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Business Organizations Outline

I. Introduction and Background A.

The Development of the American Business Corp: A Historical Overview 1. Corp are creatures of state law and are formed under laws of that specific state; this indicates the internal working of the corp. 2. Board of Directors (BOD) runs a corp. not the shareholders; this is a control issue 3. Close Corp small family operations where shareholders are also people who run the day to day business 4. In the west the first things that looked like corps were churches. They went beyond a family and lasted longer. 5. Canon law recognized that they would have indefinite life. It was a separate entity and perpetuated among itself. 6. In England, began to charter entities for certain purposes, used a lot for civic purposes. There were limitations get charter from Parliament; had set term of years, had to be renewed; govt had the right to change the terms of the charter at any time. Huge advantage if one died the whole enterprise was not wiped out and didnt have to start all over; liability for debts was limited to the amount of $ you put in; limited liability issue allowed more people to get involved than normal. 7. The US is considered the home for corps b/c found a way to take advantages of the strengths and got rid of a lot of the limitations. The scope has grown tremendously and the capital accumulation is outrageously huge. B. Agency 1. 1. Agency; Principal; Agent Agency is the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act The one for whom action is to be taken is the principal. The one who is to act is the agent. 2. Agency when one person acts w/the and thru the authority of another 3. Agency relationship can exist w/out any intent to have created it. 4. Need: Mutual consent To act on someones behalf W/in someones control 5. An agent can bind a principal in K when agent is acting w/in his authority Actual authority P tells the A to act upon his behalf; agent has to believe from the communication that he has the authority to act and it must be reasonable; 26 Creation of Authority; general rule can be created by written or spoken words or other conduct of the P which, reasonably, interpreted, causes the A to believe that the P desires him to so act on the Ps account Apparent authority 3rd party reasonably believes that the A has authority to act on behalf of the P; usually done thru actions 27. Creation of Apparent Authority; general rule created as to a third person by written or spoken words or any other conduct of the P which, reasonably interpreted, causes the third person to believe that the P consents to have the act done on his behalf by the person purporting to act for him. Authority by estoppel apparent authority w/out P taking any action at all; somehow it would be unfair for the 3rd party not to recover from the P

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Inherit authority exists for the protection of persons harmed by or dealing w/a servant or other agent; exists to catch cases that didnt fit in anywhere else and not right for 3rd party to be harmed by the A Ratification 82 affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account, whereby the act, as to some or all persons, is given effect as if originally authorized by him Can also be liable in tort for youre a If authorize conduct Respondeat superior doctrine have control and he is performing work for you; servants are subsets of agents; not liable for ind K b/c have no control; there is a frolic and detour exception to being liable b/c not w/in the scope of their employment P owes duties to A Compensation Reimbursement Indemnification for cost incurred w/in scope of employment Fiduciary duty A owes duties to P Duty of loyalty cant take unapproved benefits; cant act on behalf of another if in conflict w/P; cant compete; but if disclosed then it is ok but if no consent from P then liable for breach Duty of care act w/due care and liable for negligence Fiduciary duty How to end agency relationship Voluntarily and completely at will Expire at end of certain period End when condition or purpose has been fulfilled or accomplished Authority also ends but apparent auth may still exist must do something to let 3rd parties know the agency is over

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Partnership 1. Default rule dont have to create one knowingly 2. When two or more people are in a business as co-owners for a profit In business implies continuous basis Co-owner implies share profits and losses 3. Managed by each partner equally unless agreed otherwise 4. Majority vote wins but must be unanimous if want to admit a new partner 5. If a statute provides, may opt out of default rules by making K; must be agreed by all partners and signed by all partners 6. Every partner is an A for the partnership 7. Profits and losses are shared equally, unless otherwise provided 8. Partnership interest is not transferable but can assign economic interest; that new person is not a partner and doesnt have any of the regular rights 9.

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Duties to partners Fiduciaries to each other Duty of loyalty main duty; held to a high standard; need notice and consent not to breach this duty Duty of care Duty of disclosure How they end Dissociation allows partner to leave w/out dissolving the partnership If partnership buys him out they dont have to dissolve and can continue the business

If partners cant agree then a judicial proceeding, appraisal, will be held and the ct will determine the partnerships worth If partnership does end you must wind up/liquidate sell off all assets and split accordingly; creditors get paid first and then whoever loaned $ and then who paid capital contributions and then split what is left, if anything

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Nature of the Corporation A. The Role and Purpose of Corporations 1. You form a corp by selling shares of stock; stockholders invest $ into the equity and get an interest in the profits of the co; however they do not run the company. 2. The BOD runs the corp; they are elected and manage the affairs of the corp; usually a small group of people and usually have other jobs and meet 6 to 8 times a year. 3. AP Smith Mfg. Co. vs. Barlow Provision in co charter not to allow donations to universities; Pres of the co wanted to donate $1500 to Princeton Shareholders felt that donation wasnt going to do anything to build the business or make more $ for the shareholders Co defended itself by saying donating to higher education; the profit here was in education; come up w/more indirect benefits; possibly be educating future workers Ct notes that this is not a pet charity and not for personal reasons 4. Dodge vs. Ford Motor Co. Ford owned 58% of the co and Dodge Bros owned 10% Ford stopped special dividends and wanted to put that $ back into the co in order to build plants so that he could quit outsourcing and be able to do everything himself Dodge Bros sued and argued that Ford wasnt wanting to benefit them anymore and that the plant was to satisfy his own personal dreams; claimed what Ford was doing was against the best interest of the corp. Ct sided w/Ford and let him build the plant but still has to pay out special dividends; ct basically lost its nerve b/c easy to pay out $ but hard to stop someone from building plant; the ct could have really harmed his business if didnt allow him to build the plant; much bigger consequences w/this issue

5. Equity proportional share of the profits; equity holders (shareholders) split up the corp profits; gives you the right to dollars in earnings; residual holder after all other claims are paid off; riskier than being a creditor but he potential pay off is better 6. Financial Statements Balance Sheet shows assets and liabilities and how much equity your shareholder has; always done at end of fiscal period; shows total assets and liabilities; shows shareholder equity and whether they lost or made $. 7. Shlensky vs. Wrigley Wrigley owed the Cubs; had other owners One of the other owners sued b/c wanted to install lights in order to have night games (one of the few that didnt have it at the time) Wrigley claimed beneficial to neighborhood not to have lights claims Wrigley was rich and selfish and didnt care if the Cubs made $; claimed he though baseball was a day time game and was just stubborn Ct held for Wrigley; Ct justifies by saying there was no proof that if install lights that more people will attend night games; Ct says that didnt prove his arguments Ct began applying business judgment rule ct is not there to run a corp, that is what the board is for; as long as the board acts w/good faith and on a reasonable basis and

they make an informed decision the cts will not second guess what they do; that is what happened here b/c no fraud, no bad faith and no conflict of interest 8. Best way to rebut the business judgment rule is to bring up a conflict or s how that there is a contrary believe; you must look to the best interest of the corp; must be able to prove not acting in the best interest of the corp.; show legit reasons consistent w/not acting in best interst of the corp through community. How to form a Corp 1. Must file Articles of Incorp. w/the Sec. of States Office; the state stature sets out exactly what has to be included in the document Names Officers Number of shares of stock Name and address of directors or person who incorporated the co You can add additional info but above MUST be included If dont want default rules as provided in state law, you can derogate from them by providing provisions in the Art of Incorp 2. In La, have to file initial report which lists agent for service of process; so if the notices are due there is a way to find them 3. In La, must also file affidavit from agent of service of process that says they are the agent and they will accept things on behalf of the corp. 4. The incorporator has liablities and obligations under state obligation law until the board is elected; they are a fiduciary to the corp; they want the board to get elected as quickly as possible in order to take the liability away from them 5. Bylaws are subtext; work out details of how meetings are conducted; days notice to give shareholders; more technically detailed info; put here b/c a board can amend bylaws and dont have to go thru shareholders, they can do it on their own 6. Form matters, it is not just substance. Must follow formalities as set in state statute. 7. A corp can act just like people and they are distinct from the officers and directors and have a separate roll in the process 8. When on the board you have duties and have to make disclosures or the corp will be able to recover for neglect 9. If technically follow your duties and board approves it then not going to be held liable. C. Promoters and the Corporate Entity 1. Southern-Gulf Marine Co. vs. Camcraft, Inc. made vessels corp was in process of being formed into a corp when signed K w/ ; Barrett signed the K on behalf of Southern Gulf then tries to pull out of K b/c Southern Gulf incorporates in Cayman and not in TX as previously said Ct doesnt let out of the K b/c they were given notice b/c Pres of Camcraft signed acceptance and acknowledged Southern gulf formed in Cayman instead of TX; he consented in a way for the substitution The Corporate Entity and Limited Liability 1. Walkovszky vs. Carlton hit by one of s taxi cabs owns 10 corps, all of which have two cabs and all w/minimum insurance; no assets in the corps Ct doesnt see misbehavior by so an agency argument wont work then argues corp veil option ct says good policy argument but not sufficient to pierce the veil; need extra wrongdoing to pierce B.

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2. Enterprise Liability if cant pierce the corp veil then try to prove this instead; all entities operate as one and it is run like one business; but dont get at any personal assets of any of the shareholders. 3. Sea-Land Services, Inc. vs. Pepper Source is suing b/c stiffed them on a shipping bill (when shipped peppers) entity no longer exists so goes after Marchese and the other 5 companies that he owns; they argue no formalities and want to get to him personally (corp veil theory, not enterprise liability) Piercing Corp Veil Theory A corp entity will be disregarded and the veil of limited liability pierced when two requirements are met: (1) there must be such unity of interest and ownership that the separate personalities of the corp and the individual no longer exists; and (2) Circumstances must be such that adherence to the fiction of separate corp existence would sanction a fraud or promote injustice. Unity of interest (1) the failure to maintain adequate corp records or to comply w/the corp formalities; (2) the commingling of funds or assets (3) undercapitalization; and (4) one corp treating the assets of another corp as its own Ct finds a unity of interest here b/c Marchese used funds to pay his alimony, bills and vacations; he didnt even have a personal bank acct; Marchese never held annual meeting; cant remember if he filed articles and they didnt have bylaws Ct says denied recovery is important but not the injustice the ct is looking for; Ct remands On remand the ct finds other injustices he was evading other creditors and avoiding taxes and that was enough for ct to establish injustice Ct allowed piercing of veil 4. If you pierce the veil then shareholders are at risk for liability, depending upon state rules; must show unity of interest and injustice. 5. Kenney Shoe Corp. vs. Polan Polan in 100% shareholder of Ind. Realty and Polan Ind.; Industrial signs lease w/; they then sublet to Poland Ind. First rental came from Polan personally to Industrial and then no other payments were made Income from the sublease was the only source of income for Industrial Polan didnt put in any $ when formed Industrial; didnt elect officers; didnt issue stock certificates and there were no other assets to satisfy the lease obligation tries to pierce the veil in order to get their $ Ct looked at undercapitalization and failure to carry out corp formalities and ruled the test was satisfied and allowed pierce of the veil If Kinney would have run a credit check could argue they were assuming the risk of nonpayment; Kinney might also could have asked for collateral or asked Polan to sign the K as a guarantee To avoid this result Polan could have protected himself by putting in a minimal amount of capital, elected director and issued stock certificates Prof thinks injustice here is very thin and ct was wrong in its application 6. In re Silicone Gel Breast Implants Products Liability Litigation Bristol Meyers is the parent co of MEC (owns 100%); MEC manufactured breast implants; Bristol shareholders are not the shareholders of MEC but Bristol itself is the lone shareholder The totality of circumstances must be elevated in determining whether a subsidiary may be found to be the alter ego or mere instrumentality of a parent corp: (1) the parent and the sub have common directors or officers (2) the parent and the sub have common business departments

(3) the parent and the sub file consolidated financial statements and tax returns (4) the parent finances the sub (5) the parent caused the incorp of the sub (6) the sub operates w/grossly inadequate capital (tricky) (7) the sub receives no business except that given to it by the parent (8) the parent uses the subs prop as its own (9) the daily operations of the two corps are not kept separate (10) the sub does not observe the basic corp formalities, such as keeping separate books and records and holding shareholder and board meetings Bristol had control over MEC: (1) made sure manuf process was going as should; (2) approved their budget (3) set up employment policies (4) put logo and name on packaging (5) purchased ins for them (6) suspended sales of certain products (7) officers of MEC were hired by Bristol and paid on their scale Here have common directors and officers; some common business depts.; had consolidated financials; set the salaries Ct doesnt let Bristol out on the MSJ 7. Frigidaire Sales Corp vs. Union Prop, Inc. wanted limited partners to be held personally liable Ct refuses to pierce the veil here; Ct says proper formalities here were met; there was no misrepresentation who were officers; there was no evid of unity of interest and that is necessary to pierce the veil; Ct doesnt find injustice here either 8. Principles to apply when trying to pierce the veil keeping up w/formalties and adequately capitalization of the corp shouldnt be at any risk for pierce; but if you do sacrifice the formalities then you are at risk (Kinney); usually even having total disregard for formalities is not enough to pierce must be some showing of injustice; proof can be easy (Bristol) or it can be more difficult (Pepper Source); most states require that result would not be equitable try to tie some sort of shortfall to injustice key to success in these cases is to show that it is just unfair that you cant recover for whatever the entity did to you, whether K or tort 9. Even if you cant pierce the veil thre are other theories of liability to get shareholders or sister corporations direct liability (breast implant case) enterprise liability could be liable for fraud (but extremely hard to prove) III. Duties of Officers and Directors A. Duty of Care 1. Business Judgment Rule Test: (1) Is there a conflict? (2) Decision by the board: (a) was it in good faith; (b) informed basis; and (c) in best interest? 2. Smith vs. Van Gorkom Van Gorkom is CEO of Trans union; he approaches Pritzker about buying the co; board knows nothing about this; Pritzker agrees to buy but lock in price to avoid ebay problem Van Gorkom gets atty to prepare paperwork and then tells the board about it; board approves it only b/c he tells them that if they dont they will get sued on fiduciary duty Shareholders sue trans union Ct uses BJR test:

(1) Is there a conflict? No b/c no conflict b/w trans union board and Pritzker (2) Decision by the Board: (a) was it in good faith it doesnt seem the board acted w/bad faith (b) informed basis this is a problem here by the board; ct said you had no idea what Van Gorkom knew when he was presenting the stuff to you, no written materials, no expert opinions, there was no merger agreement to read, no deliberation when this was just sprung on you; Ct determines there was not an informed decision; ct uses standard of gross negligence (c) best interest nor did the board not act in the best interest of the business; they did not upon their fiduciary duty Market Test ??? Board can still be held negligent if shareholders getting more than the premium market value as is here; there was no research to see what the control premium should be and how high someone should pay 3. Technicolor Ct will decide on fact basis whether the whole transaction was fair; Entire fairness test: (1) fair price; (2) fair dealing 4. Brehm vs. Eisner Eisner was CEO of Disney and he picked his successor, Ovitz; he gets a HUGE K Ovitz does a terrible job; everyone complains about him; Ovitz begins looking for another job but doesnt want to get fired so that he can get the big severance package Disney eventually fires him and the shareholders are upset at what he gets Shareholders claim duty of care breach for negligent hiring and duty of care breach for not firing him for cause and allowing him to receive the 140 million $ package Ct uses the BJR test This ct sets the market on other side of Van Gorkom of how bad thins can be and not trigger liability 5. Francis vs. United Jersey Bank Pritchard doesnt get the benefits of the BJR analysis b/c it protects people that are active and she didnt make any decisions or display any basic understanding of the business; Ct said if dont pay attention and abdicate your duty then no protection of the BJR B/c of the complete failure of a director to monitor the business of the co the ct doesnt give protection of the BJR and eventually holds them liable 6. Derivative Action When the corp is the only proper Shareholders step in and attempt to sue on behalf of the co to recover from them personally the damage that they have caused Make demand upon the board; board is still given power to run the corp; board can step in and decide whether to proceed 7. Caremark Intl Ct says the board cant be expected to know every little thing going on and a company needs to get the most important type of info up to them Ct says the board needs to set up a system so that most important things will get to them; sort of a monitoring device and if dont do this can be subject to liability Ct said here there was enough monitoring by the board: training programs, manual and enough safeguards for the ct to say they were acting to monitor the situation 8. The BJR protects rationale risk taking by directors; it is easier to think of something in hindsight rather than in the heat of the moment. The BJR protects people who are making the immediate decisions regarding the co. We want boards to take economic risks. B. Duty of Loyalty Directors and Managers

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Bayer vs. Beran Pres of the cos wife was hired to sign in the musical advertisement hour; she worked at the Metro Opera House and was a professional singer; she also made recommendations of other musicians to hire for the musical hour Ct says that when you raise an argument and the ct agrees that there is a conflict then the burden switches over to the , the board, to show they made a fair and reasonable decision (inherent fairness); must prove that the decision was fair to the shareholders Ct said the decision to hire wife was fair; ad campaign was legit and wasnt intended to foster or boost the wifes career; pay scale was like what they were paying the other singers Ct said program was to benefit the co and not the wife Notice the Pres was the only one w/a conflict; you have the whole board here who is being questioned b/c of the Pres only; Ct assumes it as a conflict b/c who wants to cross their boss on a decision Lewis vs. SL &E, Inc. Ct doesnt apply the BJR here b/c both boards for the separate companies are the same; whole board of one of the companies is benefiting Ct says burden must switch and must show fair and reasonable decision; in this case they didnt show a fair and reasonable decision; there was no effort to tie value of prop to the stock Types of valuation methods (1) Book Value shows on financial sheets equity of the shareholders; positives are they are objective and easy to verify; negatives are that there is no correlation b/w what true worth and what costs are; this is critical in other methods of determining worth; it is a starting point for more accurate evaluations of a company (2) Market Value what a willing buyer would pay a willing seller; accuracy depends entirely upon the market (3) Inherent value what the company is really worth; it is a professional value of a business; how much $ this company can make regularly; there is some guess work involved here b/c really trying to figure out how much it will make in the future and will it exceed the cost and if so by how much (discounting cash flow method) (4) Asset Value how much $ you can get by selling off all the pieces of the company; usually not used to value a current on going business

Corporate Opportunities 4. Broz v. Cellular Info Systems, Inc Broz owns 100% of RFBC; CIS is a competitor and Broz is on the board and a shareholder; a license comes up for sale but dont think that CIS is good candidate so approach Broz to purchase license on behalf of RFBC Is this corp opportunity? Ct said the opportunity didnt come to Broz as he was in his scope as a director of CIS; he knew CIS wouldnt and couldnt purchase yyyyybout oil and gas production) Duran claims that failure to register this security is a violate of the Securities act of 1933; defense was that it was a non public offer and was exempt b/c it was a private offer Ct must look to: (1) number of offerees and their relationship to each other; (2) number of units; (3) size of the offer and (4) manner of the offering (this is the one the ct really concentrates on) Ct says the more sophisticated the investor the less info you need to provide but the less sophisticated the investor the more info that the co needs to provide; Ct goes further and says if really sophisticated dont have to show you gave them the info but only that the investor had access to it 8. The ruling in Doran caused problems so the SEC implemented new rules:

Regulation D series of safe harbors that issuers can use to come w/in the private placement exemption and avoid or reduce their required disclosure. 9. Escott vs. BarChris Const. Corp. 11 case material misstatement or omission Once proves a 11 violation then ct moves to who is liable The company itself cannot use a defense; they are not provided a defense; others who signed the registration is allowed to use a due diligence defense but must prove they reasonably investigated and didnt find errors Experts are only responsible for that portion of the registration statement that they have expertized Ct found directors liable Ct found Treasurer and CEO liable Ct found in-house-counsel and Sec. and Director liable Ct found outside director liable b/c investigation not specific enough Ct found director liable whos law firm counseled ; Ct said can anticipate times when duties as a lawyer and as a director must go to one or the other Ct found expert liable 10. Rule 10(b)-5 of the 1934 Act Individuals can sue to enforce this rule, which is different from other rule which can only be enforced by the SEC It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any nation securities exchange, (a) To employ any device, scheme or artifice to defraud, (b) To make any untrue misstatement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection w/the purchase or sale of any security. 11. Basic Inc. vs. Levinson ** (impt 10b case) Basic mad three public statements denying merger w/Combustion; they didnt deny but flat out lied and did so three times Shareholders of Basic are suing b/c they sold stock b/w time of negotiations and before acquisition; claim that b/c Basic lied and they relied on their lies and sold their stock at an artificially low price need to prove: (1) A material misstatement or omission; (2) Material misstatement or omission must be in connection w/purchase or sale of the security; (3) Scienter has to be intentional or reckless; and (4) Causation Ct rejects the agreement in principle test and says that if a reasonable investor would consider it important then they would have to disclose it and it is therefore material Ct uses Judge Friendly probability rule Basic could have probably just stated no comment when asked about possible but merger and probably would have been ok Fraud on the market theory ??? 12. West vs. Prudential Securities, Inc. Hoffman is a stockbroker for Prudential; he told 11 of his clients there was going to be a certain acquisition that would result in a large premium; but he was lying and acquisition never happened Ct said no evid that the info leaked from clients to the public and therefore this was a private offer (Basic was a public newspaper)

Ct said that private statements cannot move the market 13. Pommer vs. Medtest Corp. s were in development of a medical process; they were trying to obtain a patent; all that was in Medtest was this intellectual propery One of the two shareholders sold security to a couple but told them there was a patent on the medical process Ct said it is possible that the statement was material and there is a different in knowing have a patent and the possibility of getting one But the Ct remanded for decision 14. Santa Fe Industries, Inc. vs. Green **(impt 10b case) Short form merger provided by state statute; only applies if own more than 90% of a company; board adopts a plan of merger and once it is approved it can be implemented; dont have to inform the other shareholders by law but only to notify them w/in 10 days after its adoption There is remedy if the minority shareholders are unhappy statute provides they may demand an appraisal of their shares and be paid a fair appraisal value of their shares Santa Fe owns 95% of Kirby lumber and wants to acquire the remaining 5% by short form merger The minority shareholders claim they were paid inadequately for their shares SC says state law breach of fiduciary duty alone is not going to satisfy a 10b claim b/c it is federal and federal provides for specific types of harm s here could due for their appraisal Ct says claims relating to mergers that dont have misstatements or omissions and when are not satisfied the decisions are left to the state cts 15. Deutschman vs. Beneficial Corp. Beneficials insurance division has a bad quarter and stock started going down; s claim they lied in order to keep the stock from doing down even more and if they hadnt lied then stock would have continued to drop had call and put option and when price dropped he had to buy at artificial price Ct ruled had standing as purchaser to seek damages under 10b; but still must prove at trial IV. Problems of Control A. Shareholder Voting Control 1. Stroh vs. Blackhawk Holding Corp. Ct says that the ownership of stock means that the propriety rights are given to participate in (1) the control of the corp and (2) in its surplus or profits or (3) in the distribution of assets Ct says corp can place any restrictions on the corp as long as they dont deny voting power can prefer one class over another However if there is fraud that is different 2. State of Wisconsin Investment Board vs. Peerless Systems Corp. Ct uses the Blasius test instead of intrinsic fairness b/c there is no transaction at issue here Blasius Test ??? the where a certain

3. If there is a duty of loyalty question, generally you apply the intrinsic fairness test to determine if the directors actions were intrinsically fair (by sum total of all of their actions). It is usually used in circumstances transaction is in question. B. Control in Closely Held Corporations

1. State statutes provide for close corps; shareholders have a more direct role than normal. 2. Ringling Bros. Barnum & Bailey vs. Ringling Directors have agreement that will vote together on the same director; if cant agree then arbitrator is to come in and tell them who to vote for; one of the directors doesnt vote how agreed Ct says the concept of this agreement is ok and acceptable; shareholders can in advance work together to elect directors; they are supposed to act in own self interest and it is perfectly legit. Vote pooling agreements are legal Come from this case: (1) pooling agreement is ok; (2) only as good as the terms themselves in the K; (3) more adequate planning in advance could resolve the disaster on back end of pooling agreement; put in agreement in advance that would give arbitrator authority to enforce the agreement and give remedies if breach and explain damages if breach 3. McQuade vs. Stoneham Shareholders agree to elect themselves directors and as directors they agree to appoint themselves as officers McQuade, one of the shareholders, was also a magistrate judge; there was NY state statute that provided that a magistrate couldnt hold another office at the same time Ct says shareholders can agree to do whatever they want; dont owe obligations to anyone except for themselves; they can get together in advance and agree to elect directors But about the directors electing officers ct says that is unenforceable; some thing may come up in the future that would require you to breach fid duty just to still be in accordance with the K; Ct says cannot abdicate that role by agreeing in advance that could harm minority shareholders and possibly make you breach your fiduciary duty as a board member and not allowed to react to certain consequences 4. Clark vs. Dodge Opposite outcome from McQuade , owns 25% and owns 75%; they agree (1) Clark agrees to give up formula; (2) Dodge agrees to put Clark on the board and (3) keep Clark as the general manager Different from prev case b/c have full 100% here and didnt have that in McQuade; also different b/c general manager clause allows Dodge to get rid of Clark if he had to, so allows him to live up to fiduciary duties Ct found this K agreement was valid and ok 5. McQuade and Clark give uncertainty so state legislatures have given some suggestions as how to satisfy but not completely resolve this issue: (1) bylaws of a corp can provide for other mods of electing officers, instead of the board picking them (2) employment Ks if protect the job by K then dont have to worry about board acting consistent w/fiduciary duties and also employee has K rights separate; the board can do what it needs to do but there is a built in remedy for the employee. 6. Ramos s. Estrada Two different groups combined together but each member of each group had agreement they would stick together when it came to voting; one of the members didnt vote how she was supposed to and then ousted and shares were sold to the rest of the group (as was provided in the agreement) argues that mad at her for using judgment as a director and really punishing her for conduct as a director; ct doesnt buy that argument 7. Black Letter Rules of Close Corps Shareholder agreements are ok; not weighed upon by fiduciary duties b/c shareholders dont have fiduciary duties; but there is that 1% of the time when duties will apply??

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If 100% of the shareholders agree to take actions then that is also ok b/c no minority shareholder is there getting damaged; everyone agrees in advance and that is fair (Clark) 8. Gray area When own less than 100% of stock get together in advance and agree ct will look to see if there is a public detriment that would conflict w/any fiduciary duty in that case; if dont have a reasonable explanation then the ct will not uphold b/c no way for directors to use their judgment in consistent w/fiduciary duties; but nobody knows exactly how far have to go to be reasonable (Galler) Abuse of Control 1. Wilkes vs. Springside Nursing Home, Inc. Wilkes buys prop thinking it would be profitable; he finds three other investors and they build the nursing home They have an informal agreement that they will each get a seat on the board; they will all be active in the management and each will take equally Disagreements began among them and they kicked Wilkes off the board; he now has no salary, no board seat and no prospect of getting $ from dividends Ct said others did it for the sole purpose of getting him out, freezing him out Board has to show (1) legit business reasons for firing Wilkes and if cant show business purpose then they lose; (2) Minority to prove that there was a less harmful alternative Ct doesnt get to second step b/c found that there was no business purpose for dismissing Wilkes; Ct requires other three men to pay Wilkes personally What did the ct think the guys did wrong? Took away return on investment; offered him what ct considered an inadequate price What could they have done differently to make it legit and wouldnt have breached their duties? Could have tied $ pay out to shareholders to performance of duties; could have followed formalities a lot better; could have refused to pay anything for his shares What types of claims could have had if ct applied only typical standard? Could have filed a derivative action that payments were not legit for business (but very hard to prove); could also sue for rights he had as an employee What could have been done in advance to avoid going to ct? could have had a buy sell agreement to buy out fellow shareholders; maybe if had employment K for the services that he provided 2. Ingle v. Glamore Motor Sales hired as sales manager; later allowed to by in to 40% of the company as provided in shareholders agreement; terms also provided that if Ingle ever fired or wasnt employee any longer then Glamore could purchase his stock For 16 years Ingle is employed by and is a shareholder; he spent his whole career w/this company; ct says probably an expectation here Ingle is let go and Glamores son wants to buy his stock Ct notices that Ingle has two relationships: (1) employee and (2) shareholder claims, as Wilkes did, and there was no business reason for his firing Ct says there is a different w/duty to minority shareholder and duty owed to an employee; Ct says the status as a minority shareholder isnt enough for Wilkes principle to apply Difference b/w this case and Wilkes: (1) there was written and signed agreement in Wilkes; (2) Ingle was employee before he was a shareholder, Wilkes started and founded the nursing home; and (3) Ingle got $ for his shares Ct says Ingles complaint is really an employment complaint and is not really a shareholder complaint; he wasnt complaining enough about mistreatment as a shareholder

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What did the ct think the guys did wrong? As shareholder didnt treat wrong but problem was how was treated as an employee What could they have done differently to make it legit and wouldnt have breached their duties? Look more closely to the terms of the agreement What types of claims could have had if ct applied only typical standard? No shareholder remedies; really only recourse was as an employee What could have been done in advance to avoid going to ct? had a buy sell agreement here; could have had an employment K for services that he provided Sugarman vs. Sugarman Involves a (1) derivative action and (2) freeze out claim Ct finds on derivative claim Leo has wasted corp money Ct finds on freeze out claim Need to show bad faith; all the evid put together showed an intent to freeze out minority shareholders by the majority shareholder; even though each piece of evid by itself would not be sufficient, if you put all of them together that is sufficient evid What did the ct think the guys did wrong? Paid himself and his father too much $; pension wasnt justified and his salary was beyond what he should have gotten paid; didnt pay out dividends; or give family jobs; also mad inadequate price offer to minority shareholders for the price of their shares What could they have done differently to make it legit and wouldnt have breached their duties? Paid himself a reasonable amount; probably should have just not made an offer instead of an inadequate one What types of claims could have had if ct applied only typical standard? They actually did sue as a derivative action and that is the only action; problem w/that is that if win the $ comes back into the company What could have been done in advance to avoid going to ct? could have had a buy sell agreement Smith vs. Atlantic Prop, Inc. Wolfson finds prop and puts up $50,000; finds three others and they each put up $12,500; the put the prop into a Corp They entered into an agreement which stated needed 80% vote to be able to do whatever; means individual gets a veto; Wolfson wanted this provision b/c he didnt want the other three ganging upon him The business becomes profitable and they get into a dispute over dividends; Wolfson claimed he wanted to put the $ back into the co; the others wanted to get paid dividends They fight over this for years and are assessed a tax penalty by the IRS for 7 years Other three shareholders ask: (1) dividends; (2) removal of Wolfson as director; and (3) reimbursement of penalty taxes by Wolfson Ct said the provision regarding the veto power reversed the general rule of the majority having control Ct says Wolfson was avoiding paying taxes on dividends; didnt buy his argument of putting back into the corp Case show extension of Wilkes principle can be done in reverse; minority acting selfishly What did the ct think the guys did wrong? Blocking dividends w/out legit reason; he had no alternative and was avoiding taxes and acting out of spite What could they have done differently to make it legit and wouldnt have breached their duties? Needed a viable alternative, needed a plan that he wanted improvement What types of claims could have had if ct applied only typical standard? Could have petitioned ct to dissolve the co (if deadlocked) What could have been done in advance to avoid going to ct? could have had buy sell agreement; could have had a separate shareholders agreement Jordan v. Duff and Phelps, Inc.

Jordan quit job and had to sell back his shares; he waits until the end of the year to leave b/c get more $ for his shares; in the meantime the co was in negotiations for a buy out; a week afterwards they announce buy out and he could have gotten million for his stocks 10b5 claim must prove material misstatement or omission in relation to purchase or sell of a security; it has to be knowingly and has to have caused damages; must also show reliance and that wouldnt have quit working there if had known; must also prove causation more likely than not wouldnt have left Ct doesnt allow him to recover b/c say that w/the problems w/his family and his wife and mother he was going to move regardless

D.

Control, Duration and Statutory Dissolution 1. Alaska Plastics vs. Coppock 2. Pedro vs. Pedro Three brothers own co together; they all work their and have their own responsibilities Some $ winds up missing and one of the brothers investigates into it; accountant comes in and finds nothing; second accountant comes in and doesnt find it all but finds some Other brothers go to odd brother and tell him to forget about the missing $ or he will be fired; well they fired him; and then told everybody at work that he had a nervous breakdown Ct gives him damages for the 1/3 of the co that he owned; also wins b/c brothers breached fiduciary duty; ct also found he had a lifetime K w/the co so gave him lost wages and future earnings; ct also gave him atty fees and expenses Ct felt the other brothers were stealing from the co and didnt want them to profit that way 3. Stuparich vs. Harbor Furniture Harbor consisted of a furniture store and a trailer park; sisters wanted to separate the trailer park b/c it was making a lot of $ but the furniture store was consistently losing $ ???? Transfer of Control 1. Fransden vs. Jensen-Sundquist Agency, Inc. Jensen-Sun controls majority of bank and has an ins co. in it as an entity; owned 8% of the bank Agreement that if the 52% wanted to sell their shares, Fransden would have right of first refusal to buy those shares Bank of Wisconsin wants to the bank and not the insurance co; so there is to be a merger w/ and the shareholders are going to get cash for consideration The deal is reorganized and instead of merger the corp is to sell its stock in the bank to First Wis and they get the bank and dont have to do anything at the shareholder level and therefore Fransden isnt involved b/c they sold an asset that the company itself owned, the bank Ct said the merger didnt trigger the shareholder agreement; the agreement didnt discuss a merger 2. Zetlin vs. Hansen Holdings, Inc. Control premiums by themselves are legit; cant sue if minority shareholder just b/c a control shareholder or group gets paid a premium price for their shares 3. Perlman vs. Feldmann Perlman is minority shareholder here; Feldman controls the majority block of stock here; Wilport wants to buy this block b/c they want to control the steel company b/c at

E.

4.

this time there was a shortage and they knew if they acquired this block they would get first access to the steel Wilport paid $20 a share and market price was $12; other shareholders were upset so they sued This cases raises the issues: (1) is it ok to give a control premium? And (2) is it ok to sell off corp assets or offices? Ct doesnt really answer these questions but raises the issues Essex Universal Corp. vs. Yates Yates was Pres of Republic Pictures (control block being sold here; Yates controls 28% Essex has unusual board set up; had a classified or staggered board which split directors in groups and only elected every year when director needs to be elected, not elected every year Also in the K to get immediate control of the board Ct says selling office is not ok but selling control premium is ok; not supposed to get anything extra; if getting something extra, belongs to co as a whole, you cant pay somebody and get that separately It is illegal to sell the office or corp asset; cant say if you elect me CEO I will pay you each $2 million; not exercising judgment on behalf of shareholder but getting personal gain for carrying out fiduciary duties

V.

Insider Trading and Liability Issues A. Inside information 1. Goodwin vs. Agassiz Directors in a commercial corp stand in relation of trust to the corp and are bound to exercise the strictest good faith to its prop and business However, they are not trustees toward indiv stockholders Test when buyer seeks out stockholder to buy his shares w/out disclosing material facts w/in his knowledge and not in knowledge of the seller the transaction will be strictly scrutinized Fraud cannot be presumed!!! It must be proved. Was there fraud here? Ct said no. Only knowledge was existence of a theory in thesis of geologist. He was at no obligation to expose the theory. In fact, disclosure would have been detrimental to other mining companies in which they were directors. If had disclosed the info and it would not have come true that could have resulted in liability 2. SEC vs. TX Gulf Sulphur Mining co found mineral rich spot in Canada, started buying up large pieces of land around that area They ordered it to be kept a secret but during Nov and March 7000 to 12,3000 calls has been purchased by employees Call option options to purchase shares of stock at a fixed price; so you pay a low fee to freeze that price; even if it shoots up and becomes worth much more. Benefit is it returns greater value. But it is riskier b/c you could lose all the $ you invested in the option Rumors of major oil strike were circulating Confirmed in a newspaper release. In response the VP drafted press release asserting the nature of the article was incorrect Rule10b-5 it shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails or any facility of any national securities exchange, (1) to employ any device, scheme or artifice to defraud; (2) to make any untrue statement of material fact, or to omit to state a

material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, or; (3) to engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person in connection w/the sale or purchase of any security. You must disclose publicly what you know or refrain from acting in yours or others best interest So no excuse that the corp forbid disclosure of the info Test for materiality: Basic test would a reasonably prudent investor attach importance in determining his choice of action in the transaction in question. Encompass any fact in reasonable and objective contemplation MIGHT affect the value of the corp stock or securities. Whether a fact is material will depend at any give time upon a balancing of the probability that the event will occur and the anticipated magnitude of the event. Another factor is that materiality is based on how insiders act (they though it was material. Ct said not a real predicted danger here that the corp board members will decrease (that was their argument) YES IT WAS MATERIAL and the stockholders who purchase violated the rules Corp defense Press release was not issued in connection w/the purchase of a sale or security and alternatively SEC failed to prove it was false or misleading or deceptive. in connection w/ the point of the rule was to protect the investing public and secure fair dealing. Congressional intent, only that device employed, whatever it may be, be of a sort that would cause reasonable investors to rely upon False misleading, deceptive ct remands b/c record not clear

3. Insider trading violations are a subspecies of 10b-5 violations. 4. Trick w/insider trading is that not all omissions are bad. Ct needed to come up w/some limiting principle. Whoever is doing the trading has to be breaching a fiduciary duty, specifically look at insiders. The info must be of the corp and if trading on it then you can be breaching duty and hurting people by making personal gain. You also owe duties to your shareholders. 5. Tagging the violation of breach of fiduciary duty tensions (1) tension b/w general idea that is pushed hard by the SEC that want a level playing field and only finding violations where there is a breach of fiduciary duty, lead to Chiarella (2) other tension is have seen breaches of fiduciary duty that are not alone enough to find violation of 10b-5. Santa Fe if all youve done is violate duty of care then have state law remedies for that and dont have fed securities law remedy; separated state law duty breach claims from 10b-5 claims. 6. Chiarella vs. US Ct used the fiduciary duty template they had created: either have to be an insider or get info from insider who breached their fiduciary duty He got the information from the acquiring company bringing in the info into his printing office No one w/fiduciary duty to target shareholders was even aware of what was going on So he bought stock of that co that was going to be acquired; but he wasnt connected to anyone who owed a fiduciary duty SC let him off; However, the ct left out what duties he owed to who SC was limited to the fiduciary analysis they had created so they couldnt hold him liable b/c didnt squarely fall w/in it This case is eventually overturned b/c of Rule 14e by SEC and the OHagan case 7. SEC was very upset about the decision in Chiarella so they passed Rule 14e3 if a company is about to commence offer and someone learns about it then they cannot trade based upon that information; used tender offer rule to stock in new limitation to apply. 8. Dirks vs. SEC

A Sr. ex-manager from Equity comes to Dirks and tells him of illegal things that have been going on (fraud and stuff) Dirks has no connection to Equity. He works for a broker dealer Dirks tells a Wall Street Journal report of what was told to him about Equity; he actually does investigating himself and finds out from some employees that something is going on; Dirks also told some of his own clients and a number of investors about what he knew Now have, tip from insider that has lead to discovery of material nonpublic info and people are using that info to sell stock at a profit SEC charged Dirks w/violation. SEC says that insider has obligation to either disclose info or abstain from trading. SECs position is that someone who gets tipped by insider then their obligation transfers to the tippee (TX Gulf Surphur) SEC says his clients that sold on his tip info violated 10b-5 b/c traded nonpublic info they received two steps back from insider. SEC says there is a clear chain of info Ct says when someone is in (1) violation of their fiduciary duty AND (2) they gain a personal benefit we can extend liability. But every time the insider discloses that doesnt automatically pass the duty but only when improperly disclosed. Ct said no personal benefit there he was only trying to expose fraud. So not bound by obligation to abstain or disclose. So no fiduciary duty breach and no personal benefit This case creates question: how do you tell if breach of fid duty and how do you tell if there is a personal benefit? 9. Chestman Husband learned of acquisition of the family grocery store thru the wife, wife learned from mother, mother learned from husband. Ct didnt find husband liable of insider trading b/c had no fiduciary duty SEC also got very upset about this decision so they made another rule 10. SEC rule for when relationship of confidence exists and when duty is imposed upon tippee: (1) if make agreement to keep something confidential then inherit insider duties (2) if they have a pattern of sharing confidences (3) if have direct family relationship that imposes a relationship of confidence (spouse, parent, sibling, or child) 11. 14(e) 3 special rule that imposes duty of disclosure on anyone who trades in securities when in possession of material information that know is nonpublic; abstain or wait for disclosure; tender offer 12. US vs. OHagan OHagan is an atty who works at law firm that was hired by GrandMet. GrandMet is preparing a tender offer of acquiring Pillsbury. So OHagan owes duties to GrandMet and his law firm, Dorsey; but doesnt owe any duty to Pillsbury OHagan buys stock in Pillsbury at market price; then tender offer is announced and he sells his stock and makes over 4.3 million SEC prosecutes a 14e3 case and a 10b-5 action OHagan uses Chiarella argument and thinks he is ok SEC gets around that by saying he owed duty to GrandMet and his law firm and he breached those duties. He took their valuable info and used it form his own personal benefit. Just like the CEO of Pillsbury couldnt use the info to make a profit, he cant use it either SC adopts the misappropriation theory. It overturns the Chiarella case. Ct ruled that if you woe a duty to someone else and you misappropriate that info and use it form your own personal benefit then the ct will hold you liable Misappropriate theory: rooted in the fiduciary duty analysis. Ct still dying the violation to the breach of a duty. This theory broadens the scope of possible group of people who violate could owe duty to. Now anybody w/ a similar relationship of trust

B.

and confidence and you owe that duty to them and it is their info then this theory applies. If you improperly take that info and trade on it then can be held liable for 10b5 violation. W/OUT ELEMENT OF DECEPTION THERE IS NO MISSAPPROPRIATION THEORY. For 10b-5 action there has to be deception and in this case there is deception b/w OHagan and the people he owes duty to Ct says SEC has not exceeded their authority w/14e3 and OHagan is clearly liable here

Short-Swing Profits 1. 16 of the SEA of 1934: (1) Requires insiders to disclose all of their trades. Anytime you buy or sell stock, have to file report w/the SEC and that puts the world on notice that the insiders are trading. (2) Requires that any insider who makes a profit off purchase of sale w/in 6 months of each other must reimburse the corp. **This is the key element. 2. 16(a) only applies to those companies that hit threshold. Not every single person that has ever filed a business corp, really only big companies. 3. 16(b) Officers, directors and 10% shareholders must pay to the corp any profits they make w/in 6 month period from buying and selling the firms stock. Any stockholder of the company can sue to recover the profit. But the profit must go back into the company. 4. Officers and directors are subject to 16b if they occupy that position either at the time of the purchase or at the time of the sale. 5. Cts consider classes of stock separately. Shareholder is laibel for the short swing profits that he or she makes on any class of stock. 6. To calculate a companies recovery a ct must match a defendants purchases w/his sales. The cts match stock sales and purchases in whatever way maximizes the amount the company can recover. 7. Reliance Electric v. Emerson Electric Emerson is buying stock in Dodge; Dodge and Reliance eventually merge When Emerson realizes merger they need to get rid of stock so they sell and go from 13.2% shareholder to a 9.96% shareholder Emerson sold remaining stock in a second sale Reliance brings a 16b action claiming two sales w/in 6 months; argued that they were deliberately trying to get around the 16b rule and that they planned to sell stock in two separate sales Emerson claims that for the second sale they were not a 10% shareholder Do you take into account the transaction that makes you a 10% shareholder? Ct says NO. Since below 10% in the second sale then not liable under 16b. There is no obligation to pay back. This case shows that cts look to form over substance. Were you an officer, director or 10% shareholder and if you were then you will be liable for that profit. It is a strict rule and if you dont meet form of the rule then not going to apply 8. Foremost-McKessen vs. Provident Securities Ct rules that have to be a 10% shareholder before the purchase or sale of the stock for 16b to apply. The transaction that made them a 10% shareholder and elevated them to that status cant be used to show a profit. The rule only applies to someone who is already a 10% shareholder. 9. Kern County Land Co. v. Occidental Petro Corp. OPC is trying to acquire Kern thru merger but the merger fails Kern decides to tender offer for shares of stock, willing to buy 500,000 shares; they extend to the offer for another month At the end of the term they end up w/over 800,000 shares

Kerns officers sent letters to shareholder telling them not to sell b/c of a possible merger w/Tenneco Board approves merger w/Tenneco; There is an option that Tenneco agrees to buy back shares that OPC is going to get and to make sure dont have 16b liability they must wait 6 months and a day Kern points to the merger as a sale; and there are two points w/in 6 months where gave up rights and securities and want those to be consider as sale Ct says that neither of them are sales. Ct looks at formalities. No liability b/c purchase sale was 6 months and 3 days apart. The exchanges were not sales for the 16b purpose Ct says look to see if there was any speculative abuse or any opportunity to improperly use insider info. Ct will use this to determine if something is a sale. Ct says look to the purpose of the act when looking to expand sale. Ct found no evid that management was helping OPC here.

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