to protect ERs after agency relationships end. Cs
may be worried that the former EE will disclose trade secrets, etc
i Factors to determine its enforcement
a The clause must be tailored to target specific knowledge that needs to be prevented
from disclosure (ex – KFC recipe)
b Qs: what did the EE create? What were his duties? How were things done before
and after EE was hired? What are EE’s duties at his new job? How close is the new
role going to be to his old role with the former ER?
c Before signing a non-compete clause ask – the scope; geographic limitations;
duration; definition of “competition’’
3 AUTHORITY
A ATTRIBUTION – generally, the rational for imposing liability based on the existence of
benefits to the P is simply that those who gain from the actions of another should
sometimes be held to answer for costs inflicted by those actions (NOTE – a finding of
control along or benefits to the P alone are NOT ALWAYS SUFFICIENT to a finding of
agency
B THINGS TO KEEP IN MIND
i Level of CONTROL necessary to find liability
ii Why control alone is usually insufficient to find liability
iii When benefit to P plays an important role in the court’s decision
iv Does benefit alone justify liability
v Separate rationales b/w the trot and contexts
C ACTUAL AUTHORITY – created by a manifestation from the P to the A that the P
consents to the A taking actions on the P’s behalf.
i To evaluate, look to:
a Communications b/w P and A
b It may exist even without a written K
ii IMPLIED AND EXPRESS ACTUAL AUTHORITY
a Express Actual Authority (EAA) – specific command given to an agent to do a
particular task (like based on a written or oral command)
b Implied Actual Authority (IAA) – those things that are necessary to fulfill the agency
relationship. There are other actions that have to be taken in order to fulfill the EAA
c LIABILITY – the P can only be held liable for actions of the A, whether expressly or
impliedly granted, IF THEY FALL WITHIN THE SCOPE of the agency
iii CASTILLO V. CASE FARM – DF hired ATC to recruit people to work at Df’s chicken
processing plan in another state. The housing conditions were bad as well as the
means of transportation to the Df’s location (action brought by the workers)
a ANALYSIS – EAA exists where P has made it clear to A that he wants the act under
scrutiny to be done. EAA implicates certain IAA to do all things PROPER, USUAL,
AND NECESSARY to exercise that EAA
(i) As applied to this case – Case Farms gave EAA to hire workers. Court says
that there is IAA consisting of doing tings PROPER, USUAL, AND NECESSARY.
Court looks to how this was carried out in the past. In the past, Case Farms
assisted EEs with housing and transportation. ATC knew that these activities
were “proper, usual, and necessary” to the hiring of EEs. So ATC was acting
within the scope of the agency when offering these things to the EEs.
(ii) Note – a K is not necessary to impose IAA (as was the case with ATC and
Case Farms)
D APPARENT AUTHORITY
 Apparent Authority: One person may bind another in a transaction with a 3rd person,
even in the absence of actual authority, when the 3rd person REASONABLY
BELIEVES—based on MANIFESTATIONS by the purported P—that the actor is
authorized to act on behalf of the purported P (RST 3rd A 2.03)
i LIABILITY UNDER APPARENT AUTHORITY – liability can arise under 2 situations
under apparent authority
a (1) where persons appear to be agents, even though they do not qualify under the
definition
b (2) where agents act beyond the scope of their Actual Authority
c Manifestation – RST 3rd A – a person manifests consent or intention through written
or spoken words or other conduct
(i) NOTE – App Auth can exist even if the manifestations reaches the 3rd party
through an intermediary, AS LONG AS IT CAN BE TRACED BACK TO THE P
ii KEY POINT IN FINDING APPARENT AUTHORITY
a (1) The manifestation must emanate from the P and must be received (directly or
indirectly) by the 3rd person; AND
b (2) The scope of the agent’s apparent authority depends on the 3rd person’s
reasonable interpretation of that manifestation
(i) REASONABLENESS – look to prior dealings b/w the parties, customs and the
nature of the transaction
c NOTE – there is no apparent authority if there is an UNDISCLOSED PRINCIPAL
(P MUST BE KNOWN)
iii FACTORS IN EVALUATING APPARENT AUTHORITY
a Did agent have authority to accept something on P’s behalf and change any
agreement?
b What has been the conduct in the past? Has the agent had power of
acceptance/modification in the past?
c Is there a manifestation by the P that would lead the 3rd party to believe there was an
agency relationship?
d COOK PEST CONTROL HYPO – this dealt with a dispute over whether the Cook’s
agreement was actually modified, as the Rebars were arguing.
(i) To argue for the Cooks that there was no apparent authority
(a) The “agent” never had power of modification in the past
(b) If there was a non modification clause, the Rebars would be screwed
because that means the agent could not have modified the agreement
(ii) The Rebars would argue the opposite, but if there was a non modification clause,
they are out of luck
iv QVC CASE – QVC hired NTA to serve as a contact with vendors in 50 states for a
nation wide tour. NTA hired DCCA for assistance in Illinois, and RJ was the DCCA EE
responsible for the project. Although QVC told all potential vendors that there is no K
until they receive a purchase order directly from QVC, there was confusion when RJ
sent Bethany a letter congratulating them on being chosen (they were in fact only an
alternate). They buy more product in anticipation of the sales produced from the show.
QVC doesn’t put them on. Bethany sues. (The chain: AVC-NTA-DCCA-RJ-Bethany)
a ANALYSIS – Apparent Agency exists when 1) P consents or knowingly
acquiesces to agent, 2) 3rd party has reasonable belief that the agent has
authority from P, 3) detrimental reliance
(i) SCOPE OF APPARENT AGENT’S AUTHORITY – determined by the authority
that a reasonably prudent person might believe the agent to possess based on
the actions of the P
(ii) AS APPLIED HERE - Legal claim we look for to find Apparent Authority –
(a) Did QVC consent or knowingly acquiesce to agent?
 1. Silence of P when they knowingly allow another to act form them as their
agent can give rise to Apparent Authority
(b) The 3rd party’s interpretation of QVC’s actions to make that 3rd party think that
there is a relationship b/w the agent and the P (Bethany is 3rd party; RJ/DCCA
is agent; P is QVC)
1. P has to do something to lead the 3rd party to believe that the agent was
actually P’s agent)
(c) H: QVC told vendors that the only K is the purchase order. There is no
E that indicates that any one else but QVC had the authority to contract
on QVC’s behalf.
1. R: Not reasonable to believe that RJ had contract authority; QVC
stressed the purchase order; Purchase order is the only K
4 RESPONDEAT SUPERIOR (TORTIOUS VIOLATIONS; NOT CONTRACT VIOLATIONS)
 Under the doctrine of Respondeat superior (RS), principal/ERs are vicariously liable
(i.e. RESPONSIBLE) for the torts of their EEs/Agents that arise within the scope of
the EE’ employment (RST 3rd A §2.04)
 GENERAL ANALYSIS
o Ask what liability you are asserting
 If it is CONTRACTUAL liability, LOOK TO AUTHORITY
 If it is a TORT liability, LOOK TO RESPONDEAT SUPERIOR
o Then, ask if the person was acting under the scope of their employment
A Generally, the distinction b/w EE and INDEPENDENT CONTRACTORS (or non-EE
agents) is important because EEs and independent contractors create different
potential liabilities for their principles. ERs must not only CONTROL their EEs, but they
must have SELECTED the agent in a CONSENSUAL manner.
B EMPLOYEE DEFINED – an agent whose P controls or has the right to control the manner
and means of the agent’s performance of work
C SCOPE OF RS – it is limited to the employment relationship b/c an ER has the right to
CONTROL how the work is done. So control is a big element here.
D INTENTIONAL TORTS
i GENERALLY, the ER will NOT be held liable, unless the intentional tort is found to have
been in
(i) FURTHERANCE OF THE EE’s POSITION OR DUTIES; OR
(ii) SERVING THE ER
E INDEPENDENT CONTRACTORS – You can have an agency relationship possibly even
with someone who is not an EE. Again, the thing to look for always is the degree of control;
look to a CONTINUUM OF CONTROL
i Ps are NOT responsible for the torts of their INDEPENDENT CONTRACTORS,
UNLESS the tort arises out of an area over which the principal exercises control or
falls within one of the following EXCEPTIONS:
ii (1) Inherently dangerous activity – includes any activity which is likely to cause harm
or damages UNLESS some precautions are taken
iii (2) non-delegable duty – one that a person MAY NOT AVOID by the mere delegation
of a task to another (legal duties by attorneys, medical duties by docs, etc)
iv (3) Negligent Hiring – P hires and indy contractor; includes a consideration of the
process of hiring and the reputation of the contractor himself
v SEE P&G HYPO BELOW
F WARE V. TIMMONS (master/servant relationship) – girl goes in for some procedure and
dies. Gift suffered cardiac arrest due to incorrect removal of the tube. Girl gets brain
damage and dies. Nurse, under law, must be supervised by a doctor. (Chain –
nursedoctorcorporation).
 i ISSUE – can doctor be held liable for nurse though they both are EEs of C?
iiANALYSIS – RESPONDEAT SUPERIOR – PF MUST ESTABLISH AN ER/EE
RELATIONSHIP. TO BE A MASTER:
a RIGHT OF CONTROL TEST (majority requires more than the right to control)
(i) RIGHT TO CONTROL  one must have the POWER TO SELECT a servant
(ii) VOLUNTARY CONSENT  Must have VOLUNTARILY CONSENTED into the
relationship (the right to select and dismiss the alleged servant)
b TEST APPLIED TO THIS CASE:
(i) RIGHT OF CONTROL Doctor conceded that he had the right to control
the nurse’s actions. Law says C can’t practice medicine – only the doctor
can
(ii) VOLUNTARY CONSENT (“right of selection”) – in the Co-employee context,
each agree to enter in a relationship w/ER. ER establishes what
relationship each EE will have w/each other. It follows that the EE’s
relationship w/each other is NOT consensual – supervisors do not willingly
choose to work w/subordinates and vice-versa)
(iii) RESULT – Doctor cannot be held liable b/c of prong 2
c NOTE – Doctor was S/H, but cannot be held liable in this situation if it wouldn’t
be imposed upon him under RS
G HYPO – P1-3 (page 44-45) – RESPONDEAT SUPERIOR AND INDEPENDENT
CONTRACTORS (SEE ABOVE FOR INFO ON THIS SUBJECT)
i P&G hired fold to do corp info gathering (dig for info about rivals). Those folk
were contractors. Those workers misrepresented themselves to get info from
Unilever that they would not have had access to otherwise. P&G found out and
fired them.
a Analyze degree of control P&G had over workers with respect to the way they
were doing their task
b If P&G did not know about this, there is no actual authority to commit this tort
c If P&G has the right to tell them and is involved in the operations, they will be
held responsible for the tort regardless of whether P&G told the workers to do
it
d PROTECTION – draft K saying what sources to use to get info from
competitors; note – the bad thing about this is that they could still be held
liable
5 FRANCHISING – KRISPY KREME
A Business Formal Franchise – sells an entire system of doing business. McDonald’s allows
to build a McDonald’s franchise and dictates exactly what you have to do
B Contracting out of Agency Relationships – default rules can be negotiated. Therefore,
the parties can agree not to create an “agency” relationship.
i DOES THIS SOLVE THE AGENCY PROBLEM?
a Contractual Claims – The majority of courts generally have REFUSED to find a
principal/agent relationship b/w franchisors and franchisees – this is usually
negotiated, and if they opt out of the relationship, so suffer the consequences
independently. LOOK TO AUTHORITY – Ps and As involve FDs
b Tort Claims - For purposes of a tort claim by a 3rd party, the courts are more likely to
find this agency relationship because the Franchisor is largely in control of how the
franchisee does business (McDonald’s coffee burned a customer; she sued and won
b/c the temperature of the coffee was regulated by the Franchisor)

II ORGANIZING A CORPORATION
1 INCORPORATION
 A Corporation is a legal fiction, but it is a fiction with 4 important qualities: 1)
Centralized Mgt; 2) Continuity of life; 3) Transferability of ownership; 4) Limited Liability
A GOVERNANCE – THREE DIFFERENT ROLES
i Shareholder – they are considered “owners” although their power is very limited. Law
allows them to vote, sell and sue

ii Officer – In charge of the day-to-day operations. They’re often on the BOD

iii Director – They are traditionally understood as individuals that supervise (manage) the
C. They act as a unit. They are elected by S/Hs to supervise the officers and represent
the S/Hs.
a Role in a Public-C – hire; advise; supervise; and fire the CEO if needed
b They meet continuously throughout the year and have limited rule in the mgt of
Public-Cs except in times of crisis
c INSIDE V. OUTSIDE DIRECTORS
(i) INSIDE DIRECTORS – Employed fulltime by C as officers in addition to their
roles on the BOD
(ii) OUTSIDE DIRECTORS – Board members that do NOT work for the C in any
capacity other than as a director (Congress emphasizes these more Post-Enron)
B PUBLIC V. CLOSED CORPORATIONS
i Public - Officer, director and S/H are 3 distinct groups; Must abide by a demanding set
of securities law (dealing with info disclosure mostly); Subject to the threat of being
taken over by another C gaining control of a majority of the C’s outstanding stock; Can
buy and sell C stock in the open market
ii Close - The three groups tend to overlap; Are not under a demand by as many laws as
Public-Cs; Hard to buy or sell the stock (tends to stay within the C)
C CREATION AND INITIAL ORGANIZATION
 Corporate Law is established by the state and each has adopted a corporate code
that set the rules on how a C ought to be run. State corporate law varies. States set
the rules for a whole lot of the corporate law.
 INTERNAL AFFAIRS DOCTRINE – Incorporation is governed by the law of wherever
it incorporates, but it doesn’t have to be located there. You can choose to
incorporate in any of the 50 states, and the internal affairs of that C will be governed
by the state where you incorporated. (Almost 50% of incorporation occurs in DE).
i PROCESS OF INCORPORATING
a MBCA § 2.01 on Incorporators – one or more persons may as the incorporator of a
C by delivering articles of incorporation (AOI) to the secretary of state for filing
b MBCA § 2.03 on INCORPORATION
(i) Sets forth that the C is born (exists) upon the filing of the AOI
c MBCA § 2.02(a) on AOI (SUMMARY) – The articles MUST include:
(i) A corporate name (MUST MEET MBCA 4.01)
(ii) Number of shares the C is authorized to issue
(iii) Street address of the C’s initial registered office and the name of its initial
registered agent at that office; AND
(iv) The name and address of each incorporator
(v) NOTE – The AOI may include a number of other things (see MBCA 2.02(b))
d NOTES ON AMENDING AOI
(i) Can ONLY be changed by a vote of the S/Hs and subsequent approval by the
board
(ii) Bypassing the S/H Vote – BOD can collaborate to amass their shares and
simply authorize the decision. Otherwise, the process of soliciting proxies and
actually calling the S/H meeting is extraordinarily time consuming
 e OPTIONAL PROVISIONS (MBCA 2.02(b))
(i) S/H Liability – S/Hs usually have limited liability, but MBCA 2.02(b)(4)(v) permits
a C to impose liability upon S/Hs under specified circumstances if that is
desirable
(ii) Nature of Director Liability – MBCA 2.02(b)(4) authorizes the inclusion of a
provision in the articles that limits or eliminates the liability of the directors to the
C or its S/Hs for monetary damages. S/Hs decide upon the inclusion of such
provision and thus can also allocate the risk b/w the directors and the C
(a) EXCEPTION (Can’t be freed from liability)
1. Liability arising out of improper financial benefits received by a director
2. Intentional harm to C or S/Hs
3. Unlawful distribution
4. Intentional violation of Criminal Law
(iii) Initial Directors and Mgt Provisions – it may be a smart move to include the
names and addresses of the C’s initial directors as well as some basic mgt
provisions
(a) CHARTER – May include provisions for managing the business and
regulating the affairs of the C
1. Provisions are often placed in the charter to protect them from change by
the S/Hs. The BOD has to propose a change, and then the S/Hs must
vote to approve it or not.
ii PRO-INCORPORATION (AFTER)
a MBCA § 2.05 – ORGANIZATION OF C
(i) After Incorporation, the directors named in the AOI meet at the behest of the
majority of the directors and complete the process of organization by electing
officer, adopting by-laws, and other business
(ii) If the directors are not named in the AOI, the majority calls for a meeting to
appoint all of those people
(iii) NOTE – if there is no meeting, the organizational completion can be done by
providing evidence of ONE OR MORE SIGNED WRITTEN CONSENTS by each
incorporator describing the actions taken
b MBCA § 2.06 – BYLAWS
(i) The incorporators or the BOD shall adopt the initial bylaws
(ii) Under corporate law, S/Hs (under MBCA 10.20) always have the power to
change the bylaws and you cannot take that power away from them.
(a) Obviously, if you wanted to prevent the S/Hs from changing something,
you would put it in the charter
iii GRANT V. MITCHELL – (3 people started a company and then turned it into a
Corporation. Grant was the money guy along with Mitchell and Meltzer, who were the
ones doing the hard work. Incorporated but never named a board). Grant named
Mitchell to the board
a ANALYSIS
(i) DGCL § 108 – the incorporators must hold an organization meeting after
filing the charter in order to 1) elect directors to serve until the first annual
meeting of S/Hs and 2) to adopt bylaws
(a) NOTE – If there is ONE incorporator, no named directors/officers 
INCORPORATOR MUST HAVE A MEETING W/HIMSELF TO COMPLETE
THE ORGANIZATIONAL STUFF (elect Ds/Os; adopt bylaws; etc)
(ii) Determining the presence of an organization meeting – Courts will not only
rely on the [non]presence of certain formalities, they also consider other
EVIDENCE:
(a) Notes taken during the incorporation process
 (b) Foreign Corporate Certificates
(c) Meeting Minutes
b AS APPLIED TO THIS CASE
(i) Court relied upon the notes of C’s law firm and the foreign corporation
certificate to say that he had already acted to appoint himself (GRANT) and
Mitchell to the board. Court rejects Grant’s reliance on formalism
(ii) The corporate notebook included the charter, the certificate, the unsigned
directors’ consent and the bylaws  Evidence that:
(a) Grant created a two person board of Mitchell and grant
(b) The board by informal means appointed Grant as President and Mitchell
as Treasurer and Secretary
(iii) RESULT – the naming of the two directors led to the conclusion that there
was a board formed
2 CAPITAL STRUCTURE
 Generally, the capital structure of a C is the combination of claims sold by the C – those
claims generally can be divided into two types: equity and debt claims
A TYPES OF CAPITAL
i EQUITY – Generally, S/Hs own stock, and stock is an equity claim against the C.
Equity=power to control=right to vote=right to dividends/distributions
a AOI – authorizes the issuance of equity interests in the C by defining the type and
number of equity interests that the C is allowed to sell.
(i) Allows different classes of stock and different series within a class
(ii) See MBCA 6.01
b Determining S/H ownership relative to other S/Hs: Must find out
(i) What %’age of shares of the entire class the S/H owns; AND
(ii) What the rights of that class are
c Common Stock – these holders have the most power (voting rights) b/c they have
every incentive to take risk since they know that they would get paid back last.
Make more money so that those ahead can get paid and there’s some leftover for
the c/s holders.
ii DEBT – (bonds) a promise that you have loaned the C money and it will pay you back
in a certain period of time with interest. The guarantee is a formal K called an
‘”INDENTURE”
iii EQUITY V DEBT – there are tax advantages to debt. There are also risks b/c
payments are required at fixed times regardless of profits. Taking on debt can be good
for S/Hs in that it allows the company to leverage the S/H’s investment (returns on
borrowed money>cost of borrowing). Debt obligations, though, increase risk of stock
ownership (b/c c/s holders get paid after everyone else).
B MBCA § 6.01 on Authorized Shares (summary)
i The Articles MUST set form any classes of shares and series of shares within a class,
and the number of shares of each, that the corporation is authorized to issue.
a If more than one class or series is authorized, the Articles MUST prescribe a
distinguishing designation for each and describe the terms, preferences, rights, and
limitations of that class or series before they are issued.
b There MUST be at least one class or series of shares that have unlimited voting
rights and at least one class or series (which may be the same class or series as
that with voting rights) that is entitled to receive the net assets of the corporation
upon dissolution.
c The corporation MAY authorize one or more classes or series that have:
(i) (1) Special, conditional, limited, or not voting rights;
(ii) (2) That are redeemable or convertible as specified in the Articles;
 (iii) (3) That entitle holders to dividends; AND/OR
(iv) (4) That have preference over other classes with respect to distributions including
those given at dissolution (previous list isn’t exhaustive).
d Terms can be dependent upon facts so long as they are objectively ascertainable,
and terms of shares may sometimes vary among holders of the same class so long
as the variations are expressly set forth in the Articles.
C MBCA § 6.21 on issuance of Shares
i This section grants powers to the board, but the shareholders can reserve the powers if
it is so stated in the Articles.
a If NOT so stated, the board may authorize shares to be issued for consideration of
any benefit to the corporation (cash, promissory notes, services, or other securities
of the corporation).
b The Board MUST determine consideration is adequate before issuing the shares.
The corporation can place in escrow the shares while waiting for performance by the
other party.
c But shareholders have to approve issuances of shares or options for shares if:
(i) (1) The shares or rights are issued for consideration other than cash or cash
equivalents; AND
(ii) (2) The voting power of the shares that are issued/issuable will comprise more
than 20% of the voting power of the corporation that were outstanding
immediately before the transaction (see MBCA in order to learn how to calculate
the 20% voting power).
D MBCA § 7.21 on Voting Entitlements
i Unless otherwise provided in the AOI, each outstanding share is entitled to one vote at
the S/H’s meeting regardless of class.
a NOTE – See the MBCA for some exceptions that don’t allow votes on shares owned
by a second C and shares that are redeemed by the C before the meeting
E Pertinent DGCL Provisions
i DGCL § 152 – gives the BOD the power to determine the nature and amount of
consideration for which they will exchange shares of the C’s stock
ii DGCL § 157 – Requires that the BOD approve in WRITING any issuance of “rights
or options”
F GRIMES V. ALTEON – The ISSUE here was whether the CEO’s oral promise to a S/H
(regarding selling to the S/H private shares) is enforceable where the BOD has not
approved it and where there was no written instrument created
i ANALYSIS
a DGCL § 157
(i) If it is a right under this section, then only the BOD can make the decision
(ii) If C is going to sell new shares to the public, the BOD needs to authorize it in
writing
(iii) NOTE - § 152 vests broad powers to the BOD with respect to capital
structure (DE courts think it extremely important that such an important
decision be made by the BOD)
b The statutory scheme as a whole:
(i) Consolidates in the BOD the exclusive authority to govern and regulate a C’s
capital structure, and
(ii) Attempts to ensure certain in the instruments upon which the C’s capital structure
is based
c THEME - DE courts try to make the message that Capital Structure is a
FUNDAMENTAL decision of the C and those fundamental decision should ONLY be
made by the BOD (This is why § 152 gives BOD broad powers re: Cap Structure)
ii AS APPLIED TO THIS CASE
 a DGCL §§ 152 & 157 – The CEO’s alleged promise would have restricted the
amount and nature of the consideration the C could receive, and so BOD
approval is required both on legal and policy ground
(i) The promise here would be an “option”, and under § 157 this would require
approval in writing by the BOD. This is true even if this was a good
business decision b/c it is only in the BOD’s province to make this decision
b Result – The promise was a “right or option” within § 157 and needed BOD
approval in writing
3 DIRECTORS AND SHAREHOLDERS
 Generally, all directors are elected by the S/Hs at an annual S/H’s meeting by a plurality
of votes UNLESS
o Otherwise provided in the AOI; (see MBCA § 7.28(a); DGCL § 213(2));
o The directors terms are STAGGERED (MBCA § 7.03(c)); OR
o A vacancy in a directorship occurs mid-term
A DIRECTORS
i ELECTIONS & STAGGERED BOARDS
a STRUCTUAL ELEMENTS – “STAGGERED” & “CLASSIFIED” refer to a board that
allows for classes of directors to be elected for multiple year terms.
(i) The structure of staggered boards is such that there is always a majority of
directors who are continuing without the need for re-election
b ANTI-TAKEOVER DEVICE – Having a staggered board acts as a powerful anti-
takeover device, as an insurgent would be required to win two annual elections to
gain a majority of seats on the board.
(i) MBCA § 8.05 – specified that each director holds office until the annual meeting
following his or her election UNLESS TERMS ARE STAGGERED
(ii) MBCA § 8.06 & DGCL § 141(d) stipulate where the provision for a staggered
board must appear within the corporate documents
(a) MBCA – the staggered board must appear in the AOI
(b) DE - Provision for a classified board can be placed in the AOI OR the BY-
LAWS
ii REMOVAL OF DIRECTORS – Generally, Directors may be removed from the BOD by
S/Hs, with or without cause, UNLESS THE CHARTER provides that directors may be
removed only for cause (MBCA § 8.08(a))
a DE – DE law shifts this default rule from one in which a “for cause” limitation on
removal must be specified in the charter to a default rule in which there is a “for
cause” limitation on removal unless the charter provides otherwise
(i) NOTE – This additional provision is ONLY triggered for Cs that have a
STAGGERED BOARD.
iii BOD MEETINGS & DIRECTORS’ ACTION ON CONSENT – Corporate laws now
permit directors to be considered “present” at a meeting even if they are not physically
present but, for example, call in (MBCA § 8.20(b)).
a BOD can act WITHOUT holding a meeting
(i) MBCA § 8.21 – BOD can act without a meeting if they ALL consent in writing to
the action, as long as the charter or bylaws of the C do not provide otherwise
(ii) CLOSED Cs – Actions by written consent are particularly common in Close Cs
where informal Ks among directors are common
b REQMT’S FOR MEETINGS, NOTICE, WAIVER & CONSENT
(i) Directors may act at meetings that may be held regularly, as specified in the
bylaws, or at a special meeting, which requires a notice of the date, time and
place of the meeting, but not the purpose (unless charter/bylaws require it)
(a) See MBCA § 8.22
 (ii) Directors may waive notice of a meeting, either in writing or simply by
participating in the meeting (MBCA § 8.23)
(iii) STATUTORY QUORUM (“SQ”) – A majority of directors being present satisfies
SQ reqm’ts, but the charter or bylaws of the C may alter the quorum reqm’t to
specify more or less than a majority (MBCA § 8.24(a&b))
(a) A majority vote of the quorum of directors is required to act, unless the
charter/bylaws prescribe a greater numbers (MBCA § 8.24(c))
iv BOARD COMMITTEES – BOD may act through committees comprised of one or more
directors (MBCA 8.25(a))nhj
a MBCA 8.25 – Rules that apply to BOD meetings apply to committees
b MBCA 8.25(d) – Actions taken by committees can carry equal weight as actions by
the entire BOD
c MBCA 8.25(e) LIMITATIONS – Corporation statutes place some limits on the
matters that may be delegated to a committee
(i) Actions requiring S/H APPROVAL cannot be delegated to committees
(ii) Committees cannot change the bylaws of the C
(iii) Committees cannot fill vacancies or authorize dividends (except pursuant to
formulas that the entire BOD has adopted)
v NEED FOR AND PURPOSE OF BOD (MBCA § 8.01) – Unless there is a S/H
agreement valid under MBCA § 7.32 that says otherwise, ALL CORPORATIONS must
have a BOD (Public Cs are req’d to have a BOD and Close Cs do away with it via a S/H
Agreement)
a All Corporate powers shall be exercised by or under the authority of the BOD of the
C, and the business affairs of the C shall be managed by or under the direction and
oversight of its BOD (also subject to MBCA § 7.32 – S/H Agreements)
b PUBLIC CORPORATIONS – the BOD’s oversight responsibilities include attention
to:
(i) Business performance and plans;
(ii) Major risks to which the corporation is or may be exposed;
(iii) The performance and compensation of senior officers;
(iv) Policies and practices to foster the corporation’s compliance with law and ethical
conduct;
(v) Preparation of the corporation’s financial statements;
(vi) The effectiveness of the corporation’s internal controls;
(vii) Arrangements for providing adequate/timely information to directors; AND
(viii) The composition of the board and its committees, taking into account the
important role of independent directors.
B SHAREHOLDERS
 Generally, S/Hs exercise their right to vote for directors in a S/H meeting. Under
some circumstances, S/Hs can act “ON CONSENT” and not have a meeting. DE law
says that a majority of S/Hs can act “ON CONSENT” (i.e. S/Hs get together and sign
a document to vote the director off w/o having to call a S/H meeting. The MBCA
differs in that it requires a unanimous agreement to act “on consent”.
 S/Hs posses important control rights (such as right to elect directors, vote on
certain transactions, assets after creditors have been paid, etc)
i SHAREHOLDER VOTING
a Basic elements include…
(i) Each share of common stock carries one vote (MBCA § 7.21(a)).
(ii) Shareholders vote on the election of directors (MBCA §§ 8.03, 8.08) AND on
certain fundamental transactions such as…
(a) Amending the corporation’s charter (MBCA § 10.03);
 (b) Amending the bylaws (MBCA § 10.20(a));
(c) Approving a merger (MBCA § 11.04(b));
(d) Approving the sale of assets not in the ordinary course of business (i.e.,
selling all or substantially all of the assets of the company; see MBCA §
12.02);
(e) Approving the dissolution of the company (MBCA §14.02); AND
(f) Shareholders may vote to ratify conflict-of-interest transactions (MBCA §
8.61(b)(2)).
(iii) Shareholders may vote at a shareholders’ meeting either in person or by proxy
(MBCA §7.22(a) and 7.25(c).
(iv) Majority vote wins except in director elections, when only a plurality is required
(MBCA §7.28(a)).
b Note: Most of these rules may be altered within the prescribed limits by
provisions in the corporation’s charter or bylaws.
c In addition, the law provides that shareholders may aggregate their votes in a
shareholders’ agreement or a voting trust, which are control devices used in closely
held corporations but not public corporations.
d Shareholders typically vote on only the following: board seats, extraordinary
transactions, changes or amendments to the charter/articles, and shareholder
proposals.
ii PROXY VOTING
a Modern statutes allow S/Hs to vote their shares either in person or by proxy (MBCA
7.22(a)). A proxy is the authorization given by a S/H to another person to vote the
S/H’s shares. The holder of a proxy is an AGENT subject to the control of the S/H
and having FDs to the S/H (this is norm in Public-Cs)
iii STRAIGHT v. CUMULATIVE VOTING
a STRAIGHT VOTING - Voting for directors is completed by a way of a “STRAIGHT
VOTING” system, under which a MAJORITY voting coalition will win every seat on
the board
(i) Each S/H votes all of his or her shares with respect to each open seat on the
board
(a) If I have 100 shares and there are 9 open seats, I can vote 100 shares for
each of the nine people I want
(ii) Therefore, if one S/H or a voting coalition owns 51% of the shares of a company
under straight voting that majority block will elect EVERY director
b CUMULATIVE VOTING – Allows S/Hs to concentrate their voting power by
“cumulating” all of the votes associated with their shares and voting them in a block
for a limited number of nominees (more common in Close-Cs as a control device)
(i) EFFECT – assures minority S/H’s representation on the board in proportion to
their voting strength
(ii) DEFAULT RULE – the default is STRAIGHT VOTING, but Cs can opt for
cumulative voting in the charter, bylaws, of AOI (MBCA 7.28(b))
(a) DGCL 214 – provision for cumulative voting must appear within the certificate
of incorporation
c NOTE re: MINORITY VETO POWER – if you combine cumulative voting AND a
SMJ REQM’T for elections, then you have essentially given the minority VETO
power
iv S/H MEETINGS
 MBCA 7.01 – C statutes provide for annual meeting for the election of directors,
and unless directors are elected by written consent instead of an annual meeting,
which would be unusual in a public C outside a contest for control, C statutes
require that companies hold an annual meeting
 o S/Hs are given the power to seek a JUDICIAL ORDER setting a date for the
annual meeting if there has been a FAILURE to hold the annual meeting as
required (MBCA 7.03(a)(1))
o The statutes also permit THE CALLING OF SPECIAL MEETINGS to vote on
particular issues that may arise between annual meetings (MBCA 7.02)
a SPECIAL MEETINGS – these are often called to replace directors as part of a
hostile takeover attempt or to seek the S/H’s approval of a friendly takeover or
merger proposal
(i) DGCL 211(d) – BOD has power to call a special meeting; S/Hs can have this
power if it is provided to them in the charter or bylaws
(ii) MBCA 7.02(2) – BOD or a 10% S/H can call a special meeting
b NOTICE ON MEETINGS – The process for calling a special meeting (including date,
time and place) is provided in the charter or bylaws (the same goes for the annual
meeting)
(i) MBCA 7.05 – ALL S/Hs meetings MUST be preceded by notice to the S/Hs that
specifies the business to be done at the meeting
(a) Insufficient Notice – consequence of insufficient notice is that all actions
taken at the meeting are voidable by S/Hs who did not go
c SETTING THE RECORD DATE – b/c shares of stock are bought and sold
constantly in Public Cs, special procedures have been developed to determine who
has a right to vote
(i) MBCA 7.07(a) – if a S/h owns stock on the record date, s/he must be given
notice of a meeting (the record date is fixed by the BOD)
(ii) MBCA JDXs – Record date cannot be more than 70 days before the meeting
date (MBCA 7.07(b))
(iii) MBCA 7.25 QUORUM REQM’T – s/Hs holding a majority of shares MUST be
present, unless otherwise provided in the charter or bylaws, to constitute quorum
C ALDERSTEIN V. WERTHEIMER – SM is the C; The CEO (ADST) of SM sucked (he was
also a MAJ S/H and Chairman of the board) – he was accused of sexual harassment and
was lying to the BOD and investors about profits/revenue. BOD tries to oust him – They
find an investor (R) and get him to be a majority S/H by tricking ADST in calling a BOD
Meeting (since bylaws req’d CEO to call it).BOD must accomplish 3 tasks: 1) get R to be
the maj S/H; 2) Fire ADST; 3) R has to act “ON CONSENT” to pu ADST off the board.
ADST did not know about the plan.
i ANALYSIS (DE Courts have very broad equitable powers)
a DGCL 225 – Allows the court to determine the validity of contested elections
of directors.
b DE courts can use their equitable powers to impose additional duties on BOD
that aren’t spelled out in the statutes (like standards of fairness)
ii AS APPLIED TO THIS CASE
a ADST has 73% of the vote (controlling S/H), is president and chairman of BOD –
getting rid of him is difficult – this is why the BOD created that plan to oust him
(i) 3 member board in this case – ADST, if fired, can act “ON CONSENT” and fire
the other 2 members – so, even though the other 2 members could out vote
ADST, this is why they didn’t just up and fire him
b RESULT – Court imposes this standard of minimum fairness upon the BOD
and it was violated by not giving notice to ADST about the plan with R.
Though the meeting was a true meeting that was held, the actions had to be
invalidated b/c of lack of notice to ADST about the true actions that were to be
taken.
iii PROF WELLS – Absent some provisions, a majority S/H can get rid of a member
of the board
III LIMITED LIABILITY/PIERCING THE CORPORATE VEIL
Limited Liability increases the cost of debt (higher cost of borrowing) and decreases the
cost of equity to the C (s/h must pay creditors to assume some of the risk of failure). This
presents the problem of MORAL HAZARD in that there is an incentive to engage in riskier
than optimal activities b/c they are not forced to pay the total costs of that behavior.
1 MBCA 6.22 – S/H Liability – A s/h IS not liable to the c or its creditors w/respect to the shares.
Also, unless otherwise provided in the AOI, a S/H of a C is not personally liable for the
acts/debts of the C (obviously, a S/H can becomes liable by reasons of his own conduct)
2 GENERAL REQMT’S FOR PIERCING THE VEIL
A THRESHHOLD QUESTIONS – In analyzing cases seeking to pierce the veil, you must
determine whether the liability may attach to the S/H directly by reason of the S/H’s own
actions instead of recognizing the liability as a Corporate Liability that must be paid by the
S/H personally
i Corporate Formalities – have they been followed?
a If there is no personal liability, the first question under the analysis is whether the
corporate formalities have been carefully observed
(i) Examples – C has a separate bank account; no comingling of personal and
corporate funds; regular meetings of directors and S/Hs; corporate records
b IF THE FORMALITIES HAVE BEEN FOLLOWED, FEW COURTS WILL PIERCE
ii Fairness – is there an injustice that links the wrongdoing to the harm?
a Most courts also require a showing of injustice or unfairness to link the wrongdoing
to the harm. TWO TYPES of injustice are most common:
(i) Where the disregard for the corporate entity has been visible to a third party and
that third party has reason to be confused about whether he or she was dealing
with a C or an individual; OR
(ii) Where the S/H has disregarded the separateness of the C’s funds and treated
them as her own (i.e., if the S/H doesn’t observe the distinction, creditors
shouldn’t have to)
iii S/H relationship – the S/H must be active, not passive, for the courts to impose liability
upon him as a result of veil piercing
iv NOTE – courts will not step in every time something is unjust, they like to see additional
things like if the responsible parties weren’t competent enough to do what was required
of them. If this is the case, then the court doesn’t care to make the distinction b/w S/H
and C b/c neither did the S/H care to make that distinction (that is why we have
formalities; it distinguishes S/Hs and Cs). Piercing is usually done with Closed Cs.
B SOERRIES v. DANCAUSE – Under aged girl goes into club drunk. No one checked
her ID. She drinks more and she leaves wasted. She drives inebriated, crashes, and
dies as a result. Soerries commingled individual and corporate assets (he assumed
C’s financial liability, waived corporate rental pmts, etc)
i ANALYSIS
a Piercing the veil [in GA] is used to remedy injustices where a party has
overextended his privilege in the use of a corporate entity in order to defeat
justice, perpetrate fraud or to evade contractual or tort responsibility
b There must be evidence of abuse of the corporate form.
c Pf must show that the Df disregarded the separateness of legal entities by
commingling on an interchangeable or joint basis or confusing the otherwise
separate properties or control (ALTER EGO DOCTRINE)
ii AS APPLIED TO THIS CASE
a Soerries commingled individual and corporate assets: he assumed C’s financial
liability, waived corporate rental pmts on property he personally owned, and using
corporate funds to directly pay his personal mortgage notes and other expenses
 b RESULT – there is an injustice in that a girl died b/c the C served her alcohol
while she was drunk and underage. Corporate formalities were not followed.
S/H was active. The veil is pierced.

IV CLOSED CORPORATIONS: SPECIAL ISSUES – HOW S/Hs CAN PROTECT THEMSELVES

1 SHAREHOLDER AGREEMENTS (see MBCA 6.22 and 7.32)
 Generally: Shareholders in closely held corporations often decide to vary the
default rules contained in the corporation statutes. Because the number of
shareholders is small, highly tailored arrangements allocating control are often
feasible. One way to do this is through shareholder agreements, which are simple
contracts among shareholders. These agreements are usually directed at
providing minority shareholders with rights (if they were majority holders they
wouldn’t need such protections) including affirmative rights (e.g. right to name
certain officers or to dividends) or negative covenants (e.g. right to veto certain
transactions). Minority shareholders often seek representation on the board of
directors through “voting pool” agreements which obligated shareholders to vote
together as a single block (MBCA § 7.31). Although earlier courts were skeptical
of many shareholder agreements, the modern trend is to allow for greater
contracting freedom.
A MBCA 7.32 on S/H Agreements (SUMMARY) – even if it is otherwise inconsistent with the
MBCA, S/Hs may form effective agreements on a wide range of things (see MBCA 7.32(a)
(1-8) – (a)(8): provides especially broad powers).
i MBCA 7.32 – Agreements that hinge on the responsibilities of the directors
a THESE ARE UNDER 7.32(b)
(i) UNANIMITY – The agreements must be UNANIMOUS and be included in the
charter or bylaws or in a separate agreement
(ii) DURATION – The agreements are limited to 10 years, unless otherwise provided
b THESE ARE UNDER 7.32(c)
(i) LEGEND – There must be a legend on the share certificate to notify transferees
of the S/H’s agreements
c THESE ARE UNDER 7.32(d)
(i) LIMITED TO CLOSE Cs – S/H agreements are limited to close corporations –
SHAs cease to be effective once a Closed Corp becomes public
d THESE ARE UNDER 7.32(f)
(i) S/Hs will not have personal liability even if the effect of the agreement is to crate
a partnership or eliminate some element of the corporate formalities
ii MUST CONSIDER MBCA 6.22 – No S/H liability, unless otherwise provided in the AOI
(SEE ABOVE TO 6.22)
B RONNEN v. AJAX – There was a SHA b/w N (brother) & R (sister) which granted N the
right to vote R’s shares with respect to “any and all matters relating to the C’s day-to-day
operations and corporate mgt. However, it also reserved R a spot on the BOD; it capped
N’s salary; and it gave R the right to vote in connection with “major corporate policy
decisions.” R gave up the voting rights listed above in exchange for N’s promise not to
exercise an option on her shares. In this case, R refused to vote with N in a BOD election
b/c she felt the SHA didn’t give him the right.
i ANALYSIS
a SHAs concerning “major corporate policy decisions are limited to events such as
M&As, not day-to-day corporate management and operation decisions such as the
election of directors.
b S/Hs don’t control corporate management; therefore it would be inappropriate to let
them do so via SHAs.
 c SHAs are to be construed in a manner that doesn’t render any objective or term
meaningless
ii AS APPLIED TO THIS CASE
a Court found agreement conferred power to vote for directors to N. Case of K
interpretation
b Court had to pick b/w 2 people both whom looked in the wrong
c K expressed what R could vote for, so that means she had to have been
excluded from other functions
d SHA would NOT pass under MBCA 7.32 b/c agreement only valid for 10 years
unless otherwise specified, and this was 13 years
iii ADDITIONAL NOTES
a R retains the right to vote on any corporate re-organization b/c it is a way for her to
lock in the protection she got; this way any capital restructure would not dilute her
ownership w/o R’s consent
b SHA provided for a cap on N’s salary – this is b/c in order for N to get more money
from the C, he would have to distribute a dividend. Dividend distributions must be
proportional among the class (which would get R more $ too). Also, this keeps more
$ in the C
2 TRANSFER RESTRICTIONS
 Closed Corporations impose transfer restrictions on corporate stock to be able to
control selection of business associates, to provide certain in estate planning, and to
ensure that the C complies with close corporation statutes. They are imposed in the
charter or bylaws for the C or in a separate agreement among S/Hs or b/w S/Hs and the
C (See MBCA 6.27)
A Where are the restrictions located?
i MBCA 6.27 – They are imposed in the charter or bylaws for the C or in a separate
agreement among the S/Hs or b/w the S/Hs and the C
a THE RESTRICTIONS MUST – Transfer restrictions are valid if they pass a two
prong test:
(i) MBCA 6.27(a & b) – Comply with the formal reqm’ts relations to adoption of the
restriction and must be CONSPICUOUSLY NOTED ON THE SHARE
CERTIFICATE (REQM’T ALSO FOUND IN DGCL 202(a & b))
(ii) ARMOUR CASE – adds the reqm’t that the restriction be imposed on its
Certification of incorporation or bylaws
(iii) The restrictions must be for a PROPER PURPOSE
(a) General test for this is the REASONABLESS OF THE BUSINESS
PURPOSE
ii COMMON RESTRICTIONS IMPOSED – MBCA 6.27(d)
a The shareholder must offer the corporation or other shareholders the option to
purchase the shares, either at a price specified by prior agreement or at the price
offered by the prospective third-party purchaser (an “option”);
b The corporation or other shareholders are obligated to purchase the shares (a “buy-
sell” agreement);
c The corporation or other shareholders must approve the transfer of the shares (a
“prior approval” or “consent requirement); AND
d The shareholder is simply prohibited from transferring to certain persons or
classes of persons.
e ALSO SEE DGCL 202(c)
iii VALIDITY OF TRANSFER RESTRICTIONS
a It is important to note that all transfer restrictions may not affect shares issued before
the restriction is adopted unless the S/Hs vote in favor of the restriction (MBCA
6.27(a))
 (i) USUALLY ENFORCED  OPTIONS and B/S AGREEMENTS are commons
forms of transfer restrictions (normally upheld by courts)
(ii) PROBABLY ENFORCED  PRIOR APPROVALS are normally enforceable as
long as approval may not be unreasonable
(iii) PROBABLY NOT ENFORCED  FLAT PROHITIONS are usually held
unreasonable (viewed very skeptically by courts)
b SPECIAL VALIDITY REQM’TS FOR B/S AGREEMENTS
(i) Prices in these types of agreements must take one of the following four forms:
(a) FIXED PRICE – must be updated regularly to reflect the current value of the
shares
(b) BOOK VALUE – this is the most popular measure b/c it is easy to determine.
A problem with this is that it is based on historical values, and may not reflect
true underlying values
(c) APPRAISAL – this has the potential to be very good but parties have to
decide before hand what basis the business should be appraised on
(d) FORMULA – this is complicated
B CAPITAL GROUP v. ARMOUR – H & W are ‘tees of a revocable trust. H is EE of C2 (a
sub of C) and a director of C. C requires its S/Hs to enter into a STOCK RESTRICTION
AGREEMENT (SRA) which mandates that a S/H can’t transfer stock to a non-EE; C has
right to redeem if non-EE gets the stock. H&W create a trust and put C stock in it. H&W
can’t distribute the stock w/o C’s consent under the trust agreement (which refers to the
SRA). Once the trust is revoked, C can redeem. H&W consent to be bound by the SRA in
a joinder agreement. H&W divorce and W wants an interest in the stock held in trust. C
does not like this and joins suit.
i ANALYSIS
a Right to dividends is a common hallmark of ownership. If the Transfer Restriction
precludes someone from having an “interest of ownership”, then an interest in
dividends is not allowed
b A restriction is valid if it is reasonably necessary to advance the C’s welfare or attain
the objectives set forth in the C’s CHARTER.
c VALIDITY DETERMINATIONS – validation of a restriction requires balancing the
policies served by the restriction against the traditional judicial policy favoring the
free transfer of securities.
d BURDEN – the burden of proving a restriction UNREASONABLE is on the party
contesting the validity of the restriction.
e REASONABLESNESS –is there a legitimate business purpose in general;
reasonableness is not applied as to the individual (i.e. the question is not “is this
reasonable as to the individual, but is there a business purpose to it)
(i) The restrictions do not have to be the least restrictive, only reasonable
(ii) You can’t unreasonably restrict people from selling shares
(iii) ASK
(a) Was there a valid business purpose?
(b) Could this purpose have reasonably been achieved without the
restrictions?
ii AS APPLIED TO THIS CASE
a W’s arguments that she would not be an owner and only have an interest in
dividends is not valid because a hallmark of ownership is an interest in the dividends
b Courts looks at commons definitions of language inside the TRANSFER
RESTRICTIONS and concludes that “TRANSFERS” include DISPOSITIONS and
ASSIGNMENTS, which would preclude W from getting assigned an interest
c VALID BUSINESS PURPOSES
 (i) Limit the number of S/Hs – this is valid b/c the C wanted to maintain a number
below that which would require them to follow certain Federal Disclosure Laws
and the C wanted to prevent that
(ii) Align EE’s interests with that of the C – C had this purpose and it would not be
served if W got what she wanted
d RESULT
(i) W is left arguing reasonableness which the court says did apply. She must
show that that the restrictions were unreasonable which does NOT mean
that it was unreasonable as to her; she must prove that it serves no valid
business purpose
(a) Was there a valid business purpose?
1. A: Yes, the C had an interest in ascertaining that they do not fall
under the Federal Disclosure Laws and also wanted to align the EE’s
interests with that of the C
(b) Could this purpose have reasonable been achieved without the
restrictions?
1. A: Without the restriction, C risks falling under Federal Disclosure
Laws. The restriction need not be the least restrictive, only
reasonable. The restriction is reasonable to serve the C’s purpose
and could not be ascertained without it.
(c) W knew what she was getting into and is evidenced by agreeing several
times to be bound by the SRA
3 VOTING TRUSTS
 In the context of trusts, legal title of the shares is transferred from the S/Hs to the
voting trustees. S/Hs retain the financial rights belonging to the shares, but the
trustees possess exclusive voting power.
 The voting trustees typically issue voting trust certificates to the beneficial
owners of the shares and these certificates can usually be transferred.
 The purposes of voting trusts are varied, but they generally work to ensure
continuity of mgt and consistent voting. They are often used as part of a reorganization
plan, and they can prevent dissention among factions of S/Hs.
A Modern Judicial View – they are enforceable UNLESS contrary to public policy
B MBCA 7.30 – RULE
i FORMALITIES – Agreement must be SIGNED and must SET OUT THE PROVISIONS
OF THE TRUST (which may include anything consistent with its purpose)
a Shares must be transferred to the trustee
ii MORE FORMALITIES – AFTER the agreement is signed, the trustee shall prepare a
list of names and addresses of all the benes of the trust, along with the amount and
classes of shares they are to receive, and deliver copies of the same to the C’s
principle office
iii EFEFCTIVE DATE – Voting trusts become effective on the date the first shares subject
to the trust are registered in the trustee’s name
iv DURATION – Trusts CANNOT extend longer than 10 years unless an extension
agreement is signed
C FIDUCIARY DUTIES – The trustee has a FD to vote the shares in the best interest of the
S/H and in the way the agreement dictates the trustee should vote the shares
4 CLASSIFIED SHARES (AS A MEANS OF CONTROL)
 MBCA 6.01; DGCL 151 – Generally, Corporations statutes allows Cs to create more than
one class of shares, with each class having unique rights.
 The primary purpose of classifying shares is to allocate control among the various
classes of S/Hs
A MBCA 6.01; DGCL 151 – Classified stock can have whatever right the parties want to give
them but must be noted in the AOI
B The way in which control may be allocated by assigning different rights to different
classes of shares are infinite; they include –
i Giving a class veto power over all decisions
ii Giving a class no voting power
iii Allowing a class to vote only on certain matters
iv Providing the right to board representation to certain classes
C BENCHMARK CASE – BM invested in the first two series of C’s preferred stock. When
more money was needed, CIBC invested in C $145mil. As a result, BM’s status become
junior preferred, CIBC had controlling interest b/c of ownership of senior preferred. C’s
Certificate of Incorporation (“Certificate”) states: (1) junior preferred can vote on actions that
would materially adversely change the rights, preferences and privileges of the junior
preferred; (2) junior preferred is entitled to a class vote before C authorizes or issues any
other equity security senior to or ion a parity with the junior preferred. C now needs more
financing, and only CIBC is willing to provide it. C wants to issue Class D preferred to
CIBC, but can’t because of the Certificate. So they enact a merger with a subsidiary
created solely for the purpose of the merger. There was a provision in the corporation’s
documents that denies shareholders a vote on a merger with a wholly owned subsidiary,
and the corporation is able to alter the Certificate in the process of a merger (they did so
here and hook out many of the rights). The sale of the new stock would result in a reduced
liquidation preference, among other things, to the junior preferred. BM’s equity would go
down from 29 to 7 percent. The question: did BM have a right to vote?
i ANALYSIS
a INDEPENDENT LEGAL SIGNIFICANCE DOCTRINE (“ILS”) – DE courts use this
doctrine which holds that when the terms of a classified share agreement are
violated by a corporate transaction (e.g. a merger) that occurs after the formation of
such an agreement, DE courts WILL UPHOLD such a transaction when it complies
with the reqm’ts of FAIRNESS and ALL OTHER STATUTORY REQM’TS
(i) Rational – a merger is an act of independent legal significance, and when it
meets the reqm’ts of FAIRNESS and ALL OTHER STATUTORY REQM’TS, the
merger is valid and not subordinate or dependent upon any other section of the
DGCL, such as sections dealing certificate amendments.
(a) This suggests that the DE court is more concerned with formalism than
looking to the actual injustices that played out.
(ii) NOTE – DE courts emphasize that S/Hs have a lot of protection that they
can negotiate in their favor. These are sophisticated business men and
should know to obtain protection, and if they don’t then that is their fault
ii AS APPLIED HERE
a The court held: (REFLECTING THE ILS TEST)
(i) The harm to BM was caused by the merger, not by a charter amendment
(ii) BM had no separate voting rights – either by statute or by contract – with respect
to the merger
b The merger provision of the DE statutes is independent of the provision on the
charter amendments. Unfortunately for BM, the K was incomplete. It prohibited
preference stripping using language that did not identify mergers as the potential
mechanism
c RESULT – The protection provisions IN A CERTIFICATE OF INCORPORATION,
which req’d a series and a class vote of the p/s under certain circumstances, DNA,
absent an express provision to the contrary (it should have specified “mergers”), if
such circumstances are achieved through a merger rather than as a result of an
amendment to the certificate of incorporation pursuant to DGCL 242
 iii HOW TO PREVENT THIS
a Basic Drafting Tips. Clearly, at a minimum investors will want to ensure that the
protective provisions in the Charter contain a provision that requires a vote of the
relevant series of preferred stock in order to amend those protective provisions
“whether by amendment, merger, consolidation or otherwise.”
(i) In addition, the investors will want to delete any seemingly innocuous exceptions
to this voting requirement for change of domicile mergers and the like, which
were common carve outs before the Benchmark case.
b Be Clear and Be Specific. The court clearly indicated its intent to strictly construe
Charter provisions, so the draftsman should be clear and be specific throughout
every provision of the Charter. Investors should make sure the provision is drafted
clearly enough to be enforced in Delaware.
c Include a Catchall. Investors should include a catchall provision that requires a vote
of the preferred before any action may be taken that adversely affects or harms
the interests of the preferred stock
(i) Give Examples. Examples should be given that clearly show how liquidation
proceeds will be divided among various series and classes of shares.
(ii) It would make sense to give examples where a merger triggers the liquidation
event to further drive home the point that mergers are treated as deemed
liquidations.
5 CUMULATIVE VOTING – STAGGERED BOD and STRAIGHT VOTING
 Cumulative voting is a method of counting S/H votes in director elections in which each
S/H is entitled to cast a number of votes equal to the number of such S/H’s shares times
the number of directors to be election
A CUMULATIVE AND STRAIGHT VOTING
i CUMULATIVE VOTING FORMULA = # of Shares x Board seats = your vote #
a A S/H under this method may cast all of his or her votes in favor of a single director
rather than allocating them among candidates
(i) C has 3 directors and one of the S/Hs owns 500 shares of c/s. The S/H is
entitled to a total of 1,500 votes (500 x 3) which he may allocate among as
many or as few directors he chooses
b The effect of cumulative voting is to assure minority S/H’s representation on the
board in proportion to their voting strength
c To calculate the number of shares required to elect ONE director under CV is:
(i) [(number of shares voting overall X number of directors desired to be elected)/
(Directors to be elected + 1)] + 1
ii STRAIGHT VOTING – Voting for directors is done by STRAIGHT VOTING, under which
a majority voting coalition will win every seat on the board. Each S/H votes all of his
shares with respect to each open seat on the board. Thus, if one S/H or voting coalition
owns 51% of the shares of a company, under straight voting that majority block will elect
each director.
a I have 100 shares and there are 9 BOD seats – I can vote 100 shares for each
of the 9 people I want
iii DEFAULT RULES – the default is straight voting, but Cs can opt for CV in the charter
or bylaws (MBCA 7.28(b))
a DGCL 214 – under this statute, a provision for CV MUST appear within the
CERTIFICATE OF INCORPORATION.
b CV is more common in CLOSE-Cs as a control device than it is in Public Cs
iv NOTE – combining CV and SMJ essentially gives the minority S/H a VETO power.
This can be implemented for all transaction or just the major, extraordinary
decisions
B STAGGERED BOARD
 i Staggered boards – in a staggered board there is always a majority of directors who
are continuing without the need for re-election.
a This serves as a powerful anti-takeover device – an insurgent would have to win 2
annual elections to gain a majority of seats on the board.
ii MBCA 7.28(a) – All directors are elected by the S/Hs at an annual S/H’s meeting by a
plurality of the votes unless otherwise provided in the AOI, unless the terms are
staggered – MBCA 8.03(c); OR a vacancy in a directorship occurs mid-term.
iii MBCA 8.06 – AOI can provide for a staggered board.
a DGCL 141(d) – the provision for a classified board CAN be placed in the AOI OR
the BYLAWS
iv NOTE – Staggering the board can defeat the effect of CV (e.g. if there is a 3 director
board and only one is elected each year, CV isn’t going to make a difference)

6 SUPERMAJORITY REQUIREMENTS
 An easy way to ensure a minority voice in corporate affairs is to provide for
supermajority quorum requirements and voting. In effect, for SMJ reqm’ts give a
minority S/H veto power over corporate decisions without offending corporate norms
b/c corporation statutes allow high quorum and voting reqm’ts
o DGCL 216 – requires specification in the charter OR bylaws
o MBCA 7.27 – requires specification in the charter
 SMJRs may also be applied to actions of the BOD
o DGCL 141(b) – in the bylaws or charter
o MBCA 8.24 – also in the bylaws or the charter
 SMJR provisions may apply to certain transactions or to all transactions (although the
potential for deadlock is high when SMJRs apply to all transactions
A DIFFERENCES B/W DGCL AND MBCA ARE IMPORTANT HERE
i DGCL – SMJRs can be adopted through simple majority vote (DGCL 242(b)(4)).
a REPEAL IF IN THE CHARTER – When SMJ voting requirements appear in the
charter, they can be amended or repealed only by the greater vote specified in the
charter provision (id).
b REPEAL IF IN THE BYLAWS – Surprisingly, there is no such statutory restriction on
the amendment or the repeal of SMJ voting requirements that appear in the bylaws.
As a result, SMJ voting requirements that appear in the bylaws may be amended or
repealed by a MERE MAJORITY unless the bylaws themselves dictate that such an
amendment requires a greater vote
ii MBCA – Any amendment to the AOI that adds a greater quorum or voting requirement
must meet the same quorum or voting reqm’ts and be adopted by the same vote as
req’d by he proposed provision (MBCA 7.27(b)). The amendment or repeal of SMJ
provisions requires a SMJ vote (id)
B HOW TO ANALYZE
i First ask whether it I the S/H or the Directors that have the reqm’t
ii Then ask where you should put a SMJR
a If you really want to make it tough to change, put it in the charter
b If it is a more day-to-day change, you put it in the bylaws b/c they are easier to
change
(i) Bylaws – the SMJR can be changed by a mere majority unless otherwise
specified in the bylaws
(ii) Charter – The SMJR can only be changed by the greater vote specified in the
charter provision
7 PREEMPTIVE RIGHTS
 Generally, preemptive rights are the rights of a S/H to subscribe to the portion of any
increase in a C’s capital stock necessary to maintain the S/H’s relative voting power as
against other S/Hs. Preemptive rights may be granted or denied by the AOI.
A DEFAULT RULE – The default rule is against preemptive rights. B/c preemptive rights
complicate the issuance of new shares, public corporations rarely have them
B NOTE – in order for a preemptive right to work, that is if you have a preemptive right,
you must have the $ to buy the additional shares so that you maintain a constant
level of ownership.
C KIMBERLIN v. CIENA – KB is a venture capitalist and gets involved with C early on. KB
has a controlling ownership of ST. KB provides capital to C (pursuant to a SHA) in
exchange for Series A P/S, which KB had the right to underwrite, but wasn’t given the
chance to. KB then gets Series B and the same underwriting issues occurred, and KB and
C settled for terminating the SHA in exchange for stock. When financing hits Series-C, it
seems to include a PREEMPTIVE RIGHT. In the agreement for Series C was a provision
that allowed the right to be modified with a 67% S/H vote. There were enough votes to
waive the rights; KB’s ownership got diluted. KB complains he was defrauded
i ANALYSIS
a In the absence of ambiguous language, contracts dealing with preemptive
rights should be construed strictly and extrinsic evidence cannot be used to
circumvent clearly stated provisions.
ii AS APPLIED TO THIS CASE
a In this case, the SMJ provision allowed for preemptive rights afforded to investors
during previous offering to be overridden by a 67% SMJ. Despite an oral agreement
b/w KB and the CEO of C, the purchase of Class B P/S by KB did not protect these
alleged preemptive rights and the same were properly overridden by a 67% vote
(i) Expectations and common trade usages should not be considered b/c the K was
neither (1) Intentionally silent, NOT (2) widely ambiguous
(ii) A breach of DOL or the duty of good faith cannot really be demonstrated b/c the
directors of C did not receive disproportionately higher allocations during the
future offering, therefore self dealing or self interest did not come into play at
all
b RESULT – Court rules not to give KB back his preemptive rights.
8 DEADLOCK
A Deadlock – it occurs when the S/H vote is evenly divided. Occasionally, business planers
intentionally provide opportunities for deadlocks – Rational: some business relationships
should not proceed unless there is a unanimous assent to the actions
B Result of Deadlock – Deadlock usually leads to dissolution of a C.
i APPROVAL - The decision to dissolve typically requires approval by the directors AND
the S/Hs. After the dissolution is authorized, the C may dissolve by filing articles of
dissolution with the secretary of state.
ii JUDICIAL DISSOLUTION – In some instances, S/Hs cannot agree to dissolve. The C,
then, can be judicially dissolved upon a showing of deadlock
a MBCA 14.30 – GROUNDS FOR JUDICIAL DISSOLUTION: S/H must show:
(i) BOD DEADLOCK - Mgt is deadlocked – that is, the directors cannot agree and
the S/Hs have been unable to break the impasse on the board – and the C’s
business is suffering as a result (MBCA 14.30(2)(i))
(ii) S/H DEADLOCK – S/Hs are deadlocked – that is, the S/Hs have been unable to
elect new directors for a specified period, such as two consecutive annual
meetings. (MBCA 14.30(2)(iii))
(iii) MISCONDUCT - The majority group has engaged in misconduct. The statute
express this is various ways
 (a) Those in control have acted in a way that is “illegal, oppressive, or
fraudulent”. (MBCA 14.30(2)(ii))
(b) The corporate assets are being “misapplied or wasted.” (MBCA 14.30(2)(iv))
C CONKLIN v. PURDUE - Pf and Df leave their jobs in order to form a consulting firm (CPI)
in which each party was a director and equal S/H. There was no start-up capital, so CK
finances the operation himself. They spend a good deal of money creating a webpage
which doesn’t bring them the business they desired, so they are essentially out of capital at
that point. Although CK continued in his limited financing of the C, he viewed Perdue as
being a drain on the C’s resources. Upon telling Perdue that the business wasn’t working,
she ransacked the office and took his tax returns and a promissory note which allegedly
proved that her annual $114K “draw” was actually a loan from the C. CK wants that money
repaid while Perdue alleges CK stole CIP’s business when he created a new C.
i ANALYSIS
a RULE re DISSOLUTION – the court may invoke its equitable powers to judicially
dissolve a company in deadlock. Although the parties may never have agreed to
dissolution, the court looks back in time to determine the date upon which deadlock
became so intense that dissolution was the only remedy
b RULE re POST DISSOLUTION – After dissolution, the C may continue operations
for a limited period of time in order to wind up loose affairs (e.g., paying off
creditors, liquidating assets), but the C cannot continue to engage in the type of
business it was involved in during its existence
c RULE re DEADLOCK AVOIDANCE – Deadlock could have been avoided if:
(i) Another director is appointed that could break ties in such a small company; OR
(ii) The charter can divide powers amongst the two parties so that only one director
can make decisions regarding dissolution
d WHY RETROACTIVE DISSOLUTION?
(i) It means that all that went down could not be reconciled to the C. This
mechanism is generally in most statutes now, and courts are taking it upon
themselves to do this IF NECESSARY
ii AS APPLIED TO THIS CASE
a The court doesn’t find enough evidence to render Perdue liable for the draw, nor
does it find sufficient facts to render CK liable for breach of FDs in stealing business
b The court also deems CK’s FDs to have terminated upon the retroactive dissolution
date
9 VENTURE FINANCING AND LIMITS ON OPPORTUNISM (RED HAT STUDY CASE)
A Red Hat Case Study: After providing initial start-up venture financing, the providers wish to
protect their investment from the financial opportunism of later investors (especially those
who own common stock after the IPO) and board members.
i Dividends can be a powerful constraint on managerial opportunism, at least in
companies that generate free cash flow. In such companies, dividends deplete the
funds available to managers, thus eliminating the cushion between success and failure.
As a legal matter, the BODs have the unilateral power to declare or refrain from
declaring dividends, within the expansive limits established by fiduciary law.
ii Liquidation: “liquidation” is normally associated with the sale of a company’s assets
and the subsequent distribution of proceeds (if any) to investors. Liquidation is typically
viewed as the necessary culmination of a business failure, and the only issue for
investors is who receives the largest portion of the residue. To protect as much of the
“principal amount” of their investment as possible, holders of preferred stock usually
demand a liquidation preference – that is, the right to be repaid the original
amount of the investment prior to any payment made to holders of C/S in the
event of a liquidation. By requiring the return of the original investment to preferred
 S/Hs, liquidation rights remove any incentive that might otherwise tempt the common
S/Hs to liquidate opportunistically.
iii Voting: Voting rights are the most obvious means of controlling opportunism in the
corporate setting. The term “general voting rights” designates rights shared among all
equity holders and the term “targeted voting rights” designates rights over specified
transactions that are reserved to the venture capitalists. The targeted voting rights are
typically framed as negative covenants, thus empowering venture capitalists to veto
certain transactions.
iv Conversion: The preferred stock issued in venture capital financings is almost always
convertible into C/S of the portfolio company. Optional conversion provisions allow the
venture capitalists to convert at their discretion, usually when the company is a party to
a merger or acquisition and the proceeds to common S/Hs are more attractive than the
liquidation preference. Optional and automatic conversion provide the entrepreneur with
incentives to create a successful company and preclude actions that would
disadvantage the venture capitalist. The conversion rate is one of the most important
features of these securities because venture capital investments are structures to result
in conversion if the company executes an IPO. These provisions are usually called
“mandatory conversion.”
v Redemption: “redemption” is a general term that covers several different provisions.
These provisions are united by the fact that each involves the repurchase of shares by
the company for an amount specified in the contract. Venture capital contracts often
contain provisions giving the venture capitalists an option to force the
repurchase of their shares. Such an option, commonly known as a “put”, usually
takes effect only after the passage of several years from the date of the investment, and
the redemption price is often the same as the original issue price, though it may contain
a small premium. Venture capital agreements sometimes—though rarely—give the
company the right to redeem the shares owned by the venture capitalists. Such a
provision—known as a “call”—allows the entrepreneur to exit, presuming that it is
able to muster the necessary funds. Because call provisions would allow entrepreneurs
to redeem the venture capitalists’ shares when the company is very successful, venture
capitalists typically will not enter into investments that contain a call provision.
vi Rights of First Refusal: The rights of first refusal granted to venture capitalists are a
crucial control mechanism when used in conjunction with staged financing.
B A good business planning attorney would use the following tools:
i Shareholder agreements. Not every arrangement among shareholders is a
Shareholder Agreement. A Shareholder Agreement does more, and it is outlined in
Model Act 7.32. Shareholder agreements can say who is going to be an officer, etc.
Looking at 7.32, be aware that a typical shareholder agreement needs to be put into
a charter, notice of it has to be in a stock certificate for shareholders. The model
act limits these to 10 years unless otherwise set.
ii Transfer restrictions of shares. Maybe one corporation was formed by two
individuals. They don’t want the number of shareholders to rise to a certain level where
they might be subject to securities regulations or might have trouble being an S-Corp.
But they need to provide some way to transfer shares if someone wants out. And there
has to be notice here too. There is also a reasonableness test that is used here.
iii Voting Trusts – see above for “VOTING TRUSTS”
iv Classified Shares – Benchmark Capital. You give a S/H all of a class of shares and
then put in the charter that you need approval of this class for major transactions. They
can protect a shareholder
v Pre-emptive Rights – These allow a S/H to purchase pro-rata a certain amount of
future issues of stock to maintain their level of ownership
V CLOSE CORPORATIONS – MINORITY OPPRESSION
 The potential for conflict is acute when a S/H or group of S/Hs own a controlling interest
in the C. This situation raises the possibility of “MO”. Courts have consistently held that
the will of the majority governs business Cs in all actions within the bounds of the
corporate charter. Nevertheless, courts are cognizant of the possibility that majority rule
will elad to unfair results for minority S/Hs.
1 OUTLINE FOR THIS SECTION
A What should the law do to protect the minority S/H against harm imposed by the
Majority S/H
i This differs among states, but the consensus is that some actions is necessary
B Examination of various possible remedies for MINORITY OPPRESSION
i Ex – Dissolution; buyout; etc
C Possible meaning of “OPPRESSION” and whether different definitions produce
disparate results
2 WHAT SHOULD THE LAW DO TO PROTECT THE MINORITY AGAINST THE MAJORITY?
A FIDUCIARY DUTIES – Close Cs are also bound by FDs. These vary. There are different
kinds of fiduciaries – someone who is charged with a duty of putting others interests ahead
of their own. When you are presented with a question of FD, ask to WHOM you owe a FD
and what does that FD entail. Just saying that there are FDs is not going to be enough to
answer a question of FD
B MINORITY OPPRESSION & THE LACK THEREOF
i DE – Courts do NO believe in “MO”. This is b/c when entering into a minority S/H
situation you can bargain for protection. DE courts are not very sympathetic in these
cases
ii Mass – Mass. Courts have adopted a heightened standard of FD in the case of closely
held Cs.
a DONOHUE Standard – Majority S/H in a Close C owe each other a heightened FD
of “UTMOST GOOD FAITH AND LOYALTY”
b When the majority S/H does something and the minority challenges it: WILKES
TEST
(i) Majority S/H will have to show: A LEGITIMATE BUSINESS PURPOSE – must
have a legit business purpose to the action taken
(ii) Minority S/H burden: A LESS HARMFUL ALTERNATIVE – One that would get
everyone to the same place w/o having to harm the minority so much
(iii)COURTS: The courts will weigh the business purpose with the alternative
iii MASS. v. DE
a Nixon v. Blackwell (DE case) – responded to the Mass. decision in DONOHUE by
saying that minority S/H could bargain for protection before buying into be a Minority
S/H. They can use the tools provided for their protection and they are not willing to
create ad-hoc rules
C LESLIE v. BOSTON SOFTWARE – Plaintiff here is the frozen-out minority shareholder in
a closely-held corporation. The shares are pretty evenly distributed, with each of the
founding partners, K, G, and L owning approximately 1/3 of the stock. Here, K & G have
banded together to remove L from the business based on disagreements over
compensation, customer complaints, and complaints from co-workers. L sued, claiming that
he is not receiving distributions as he should, and that K & G are mismanaging the
corporation.
i ANALYSIS
a Minority S/Hs have a hard time cashing out b/c there is no ready market for the
shares. Courts will protect S/Hs from situations where they cannot economically
benefit from stock ownership because of oppression.
b DONOHUE TEST – this wasn’t meant to impose upon Close-C’s S/Hs a strict
rule of duty when there’s a legitimate business purpose
 (i) You must ask if there was a LEGITIMATE BUSINESS PURPOSE
(ii) Is there a LESS HARMFUL ALTERNATIVE
c WILKES STANDARD – The FD rule imposes doesn’t limit “legit action by the
controlling group in a close C” that is taken to manage the C in the best interests of
all concerned”
ii AS APPLIED TO THIS CASE
a The WILKES standard applies and L is owed the duty of utmost good faith and fail
dealing (as a founder and 1/3 S/H).
(i) The court acknowledged that with an ordinary EE, the termination would have
been justified, but since he is an owner, K & G did not act with utmost good faith
b LEGIT BUSINESS PURPOSE
(i) There were a lot of good business reasons to fire L. He was hard to work with
and kind of threatened K and G.
c LESS HARMFUL ALATERNATIVE
(i) Even though the majority demonstrated good business purpose, the minority S/H
can show that there is a less harmful alternative – What the court actually did is
use its own powers to come up with their own less harmful alternative. It
provides this odd list of things.
d RESULT – The court gives L more than what he was entitled to; they do NOT give
him his job back b/c the situation was just so tense. Since he lost his job, his
severance should be X. He gets distributions that were essentially a dividend that K
and G received. He is reinstated into the BOD
(i) NOTE – here, there no “good” decision. Court has given itself a whole lot
of power to restructure the board. L could have looked out for himself a bit
better.
3 POSSIBLE REMEDIES FOR MINORITY OPPRESSION
 In minority S/H cases, the court is willing to get very deep into the working and facts of
the case – but this is only really true for closely-held Cs. The courts give much greater
deference to the working of Public Corporations.
A Remedies for MO – There are THREE general types of remedies that are available for a
disgruntled minority owner of a closely held corporation
i BUYOUT – The most common alternative remedy is the buyout, which is now available
in about half of the states. Courts have become increasingly willing to use buyouts as a
relief, even if it is not provided by statute.
ii DISSOLUTION – Many modern statutes provide for judicial dissolution based on
“oppressive conduct” by the majority S/H. Legislatures have also provided additional
remedies as alternative to dissolution
a SEE MBCA 14.30 FOR JUDICIAL DISSOLUTION (UNDER “DEADLOCK”)
b MBCA 14.34 – Permits C or the S/Hs to purchase the shares of a S/H petitioning for
dissolution.
(i) Purpose of this is to eradicate deadlock and prevent strategic use of
judicial dissolution
iii CUSTODIAN/RECEIVER – Many statutes now authorize appointment of a custodian or
provisional director.
(i) MBCA 14.32 – Eradicates deadlock and allows the court to appoint a receiver or
custodian to the C.
(a) The receiver is responsible for winding up and liquidating the C.
(b) The custodian manages the C and is responsible largely for staying the
course.
iv OTHER ALTERNATIVES (PROVIDED BY STATUTES)
a Cancelling/Altering the charter/bylaws or a corporate resolution
b Directing/Prohibiting any act of the C/SH/Directors/Officers, etc
 c Selling all property of the C to a single purchaser
d Dividends or Damages
e Some statues give the court to empower any equitable relief deemed appropriate
plight
B NAITO v. NAITO – H (founder; deceased) established a business with h8is two sons, S
and B (Each 50% holder of voting stock). To build the C and avoid taxes, very little was
distributed in benefits and dividends, making employment with the C (which family
members were all but guaranteed) the only way to achieve benefits. B took higher risks
and enjoyed the spotlight, which Sam’s family felt B was trying to dominate S. After B died,
the B/S agreement allows S to purchase 5 shares of voting stock (which gives S a
majority). Largely at issue was the fate of the 3rd generation, which had recently become of
employment age. S shut out the 3rd generation on the other side by refusing them
employment or giving them limited roles and paying them lower salaries. S also paid B’s
widow a less than expected pension while giving the 3rd generation on his side a larger role
in running the business. Finally, S’ puppet BOD refused dividends despite the large profits,
thus causing financial hardship on the other S/Hs.
i ANALYSIS
a Majority or controlling S/Hs owe FDs of loyalty, good faith, fair dealing, and full
disclosure to the minority, and violation of this is likely to be deemed oppressive.
b A finding of breach of FD is more of an “attitude” (i.e. sense of injustice) than a well
defined rule.
c Where it is difficult to make a distinction b/w the BOD and the controlling S/H, the
court may properly consider the S/H as oppressive even if the BOD approved the
conduct
d RULE re: DIVIDEND REMEDIES – in order to rectify “MO” based on the failure to
pay dividends, the plan to remedy the situation need not be extraordinarily specific,
such as stipulating specific dividend amounts, but must solely require the C to adopt
a plan that will improve the amount of equity being distributed
ii AS APPLIED TO THIS CASE
a The court is at first hesitant to find a breach of duty b/c S and B did in fact agree to
the B/S agreement which gave S control (i.e. the Pfs were shut out b/c of the B/S
agreement, NOT b/c of oppression).
b The court seems to feels as though the other family brought this upon themselves,
and much of what S did can be viewed as an appropriate response to practical
problems rather than as oppression.
c RESULT – However, the court concluded:
(i) The business was making plenty of $ and should be declaring some dividends;
AND
(ii) The repurchase offer was not a good faith effort to provide reasonable
distribution
NOTE – in light of these two conclusions, the court feels as though the minority
has been deprived of ownership (which is oppressive). For these reasons, there
was a breach of FD
(iii)REMEDY – Trial court went too far in stipulating a specific amount to be paid as
a dividend. The Supreme Court instead is satisfied with the dividend policy the C
adopted after the lawsuit (which was a significant improvement). It mandates
that the C continue for 5 years the policy it adopted to make more
REASONABLE DIVIDEND PAYMENTS
4 THE MEANING[S] OF MINORITY OPPRESSION
 Generally, “oppression” is not defined by the modern state corporate law statutes, thus
leaving the task to the courts
A COMMON DEFINITIONS
 i Burdensome, harsh, and wrongful conduct that is a visible departure from standards of
fair dealing
ii A breach of duty of fair dealing, which is enhanced in the close corporation setting
iii Frustration of the reasonable expectations of the minority S/H
iv SPLIT IN THE COURTS re ANALYSIS OF “MO”
a A REASONABLE EXPECTATIONS approach (OFTEN PRESENT IN STATUTES)
views the problem SUBJECTIVELY from the minority S/H’s perspective (and
considers his expectations in light of the treatment he is currently facing)
b The BURDENSOM, HARSH, AND WRONGFUL CONDUCT focuses on the actions
of the majority S/H in an OBJECTIVE manner in order to determine whether such
conduct was actually unreasonable or malicious
B KIRIAKIDES v. ATLAS FOOD - Alex is the majority shareholder and his brother and sister,
John and Louise, are in the minority. Although both bothers were on the board, Alex made
many important decisions without consulting John, sometimes doing the exact opposite as
what they agreed to. Alex seems to have tricked John into selling some of his property at
lower than market value and also removed John from his position as President.
i ANALYSIS
a When the “reasonable expectations” approach is NOT necessitated by statute, a
court may determine to use another method of balancing the expectations of the
moving party with the objective analysis of the majority’s conduct
ii AS APPLIED TO THIS CASE
a The court endorses a totality of the circumstances approach
(i) The court looks to the statute and concludes that the words “OPPRESSIVE” and
“UNFAIRLY PREJUDICIAL” are elastic terms whose meaning varies with the
circumstances presented in a particular case.
(a) FACT SENSITIVE ANALYSIS
(ii) FACTORS COURT LOOKS AT
(a) Deprivation of Ownership
(b) Deprivation of Dividends
(c) No prospects of benefits of owning stock
(d) Lack of an open market to unload the shares
(e) The extremely low buyout offer by Alex
(iii) John was deprived of economic benefit of owning stock in the C while the
majority were still netting economically.
b RESULT – The court arrives at the conclusion that there should be a buyout where
the parties settle upon a value of the shares. Court thinks the buyout is the fairest
way of dealing with this and encourages the parties to negotiate a buyout settlement.
VI PUBLICLY HELD FIRMS: SEPARATION OF OWNERSHIP AND CONTROL
 One of the defining features of a Public-C is the separation of S/H ownership from
effective control – that is, while S/Hs are understood by many to be the owners of the C,
their powers of control over the C are limited compared to other types of ownership
o Even where S/Hs have power – for example, the power to elect directors – that
power is relative:
 In the overwhelming majority of cases, S/Hs react to the nominees
presented by managers rather than bringing forth their own nominees.
 Managers of large Public-Cs have the power to make almost all of the decisions in the
C, and centralized power is necessary if anything at all is to be accomplished on a daily
basis.
o But what ensures that managers are making decisions that are in the C’s or S/H’s
best interest? Among some mechanisms….
  BOD – there still exist conflicts b/w aligning all these interests. The BOD
might be friends with the CEO or might just do all that the CEO wants since
the BOD might just be interested in the BOD salary while only working 4
days a month
 STOCK OPTIONS – compensate the executives with stock in the C so that
they have an incentive to increase its value
1 SHAREHOLDER VOTING
A GENERALLY
i State Corporate Law generally identifies the types of issues on which S/Hs may or must
vote. For public Cs, federal law sets out the procedures by which voting occurs and
explains what info must be provided to S/Hs prior to their votes
a STATE LAW – Common S/Hs have a number of voting rights, including. . .
(i) The right to determine who will be on the BOD
(ii) The right to vote on fundamental transactions
(iii) The right to vote on amendments to the charter or the bylaws; AND
(iv) The right to vote on S/H proposals
b PROXY PROCESS – Process by which voting occurs in a Public C
(i) PROXY – authority given by one S/H to another to vote their shares
(a) Most often, proxies are successfully sought by incumbent mgt, which means
that mgt has the right to cast most S/H’s votes! Yes, Fed Sec Law require
disclosure of how the shares will be voted
(ii) FED SECURITIES LAWS – require that when management solicits proxies that
they indicate to the S/Hs EXACTLY how their shares will be voted
ii CORPORATE ACTIVISM – the last decade has seen a dramatic increase in corporate
governance activism by large S/Hs
B UNISUPER v. NEWS CORP – C was facing a hostile takeover (t/o) and instituted a poison
pill policy that could be extended by a vote of the S/Hs. The S/Hs bargained for a board
policy – most of the stipulations made it into the charter, except the part of the poison pill
(although it was part of the agreement regardless) In this case, the institutional investors
(S/Hs) gave one extension, but were then going to be enticed by a good offer that was
going to be made by a third party. The S/Hs had to approve any further extension of the
poison pill. The BOD extended the poison pill w/o S/H approval, claiming that DGCL
141(a) required any limitation of board power to be stipulated in the articles.
i ANALYSIS
a DGCL 141(a) – precludes a BOD from ceding managerial power to outside groups
or individuals, but it DOES NOT PRECLUDE BOD FROM ENTERING INTO A K.
(i) If the BOD enters into a K to keep in place a policy that others rely upon (like the
S/Hs) to their detriment, it is enforceable regardless if it is typically revocable
(ii) If BOD has power to adopt policies it MUST follow that they have the POWER
TO RESCIND, but a contract changes things
b S/Hs are not an “outside group” and since BOD’s power comes from its S/Hs, as
long as it doesn’t grant this power to a group of S/Hs but the S/Hs at large, the BOD
must give way – when S/Hs exercise right to vote in order to assert control over the
business and affairs of the C the BOD must give way
c Synthesis – BOD’s power is never unlimited and always constrained by a FD to its
S/Hs, so giving S/Hs more is not as bad as outsourcing to someone else the BOD’s
discretion.
ii AS APPLIED TO THIS CASE
a BOD asserts that DGCL 141(a) precludes the grant of power that was given to the
S/Hs in this case – BOD adopts the provisions in the charter and then a year later
“un-adopts” it to extend the poison pill. Court agrees that BOD cannot cede its
 power out, but in this case the power was ceded to its S/Hs. BOD made a K with all
the S/Hs, and the statute does not preclude the BOD from entering into Ks with the
S/Hs at large
b RESULT – Pfs adequately made a breach of contract claim and now must prove the
contents of the K (that the Board Policy was irrevocable)
C BLASIUS – B bought 9.1% of C and incurred a lot of debt by doing so. They proposed a
restructuring to BOD of C that would include C incurring a lot of debt to pay a dividend to
S/Hs of C. B would receive a whole lot of $ from this as a major S/H; B’s motivation for this
is that it incurred very expensive debt in the purchase of a 9.1% interest in C and needed to
make debt pmts quickly. BOD shot it down. B, then, created a SHA to expand the number
of BOD seats from 7 to 15 and appointing 8 of their allies (thereby having a majority of the
BOD). B’s aim was to change the by-laws that had a top limit on seats on the BOD – a
50.1% S/H vote would change the bylaws. C reacted by adding 2 members to the BOD
whereby B would not have a majority.
i ANALYSIS
a GOOD FAITH RULE (Deferential Business Judgment Rule)
(i) It is established in DE Corporate law that a BOD may take certain steps – such
as the purchase by C of its own stock – that have the effect of defeating a
threatened change in corporate control, when those steps are taken advisedly, in
GOOD FAITH pursuit of a corporate interest, and are reasonable in relation to a
threat to legitimate corporate interests posed by the proposed change in control.
(a) RATIONAL – The reason that justifies those managers having such powers
over the resources of the C is b/c the S/Hs have that power as well. A reason
we allow managers to run Cs is b/c underpinning that is a S/H vote. The BOD
cannot be allowed to set themselves up as emperors over the S/Hs
(ii) When a BOD acts to thwart a S/H vote involves the question of who has authority
w/respect to a matter of internal governance
(a) Judicial review of such actions involves a determination of the legal and
equitable obligations of management towards its S/Hs, which MAY NOT be
left to the BJ or management (BOD CANNOT JUST DETERMINE ITS OWN
SET OF OBLIGATIONS TO IT’S THE S/Hs)
b COMPELLING JUSTIFICATION RULE – would strike down, in equity, any BOD
action taken solely to thwart a S/H vote -- BOD would have the burden of
demonstrating a compelling justification for such action
(i) If no compelling justification  courts intervene to protect “established principles
of corporate democracy”
ii AS APPLIES TO THIS CASE
a The S/H franchise is being undermined here, and this upsets the court.
b C could have made its best case to the S/Hs and persuaded them that B’s proposal
was a bad idea. What C did here is cut off that discussion to the S/Hs and the BOD
took it upon themselves to decide on behalf of the S/Hs. BOD violated the duty of
loyalty to S/Hs by thwarting the vote
c RESULT – unilaterally undermining S/H voting rights by increasing the board size,
and then filling the resulting vacancies, to nullify an insurgent’s pending consent
solicitation to place its nominees on the board is INAVLIDATED
2 FEDERAL PROXY RULES
 The SEC does not review whether a C should issue new securities, given its capital
structure, or even whether a C is at risk for not being able to pay on its bond
obligations. Rather, when SEC staff members review disclosure documents, they are
looking to see if the risks of an investment are adequately disclosed.
A MANDATORY DISCLOSURE – 2 GENERAL POINTS SHOULD BE EMPHASIZED
 i DISLCOSURE – For Public Cs, disclosure is a continuing thing. They are required at
fixed times throughout the year and in the occurrence of special event to update their
disclosure
a REASON – meant to provide mechanisms of accountability to the S/Hs that
Congress thought were lacking so that S/Hs would know what managers are doing
w/their C and could react accordingly – KEEP INVESTORS AND POTENTIAL
INVESTORS INFORMED AT ALL TIMES
ii CORPORATE GOVERNANCE DISCLOSURE
a Disclosure is required regarding who the managers and directors are and what their
financial compensation is from the C
b Information about significant conflicts of interest that might exist between the C and
its officers has to be disclosed as well.
B PROXY STATEMENT AND REGULATION
i PROXY STATEMENT – statement of disclosure provided to the S/H whenever the S/Hs
have the right to vote and thus whenever the S/H proxy is being solicited
a Proxy statement must be provided directly to the S/Hs whenever the S/Hs have the
right to vote and thus whenever the S/H’s proxy is being solicited.
b The proxy solicitation process in a public corporation is the voting process -
Regulatory activity aims at the accuracy and comprehensiveness of the proxy
statement
c Federal Law – details what your proxy is going to look like. It must say how the
S/Hs vote will be voted if the S/H does not say how it should be voted. Federal law
requires that the S/h be allowed to share S/H proposals to other S/Hs though the
proxy process
(i) Applies to any Public Reporting C (any C that lists their stock on a n exchange
and any C with assets exceeding $10m and with more than 750 S/Hs.
(ii) 14(a) of the 1934 Act – applies only to S/H communications that are defined as
“proxy solicitations.” Only communications seeking voting authority are regulated
under this section.
ii PROXY SOLICITATION – Federal Proxy rules apply only to proxy solicitations – which
usually occurs in preparation of the annual meeting and/or in the even of something
extraordinary – each item on the agenda has to be accurately described
a DEFINITION OF “SOLICITATION” - SEC RULE 14a-1(1) defines it to include:
(i) The informational document accompanying the proxy card
(ii) Request To Sign – any request for a proxy even if a proxy card does not
accompany it
(iii)Request NOT to Sign – Any request to not sign or to revoke a proxy; AND
(iv) The Sly – any other communication “under circumstances reasonably
calculated to result in “S/Hs signing, not signing, or revoking a proxy”
b DEFINITION OF “PROXY” – SEC defined “proxy” very broadly to include any action
that gives or withholds authority concerning issues on which S/Hs may decide
iii LIABILITY FOR MISLEADING PROXY DISCLOSURE
a RULE 14a-9 (SEC) – it renders a C liable for false statements of material facts in its
proxy statements. Must determine whether the misstatement or omission was a
“material fact”.
(i) “Material Facts” – means “a reasonable S/H would consider important in
deciding how to vote” – generally, financial facts concerning the value of
securities or the value of a transaction are material
(ii) Provides an Implied Private Right of Action for the S/H for violations
C LONG ISLAND LIGHTING – Long Island is a public utility company. Dfs published
advertisements that accused LI of mismanagement and of attempting to pass through to
rate-payers needless costs relating to the construction of a nuclear power plant. Claiming a
 federal violation of proxy regulations, LI asked for an injunction prohibiting the Dfs from
soliciting proxies until they make appropriate filings with the SEC and correct the false and
misleading advertisements.
i ANALYSIS
a Chain of Communications Theory – a newspaper ad could be a proxy solicitation
if motivated to advance a pending S/H insurgency.
(i) Was it reasonably calculated to influence the S/H’s votes?
(a) Determine whether the challenged communication, see in the totality of the
circumstances, is “REASONABLY CALCULATED” to influence the S/H’s
votes – if it is, it can be seen as a “solicitation” under the proxy rules
even though it did not mention proxies
(b) Deciding whether a communication is a proxy solicitation does not depend
upon whether it is “targeted directly” at S/Hs.
(c) Determination of the purpose of the communication depends upon the nature
of the communication and the circumstances under which it was distributing.
ii AS APPLIED TO THIS CASE
a “The extent to which the activities of the Dfs amount to a solicitation of the proxies of
S/Hs of LILCO may determine whether or not their actions are protected by the 1st
amendment.”
b RESULT – There is a 1st amendment issues at play and the court remands
iii LEGISLATIVE RESPONSE – The SEC amended its proxy rules to allow more
communications among S/Hs free of a need to distribute a written proxy statement.
a The Allowed Communications are for situations in which a person simply wants to
communicate about a matter of corporate governance or about proposals on the
agenda without seeking proxy authority
b The Amendments are Intended to allow large institutional S/Hs to communicate
more freely among themselves about corporate performance and about the quality
of management
3 SHAREHOLDER PROPOSALS
 Generally, one of the few proactive powers that S/Hs exercise in a Public-C is the power
to propose “S/H Resolutions” for action at the annual S/H’s meeting, and to require the
company to include those resolutions in the C’s proxy statement.
 If a particular group of S/Hs want to imitate a change to the bylaws, for instance, or
suggest that the BOD study a particular issue, the S/Hs would send a “S/H’s
Resolution” and a 500 word supporting statement to the C well in advance of the
meeting and ask the C to include the result and the supporting statement in the proxy
statement
 Some of these proposals are social activist proposals and others are considered
Corporate Governance proposals. Both are growing in popularity and success, and
they are usually brought by institutional investors
A HOW S/Hs GET HEARD
i They select a slate of Board Members
ii They can get the By-Laws changed
iii They can also launch an insurgent campaign
a C can decide to include the campaign in its proxy to S/Hs, but if they decide not to
then S/Hs can use Rule 14a-7
b R14a-7 – S/Hs have the right to access the S/H list and mail its proposal out
separately, but this is expensive, so it is not a realistic option in most cases
B GETTING THE S/H PROPOSAL ON THE PROXY (PROCEDURAL REQM’TS)
i RULE 14a-8 – allows a S/H to include proposals in the proxy statement (14a-7 is the
back up) if you meeting the PROCEDURAL REQUIREMENTS:
 a OWNERSHIP - $2,000 of C’s stock OR 1% of Shares Outstanding (whatever is less)
b DEALINE – S/H must send the proposal 120 days from when the proxy is sent; AND
c EXCLUSION – The proposal must NOT fall within the 13 reasons set out in 14a-
8(i),Q9 (SEE PAGE 463-64 OF BOOK FOR THE REASONS)
ii PROCESS – at the end of the day, the C decides if it is appropriate to include the
proposal in the proxy. C can exclude the proposal it has a “GOOD REASON” not to
include it, such as:
a Illegality of proposal – such as ordering the BOD to do anything (S/H cannot dictate
to the BOD to do anything)
b De Minimus Requirement – must have to do with at least 5% of the C unless it raises
significant social policies
c Cant relate to ordinary business functions
d Cant relate to personal grievances
iii NO ACTION LETTERS – A company will write to the appropriate office in the SEC,
describe an action it seeks to take (such as not including a shareholder activist’s
proposal in its proxy materials), and explain to the SEC its rationale for why the
company believes such an action is proper under the applicable securities law, rules,
and regulations.
a If the SEC staff member who handles the letter agrees with the company’s rationale,
he or she will write back that he will recommend no enforcement action against the
corporation. No-action letters are technically not precedents on which parties can
rely.
iv APACHE CASE – NY Pension Funds sent a “S/H Proposal” to be included in C’s proxy
statement under R14a-8. C denied it and filed a “No-Action Letter” to the SEC. The
SEC advised them that they would not pursue any kind of action if C decided to exclude
the proposal from the proxy statement – SEC okays it under the “ordinary business rule”
under R14a-8(i)(7). NY Pension Funds take it to court. (The thing Pf wanted to change
was the hiring practice of the C in that they sexually discriminated)
a ANALYSIS
(i) A No-Action letter is an informal response and does not amount to an official
statement of the SEC’s views. They are interpretive and not binding law.
(ii) R14a-8 proposals that meet the requirements must be included in the proxy
statement. If it fits the exceptions in 14a-8(i), C can exclude.
(a) 14a-8(j) – requires that before exclusion, C file its reasons w/the SEC along
w/the exception
(iii)14a-8(i)(7) - ORDINARY BUSINESS OPERATIONS RULE
(a) A proposal that does not concern a significant policy issue (for, if it did, it
wouldn’t be “ordinary business) but nevertheless implicates the ordinary
business operations of a C is properly excluded.
(b) EXCEPTIONS TO THIS RULE
1. SIGNIFICANT POLICY ISSUES (MUST NOT MICRO-MANAGE)
i. A proposal concerning the ordinary business operations of a C that
implicates a significant policy issue is ONLY excludable under that
section if it seeks to MICRO-MANAGE the C by probing too deeply into
matters of a complex nature upon which S/Hs, as a group, would not
be in a position to make an informed judgment. (social policy issues
can trump ordinary business operations)
b AS APPLIED TO THIS CASE
(i) In this case, advertising and the sale of goods are ordinary business matters and,
because the proposal has to be read as a whole, the proposal is properly
excludable as a result of its provisions concerning marketing and sales.
 (ii) RESULT – The court reasoned that S/Hs, as a group, are not positioned to make
informed judgments as to the propriety of certain sales and purchases
(iii)NOTE – The proposal was poorly drafted. They included many principles and a
couple of them dealt with too many ordinary business functions. The court
worries about S/H Micro-Management
C BYLAW RESOLUTIONS – S/Hs can sometimes initiate corporate change by amending the
bylaws. However, it is a difficult issue. Even though the S/Hs can vote to amend the
bylaws, ONLY the directors can propose the amendments to the bylaws. How is this
process carried out? S/H proposals can affect bylaw amendments and proxy contests
allow S/Hs to put directors in power who will push through their prerogatives. If the
proposal merely discusses processes for the future (e.g. cumulative voting, director
qualifications, majority vote for a director election) and does not create an
immediately contested election, then it is allowable.
i CA v. AFSCME – AFSCME submitted a proposed stockholder bylaw for inclusion in the
Company’s proxy materials for its 2008 annual meeting of stockholders. The bylaw, if
adopted by CA’s shareholders, would amend the company’s bylaws to provide for
reimbursement of expenses incurred in connection with nominating candidates to the
board of directors. This raised two issues: (1) is the proposal a proper subject for action
by shareholders as a matter of law? (2) Would the proposal, if adopted, cause CA to
violate any law to which it is subject?
a ANALYSIS
(i) S/Hs have the power to adopt, amend, and repeal the bylaws (MBCA 10.20;
DGCL 109) – BOD has this power if in the AOI
(ii) SCOPE OF S/H POWER TO AMEND BYLAWS
(a) The power of S/Hs to amend the bylaws under DGCL 109(a) must be
consistent with the power of the board to manage the corporation under
DGCL 141(a)
(b) DE Court also states that the proposed bylaw related to the process of
director elections is a proper subject for S/H action under DE law:
1. “Although bylaws may not mandate how the BOD should decide specific
substantive business decisions, they may define the process and
procedures by which those decisions are made”
b AS APPLIED TO THIS CASE
(i) The court finds a distinction b/w bylaw amendments which impact process (which
are things S/Hs are permitted to change) and those that impact substantive
business decisions (which the court says S/Hs are not allowed to change).
(ii) RESULT – The court finds AFSCME’s proposal is procedural, and therefore
allowed. However, AFSCME fails the second prong. The court concludes that
the bylaw would violate the prohibition against contractual arrangements that
commit the BOD to a course of action that would preclude them from fully
discharging their fiduciary duties to the C and its S/Hs.
(a) The court ponders a situation where a proxy contest is motivated by personal
or petty concerns that fail to further C’s interest, and the BOD’s FD to deny
the reimbursement could not be fulfilled due to the bylaw’s reqm’t to
reimburse
(b) NOTE – it probably would have been valid if the BOD was vested with
the ability to DENY reimbursement if required by the Director’s FDs.
D SEC’S ADOPTION OF TWO PROPOSALS LAST YEAR
i Say On Pay – has to do with executive compensation (are executives getting paid too
much?) Dodd Frank and the SEC implemented a new rule that says that every 3 years
S/Hs get a vote in the compensation arrangements in C’s top executives. (this is a very
passive voice thing; it has no real force)
 Rule 14a-11 – S/H Nominations – S/Hs can nominate BOD members and have them
ii
included on the proxy statement. This is not a chance for small S/Hs to have
themselves included as a nominee on the C’s proxy statement.
a REQM’TS
(i) 3 & 3 Rule – if you meet the 3% floor and have owned those shares for 3 years,
then you will be able to nominate members and have them included on the ballot.
(ii) Limitation – the most you can nominate is up to 25% of the BOD (thus, you
cannot get a majority this way)
4 ENRON & SOX
A Composition of Audit Committee: Every public company must have an audit committee
comprised exclusively of independent directors responsible for hiring the auditors and
supervising their work.
i Being “independent” is defined as: “not having any affiliation with the audited
company other than as a board member and not receiving any business income or
consulting fees from the audited company other than income related to being a board
and committee member.
ii SOX also directed the SEC to promulgate rules to require disclosure of whether the
audit committee has at least one financial expert, and if not, why not. This is important
because it is the first really big intrusion into matters traditionally left to the states. See
SOX § 301 and § 407.
B CEO Certification: Requires CEOs and CFOs of reporting companies to personally certify
the accuracy of their company’s financial statements, and that they have evaluated the
effectiveness of their internal financial controls and have confidence in them. See SOX
§302.
i Internal control assessment must occur regularly, and this amounts to additional
company costs of $4mm to $4.5mm (prohibitively expensive in some cases). If they are
knowingly or willfully wrong, the penalty is prison. This circumvents the duty of care by
getting around exculpation, insurance, and indemnification. See SOX § 404.
C Restatement of Financial Results: If the financial results have to be restated due to
misconduct, the CEO and CFO have to reimburse the corporation for any bonus or
incentive based compensation earned during a 12-month period after the issuance of the
financial statements to be restated. See SOX § 304(a).
D Conflict of Interest Transactions: SOX prohibits public reporting companies from
extending credit or arranging for the extending of credit, directly or indirectly, for personal
loans for executive officers or directors. See SOX § 402.
E Attorney Responsibility: Section 307 of SOX requires the SEC to “develop minimum
standards of professional conduct for attorneys appearing before or practicing
before the Commission through their representation in any way.”
i SEC promulgated Rule 205, which requires “up the ladder” reporting. Also permits,
but does not require lawyers to disclose confidential client information to the SEC to
prevent a client from committing a material violation that is likely to cause substantial
injury to the financial interests of the issuer or investors.
F Public Company Accounting Oversight Board: Established to regulate the accounting
profession. It is a non-profit organization subject to oversight by the SEC which has
authority to establish rules for audits, and the power to adopt standards suggested by
professional organizations.
G Extension of Credit to Officers: Loans and extensions of credit from the corporation may
no longer be made to officers. This basically obliterates DGCL § 411’s creation of an ability
to do so by the corporation.
H Auditor Independence: Basically, SOX prohibits auditing firms from providing non-
audit services (e.g., financial advice) so that they would have a great degree of
independence. They may still provide tax-consulting services though.
 I Code of Ethics: The reporting corporation has to state whether or not they have a code of
ethics for senior financial officers, and if not, why not.
J Officer’s and Directors’ Removal: Expands the SEC’s ability to seek removal and ban
from similar positions due to unfitness.
K Lawyer’s Responsibilities: SOX directed the SEC to adopt rules requiring attorneys who
appear before it to report “evidence” of securities laws violations, breaches of
fiduciary duty, and similar misconduct to a reporting company’s chief legal counsel
or CEO, and if they officers fail to act appropriately to the board’s audit committee, its
independent directors, or the board as a whole. See SOX § 307.
L Real Time Disclosure: Companies must disclose material changes on a rapid and current
basis. Off-balance sheet transactions must also be disclosed. Requires disclosure of all
material off-balance sheet transactions
M Other noteworthy provisions include: (1) whistleblower protection; (2) securities
analysts’ independents; AND (3) enhanced criminal penalties for violations.
VII FIDUCIARY DUTIES: DUTY OF CARE
 Generally, though usually not treated as agents in a legal sense, corporate directors
often are viewed as “agents” in the economic sense. That is, directors do not serve their
own interest, but rather the interests of “principal”. It is not clear this principal is the S/Hs
or the C or both. Like legal agents, directors owe various duties is the duty of care. The
analysis in DE and the MBCA states is similar, and MBCA JDXs often cite DE case law
1 BUSINESS JUDGMENT RULE AND DIRECTORS’ DUTY OF CARE
 In DE, the Duty of Care is judge-made and is NOT codified. Over the past 2 decades,
many states have adopted provisions similar to the MBCA (MBCA 8.30-.31).
A DUTY OF CARE – Generally, a person who undertakes an action that places others at risk
of injury is under a duty to act carefully and is liable for the failure to do so (IN THE TORT
LAW SENSE). In the corporate context, the DOC generally asks whether directors have
made decisions that injury the corporation
 Directors must act w/the honest belief that their decisions are good for the S/Hs
 The directors must also act in accordance with the duty of loyalty, and to some
extent post-DISNEY, the duty of good faith
i REQM’TS re: DOC – The DOC requires that each member of the BOD, when
discharging the duties of a director, act:
a In GOOD FAITH (especially post-DISNEY); AND
b In a manner the director reasonably believes to be in the best interests of the C
(MBCA 8.30(a))
B BUSINESS JUDGMENT RULE (BJR)
 The potential liability risk from a breach of this duty of care is near zero in the
corporate context, however, b/c of a powerful effect of the BJR (see GAGLIARDI)
 BJR conceptually – an officer who makes a mistake in judgment as to economic
conditions, consumer tastes or production line efficiency will rarely be found liable
for damages suffered by the C
 JUSTIFICATION – limits judicial interference in areas where judges are not
experts and encourages directors to serve by limiting the exposure to liability
i Business Judgment Rule
a Provides a presumption that directors have acted:
(i) In an informed manner:
(ii) With a rational business purpose;
(iii)In good faith; and
(iv) In the best interest of the C (without personal interest)
b MBCA 8.30(b) – Standards of Conduct – “behave as a person in a like position
would reasonably behave”
 c MBCA 8.31 – Standards of Liability – you have to show that the action taken was
NOT in good faith and was NOT something that the director knew was NOT
reasonable. This requires more than just a violation of the standard of conduct
(Disney – has to be more than bad faith; has to be gross negligence)
ii OVERCOMING THE BJR – To get past the BJR, Pf would have to show that the
director acted with GROSS NEGLIGENCE
a Gross Negligence – this applies to gross negligence in “process”, as in Van
Gorkem (VG), rather than results – decision can be stupid decision as long as an
informed process was followed. Even then, there is the problem of exculpatory
clauses (i.e. DGCL 102(b)(7))
b DGCL 102(b)(7) – Even where DOC claims may prevail, directors (NOT OFFICERS)
can be exculpated with a DGCL 102(b)(7) clause, indemnification, or insurance so
long as there is no accompanying loyalty issue
c Generally – the circumstances under which courts become suspicious of BOD
decisions fall into two categories:
(i) When directors are subject to a conflict of interest w/respect to the challenged
decision, courts review the decision under the standards developed under DOL
(ii) When directors fail to gather requisite info to make the challenged decision,
courts review the decision under the “gross negligence” standard”
(iii) OTHER: Fraud and Illegality
iii GAGLIARDI v. TRIFOODS (ESSENCE OF THE BJR) – Pf sued on a theory of
negligent mismanagement of the C once he was ousted. The decisions complained of
involve the relocation of the business, the purchase of items well above their market
cost, the purchase of services well above cost, etc.
a ANALYSIS
(i) In the absence of facts showing self dealing or improper motive, a corporate
officer or director is not legally responsible to the C for losses that may be
suffered as a result of a decision an officer made or that directors authorized in
good faith
(ii) BJR – where a director is independent and disinterested, there can be no liability
for corporate loss, unless the facts are such that no person could possibly
authorize such a transaction if he or she were attempting in good faith to meet
their duty
(a) Rational – You want directors not to be averse to risk. Directors would be
hesitant to deviate from rational if they knew they could be held liable. There
a risk/return tradeoff. Conservative decisions do not always make for best
business decisions, but harbor stagnation. We want to avoid a chilling effect
b AS APPLIED TO THIS CASE
(i) The court ought not to interfere with the business judgment of the directors and
officers. It is only logical and beneficial that these folk be able to do their job
without risk of suit.
(ii) The fact that the decisions may have been bad decisions is legally unimportant
c NOTE – Chancellor Allen noted a theoretical exception to the BJR for
substantively egregious decisions, and we examine the law surrounding such
decisions under the theory of WASTE
2 WHAT IS THE DUTY OF CARE? (DOC AND DECISION MAKING)
 Although, as in Gagliardi, courts are hesitant to impose liability simply for making poor
business decisions, the court is more likely to find a violation of the DOC where
directors fail to gather the requisite information to make important decisions
 It is still very rare that the courts find these violations and still DGCL 102(b)(7) will
provide exculpation otherwise
A DUTY OF CARE
 i When you accuse a director of Breach of DOC, what you are going to focus on is
PROCESS. Courts are as clear as can be with this. A BOD can make stupid/bad
decisions so long as they follow and informed process
ii INFORMED PROCESS – TO GET YOUR DAY IN COURT
a Pf must argue that the process by which the directors obtained their info was
careless and grossly negligent (see VG)
B VAN GORKOM - This was a class action brought by TU shareholders requesting the
rescission of a cash-out merger into a new company. The CEO (VG) was nearing
retirement age, and got it in his head that a leveraged buyout would be a good idea. He
pulled the price out of thin air and took it upon himself to approach PZ, the potential buyer.
Senior mgt didn’t like this at all, thinking that the price was too low. The only evidence
supporting where he got the price from was the historic stock provided and his long
association with the company. He met with senior mgt, and then proposed the merger to
the BOD that afternoon, orally, in a 20 minute report. The BOD approved the merger w/o
time to review the copies of the proposed merger agreement, but the BOD did condition the
transaction on a public auction. VG renegotiated with PZ to amend the merger, but then the
BOD had approved the amendments, again w/o much time or info to base their decision
upon. The amendments were actually substantially different from what he had told the
BOD, but he approved them anyway.
i ANALYSIS
a Gagliardi tells us that bad decision making does not get the Pf his day in court
b To claim the BJR presumption a decision making context, directors must make
reasonable efforts to inform themselves in making ht decision.
(i) The focus is on procedure, and the courts assume diligent board deliberation
ensure rational board action.
(ii) Liability is generally based on concepts of gross negligence
(iii)MBCA 8.31(a)(2)9ii)(B) – director liable if not informed about decision to an
extent the director reasonably believed appropriate in the circumstances.
ii AS APPLIED TO THIS CASE
a The court held that the BJR did not protect the directors from liability in this case b/c
the decision was not informed. The directors were grossly negligent in that they
failed to act with informed reasonable deliberation in agreeing to the PZ merger.
(i) The BOD did not valuate the C to gauge the fairness of the offered price
(ii) There wasn’t really a market test to determine the price b/c of the agreements
with PZ which substantially limited TU’s ability to seek other offers.
(iii) The court finds it insufficient that the directors are smart and experienced if they
don’t actually have any corroborating evidence for their decision.
(iv) The BOD’s reliance on advice from VG’s lawyers was grossly negligent since
they didn’t have enough info
b Subsequent actions taken did not cure the deviation from the DOC
(i) The amendments to the merger that the BOD conditioned the agreement upon
were not really in favor of the C, as they only received one offer as a result of the
“Market Test” and VG rejected it offhand.
c The S/H vote to approve the merger was not a cleansing transaction b/c the BOD
violated their duty of disclosure and the S/H vote was not informed
d The court held that the BOD’s reliance upon the reports of VG were meaningless b/c
VG had not read the merger documents himself, and did not fully disclose his role in
the merger to the board.
iii RESULT – DE SC held that the BOD violated their DOC b/c they did not follow an
informed decision process. The directors made a decision w/o really knowing the
intrinsic value of the company
C AFTERMATH OF VAN GORKOM
 iIt was open season on directors. After VG, the advice that a lot of BODs received was
to follow process closely
ii DE ADOPTS DGCL 102(b)(7)
a Authorizes charter amendments shielding directors from personal liability for
breaching their duty of care. No personal liability for breaches of duty, but directors
remain liable for:
(i) Breach of the Duty of Loyalty
(ii) Acts or omissions not in good faith or that involve intentional misconduct or
knowing illegality,
3 DUTY OF CARE AND OVERSIGHT
A DUTY OF CARE
i It is primarily a procedural requirement – a duty to make lawful decision in a well
informed, careful manner (VG)
ii DOC is also a duty to be informed about what is happening within the corporation (i.e.
oversight)
B OVERSIGHT
i Duty of oversight – Court says that there is a duty to have some from of info gathering
system. Now, the BOD is responsible for making sure that the C has info reporting
systems. Duty of oversight is they duty to have an info reporting system in place that
will keep BOD informed about what is going on with the C.
ii Standard of Liability – the only way you can be found liable will be with a finding of a
sustained or systematic failure of the BOD to exercise oversight (such as the utter
failure to get info) such that the BOD breached their duty of good faith (good faith
discussed in Disney)
iii Generally – In some situation where the entire board is accused of failing to act, the
BJR is not available. BJR only protects “judgments” and DNA when the board has NOT
taken any action (unless inaction was an affirmative informed decision)
a Caremark Claims – these involve situations in which a board is accused of failing to
act in instances of corporate wrong doing that the board is accused of failing to
detect, prevent, or stop.
b Oversight cases generally arise where EEs of the C have engaged in illegal activity
and the C is ultimately forced to pay large judgments to the government or 3rd
parties. Derivative Pfs claim that directors breached their DOC by failing to
implement an effect law compliance system
iv CAREMARK – C was involved in some transaction where they would pay physicians for
referrals of patients involving Medicare/Medicaid. There was some question as to the
legality of this in that no one knew if this violated the Anti Referral Payment Laws. BOD
was advised by experts that it was most likely okay. C still publicly stated that the
legality of it all was still questionable. S/Hs do not claim affirmative illegal acts on behalf
of the BOD, but claim that there was insufficient oversight on behalf of the BOD. They
say that the BOD should have known that something was going on.
a ANALYSIS
(i) Absent grounds to suspect deception, neither corporate boards nor senior
officers can be charged w/wrongdoing simply for assuming the integrity of EEs
and the honesty of their dealing on the C’s behalf
(a) BASIS FOR THIS VIEW
1. DE cases emphasize the importance w/which Corporation law views the
role of the BOD
2. Adequate info gathering is essential to satisfy BOD’s duty of oversight that
is imposed by DGCL 141
3. Potential impact of Fed Sentencing guidelines for violations (targeted at
specific kinds of acts)
 (b) IMPLICATIONS – directors can avoid liability by assuring that info and
reporting systems exist in the organization that are reasonably designed to
provide to senior mgt and the board itself, timely accurate info sufficient to
allow mgt and the BOD to reach informed judgments
(ii) GOOD FAITH EFFORT – The info gathering system does not have to be perfect
and is subject to the BJR. BOD must have good faith judgment that its system
is adequate
(iii)TO SHOW BREACH OF DOC: Pf must show:
(a) Either: Directors knew of the violations; OR should have known that the
violations were occurring; AND
(b) The directors took no steps in a good faith effort to prevent or remedy that
situation; AND
(c) Proximate Cause – Such failure caused the losses complained of
(iv) HIGH STANDARD OF LIABILITY
(a) Lack of Good Faith necessary to impose liability:
1. A sustained or systematic failure of the board to exercise oversight –
such as an utter failure to attempt to assure a reasonable info and
reporting system exists.
b RESULT – dismissal of claims asserting director fault b/c there was no substantial
evidentiary support provided
4 WASTE
A Delaware has said that “a board of directors enjoys a presumption of sound business
judgment, and its decision will not be disturbed if they can be attributed to any rational
business purpose.” Today the claim of “waste” often arises in the context of executive
compensation (see Disney).
B STANDARD TO SHOW WASTE
i Must allege with particularity facts tending to show that “no reasonable business
person would have made the decision that the BOD made under the circumstances”
5 THE ROLE OF GOOD FAITH, AND THE DUTY OF CARE
 In DISNEY & STONE, the DE SC ultimately held that good faith is not a freestanding
duty, but rather an element of the duty of loyalty. This contrasts CAREMARK, which
initially associated “good faith” with DOC.
A EXCULPATION CLAUSES
i It is significant that DISNEY & STONE consider good faith to be part of the DOL b/c
exculpation clauses do not reach the DOL (see MBCA 202(b)(4) & DGCL 102(b)(7).
This means that allegations of lack of good faith also serve to overcome exculpation.
(See DISNEY’s three types of misconduct and the liability attached to each)
B IN RE DISNEY -
i FACTS OF THE CASE
a Transaction - Ovitz was hired as president of Disney. He was fired after a couple of
months of working there and walked away with $140m. The essential challenge in
this case was of the hiring of Ovitz and the negotiations of his Employment K that
ultimately allowed him to walk away with $130m.
b Negotiations - Ovitz was friends with Eisner. Ovitz was successful at what he did.
After Ovitz negotiations with MCA fell through, he began negotiating with Disney.
After lengthy negotiations, the parties sign the compensation agreement. Ovitz gets
fired (a no-fault termination).
c S/H Claims – Disney BOD breached their duty of care and good faith by approving
the compensation agreement and the not-for-cause termination provisions. Pfs also
sued Ovitz, claiming that he breached his duties of care and loyalty to Disney by
negotiating for and accepting the NFT severance
d ANALYSIS
 (i) This case came after VG and Rule 102(b)(7) which bans monetary damages for
violations of duty of care. The plaintiffs are relying on the claim of violation of
good faith (they acted in "bad faith") which hopes gets them over DGCL 102(b)
(7)
(ii) To get their day in court, they have to jump over the BSJ and meet the standard
of liability of DGCL 102(b)(7)).
(a) Pfs allege "waste" and they also say that Disney's directors and what not
acted in "bad faith"
(iii) VIOLATION OF GOOD FAITH
(a) Court claims that there are three different categories of fiduciary behavior that
may be characterized as “BAD FAITH”:
1. Deliberate subjective intent to harm the company
2. Any action taken in gross negligence
i. Court – Gross Negligent Conduct without more is not enough to
constitute a breach of the fiduciary duty to act in good faith
3. Conscious disregard for one’s responsibilities
(iv) BAD FAITH & EXCULPATION (spectrum b/w subjective intent and gross
negligence)
(a) Subjective intent to harm the C cannot be exculpated
(b) Grossly negligent conduct without any malevolent intention without more can
be exculpated b/c it is not actually a breach of good faith
(c) Dereliction of duty – this cannot be exculpated because:
1. It is misconduct that is more culpable than simple inattention (like grossly
negligent conduct) or failure to be informed; AND
2. Statutory interpretation of DGCL 102(b)(7)(ii) suggests that the legislature
wanted it this way via disjunctive definitions.
(v) WASTE – this claim implies that no rational business person would have made
that decision. It is difficult to think that the BOD will ever not have a rational basis
at all for its decisions. DE courts will stretch their minds to find a rational
business purpose behind the BOD’s action (note, BSJ=court will not 2nd guess)
e AS APPLIED TO THIS CASE
(i) Ovitz: Court found that Ovitz did not breach a duty as a fiduciary by negotiating
and entering into the agreement b/c he had not yet become a fiduciary, and did
not until he took the job. Also, Ovitz played no part in the BOD’s decision to
terminate him w/o cause, so there was no duty regarding the second claim either
(ii) BOD: court asserted there was not DOL breach, so the only way to rebut the BJR
is those breach of DOC or GOOD FAITH. In determining whether the
compensation committee was adequately informed when they approved the
agreement, they looked to see if they followed the “best practices” and found
that, although the process fell below best practices, it did not fall below the
standard for the DOC
(a) The compensation committee was adequately informed about the magnitude
of the NFT payout if Ovitz didn’t work out, and the committee was reasonable
in relying on the expert’s analysis of the agreement according to DGCL
§141(e). They tried to fire him FOR CAUSE, but after extensive research the
C concluded it could not get away with it.
(b) BOD did not breach DOC in approving Ovitz as president since BOD
considered other candidates and found that Ovitz was the best match
(iii) WASTE - The way we look at the K, Ovitz was owed $130m, but that is not how
you determine waste. Waste implies that no rational business person would
have paid him that much. There was a rational basis behind the signing of that K
 because Disney needed a skilled executive like Ovitz and that OEA was the only
way to get him to Disney.
C STONE v. RITTER – This involved a derivative suit brought by S/Hs against directors of
AmSouth seeking personal liability for their failure to implement a monitoring system
required by the federal bank secrecy act. The S/Hs claimed that better oversight would
have revealed that bank EEs had unwittingly allowed bank accounts to be used by a couple
of scoundrels running a Ponzi scheme. Federal banking authorities found that AmSouth’s
monitoring program was “materially deficient” and imposed record setting fines and
penalties of $50m.
i ANALYSIS
a GOOD FAITH – Discussion of CAREMARK/DISNEY
(i) Lack of Good Faith – “necessary condition” for director oversight liability – a
sustained or systematic failure of the BOD to exercise oversight: such as an utter
failure to attempt to assure a reasonable info and reporting system exists
(ii) A showing of bad faith conduct (DISNEY) is essential to establish director
oversight liability b/c bad faith conduct is a breach of the DOL
(iii)A failure to act in good faith is NOT conduct that results in direct imposition of
fiduciary liability. Examples of Failure to act in Good Faith:
(a) Intentional acts with a purpose other than in the best interest of the C
(b) Intent to violate applicable positive law; or
(c) Intentional failure to act in the face of a known duty to act (conscious
disregard for your duties)
b DUTY OF LOYALTY
(i) Breach of the Duties of Loyalty and Care establish director liability. Good faith is
a subset of the DOL.
(ii) Breach of good faith CAN establish liability, but since it is under the duty of
loyalty, it follows that to establish liability you need bad faith behavior that breach
the DOL
(iii) 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
(a) Failure to act in good faith only indirectly can result in liability through the DOL
– you can’t act loyally towards the C without a good faith belief that the
actions are in the C’s best interest
c RULE re: ESTABLISHING DIRECTOR OVERSIGHT LIABILITY
(i) Imposition of liability requires a showing that the directors knew that they were
not discharging their fiduciary obligation (conscious disregard of their
responsibilities); & EITHER:
(a) The directors utterly failed to implement any reporting or information system
or controls; OR
(b) Having implemented such a system of control, the directors consciously failed
to monitor or oversee its operations thus disabling themselves from being
informed of risks or problems requiring their attention
ii AS APPLIED TO THIS CASE
a The court found that the bank had implemented a monitoring system that was
deigned to present information on compliance with the Bank Secrecy Act
requirements.
b That the system failed, according to the court, was not enough to establish a
“sustained or systematic failure of the board to exercise oversight.”
c RESULT – The court held that the directors had not engaged in a deliberate failure
to exercise oversight.
6 THE SHAREHOLD PRIMACY NORM (CHARITY AND WASTE)
  S/H Primacy involves identifying to whom the duty of care is actually owed. The MBCA
requires directors to make decisions in the interests of the C and its S/Hs. Courts often
conclude that the S/Hs are the primary beneficiaries of the DOC. This aspect of the
DOC is often called the S/H Primacy Norm
 In Dodge v. Ford, Henry Ford decided to discontinue any special dividends to the S/Hs.
This was after the Dodge bros attempted to become competitors of Ford. The Dodge
bros were also Minority S/Hs of Ford. Ford was a majority S/H. Though Ford defended
his decision by saying it was due to the business purpose of making the vehicles
cheaper and benefitting mankind, the court concluded that the C is organized and
carried out primarily for the S/Hs. The powers of the directors are to be employed to
that end. The discretion of directors is to be exercised in the choice of means to attain
that end.
 KAHN shows that even an attenuated connection b/w expenditure and S/h benefit will
be upheld, especially in the context of charitable contributions.
A ASSUMPTION – A business corporation is organized primarily for the profit of the
S/Hs, as opposed to the community or its EEs
B MBCA – requires directors to make decision in the interests of the corporation and its S/Hs.
Courts often conclude that the S/Hs are the primary benes of the DOC.
C KAHN v. SULLIVAN – C was asked to fund a museum that will host former CEO’s art
collection (approximately $50m). Museum was named after Armand Hammer and not C.
C argues this would attract good will to it. Board had created a SPECIAL COMMITTEE
especially for this project. Under the surface, Hammer is the CEO and he wants this to
happen. Two groups of S/Hs sued that this was a wasteful donation. There were 2 claims:
Directors failed to property inform themselves (DOC) and Waste.
i ANALYSIS
a RULE re: BJR & S/H PRIMACY – Even an attenuated connection b/w expenditure
and S/H benefit WILL be upheld, especially in the contest of charitable contributions
under DGCL 122(9) (statute places no limit on amount only that it be reasonable)
(i) Reasonableness – informed decision, independent counsel, special committee,
review of the transaction by experts who are disinterested
b RULE re: WASTE – no rational business person would make this decision
(i) Not every charitable gift constitutes a valid corporate action
(ii) To argue that it is NOT waste: Goodwill, publicity, etc
c SYNTHESIS – as long as the directors are able to articulate some beneficial
business purpose for whatever activity they’re undertaking, the best interests of the
S/Hs will not trump a decision by the board to pursue a given activity that may not
appear first on S/H agendas, as long as the directors don’t allocate an exorbitant
amount of corporate funds to undertake such a project.
(i) In order to analyze this last element, compare the overall worth of the C and how
much cash it has on hand against the significance of the particular expenditure
ii AS APPLIED TO THIS CASE
a The court determined that the BJR would have been applicable to any judicial
determination of the Special Committee’s decision.
b Also, charitable donations are authorized under DGCL 122(9) – the gift to the
museum was within the range of reasonableness and it was reasonably probable
(i) Having the CEO’s name on the building and the existence of such a large
contribution to the arts would generate goodwill
c WASTE – the Pfs would have failed on the waste claim. BJR applies in S/H primacy
situations
d RESULT – BJR applied to the special committee’s decision. Waste is shot down.
VIII DUTY OF LOYALTY
 Any time a director or manager participates in a transaction involving a conflict of interest
– a transaction in which the director or manager may be motivated not only by the interests
of the C but also by self-interest – the DOL is implicated
 Courts scrutinize cases raising DOL issues much more carefully than those raising duty of
care issues. As a result, directors do not initially get the benefit of BJR protection in these
cases, although they can act to try to reinsert that protection through the use of various
procedural mechanisms, though courts will continue their scrutiny in situations involving a
“controlling S/H”
1 DUTY OF LOYALTY
A DUTY OF LOYALTY
i DOL requires that the directors serve the interest of the C over their self interest. Cases
involving DOL include issues of:
a Self-dealing and conflict of interests
b Cases involving a majority or controlling S/Hs
c Cases involving the expropriation of corporate opportunities
ii GENERAL POINTS
a B/C of concerns that directors have acted in their own self interest in these
transactions, courts scrutinize cases raising DOL issues much more carefully
(i) Directors do not initially get the benefit of BJR protection in these cases, although
they can act to try to reinsert that protection via procedural mechanisms
b Pay close attention to the procedures companies use to approve conflict of interest
transactions and the effects of these procedures on the judicial process
c Courts will maintain a skeptical attitude in cases involving controlling S/Hs, b/c there
is the specter of a controlling S/H removing directors who too stubbornly refuse to
approve a conflict of interest transaction a controlling S/H proposes
B CONFLICT OF INTEREST TRANSACTIONS
i Corporate law attempts to identify “bad” transactions – those that are unfair to the
company and its S/Hs – while allowing “good” transactions – those that are fair – to go
forward.
ii DESCRIBED: A conflict of interest exists when the director knows that, at the time he is
asked to take action with regard to a potential transaction, HE or a person related to
him…
a Is a party to the transaction; OR
b Has a beneficial financial interest in the transaction: AND THEN exercises his
influence to the detriment of the C (MBCA 8.60)
iii MAJORITY OR CONTROLLING S/Hs
a Majority or controlling S/Hs are fiduciaries of the C and their duties to the C and
Minority S/Hs require that they not cause the C to effect transaction that would
uniquely benefit the fiduciary or that would benefit the fiduciary at the expense of the
minority S/Hs
b Who is a Major or Controlling S/H?
(i) Usually, it is a S/h who possesses over 50% ownership of stock OR can exert
influence over the C in such a manner that such a S/H has indirect control
(a) MAJORITY S/H – S/H w/more than 50% of the voting rights
(b) CONTROLLING S/H – less clear; A S/H will be deemed “dominant” if he
fulfills ONE of the following criteria (ask if BOD has any real control)
1. Owns more than 50% of the shares
2. Controls more than 50% of the BOD
3. Actually controlling day-to-day operations
4. Actually exerts complete control over the transaction in question
 c Burden of Fairness – A Majority or Controlling S/H standing on both sides of a
transaction bears the burden of proving the ENTIRE FAIRNESS of its action
(i) Entire Fairness – consists of 2 prongs
(a) Fair Dealing - Fairness of the procedure developed to approve a transaction,
and
(b) Fair Price - The fairness of the price of the transaction
iv ANALYZING THESE PROBLEMS
a Is there a conflict at all? Conflicts have a broad sweep
(i) If there is NO conflict of interest, then there is NO DOL issue
(ii) If there is a conflict of interest  HAS IT BEEN CLEANSED?
b CLEANSING – What steps did the parties take? Did those steps work?
(i) If the transaction HAS BEEN CLEANSED, then the transaction is protected and
may proceed.
(a) If those steps did work, then what is the standard?
1. If the transaction is cleansed by a vote of the disinterested directors, that
decision which cleansed the transaction will itself be subject to scrutiny,
but is typically protected by the BJR
(ii) If the transaction HAS NOT BEEN CLEANSED, then the transaction is “voidable”
by the C, and the directors who violated their DOL may be subject to damages.
c Did those steps work? See if there are any gaps in the procedures and if those
procedures worked
C KAHN v. LYNCH (CONTROLLING S/H) – Lynch (“C”) and Alcatel (“AC”) have a business
relationship (AC owns 43% of C, but is not a majority S/H). AC’s powers: 5/11 members of
the BOD; 2/3 of the executive committee; 2/4 of the compensation committee (if you were a
director, you would be incentivized to defer to AC). C has a provision in the charter that
requires 80% of S/Hs to approve certain transactions. C decides to expand the business
and wishes to acquire Telco (TL). AC did not approve and wanted C to acquire Celwave
(“CW” – owned by AC). AC decides to buy C at a low share price. C creates a committee
to negotiate the transaction. Negotiations faltered and AC threatened an unfriendly tender
offer at a lower price.
i ANALYSIS
a Controlling S/H – we impose FDs on someone who has power or control over the
property of another. DE and Corporate Law generally say that controlling S/Hs have
effective powers over the C, therefore they have FDs to other S/Hs
(i) Defined – A S/H that has domination through actual control – regardless if they
are a majority S/H
b RULE re BURDEN FOR ENTIRE FAIRNESS –
(i) A controlling or dominating S/H standing on both sides of a transaction, as in a
parent-sub context, bears the burden of proving its entire fairness
(ii) In order to SHIFT the burden of proving the unfairness of the transaction to the
Pf, the DF MUST show that the independent committee was truly independent
and able to wash the transaction
c RULE re TOTAL FAIRNESS – the two prongs (Fair Dealing and Fair Price) must be
evaluated as a whole, not separately to determine entire fairness
(i) Evidence of arm’s length dealing is strong evidence that the transaction MEETS
the fairness test, and a fair price will override unfair process to a certain extent
(a) Focus on overall benefit to C rather than knit-picking over petty crap
(ii) Non-Disclosure, on the other hand, is persuasive evidence of a LACK of entire
fairness. Entire fairness is the appropriate standard, regardless of whether there
is a washing transaction, when a controlling S/H is involved.
(iii) SEE FLOWCHART
d RULE re SPECIAL COMMITTEE EFFICACY
 (i) Controlling S/H CANNOT dictate the terms to the committee
(ii) Committee MUST have real bargaining power and should have advisors; AND
(iii) Comprised of independent, disinterested directors who have no personal stake in
the transaction
(iv) NOTE – the presence of an indy committee does not itself shift the burden
e AS APPLIED TO THIS CASE
(i) Controlling S/H – the court looked at:
(a) The other avenues that C had if they had refused AC’s offer – C sought a
“white knight” but it was shot down b/c of the 80% S/H approval requirement
and AC effectively had veto power;
(b) The legal power to say “no” – a controlling S/H can make life very
uncomfortable; if C refused the transaction, AC would still be around
1. Ultimatum by AC deprives the independent committee’s power to say no
(ii) Particular consideration of whether the special committee was truly independent,
fully informed, and had the freedom to negotiate at arm’s length
(iii)RESULT – The record reflects that the ability of the committee effectively to
negotiate at arm’s length was compromised by AC’s threats to proceed with a
hostile tender offer if their price was not approved by the Committee or C’s BOD
2 PROCEDURAL MECHANISMS TO LIMIT JUDICIAL REVIEW
A DGCL 144 & MBCA 8.31: Under statutes, COI transaction are not void or voidable if:
i The material facts are disclosed to the BOD or S/H, AND
ii Either the disinterested directors or the disinterested S/Hs authorize, approve, or ratify
the transaction
B SUBSTANTIVE & PROCEDURAL FAIRNESS – COI transactions are not void or voidable
if they are fair to the C – Most courts require some showing of substantive fairness in
addition in addition to procedural fairness
i SUBSTANTIVE – this is demonstrated by show both FAIR PRICE & FAIR DEALING
C MBCA 8.61 – Interested transactions may not be enjoined if
i Procedural Protections to remove the taint of Self Interest:
a The BOD approves the transaction in accordance w/MBCA 8.62;
b The S/Hs approve the transaction in accordance with MBCA 8.63; OR
ii Substantive protection designed to allow fair transaction even if they have never been
approved by disinterested parties:
a The transaction is fair to the C at the time it is authorized
iii Note – statutorily obtained approval is not a per se validation of the transaction –
it simply eliminates the interested-director cloud (cleanses) – the decision would
be subject to a challenge based on the DOC w/protection of the BJR
D BENIHANA – BOT (The holding company) is owned by Aoki. BOT owns 50.9% of the
common stock and 2% of the Class A stock of Benihana (BH). Aoki marries and rewrites
his will to give control of BOT to the wife. This worries Aoki’s kids and the C. BH is in need
of an injection of capital. The possibilities considered were a bank loan or the issuance of
p/s. A BOD member of BH owns 30% of BFC and promotes to the other members a sale
of the stock to BFC. Abdo gives a presentation to the board and then leaves so as to
cleanse the transaction and create a fair and disinterested transaction. An INDEPENDENT
COMMITTEE is created to study this transaction as well as the other offers. They approve
the BFC offer and reject the others. Aoki sues (he is worried b/c his ownership would be
diluted). Aoki claims it was an uninformed decision, entrenchment and preemptive rights.
i ANALYSIS
a DGCL 144 – SAFE HARBOR – this statute creates a safe harbor for interested
transactions IF:
 (i) DISCLOSURE - The material facts as to the director’s relationship or interest and
as to the contract or transaction are disclosed or are known to the BOD OR S/Hs;
AND
(ii) GOOD FAITH APPROVAL – the BOD OR S/Hs in good faith authorizes the K or
transaction by the affirmative votes of a majority of the disinterested
DIRECTORS OR S/Hs; OR
(iii) Note – if the K or transaction is fair as to the C as of the time it is
authorized, approved or ratified, by the BOD, a committee or the S/Hs, then
the COI shall not be void or voidable b/c it possesses a COI
b Standard of Review – after approval by disinterested directors, courts review the
interested transaction under the BJR
ii AS APPLIED TO THIS CASE
a Court erects a new standard and brings back the BJR: DOL easily knocks down
BJR by a showing of a conflicted party on both sides of the transaction. Once the
S/Hs and the directors approve of the transaction, all you are left with is the BJR (i.e.
you must show waste, which is nearly impossible). If process is followed (the first
two prongs, it is really hard to bring a DOL claim
b Court thought it vital that BOD know of Abdo’s involvement in order for them make
an “informed decision”. The court feels that:
(i) BOD knew by implication – Abdo was one of two who controlled BFC, it is
obvious that he would have had to approve the transaction at BFC’s end; AND
(ii) BOD had the material info when he re-approved the transaction after the fairness
opinion
c Court dismisses the personal claim against ABdo finding that he did not use
confidential info against BH – he did not set the terms of the deal himself; he did not
deceive the BOD; he did not dominate or control BOD’s decision to approve
d Court agrees that BOD cannot take action solely to entrench themselves on the
BOD – in this case action was taken merely to gain financing for the project
e RESULT – Upheld the issuance of p/s to director, which was approved by committee
of disinterested directors that considered alternative financing plans and received
fairness opinion on challenged issuance)
E WHEELABRATOR (NON CONTROLLING S/H)- This is a challenge to the merger of WH
into a wholly-owned sub of WM. The Pfs are WH’s S/Hs. The Dfs are WH and its 11
directors. Pfs claim that the Dfs violated their DOL (among other things) in conducting the
merger. The merger was a stock-for-stock transaction conditioned upon the approval of a
majority of WH’s disinterested stockholders. The 4 board members selected by WM did not
attend the initial vote, and outside counsel was present. The 7 remaining members
approved the transaction and then the other four came back so the full board approved it
too. Then the special S/H vote approved the transaction by a majority of the disinterested
vote (i.e. WM did not participate). Pfs claimed that the directors DOL was breached b/c
their COI made it so they didn’t get the best price for the merger. Pfs also claim that the
only effect the S/H ratification should have is to trigger the entire fairness review.
i ANALYSIS
a VOID/VOIDABLE – DE law distinguish b/w acts of directors that are “void” and those
that are “voidable”:
(i) Voidable – void acts are those which may be found to have been performed in
the interest of the C but beyond the authority of mgt
(ii) Void – acts which are ULTRA VIRES (without authority), fraudulent, or waste of
corporate assets
b TYPES OF RATIFICATION DECISIONS
(i) Two Types
 (a) “interested” transaction cases b/w a C and its directors (or b/w the C and an
entity in which the C’s directors are also directors or have a financial interest);
1. DGCL 144(a)(2) – provides that an “interested” transaction of this kind will
NOT be voidable if it is approved by fully informed, disinterested S/Hs.
i. Approval pursuant to 144(a)(2) invokes BJR and limits judicial review
to issues of gift or waste with the burden of proof upon the party
attacking the transaction.
(b) Cases involving a transaction b/w the C and its controlling S/H
1. These cases often involve parent-subsidiary mergers that were
conditioned upon receiving a majority of the minority S/H approval.
2. Rule re Parent/Sub Mergers – in a parent sub merger, the standard of
review is ordinarily entire fairness, with the directors having the burden of
proving that the merger was entirely fair
i. However, where the merger is conditioned upon approval by a
majority of the minority stockholder vote, and such approval is granted,
the standard of review remains entire fairness, but the burden of
demonstrating that the merger was unfair SHIFTS to the PF
ii. Burden shifting is applicable in cases involving a controlling S/H
c DOC CLAIMS– When self dealing was by a NONCONTROLLING S/H, approval by
informed, disinterested S/Hs of transaction w/the non controlling S/H not only
extinguishes any claim the BOD had acted w/o due care, but also leads DOL claims
to be viewed under the BJR
ii AS APPLIED TO THIS CASE
a There was no controlling S/H, so entire fairness review is not the standard – W was
only a 22% S/H at the time of the merger proposal, and there is no indication that
they exercised de jure or de facto control over WH.
b The applicable standard here, therefore, is the BJR w/the Pfs carrying the burden of
proof
c The DOC claim is extinguished b/c there was sufficient disclosure
3 CORPORATE OPPORTUNITIES
 Generally, a corporate opportunity is a diversion of corporate opportunity for the benefit
of a corporate director or manager. These cases involve competition b/w the C and the
director or manager. The Pf claiming redress under this doctrine must prove that the
opportunity was a corporate opportunity. The primary formulation is still the GUTH
TEST, which is outline in BROZ
 There is a special category of rules that exist to analyze the issue under DOL. We are
talking about business opportunities that somebody thinks should have been offered to
the C
A GUTH TEST – this test basically establishes four criteria that prohibit a director or manager
from usurping a corporate opportunity, along with four criteria that would allow for the same
i A director or manager may NOT take a corporate opportunity for his own if
a The C is financially able to exploit the opportunity
b The opportunity is within the C’s line of business
c The corporation has an interest or expectation in the opportunity, OR
d The corporate fiduciary will thereby be placed in a position contrary to his duties to
the C
ii He MAY take the opportunity if
a The opportunity is presented to the director or officer in his individual and not his
corporate capacity
b The opportunity is not essential to the C
c The C holds no interest or expectancy in the opportunity
 d The director or officer has not wrongfully employed the resources of the C in
pursuing or exploiting the opportunity
iii SYNTHESIZED
a If a C CANNOT take an opportunity b/c:
(i) It lacks finances
(ii) It is not in the same line of business (niche v. general business); OR
(iii) It has no “interest or reasonable expectancy:
b THEN, a director will be found to have legitimately taken an opportunity for himself.
iv NOTE – fairness, “interest or reasonable expectancy”, AND line of business, are
outlined below
B CLARIFICATION OF CORP OPP WITHIN THE DOL
i Case Law Generally:
a INTEREST OR EXPECTANCY TEST – precludes acquisition by corporate officer of
the property of a business opportunity in which the C has a “beachhead” in the
sense of a legal or equitable interest or expectancy growing out of a preexisting right
or relationship
b LINE OF BUSINESS – characterizes an opportunity as corporate whenever a
managing officer becomes involved in an activity intimately or closely associated
with the existing or prospective activities of the C: AND
c FAIRNESS – determines the existence of a corporate opportunity by applying ethical
standards of what is fair and equitable under the circumstances
C AMERICAN LAW INSTITUTE
i Any opportunity to engage in a business activity of which a director or senior executive
becomes aware, either:
a In connection with the performance of functions as a director or senior executive, or
under circumstances that should reasonably lead the director or senior executive to
believe that the person offering the opportunity expects it to be offered to the
corporation; or
b Through the use of corporate information or property, if the resulting opportunity is
one that the director or senior executive should reasonably be expected to believe
would be or interest to the corporation; or
ii Any opportunity to engage in a business activity of which a senior executive becomes
aware and knows is closely related to a business in which the corporation is engaged or
expects to engage.
D ALI Mandatory Disclosure (most courts still go case-by-case):
i General Rule. A director or senior executive may not take advantage of a corporate
opportunity unless;
a the director or senior executive first offers the corporate opportunity to the
corporation and makes disclosure concerning the conflict of interest and the
corporate opportunity;
b The corporate opportunity is rejected by the corporation; and
c (3) Either:
(i) The rejection of the opportunity is fair to the corporation;
(ii) the opportunity is rejected in advance, following such disclosure, by
disinterested directors or, in the case of a senior executive who is not a
director, by a disinterested superior, in a manner that satisfies the standards of
the business judgment rule or
(iii)The rejection is authorized in advance or ratified, following such disclosure, by
disinterested shareholders and the rejection is not equivalent to a waste of
corporate assets.
E DGCL 122(17) – CORPORATE REJECTION
 i The C can voluntarily relinquish its interests in a corporate opportunity by generally
renouncing any interest in categories of business opportunities or by rejecting a specific
deal.
ii DE’s Corporate statute permits a C to renounce, in its certificate of incorporation or by
action of its BOD, any interest or expectancy of the C in specified business
opportunities or specified classes or categories of business opportunities presented to
the C
F POLICY BALANCE – we want individuals to serves as officers and directors of Cs, but we
want them to be careful. Someone with multiple business interests might make a good
director, but if this doctrine sweeps too broadly, no one would want to serve as director for
fear of violating their duty or having to offer it to everyone. If drawn too narrowly, then there
is opportunity for directors to steal from the C
G BROZ – Broz is an outside director of CIS and owner of RFB. CIS operated in the
Midwest, and RFB in Michigan. When a 3rd company decided to sell its cellular license for
the eastern tip of Michigan, its broker contacted Broz but not CIS. Broz dutifully asked
CIS’s CEO whether CIS would be interested in buying the license from the 3rd party, and
the CEO declined since CIS was strapped for $. So, Broz went ahead on his own. Soon
thereafter, CIS’s finances turned when a large firm (PC) agreed to buy CIS and inject it with
$. Then, before its purchase of CIS, PC made a bid for the license, but Broz upped his bid
and won.
i ANALYSIS
a Rule re Corporate Opportunity and Disclosure: two basic components of the
analytical framework are laid forth by the court in Broz:
(i) The determination of whether a corporate fiduciary has usurped a corporate
opportunity is fact intensive and turns on the ability of the C to make use of the
opportunity and the C’s intent to do so; AND
(ii) While presentation of purported corporate opportunity to the BOD and the BOD’s
refusal thereof may serve as a shield to liability, there is no per se rule requiring
presentation to the BOD prior to acceptance of the opportunity
ii AS APPLIED TO THIS CASE
a The court held that Broz had not taken a corporate opportunity of CIS:
(i) First, the court questioned whether CIS had a sufficient expectancy.
(a) The 3rd party license holder had not considered CIS a viable candidate for the
license.
(b) At the time Broz bought the license CIS was in financial straits and was
actually divesting its cellular license holdings.
(c) Although PC had promised financial help, it had not yet acquired CIS.
(d) No duty to offer the opportunity to CIS just b/c PC would want it down the line
(e) Broz actually contacted CIS about it and they rejected it b/c they didn’t have
the finances to go through with it
(ii) Second, the court noted Broz’s duties to his own cell phone company, of which
CIS was “wholly aware.” CIS knew that Broz had another master, which could
well come first
b RESULT - DE courts decided that Broz did not violate his duties to CIS.
IX SUING OVER DIRECTOR’S DUTIES
1 DERIVATIVE LITIGATION GENERALLY
A Derivative Litigation – DGCL 141 says that the S/H does not have the power to sue on
the C’s behalf, but obviously the D/O will not sue themselves. Therefore, courts invented
the derivative suit. It is a designation acknowledging that the S/H’s claim is not a claim of
direct harm, but rather a claim that is derived from harm to the C – it is a way for the S/H to
sue directors/officers for breach of their FDs.
i 2 actions in one:
 a 1. Suit by the S/Hs against the C to compel the C to sue. (C is a nominal Df;
directors are real Dfs)
b 2. Action by the C against the directors and the S/Hs are, in a sense, only the
nominal Pfs.
ii Recovery – any recovery goes to the C. B/c there is little incentive for a S/H to pay for
litigation that would benefit the C rather than himself, the courts awarded attorney’s fees
for successful suits – incentivized attorneys to settle.
iii REQUIREMENTS – to weed out frivolous claims from meritorious claims
a CONTEMPORANEOUS OWNERSHIP – Pfs must have been S/Hs at the time of the
alleged breach of duty
b STANDING – Pfs must remain S/Hs throughout the litigation
c DEMAND – S/Hs must “demand” that the BOD take action before the S/H assumed
control of the litigation
(i) NOTES ON DEMAND
(a) You must go to the court and say you have demanded the C to pursue the
claim but got turned down or explain why demand is not required/futile
(b) No one actually makes demand b/c when you do, you effectively
acknowledge the director/officer’s independence
(c) Point – GO TO COURT AND EXPLAIN WHY DEMAND IS FUTILE
d SETTLEMENT – court must approve any settlement if the derivative suit is filed.
B DIRECT ACTIONS – In a direct action, the S/H makes a claim in her own name against the
C or against a director or officer of the C for a wrong that was done DIRECTLY to him
i I.E. The wrong must have impacted the S/H DIRECTLY
ii Direct Actions are often brought as class actions if the wrong effected many S/Hs
a In such cases, the S/H sues as a representative of a class of similarly situated S/Hs
who have suffered from the SAME wrong. Such suits are still “direct”
iii Examples of direct suits:
a Suit to:
(i) Compel the pmt of dividends
(ii) Enjoy an activity that is ultra vires
(iii) Claim security fraud
(iv) Protect certain S/H rights
(v) Suit in which a S/H has been denied rights
2 THE DEMAND REQUIREMENT
A GENERALLY – Since the very nature of a derivative suit is that the claim belongs to the C,
MOST states require that the S/H approach the board and DEMAND that the board pursue
litigation BEFORE the S/H is allowed to bring a derivative suit
i HOWEVER, if demand is made on the board and the board determines NOT to bring a
suit, then the decision is usually protected by the BJR. In fact, there are clear
circumstances in which the “demand requirement” is EXCUSED and no demand need
be made on the BOD
B DEMAND EXCUSABILITY - Demand is excused when asking the board to bring a suit
would be FUTILE – In order to determine when demand would be futile, one must examine
the applicable case law
i Each state will have slightly different standards, HOWEVER. . .
ii The basic concepts in each state are largely the same, INCLUDING. . .
a The S/H must show that a REASONABLE DOUBT EXISTED the BOD could have
properly exercised its independent and disinterested business judgment in
responding to a DEMAND [or the transaction itself that the suit will eventually
challenge]
 (i) This MAY INCLUDE analysis regarding conflict of interest, fraud, waste,
procedural challenges that the PF may bring in order to show that the BJR did
not apply to a given transaction, and therefore demand is NOT mandatory
(ii) ALTERNATIVELY, the PF could show that there is a reasonable doubt that the
MAJORITY of the directors are BOTH disinterested AND independent
(a) DISINTERESTEDNESS – A director is not disinterested if he or she has a
material financial interest in the challenged litigation
(b) HOWEVER, the mere fact that a majority of directors voted to approve the
transaction and are named as Dfs DOES NOT ALONE make them interested
(iii) Finally, demand is excused if the board is simply not independent and being
CONTROLLOED by the individual who is the target of the eventual suit
iii DEMAND FUTILITY STANDARD – ARONSON TEST
a Determining demand futility the Court of Chancery in the proper exercise of its
discretion must decide whether, under the particularized facts alleged, a
REASONABLE DOUBT is created that:
(i) The directors are disinterested and independent, OR
(ii) The challenged transaction was otherwise the product of a valid exercise of
business judgment
iv DE v. MBCA – DE does NOT interpret the demand requirement as MANDATORY while
the MBCA does (MBCA Universal Demand Reqm’t). In some instances, courts are
willing to “excuse” demand in cases where the directors would not be willing to act upon
demand due to some COI. These are cases where demand would be futile.
a DE courts review claims differently depending on whether demand is excused or has
already been refused by the BOD
v SUM – the easiest way for the Pf to meet the demand excused requirement is to
show that the majority of directors were interested in the challenged transaction.
a An evenly divided BOD is NOT a disinterested board and demand may be futile
as a result
C STANDARD OF REVIEW DIFFERENCES BASED ON DEMAND IN DE
i WRONGFUL REFUSAL – If Pf makes a demand, the case becomes a wrongful refusal
case. The court reviews the BOD’s decision to refuse the demand under the deferential
BJR
ii DEMAND FUTILITY – If Pf argues demand is futile and doesn’t make a demand,
namely b/c directors would benefit from the BJR protections of DGCL 141(a) and
wouldn’t have to bring the suit: The courts may scrutinize the case more carefully and
see if a wrongful refusal has been made (are directors disinterested or independent
from the conflict? Reasonable doubt standard)
a Pfs get to this point by raising allegations that support the reasonable inference that
the BJR is not applicable for purposes of considering a pre-suit demand.
b The court examines the challenged transactions to see if this reasonable inference
exists
D MARTHA STEWART – Pfs attempt to bring a derivative suit against Steward for breaching
her duties in the insider trading fiasco and also in the handling of the media attention. Pfs
did not make demand b/c they determined that the majority of directors were not
disinterested. There is no dispute as to two directors, including Stewart, and there is only a
6 member board. Thus, if Pfs can show that there is one more director that is not
disinterested, they demand would considered futile
i ANALYSIS
a RULE re DETERMINING INTERESTED DIRECTORS
(i) A director’s interest may be shown by demonstrating a potential personal benefit
or detriment to the director as a result of the decision. The PRIMAY BASIS upon
which a director’s independence must be measured is whether the director’s
 decision is based on the corporate merits of the subject before the board, rather
than extraneous considerations or influences.
(a) It is a fact-specific inquiry
(b) BURDEN – PLAINTIFF has to show lack of independence by way of
structural bias – whether discretion of the disinterested/independent director
was sterilized by the particularized factual scenario shaping the board’s
operation
1. you might look to financial ties, familiar affinity, a particularly close or
intimate personal or business affinity or evidence that in the past the
relationship caused a director to act non-independently vis a vis an
interested director
2. but having a personal friendship or a majority S/H alone is not enough in
itself without more
b RULE re DISCOVERY
(i) In general, derivative Pfs are not entitled to discovery in order to demonstrate
demand futility. The general unavailability of discovery to assist Pfs with
pleading demand futility does not leave Pfs without a means of gathering info to
support their allegations, however.
(ii) The court advises Pfs who seek to plead facts establishing demand futility that
the Pfs might successfully have used SECTION 220 books and records
inspection to uncover such facts
ii AS APPLIED TO THIS CASE
a There is an acknowledgement of personal ties, but DE courts have been reluctant to
accept “structural bias” as showing a “reasonable doubt” of independence
b The relationships alleged by PF do not lead to the inference that the directors were
beholden to Stewart and, thus, unable independently to consider demand.
(i) Coupling those relationships with Stewart’s overwhelming voting control of MSO
does not close that gap
c Seligman – the reasonable inference is that SG’s purported intervention on Stewart’s
behalf was of benefit to MSO and its reputation, which is allegedly tied to Stewart’s
reputation. A motivation by SG to benefit the company every bit as much as Stewart
herself is the only reasonable inference supported by the complaint.
d Moore – These bare social relationships clearly do not create a reasonable doubt of
independence
e RESULT – Pf failed to plead facts sufficient to support a reasonable inference that at
least one MSO director in additions to Stewart and Patrick was incapable of
considering demand. Pf was required to make demand on the board before
pursuing a derivative suit.
3 SPECIAL LITIGATION COMMITTEES
A Generally, SLCs are committees of board members comprised entirely of independent
directors that do nothing but decide whether or not to continue litigation. By the time you
get to a SLC, the BOD has already admitted that it can’t make a decision on its own. It
cannot use ARONSON
B There must be TWO or more members. In recent years, Cs have been appointing SLCs to
EVALUATE derivative litigation.
i Reasoning: Even if the board is not in a position to evaluate the litigation from an
unbiased perspective, it can still appoint a committee of unbiased members to evaluate
whether the litigation is in the best interests of the C
ii Based upon the recommendation of the SLC, the board can still move to dismiss a
derivative action, AND, assuming the special committee is disinterested, that dismissal
would be subject to the protection of the BJR
C TWO STEP ANALYSIS FOR SLCs
 iIn a case where demand is EXCUSED, DE will defer to the opinion of the SLC (whether
to proceed or whether they want to dismiss the case on behalf of the C) if both of the
following prongs are satisfied:
a The C satisfies its burden of proving that the SLC was independent and acted in
good faith; AND
ii The court determines, applying its own independent business judgment, whether
the motion to dismiss based on the SLC’s opinion should be granted
D S/H UNSATISFIED W/SLC DECISION –The S/H who is dissatisfied with the SLC MIGHT
be able to attack the judgment on limited grounds. The S/H might argue that the SLC’s
judgment was NOT proper because. . .
i Procedural Defect – Decisions was procedurally defective – the SLC used an improper
or ineffective method to investigate the case. USUALLY the SLC’s substantive
interpretation is protected by the BJR
ii Independence and Good Faith Failure – SLC failed to act independently and in good
faith, and as a result, their investigation was NOT REASONABLE
a NOTE – this requirement varies from state to state.
(i) Some JDXs only require a tangential connection b/w one of the members of the
SLC and one of the so called “interested directors”.
(ii) OTHER sates give more deference to the SLC itself and are less likely to
overturn decisions.
(iii) A small number of states, including DE, have an additional requirement that the
court exercise its own business judgment in evaluating the decision to dismiss

E MARTHA STEWART CASE AND SLCs

i ANALYSIS
a Unlike the demand excusal context, where the board is presumed to be
independent, the SLC has the burden of establishing its own independence.
b The SLC analysis contemplates not only a shift in the burden of persuasion but also
the availability of discovery into various issues, including independence
4 DIRECT v. DERIVATIVE CLAIMS
A DIRECT v. DERIVATIVE
i Only S/Hs can bring derivative suits (NOT creditors)
ii B/c derivative suits arise out of a “wrong” done to the C, ANY remedy or recovery goes
to the C – not to the S/H bringing the lawsuit
iii B/C the direct suit arises out of a wrong done to the S/H, the S/H bringing the suit MAY
collect damages
iv In a DERIVATIVE suit, the C is REQUIRED to pay for the S/H’s attorneys fees,
PROVIDED that the S/H wins the lawsuit
v More procedural hurdles in derivative claims than in direct claims
B TOOLEY v. DONALDSON – S/Hs bring a claim asking for compensation related to the
TVM which they feel they deserve as a result of the C’s 22-delay in the merger/payout
i ANALYSIS
a Under the Grimes approach, courts make the direct-derivative distinction by focusing
on who was injured and who will receive the relief:
(i) Who was injured by the alleged harm? The Corporation or the S/Hs?
(ii) Who would receive the benefit of any recovery or other remedy? The Corporation
or the S/Hs individually?
b The inquiry should be whether the S/H has demonstrated that he or she has suffered
an injury that is not dependent on an injury to the C
(i) ASK  Has the Pf demonstrated that he or she can prevail without
showing injury to the C?
 c NOTE – B/c there is no basis for a derivative claim doesn’t mean you have
sufficiently pleaded enough to make out a direct claim
ii AS APPLIED TO THIS CASE
a RESULT – the merger delay claim is direct since delay of the merger only harmed
S/Hs, not the corporation. The direct claim was also dismissed without prejudice.
5 STATUTORY EXCULPATION FROM LIABILITY
A STATUTES
i Model Act: The articles of incorporation may eliminate or limit the liability of a director to
the corporation or its shareholders for money damages for any action taken, or any
failure to take action in a breach of the duty of care, including breaches that constitute
an intentional violation of civil law (MBCA § 2.02(b)(4)(D)).
a The articles may not exculpate directors for receiving financial benefits to which
they are not entitled, for approving improper dividends, for intentionally harming the
corporation, or for intentional violations of criminal law (MBCA §2.02(b)(4)).
ii Delaware: DGCL §102 permits exculpation similar to MBCA 2.02, although under
Delaware law the corporation may not exculpate its directors for:
a Breaches of the duty of loyalty,
b Acts or omissions not in good faith,
c Acts which involve intentional misconduct
d Knowing violation of law.
iii Other Remedies: Exculpation clauses don’t prevent a stockholder from purchasing
other remedies, for example, an injunction, if the directors have breached their duty of
care.

B MALPIEDE v. TOWNSON – F (a corporation) was negotiating a merger with KB. The

terms of the merger restricted F from negotiating with competing bidders. Despite that F’s
subsequently received higher bids from two other prospective buyers, the directors of F’s
completed the merger with KB. S/Hs of F’s then sued on the ground that the directors had
breached the duty of care by failing to consider the higher bids.
i ANALYSIS
a RULE re PROCESS FOR BREACH OF DUTY PLEADINGS: Pfs challenging
director conduct have the burden to allege well pleaded facts that the conduct falls
within the exceptions
(i) If the claim is simply negligence (not gross negligence), then it is the business
judgment rule.
(a) However, gross negligence takes you out of the business judgment rule even
though gross negligence is covered in the statutory exculpation provision.
(b) Exculpation provision may cover failure of due care (by failing to stay
informed) but won’t apply to failures of good faith.
(c) NOTE - The Statutory exculpation provision defines the OUTER LIMIT of
what can be contracted and therefore further protections cannot be
contracted for by the directors
b EMERALD PARTNERS v. BERLINS (via MALPIEDE)
(i) ANOTHER RULE re PROCESS FOR BREACH OF DUTY PLEADINGS – an
exculpation provision is in the nature of an affirmative defense, requiring directors
to establish each of its elements, including good faith in a parent-sub merger
(a) BURDEN & REBUTTING BJR – S/H Pf has the burden of proving that the
BOD, in reaching its challenged decision, violated any one of the triad of FDs
(DOC, DOL, GF)
1. “it is the plaintiffs who have a burden to set forth a short and plain
statement of the claim showing that the pleader is entitled to relief”
(PLEADING STAGE)
 (b) FAILURE TO MEET BURDEN – If a S/H fails to meet this evidentiary burden,
the BJR operates to provide substantive protection for the directors and for
the decisions that they have made
(c) SUCCESSFUL REBUTTAL – the burden will SHIFT to the director
defendants to prove to the trier of fact that the challenged transaction was
entirely fair (TRIAL STAGE)
(ii) If a S/H unambiguously asserts ONLY a DOC claim, the complaint is
dismissible if 102(b)(7) is invoked. This provision does NOT defeat the validity of
the PF’s claim on the merits, but rather operates to defeat Pf’s ability to recover
monetary damages
(a) Thus, even if the BJR has been rebutted in the S/H complaint by successfully
alleging a DOC violation, the director defendants do NOT have to prove entire
fairness to the trier of fact, b/c of the 102(b)(7) exculpation
(b) NOTE - It would be a waste of time if PF was looking for monetary damages
(b/c DOL violation = rescission)
ii AS APPLIED TO THIS CASE
a DGCL 102(b)(7) of the Delaware General Corporation Law insulates directors from
personal liability for breaching the duty of care.
(i) Since the shareholders have not alleged that the directors engaged in conduct
falling within any of the exceptions to DGCL 102(b)(7), the directors cannot be
held personally liable.
b DUE CARE CLAIM – the primary due care issue is whether the board was grossly
negligent, in failing to implement a routine defensive strategy that could enable the
board to negotiate for a higher bid or otherwise create a tactical advantage to
enhance S/H Value
(i) The routine strategy would have been a “Poison Pill” (this is an action whereby
the board will create an option, maybe for current stockholders that allows for
additional votes when a certain amount of stock is accumulated by a bidder. This
would dilute the bidders stock and make it more expensive for them to take
control of the company
(ii) COURT – although, the BOD did not do this, and made some other mistakes like,
signing the restrictive merger agreement, acceptance of extreme contract
provisions which impacted its ability to obtain a higher sale price, etc. The Pfs
will have an uphill battle in overcoming the BJR
c RESULT - The exculpation provisions created by statute were created to allow
corporations to limit personal liability just for duty of care violations. The reasoning
was to allow S/H to approve the provision in order to allow directors to take risks
without worrying about negligence suits. The provision acts as an affirmative
defense. The plaintiff must prove in its pleadings that there was a violation that falls
into one of the exceptions (loyalty, bad faith, etc.)
C POST MALPIEDE & EMERALD CONSIDERATIONS
i It is clear that director protection statutes can be relied on at the outset of litigation.
ii It is also clear, however, that once a S/H overcomes the presumption of the BJR with
allegations that establish a DOL or GF claim, a director’s DGCL 102(b)(7) request for
exculpation will be examined only in the contest of the completed judicial analysis that
resulted in a finding of unfairness (i.e. after discovery, after a trial, and after a finding
that the challenged decision was unfair to S/Hs
D McPADDEN v. SIDHU – directors of i2 sold off one of their subs (TSC) to a group of
investors led by TSC’s VP, DB for $3m. DB had been appointed to conduct the sales
process. Reason for the sale was that it didn’t fit within their core business. DB had
significantly reduced projections of revenues and income when recommending to i2’s
directors how much TSC was worth, and DB didn’t solicit bids from outside investors to
 determine what the market prices of TSC was. 2 years later DB sells it to another C for
$25M. i2’s S/Hs filed a derivative suit against i2’s BOD and DB for breach of FD. i2 S/Hs
argued that allowing SC to be sold to members of TSC’s mgt for a fraction of what it was
worth constituted breach of duty of GF.
i ANALYSIS
a DGCL 102(b)(7) is limited to breaches of DOC (which is usually defined as gross
negligence). It cannot be used to limit liability to directors that breach the duty of
GF.
b BREACHING THE DUTY OF GOOD FAITH
(i) BAD FAITH – Gross negligence alone cannot constitute bad faith, and BOD
could act badly without acting in bad faith.
(a) Gross negligence – a conduct that constitutes reckless indifference or
actions that are without the bounds of reason
(b) In order to qualify as a breach of the duty of good faith (and thus not be
covered by 102(b)(7)), there must be either:
1. Actions that are motivated by subjective bad intent;
2. Conduct that rises to intentional dereliction of duty or the conscious
disregard for one’s responsibilities
ii AS APPLIED TO THIS CASE
a Pf had pleaded a DOC violation with particularity sufficient to create a reasonable
doubt that the transaction at issue was product of a valid exercise of business
judgment. Illustrating this, the Chancellor noted:
(i) i2 placed DB (TSC’s VP and head of the C that first bought TSC) in charge of the
TSC sale process despite the clear conflict of interest created thereby
(ii) the BOD’s lack of oversight over the sale process
(iii) BOD’s failure to take action despite the fact that DB made only limited attempts
to find potential buyers; and
(iv) That the BOD did not question the valuation projections of TSC, which were
produced in part by DB
b The court looked to the facts of the case and found that the directors may have been
grossly negligent (which, alone, is not enough; need bad faith) but there was no
intentional dereliction of duty (BAD FAITH) and so they were covered by 102(b)(7)
c However, the court found that 102(b)(7) is only applicable to directors and not to
officers of the C. So, DB was NOT covered.
d RESULT – DB’s actions were a breach of the DOC, and so he was potentially liable
for damages from his actions. The court dismissed the claim against the BOD.
iii NOTE – Under DE law, the DOC is a PROCESS standard. It doesn’t matter what the
result is, all that is required that there is a reasonable process for decision, it doesn’t
matter what the results are.
6 INSURANCE AND INDEMNIFICATION
A Directors and Officers Insurance (D & O): This is another way that corporations protect
directors from personal liability for their actions. The company cannot insure against
dishonesty or intentional misconduct, and insurance companies will not write policies
insuring against breach of duty of loyalty.
B Two Sides: of D&O Insurance:
i (1) for the corporation - if they get sued it will be insured against their losses.
ii (2) For the individual directors and officers - there is an integral problem with this type.
IT doesn’t insurance against:
a contracting with someone to commit a fraud or committing fraud (this is true even
though securities fraud is one of the main things directors want to be protected
against)
 C Notes: D & O insurance premiums are the same for all corporations, regardless of the size
or structure. It creates a moral hazard. If you are insured against specific conduct, you are
more likely to engage in more of that conduct because you don’t have to pay the price
D Indemnification: Corporations also enter into indemnification agreements with their
directors and top executives. They will specify the indemnification rights in the bylaws.
Indemnification rights are also specified and limited by statute (DGCL §145; MBCA §8.51-
8.57).
i Whether or not the corporation will indemnify is determined by “whether the directors,
officers, employees, or agents acted in good faith and in a manner reasonably
anticipated to be in (or not opposed to) the corporation’s best interest.”
X FRIENDLY MERGERS AND ACQUISITIONS
1 Generally, a majority S/H owes a FD to minority S/Hs to provide all relevant info that would
pertain to a proposed cash-out merger. (See WEINBERGER)
2 EXAMPLE OF A TRANSACTION THAT INVOLVES INTERESTED PARTIES AND THE
ENTIRE FAIRNESS STANDARD;
A WEINBERGER
 S owns 51% of UOP. Public S/Hs (millions of them) own the rest. S buys their
percentage at a really high price, even higher than the trading value. S elects a little
less than a majority on the board. Then, a retired S EE replaces the chairman of UOP.
They now have a majority of the BOD. S has a pile of money and wants to invest it, so
they decide to buy up the remaining shares to get all the profits. S has two officers, who
are also on the BOD at UOP to study UOP to see if it would be a good idea to buy the
remaining shares. They use their info to tell S that buying UOP would be a good deal if
they buy the remaining shares b/w $20 and $24 (they used info from UOP.)
 S calls Crawford, a CFO at UOP, and they have a meeting where they propose the
buyout merger and tell them what they are going to propose for the price
• What is the CFO of UPO’s FD to the S/Hs?
o To tell S that the offer is ridiculous (Crawford doesn’t do this)
 Crawford says that’s a good deal. But then he says, this is going to cut off stock options
to senior executives, including himself, so the deal must be renegotiated. S then issues
a press release saying that they are negotiating a deal and follow that with another
release saying that they are going to offer up to $21/share
 They hire an IB—to issue a fairness opinion to say that the price offered is a fair price.
He says they should pay $21/share. Then he flies to UOP w/the fairness opinion that
says (blank) is a fair value for this stock. The BOD meets and you get an inkling of how
the board meetings work and the members of the UOP board who also sit on S board
attend the meeting by telephone. The chairman of S says that they are gong to make
an offer for $21/share, and UOP agrees as long as the minority S/Hs agree to the deal.
UOP makes the formal presentation and the S BOD members leave so they don’t
influence the deal and the deal is approved. S directors didn’t vote. They tell S that
they need a proxy solicitation which must be approved by the SEC. The SEC makes
them say the deal was made by “discussion” and not by “negotiation” b/c they didn’t
negotiate
i ANALYSIS
a In this case, we got a Major S/H on both sides of the transaction – The individuals
that prepare a report for S to determine a fair price are directors of UOP
(i) If the transaction was approved by a majority of the minority (MOM) S/Hs the test
would STILL be ENTIRE FAIRNESS, but the burden would now be on the PFs to
show that the transaction was not entirely fair
(ii) ENTIRE FAIRNESS
(a) Fair Dealing
 (b) Fair Price
b Have we neutralized the voting power of S by requiring a MOM to approve the
deal?
(i) Yes, b/c the minority could stop the deal, no matter what the majority wants to do
with its shares. The approval hangs on the approval of the MOM b/c they are the
ones that are affected by the deal
c Was there fair dealing here?
(i) No, the S/Hs were not told about the IB report. The process followed by the IB
was not perfect b/c it was rushed so as to just get it approved (the S/Hs were not
informed about the process of the report)
d What is the problem here?
(i) Two of the directors on the UOP BOD owed FDs to UOP and they prepared the
report using UOP info and disclosed it to S, not UOP. These two BOD members
breached their duty to disclose to UOP’s board as to the true value of the C.
Thus, the other BOD members were unaware of the real price
(ii) B/c UOP wasn’t given material info, by members of the board who were also part
of the other party to the transaction, their FDs were not met.
(iii) RULE - In the absence of full and frank disclosure, the minority S/H vote
does not wash the transaction
(a) Does this mean that the majority S/H has to disclose the best price?
(b) No, the only reason this is different is b/c the UOP/S board members had a
duty to disclose b/c they had a duty to both boards
e WHEN YOU ARE ON BOTH SIDES: When directors of a DE C are on both sides of
a transaction, they are required to demonstrate their utmost good faith and the most
scrupulous inherent fairness of the bargain. This concept of fairness has 2
components:
(i) Fair dealing,
(a) Where an independent, disinterested committee negotiates the deal from a
position of power (the ability to say no, and mean it; and the ability to write
check); includes full candor (try and emulate a process that resembles an
arms length transaction)
(ii) Fair price,
(a) You can prove value by any technique or method that is generally considered
acceptable in the financial community and otherwise admissible in court,
subject only to the court’s interpretation of DE law
(b) Takes into consideration economic and financial considerations of the
proposed merger, relevant factors of which are:
1. Assets
2. Market value
3. Earnings
4. Future prospects
5. And any other elements that affect the intrinsic value of a C’s stock
ii AS APPLIED TO THIS CASE
a Because this transaction has the potential for abuse, b/c the controlling S/H is on
both sides of the deal, the controlling S/H has to prove that the deal was made using
fair dealing and a fair price
b The court found reversible error in both aspects of the fairness inquiry:
(i) First, fair dealing
(a) The Feasibility study was created and used in COI
(b) The rushed nature of the proposal was entirely driven by S to the detriment of
UOP
(c) Negotiations were not arm’s length
 (d) Minority S/Hs were denied the info about the feasibility study, so their vote
could not be considered informed
(ii) Second, fair price
(a) Pf presented expert testimony that the fair price was closer to $26/share at
time the merger was approved
c What would you do to make the process fair?
(i) If there had been bargaining at arm’s length
(ii) To show corrective bargaining show that OP had their own committee to evaluate
the price (the committee would consist of independent directors (see FN 7 pg
756 – court is saying that in a perfect world the price would have been negotiated
by completely independent directors negotiating back and forth)