Business Associations Spring 2012 I. AGENCY a. Types of Business Entities: i. 1. Sole Proprietorship ii. 2. Partnership 1. Limited Partnership 2.

. Limited Liability Companies 3. Limited Liability Partnerships iii. 3. Corporations most important 1. Closely Held Corporation 2. S-Corporation General Rule: 1 Agency (this relationship can occur in any types of business entity) i. 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. 1. The one for whom action is taken is the principal i. Principal will be responsible for the acts of the agent acting within the scope of that relationship. ii. Principal must tell the agent to act on his behalf manifestation of intent that she wants someone to act as her agent 2. The one who acts is the agent i. Agent must agree to do so. ii. Agent must be subject to the principals control ii. Other important details 1. Money need not change hands for there to be an agency relationship 2. Need not be in the form of a K so long as it is in the form of an agreement. 3. Existence of agency may be proven by circumstantial evidence which shows a course of dealing between the 2 parties. iii. 2 Types of Agency Relationships 1. 1. Master-Servant i. evidenced where a master exercised control or has the right to control the operations of the servant 2. 2. Independent Contractor i. agent type vs. non-agent type i. agent type = IC who has agreed to act on behalf of another, but not subject to the principals control over how the result is accomplished ii. non-agent type = IC who operates independently and simply enters into arms length transactions with others. 3. Franchises i. A franchisor may be held to have an actual agency relationship with its franchisee when the franchisor controls, or has the right to control, the franchisees business. i. Test = determining whether a franchise K establishes agency relationship i. Nature and extent of the control agreed upon iv. Specific Case Law: 1. Gorton v. Doty i. Rule = Ownership of a vehicle alone creates a prima facie case for an agency relationship 2. A. Gay Jenson Farms Co v. Gargill, Inc i. Rule = Creditor/Debtor Relationship

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i. Creditor who assumes control of his debtors business is liable as principal for the acts of the debtor (agent) ii. BUT, a creditor who merely exercises veto power over business by preventing certain purchases does not become a principal. c. Liability in K i. Types of Authority: 1. 1. Actual Authority principals manifestation of consent for agent to act 2. 2. Implied Authority form of actual authority whereby the consent is implied; and the principal actually intended the agent to possess power. 3. 3. Apparent Authority no actual authority; manifestations by the principal to 3 rd parties or actions by the principal in such a manner that would lead a reasonably prudent person to suppose that the agent had the authority he purports to exercise. i. Basically, an apparent agency relationship arises when a principal acts in such a manner as to convey the impression to a 3rd party that an agent has certain powers which he may nor may not actually possess. i. 2 prong analysis i. 1. principal held out the agent as having the authority ii. 2. 3rd party reasonably believed that the person was an agent of the principal iii. 3. 3rd party must show reliance on the indicia of authority originated by the principal and such reliance must be reasonable. ii. Absent knowledge on the part of 3rd parties to the contrary, an agent has the apparent authority to do things which are usual and proper to the conduct of the business which he is employed to conduct. 4. 4. Inherent Authority no actual authority; derives from agency relation for protection of 3rd parties i. Used to impose liability on the principal when there is neither authority nor apparent authority it arises solely from the principals designation of an agent who would ordinarily be in possession of certain powers. i. Requirements to show inherent agency Watteau v. Fenwick i. 1. No actual authority ii. 2. Look to the custom or what is expected by the 3 rd party iii. 3. Agency exists, but the agent has acted beyond the scope of that agency. ii. 2 situations where IA will come up i. Undisclosed Principals i. An undisclosed principal is liable for acts of an agent done on his account, if usual or necessary in such transactions, although forbidden by the principal ii. An undisclosed principal who entrusts an agent with the management of his business is subject to liability to 3 rd parties with whom the agent enters into transactions usual in such business and on the principals account, although contrary to the directions of the principal. ii. No holding out by principal iii. Unauthorized Acts of a General Agent Nogales Services Center v. ARCO i. General Agent = agent authorized to conduct a series of transactions involving continuity of service. ii. A general agent for a disclosed or a partially disclosed principal subject his principal to liability for acts done on his account which usually accompany or are incidental to transactions which the agent is authorized to conduct if, although they are forbidden by the principal, the other party reasonably believed that the agent was authorized to do

the act, and that party has not been notified to the contrary that the agent was not authorized. 5. 5. Agency by Estoppel person liable to another person who has changed his position in reliance if person intentionally or carelessly caused reliance or did not take steps to correct the others perceptions i. Where a proprietor of a place of business by his dereliction of duty enables one who is not his agent conspicuously to act as such and ostensibly to transact the proprietors business with a patron in the establishment, the appearance being of such a character as to lead a person of ordinary prudent and circumspection to believe that the impostor was in truth the proprietors agent, in such circumstances the law will not permit the proprietor defensively to avail himself of the impostors lack of authority and thus escape liability for the consequential loss thereby sustained by the customer. i. Elements: i. 1. same as Apparent Agency ii. 2. AND the fact the 3rd party did in fact change his position in reliance to his detriment. 6. 6. Ratification affirmation by person of a prior act that did not bind him but professedly done on his account i. The affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account. i. Requirements i. 1. knowledge of material circumstances ii. 2. intent to ratify iii. 3. acceptance of the results ii. Ratification is a means by which the principal can say, my agent didnt have the right to enter into this K, but Im glad she did so. Accordingly, I will affirm the transaction and agree to be bound by the K. ii. Agents Liability on the K 1. Atlantic Salmon A/S v. Curran i. An agent who acts with total honesty and acts within his or her authority will not be subject to liability. d. Liability in Tort i. Independent Contractors 1. If the control over the IC is sufficient, we might be able to find liability on the principal still, even though the usual standard is that in an IC relationship, the principal will not be liable to 3rd parties in tort. i. There is no liability for the master unless: i. 1. master retains control of the manner and means of the work ii. 2. master hired incompetent contractors iii. 3. where the activityis inherently dangerous ii. Murphy v. Holiday Inns 1. A master is subject to liability for the torts of his servant committed while acting in the scope of their employment i. A principal is not liable for the torts of his non-servant agents (IC) 2. Control it is an essential element of the definition of an agency relationship, whether one is dealing with a servant or an IC. iii. Manning b. Grimsley 1. To recover for employee assault, the assault must be in response to s conduct that presently interfered with employee. iv. Fiduciary Obligations and Duty of Loyalty Owed by Agents: 1. An agent owes a fiduciary obligation to his principal. Requiring him to exercise the utmost good faith and loyalty in advancing the interests of the principal.

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Agent cannot do anything that is adverse or detrimental to the principals interest. i. To be adverse or detrimental, the agents activity must be in direct competition with that of the principal. During Agency: i. Agent who takes advantage of the agency to make profit is accountable to the principal ii. Agent who draws business away from principal is accountable to the principal. After Agency: i. Former employee may not solicit customers of employer if customers are not readily available other than through the fact that former employee knew of their existence from former employment. i. A former employee may not solicit the customers of his former employer if those customers are not openly engaged in business in advertised locations, or where their availability as patrons cannot easily be ascertained, but has been secured by years of business effort, advertising, and the expenditure of time and money, constituting part of the goodwill of a business. Trade Secret Violation i. Requirements i. 1. breach of confidence i. taken in some unfair manner ii. 2. breach must involve a trade secret i. trade secret must have an economic value ii. there must have been efforts to maintain the secrecy.

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PARTNERSHIPS a. Overview i. Definition of a Partnership: 6 1. A partnership is an association of 2 or more persons to carry on as co-owners a business for profit 2. But any association formed under any other statute of this state, or any statute adopted by authority, other than the authority of the state, is not a partnership under this act, unless such association would have been a partnership in this state prior to the adoption of this act; but this act shall apply to limited partnerships except in so far as the statutes relating to such partnerships are inconsistent herewith. ii. Characteristics 1. No written agreement is required 2. No limited liability all partners will be liable after the partnership fails to cover the liability amount i. Pass Through Liability i. If the partnership begins to lose a lot of money, creditors can go after any money in the partnerships bank account, and if that money runs outs, they can go after each individual partner personally and force them to pay out of their own wallets. 3. Pass Through Taxation i. No tax is paid by the partnership ii. The partners pay the taxes of the partnership on their individual tax returns iii. 3 ways in which a corporation can avoid being double taxed i. 1. dont distribute dividends and instead just sell stock ii. 2. classify earnings in the form of compensation or salary since that would be tax deductible iii. 3. S-Corporation taxed just like a partnership 4. Decentralized management or control 5. Every partner is an agent of the partnership and can bind the partnership iii. Determining Existence of a Partnership - 7 UPA 1. (1) Except as provided by partnership by estoppel (16) persons who are not partners as to each other are not partners as to 3rd persons 2. (2) Joint property or common property does not of itself establish a partnership, regardless of whether or not the co-owners share any profits made by the use of the property. 3. (3) The sharing of gross returns does not of itself establish a partnership, regardless of whether or not the persons sharing them have a joint or common right or interest in any property from which the returns are derived. 4. (4) The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business, but no such inference shall be drawn if such profits were received in payment: i. as a debt by installments or otherwise ii. as wages of an employee or rent to a landlord iii. as an annuity to a widow or representative of a deceased partner iv. as interest on a loan v. as the consideration for the sale of a good-will of a business or other property b. What is a Partnership and Who are the Partners i. Partners Compared With Employees 1. The words partnership (an oral or written agreement) are not necessarily determinative of whether one in fact exists. 2. It is the presence of the essential elements of a partnership that determines whether or not one exists: i. Factors:

i. 1. intentions of the parties as evidenced through the language of any written agreements ii. 2. right to share in the profits iii. 3. the obligation to share in losses iv. 4. the ownership and control of the partnership property v. 5. split control over management vi. 6. conduct of the parties toward third persons vii. 7. rights of the partners upon dissolution ii. FENWICK V. UNEMPLOYMENT COMPENSATION COMMISSION i. Facts: Cheshire employed as cashier until new agreement entered into establishing a partnership w/ no capital investment, control, management, or debt liability, and she received the same salary (15/wk) except for possible 20%/yr. bonus of net profits; Supreme Court rules entering into agreement and labeling themselves partners not overcome by conduct of the parties of surrounding circumstances. Was she an employee? ii. Holding: "She got nothing by the agreement but a new scale of wages" iii. Analysis: i. agreement made as attempt to compromise financial needs of Fenwick and Chesire, without altering the rights from Chesire's role as an employee ii. Chesire had right to share in profits, but this element isn't dispositive iii. no share in the losses, iv. no ownership or control, v. no control of business's management vi. language used excludes Chesire from most ordinary rights of partners vii. though filed partnership tax returns and held out as partners to the unemployment board, but represented as partners to no one else viii. same rights upon dissolution as she had when an employee (presumably none iv. -Most important elements were intent, control, and risk of loss ii. Partners Compared With Lenders 1. MARTIN V. PEYTON i. Facts: Money was lent to the partnership by three other investors who were not part of the loan. ii. Issue: By lending so much money and conditioning how it was run, they in effect became partners themselves. this is important because the partnership had lost something and owned money to other people, and if these three investors that the emergency loan , if the 2.25 million loan was enough to make them partners then they would be liable for all the debts of the partnership, so pretty draconian result. Prof compared this case to the Cargil case. iii. Advice: If you were advising the three investors today, given the other entity forms available, would you have advised them to use a different organization form. Partnership has no limited liability, so if the partnership owes money, the creditor can get all hte money from th partnership and then go and individually go after all the individual partners. Yes, limited liability company. iv. Rules and Reasoning: i. A creditor who exercises control over the partnership may be deemed a partner and become potentially liable for the debts of the partnership. 2. Order of Payment Upon Bankruptcy

i. Creditors ii. Partners who are creditors iii. Partners who have put in equity or capital contributions iii. Partnership v. Contract 1. SOUTHEX EXHIBITIONS BUILDING ASSOCIATIOn i. Here the issue is not whether you can form a partnership by lending money, but if you make contract, can that contract be construed to form a partnership. One is the homebuilders association and the other is ?. Originally SEM signs K with homebuilders, but later SEM assigns its interest to Southex. So when suit is brought it is brought by Southex who stands in the shoes of SEM. ii. SEM under the K had the (1) right to 59% of the profits, (2) they bear all the loss and (3) have very substantial control over the show. They are supposed to be on the annual home builders show. Isn't this enough to make partnership under uniform partnership Act? iii. Court says no, even though owners share loss and control. iv. Lessons: Builders dont want SEM to be regarded as partners, they look at this as just a K. iv. Partnership by Estoppel 1. General Rule: i. Persons who are not partners as to each other are not partners as to 3 rd persons. However, a person who represents himself or permits another to represent him, to anyone as a partner in an existing partnership or with others not actual partners, is liable to any such person to whom such a representation is made who has, on the faith of the representation, given credit to the actual apparent partnership. ii. There must be reliance 2. YOUNGS V. JONES No Estoppel i. Some investors invest 1/2 million in venture and this business venturer had been audited by price water house Bahamas. The audit turned out to be fraudulent or at least dubious and the investment is lost so the investors are looking for someone to sue. They think price water house is at fault. They want to sue in the US and a company that has more assets, so they try to sue price water house US. The plaintiffs claimed that PW US is a partner to PW Bahamas. ii. Estoppel because the third party relied on that representation. Kind of like apparent agency. The argument is that we were told PW Bahamas was part of the PW US worldwide organization and we relied on that and to our detriment so that g8ives rise to the estoppel claim. iii. There was a brochure the plaintiffs lawyers used as evidence and it brags about the fact that PW is a worldwide organization and had offices all over, so this is good evidence to prove estoppel. But court doesnt' accept this argument because the plaintiffs couldn't prove reliance because they found the brochure after litigation started. can't say they detrimentally relied on the brochure if you didn't even know about it. iv. What about apparent agency argument here. Who would be the agent and who would be the principle? The principle would be the PW US and agent would be PW Bahamas. But won't work because you would have to show that PW US did something to hold Bahamas office out as an agent. c. Fiduciary Obligations of Partners i. General Principles 1. Partners are agents of partnerships and the same agency principles apply to these organizations

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Joint adventurers owe each other the highest fiduciary duty of loyalty while the enterprise is going on. 404 of the UPA General Standards of Partners Conduct i. (a) the only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in (b) and (c). ii. (b) A partners duty of loyalty to the partnership and the other partners is limited to the following: i. (a) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity ii. (2) to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and iii. (3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership. iii. (c) A partners duty of care to the partnership and the other partners in the conducting and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law. MEINHARD V. SALMON very important i. Facts: i. Salmon entered into a joint venture with Meinhard to lease a hotel in NY from Gerry for a term of 20 years. Meinhard provided a majority of the funding while Salmon managed and operated, although both partners were responsible for losses. Near the end of the old lease, Gerry approached Salmon with an offer for a new lease, which was signed by Realty Company (owned by Salmon). Salmon did not tell Mienhard of the new lease until the deal had gone through. Meinhard demanded that the lease be held in trust as an asset of the venture to be shared, but Salmon refused. Meinhard sued to enforce his share. A breach of a fiduciary duty was found. ii. Rules and Reasoning: i. Salmon need only have advised Meinhard of the opportunity when it arose and then both would be free to compete for the project. i. Salmon was not obligated to do the new venture with Meinhard, just notify him of the its existence. ii. The result would have been different if there had been no nexus between the business conducted by him as the managing partner and the opportunity brought to him by incident of that position. iii. Side Note: i. Joint Ventures are still covered by the UPA, but if you call it a JV then it is going to be narrower ins cope and the fiduciary obligation is limited to the scope of the agreement. SANVIC V. LACROSSE i. 4 gentlemen who have negotiated a five year lease and they are divided into two groups. Sandvick and Bragg on one side, and LaCross and Haughton on the other side. Originally they have a five year lease on land that had petroleum that they thought could extract. Sandvick is P because LaCrosse extended the lease rights by 5 years w/o telling the other two they were going to do it. So Sandvic bring suit relying on Mineheart case saying we should have been included/notified about the extension.

Why might it be important that the business intended to sale the land. Why did tht enter into the majority's analysis on why there was a breach of the fiduciary duty? They negotiated the new lease during the 6 months before the lease expired. This is problematic because La Crosse would ge. There is a conflict of interest that La Crosse and Haugten have an incentive to not actively sale during last six months because if they can delay customer for another six months they will get more money. 6. Differences Between Meinhard and Sanvic i. Sanvic is Stronger than Meinhard i. All the partners here are savvy and sophisticated knew what they were doing ii. The partners here had an incentive not to actively sale so they could get more money. ii. Meinhart is Stronger than Sanvic i. In Minehart there was 20 year lease, here only 5 ii. Minehart was a managing partner, no partners here managed iii. Partners in Sanvic had, in various permutations, leased petroleum land sometimes together and sometimes separately, so this was not out of the norm for the partnership. 7. Note to Permethius Case (Diff b/t Partnership and LP) i. What is the difference between a partnership and a limited partnership? In a partnership every partner has unlimited liability. In limited partnership, there are two kinds of partners: (1) general partners and (2) limited partners. The idea in a limited partnership (around since early part of 20th century) (*Note LLP does not equal LP). There must be at least one general partners and they have unlimited partners, and limited partners have more of passive liability. This is still used in petroleum exploration/extraction a lot for tax reasons n such. In a LP if you invest money as a LP you can only lose what you invest. Whereas the general partners have unlimited liability. That's what we have in the Prometheus case and they want to merge it with an LLC. they might want to do this because the general partners would no longer have limited liability because in LLC all the owners get limited liability. Law said you need majority of limited partners to vote in favor of the merger. The issue is do u count the votes of the daughters of the general partner. They daughters are related to the guy who controls the limited partnership and the LLC and they are going to do what their father says, so they are not neutral. ii. ii. Grabbing and Leaving 1. General Principle i. Although fiduciaries may plan to compete with the entity to which they owe allegiance, in the course of such arrangements they must not otherwise violate their FD. 2. MEEHAN V. SHAUGHNESSY Breach of Duty of Loyalty i. Facts: In this law firm case there are a couple of partners. Meum and Boil. They decide to break off from the law firm and start their own firm. They start talking to clients about what they would do if they left. Partners asked if they are leaving, they say now. The law firm sues them that in the course of leaving they breached their fiduciary duty to the firm as partners. ii. Firm argues that Partners breached duty of loyalty because setting up new shop is potentially taking up opportunities from the current firm. iii. Rules and Reasoning: i. As a fiduciary, a partner must consider his or her partners welfare, and refrain from acting for purely private gain.

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ii. Under UPA 403(c) A partner has an obligation to render on demand true and full information of all things affecting the partnership to any partner. And even if they dont ask. iv. Advice: (1) Have these issues settled in the partnership agreement and (2) Collaborate with current firm and send out a letter from both. Check the box of the one that you prefer, (3) Once you have given notice to the firm of an intention to leave, then and only then can you talk to clients about leaving with you. iii. Expulsion 1. General Principles i. 38 of the UPA i. (1) When dissolution is caused in any way, except in contravention of the agreement, each partner, as against his copartners, unless otherwise agreed, may have the partnership property applied to discharges its liabilities, and the surplus applied to pay in cash the amount owing to the respective partners. BUT if dissolution is caused by expulsion of a partner, bona fide under the partnership agreement he shall receive in cash only the net amount due him from the partnership. ii. (2) When dissolution is caused in contravention of the partnership agreement the rights of the partners shall be as follows: i. (a) Each partner who has not caused dissolution wrongfully shall have a. all the rights in (1), and b. the right, as against each partner who has caused the dissolution wrongfully, to damages for breach of the agreement. ii. (b) The partners who have not caused the dissolution wrongfully, may continue the business for the agreed term if they desire to do so, provided they pay to any partner who wrongfully caused dissolution his interest less any damages. iii. (c) The partner who has caused dissolution wrongfully shall have: a. if the business is not continued, all the rights of a partner under (1) less damages under 2(a)(ii). b. If the business is continued, the right to have the value of his interest in the partnership, less damages caused by dissolution, ascertained and paid in cash. 2. LAWLIS V. KIGHTLINGER & GRAY P Agmt Can Trump Fiduciary Duties i. Facts:L was a partner in the law firm of K & G. He abused alcohol and the firm agreed to allow L to continue as partner while getting treatment, but there was to be no second chance. He was however given a second chance. Because he had not consumed alcohol since his second trip to clinic L believed his previous status should be restored. The firm voted to sever his relationship and allowed him a weekly draw until he could get another job. According to L the firm wanted to decrease lawyer/ partner ratio and he felt that this was a breach of FD. He offered a second theory for breach of partnership agreement (breach of K). Partnership agreement required 2/3 majority vote to terminate a partner i. First Claim Termination Violated P Agreement. No. ii. Second Claim Breach of Fid Duty to Each other. No. i. He argued partners would benefit from his terminated because they would receive more shares in the partnership. ii. Unlike in Meinhart, which didnt say anything about duties owed to partners, there was a partnership agreement that

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specified how partner can be ousted and that trumped the default fiduciary duty. Rules and Reasoning: i. 31 of the UPA was used: the partners acted in good faith in accordance with the agreement when they expelled him. ii. Anytime you put language in a partnership agreement that trumps fiduciary duty, that will always prevail. iii. For policy reasons, firms should have the ability to expel their own partners.

d. Partnership Property i. Putnam v. Shoaf 1. Facts: i. Putnam sold her interest in a partnership to the Shoafs when the business was operating at a loss. The Shoafs hired a new bookkeeper. It was later discovered that the old bookkeeper was embezzling. This led to lawsuits against the bookkeeper and banks that had honored the forged checks. Putnam was allowed to intervene, claiming an interest in any funds paid by the banks. Putnams estate sought to recover one half of the judgment paid by the bank to the Shoafs (they got $68K). She lost. 2. Rules and Reasoning: i. UPA Partnership Property Rights: i. Her property rights consisted of: i. 1. rights in specific partnership property a. includes the partnership tenancy possessory right of equal use or possession by partners for partnership purposes. b. This is incident to the partnership and the possessory right does not exist absent the partnership. ii. 2. an interest in the partnership, and a. his share of profits and surplus iii. 3. the right to participate in the management. ii. The only real interest of a partner is the partners interest in the partnership i. i.e. the profits and surplus ii. THEREFORE, a co-partner owns no personal specific interest in any specific property or asset of the partnership. iii. The partners interest is an undivided interest, as a co-tenant in all partnership property. e. Raising Additional Capital i. General Principle you need more capital than you initially thought. 1. Example: i. You have a building that will be worth 10million when it is completed. In order to raise that money, you borrow 9million and you will raise another 1million in equity by selling it to (i.e. 10 investors each putting up 100K). As it often happens with construction, there are cost overruns. They need another 500K to finish the building. If they finish the building, it will still only be worth 10million. If they sell it now, they will only be able to sell it for 9million. i. If they choose to build: a. Then each investor will have to contribute an additional 50K so that for their 100K in equity, they will have had to have put up 150K i. This is better then selling it now and losing 100K of their investment. ii. Diluting the value of the ownership shares

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Lets say that each share is worth 10K, and therefore each investor has 10 shares. They are going to sell some more shares in order to raise the 500K necessary to finish the building. i. Basically, they choose to sell shares at 1K each share. ii. SO now an original investor would have 60 shares. So total, we have 600 shares for 1 million dollars in equity. iii. Approximately 1700. So we have taken shares that were originally 10K each and then diluted them to 1700. i. However, the upside would also be to take a look at the 1K shares that have now been raised to 1700. Point a common problem that businesses face is that they underestimate the capital that is going to be needed.

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The Rights of Partners in Management i. Rights and Duties of Partners - 18 of UPA 1. The rights and duties of the partners shall be determined, subject to any agreement between them, by the following rules i. (a) each partner shall be repaid his contributions, whether by way of capital or advances and share equally in the profits and surplus remaining after all liabilities are satisfied; and must contribute toward losses, whether of capital or otherwise, sustained by the partnership according to his share in the profits. ii. (b) all partners have equal rights in the management and conduct of the partnership business. ii. Causes of Dissolution - 31 of UPA 1. Dissolution is caused: i. (1) without violation of the agreement between the partners, i. (a) by the termination of the definite term or particular undertaking specified in the agreement ii. (b) by the express will of any partner when no definite term or particular undertaking is specified iii. (c) by the expulsion of any partner from the business bona fide in accordance with such a power conferred by the agreement between the parties. ii. (2) in contravention of the agreement between the partners, where the circumstances do not permit a dissolution under any other provision of this section, by the express will of any partner at any time iii. (3) by any event which makes it unlawful for the business of the partnership to be carried on or for the members to carry it on in partnership iv. (4) by the death of any partner v. (5) by the bankruptcy of any partner or the partnership vi. (6) by decree of court under 32. iii. Winding Up of a Partnership 1. Under the UPA, if a partners leaves the partnership the partnership will be terminated and dissolved. Termination of the partnership gives rise to an accounting and any partner can sell off the assets of the partnership. 2. HOWEVER, the UPA is a default rule to be used only when there is no agreement between the partners. iv. Rules

18(e) in the absence of an agreement to the contrary, all partners have equal rights in the management and conduct of the partnership business. 2. 18(h) any difference arising within the ordinary course of business of a partnership may be decided by a majority of the partners. Any act that is outside the ordinary course of business, and any amendments to the PA, may only be done with the consent of all partners. i. If however, there are only 2 partners there can be no majority vote that will be effective to deprive either partner of authority to act for the partnership. v. NATIONAL BISCUIT COMPANY IF Conflict between P and 3rd Party 1. Partner wants to limit what partnership can do 2. Facts: i. Stroud and Freeman entered general partnership for food center, both having an equal right to manage. Freeman notified National that he would not pay for more bread if ordered for his company. Freeman ordered more and National sent it. Partnership was dissolved on last delivery day. National sued Stroud for the price of bread. Is notice to the creditor, in advance, that debts will not be paid sufficient to absolve the copartner from liability for acts of the other copartner? NO. ii. Statute in case said that partnership may not be bound if (1) partner has no authority in fact and person whom he deals with (2) knows that he has no authority. iii. Freeman as a general partner, with no restrictions on his authority to act within scope of partnership had equal rights in management and conduct of partnership. Stroud could not restrict the power and authority of Freeman. iv. Strouds defense is that they had notice, but this is not good enough since it can be said that Freeman was acting within scope of his authority. The Partnership was bound. 3. Rules and Reasoning: i. UPA 301(1): In a general partnership the acts of a partner, if performed on behalf of the partnership and within the scope of its business, are binding upon all co-partners. Thus, in regard to 3rd parties each partner is responsible for the acts of any copartner. i. Key point here, we had a 50-50 split and therefore no authority under Stroud to unilaterally change the authority that the partnership conferred on Freeman. ii. No act of a partner in contravention of a restriction on authority shall bind the partnership to persons having knowledge of the restriction. iii. The partnership is bound on the contract Freeman made with Nabisco unless (1) he lacked authority, and (2) Nabisco had notice. iv. A partner that lacks authority only binds himself. 4. Advise: If Freeman was on a spending binge and Shroud didnt want to be responsible, he should have immediately dissolved the partnership. He has authority to do that. He would need to announce to the world so that anything purchased after that is only binding against Freeman. Or form an LLC. vi. SUMMERS V. DOOLEY If Conflict between P and P 1. Partner wants to broaden what partners can do. 2. Facts: Summers and Dooley enter into a partnership to operate a trash collection business. Dooley becomes incapacitated so he hired an employee to work in his place. That is ok. The partnership continues for a while, but Summers says that he wants to hire someone to work alongside him and Dolleys replacement. Dooley says no, but Summers still hired him without the consent of Dooley. 3. Summer didnt have authority 4. Rule and Holding

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401(j): Absent an agreement to the contrary, matters arising in the ordinary course of the business may be decided by a majority of the partners. ii. Since a majority of the partners did not consent to the hiring of the new worker, the partnership was not bound by Summers K with the new worker. 5. Distinction from Nabicso i. Freeman in Nabisco sought to limit what partners could do. ii. Partner seeking to hire wants to broaden what partners can do. iii. Outcome different from NBC because here, the expense incurred was not for the benefit of the partnership but rather for the benefit of one partner only. iv. National Bisquit Suit brought by Third Party v. In Summers, suit was brought by one partner against another 6. What if the Employee sued? Could he enforce his employment K? i. Yes under apparent authority theory, holding out. One of the partners hired me and he appeared to have authority and it was reasonable for me to believe he had authority. vii. DAY V. SIDLEY & AUSTIN 1. Facts: Former General Master made partner at SA. Then SA negotiated a merger with another firm, and they need to combine the offices. The other offices are larger so they move SA office of the new firm and they make Day the co-Director/Head of the merged law firm. Since new partner didnt get swanky office, he sued. His claim is that they took away his position as the TOP person in the DC office. He has two claims: (1) fraud -- he interpreted that he was told he would serve as chair as the DC office and they ended up having 2 chairs. His other claim is for breach of fiduciary duty. He should have been consulted before the merger. But there were several meetings and he only attended one. So the court said there was no breach. He loses on both claims. 2. Holding: not a misrepresentation b/c Day not deprived of any legal right, 3. Analysis i. if Day desired to remain chairman should have specified that provision be included in the agreement, the authority to control chairmanship was held by executive committee which was included in his partnership agreements ii. failing to reveal information concerning internal structure isn't recognized, since not dealing w/ profits or loss; non-executive committee members didn't have information that Day didn't iii. bruised ego doesn't constitute a cause of action, risk he assumed when joining the partnership Partnership Dissolution i. Overview 1. Buy Sale Agreements i. Buy/Sale Agreements are a way of extracting yourself from business if one person no longer wants to participate. This should be in every business agreement for a client. Answers the question what is going to happen if we split up. ii. Purpose is to work out in advance how to dissolve, or how to allow one partner to get out.A litigation free way of resolving this, it would be agreed in advance how one person could leave, what would e owed to him iii. Better to have a buy/sale agreement that covers all contingencies, the broader, and the more that is covered, the less the client will have issues later on requiring litigation. iv. These minimize uncertain and litigation. v. Trigger Mechanisms Advisable to have broadest trigger for client. i. Death ii. Disability iii. Will of any partner best for client.

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3. 4.

vi. Price Mechanism i. FMV departing person would prefer this i. Requires appraisal ii. expensive and subjective- may argue on who is the appraiser, so decide early on ii. Book Value i. usually clear and bright-line, but often not close to the fair market value ii. this is good for person who wants to bail shorty before or after setting up. iii. This creates incentive for people to stay in business because they know if they leave they wont get FMV, only book. iii. Formula (e.g, 5x earnings iv. Set price each year v. Relation to duration (e.g., lowest price in first five years) vii. Types of Agreements i. Restrictions on transfer i. can't sell shares w/o the permission of the corporation or the other shareholders ii. try to have stable direction and management, don't risk too much involuntary change iii. protect non-selling shareholders iv. very important in corp., where no restriction on selling ii. Grant entity or other investor the right, but not obligation, to purchase if a triggering event i. protect non-selling shareholders, prevents outsiders from joining and retains status quo ii. doesn't provide liquidity to sell iii. Provisions requiring the entity to purchase the interest upon a triggering event i. Protect selling shareholder by providing liquidity ii. Important in both corp. and partnership context Background: i. Important Terms: i. 1. Dissolve process of ending a partnership ii. 2. Wind Up partners who have not wrongfully dissolved partnership have a right to wind up, or the court can on application. ii. Fiduciary duty of partners lasts through the dissolution and through the wind up phase of the partnership. iii. UPA can be modified by an agreement. Causes of Dissolution: i. 31 Dissolution by Decree of Court - 32 i. (1) On application by or for a partner the court shall decree a dissolution whenever: i. (a) a partner has been declared lunatic by court of law or is shown to be of unsound mind ii. (b) a partner becomes incapable of performing his part of partnership K iii. (c) a partner has been guilty of conduct which prejudicially affects the business iv. (d) a partner willfully or persistently commits breach of PA, or conducts himself in a manner making it not practicable to carry on business v. (e) the business of the partnership can only be carried on at a loss

vi. (f) other circumstances render a dissolution equitable. ii. The Right to Dissolve 1. OWEN V. COHEN i. Owen and Cohen entered into an oral partnership agreement to run bowling alley. One partner put in 6900 capital. Within three months they begin to disagree on management of the corporation. Cohen is pain. Owen wanted to dissolve. Owen said minor differences are not enough to dissolve. i. Partnership is dissolved. ii. Rule: Generally, minor differences and grievances are not enough to dissolve a corporation, but a court may order dissolution where the disagreements are of such an extend that all confidence and cooperation between the parties has been destroyed, or where one of the parties, by his misbehavior, materially hinders a proper conduct of the corporation. i. Owen had 2 options for dissolving, 1) dissolving on his own, and 2) dissolving by court order and he opted for option #2 a. He did this because under the 1914 Act: i. A wrongfully dissolving party would lose all rights in the good will of the business, and ii. This is changed as of the 1977 Act and now even the wrongfully dissolving partner still has his rights to the good will. iii. A wrongfully dissolving party would be liable for damages for breach of the partnership agreement. iv. A wrongfully dissolving party would lose control over the wind-up. iii. Consequences for the Wrongfully Dissolving Partner under the UPA i. 1. lose control over the winding up phase ii. 2. liable for damages for breach of the PA iii. 3. good will issues 2. COLLIN V. LEWIS i. Facts: i. After entering into a long term lease of space in a building under construction, C & L established a partnership. C agreed to advance Money to equip a cafeteria which L agreed to manage. Cs investment was to repaid out of the profits. Delays and costs required larger initial investment than the parties had anticipated and C threatened to discontinue unless it began to make a profit. C sued L seeking dissolution of the partnership, the appointment of a receiver, and foreclosure of a mortgage upon Ls interest in the partnerships assets. L cross actioned against C arguing that he breached contractual obligation to provide funding. Lewis didnt do anything wrong. Here Collins was the wrongdoer. Lewis couldnt repay the balance because Collins hadnt put up necessary capital. But for the conduct of Collins there would be a reasonable expectation of profit. The court said if capital was put up then business would be profitable- this negates dissolution argument under 32(e)- dissolution is proper if business of partnership can only be carried on at a loss. ii. Rules and Reasoning: i. A partner who has not fully performed the obligations required by the PA may not obtain an order dissolving the partnership. a. Therefore, the two are stuck in their partnership. 3. PAGE V. PAGE

Facts: 2 brothers are involved. HB is the money man and George is the manager. The partnership loses money in the first few years, but towards the end, it begins to make some money. At this point, HB says that he wants to dissolve this partnership. George goes to a lawyer and sues claiming that this is a wrongful dissolution of a partnership ii. Rules and Reasoning: i. When there exists a partnership at will, partners are not bound to remain in the partnership, regardless of whether the business is profitable or unprofitable, and the partnership may be dissolved by the express will of any partner (31(b)). However, this power must be exercised in good faith (and not for the benefit of that partner or the detriment to the other partner unless that partner is compensated). THUS the is protected by the fiduciary duties of his co-partner. a. i.e. a partner may not dissolve a partnership to gain the benefits for himself, unless he fully compensates his copartner for his share of the prosective business opportunity. iii. The Consequences of Dissolution 1. PRENTISS V. SHEFFEL i. Facts: i. The partners have a falling out because Prentiss hasnt paid his share of the losses. Sheffel and Eger ask the court to dissolve the partnership and the court does so under 32(1)(d). The court dissolves the partnership and so the real issue is about whether it is proper to allow Sheffel and Eger to bid on the property. ii. Rules and Reasoning: i. Majority partners in an at will partnership may purchase the partnership assets at a judicially supervised sale. There was a partnership at will. ii. While the trial court did find that the was excluded from the management of the partnership, there was no indication that such exclusion was done for the wrongful purpose of obtaining the partnership assets in bad faith rather than being merely the result of the inability of the partners to harmoniously function in a partnership relationship. He wasnt forced to sale his interest, he had the same rights as they did to purchase 2. PAV-SAVER CORPORATION V. VASSO CORPORATION i. Facts: i. Meersman (lawyer) and Dale (inventor). Partnership is formed because they want to market this machine. Partnership exists and thrives for a number of years but then starts doing poorly. Dale, through his corporation Pav-Saver Corporation wants out and he sends a letter to Meersman saying that he wants to dissolve the partnership. This would be a wrongful dissolution because the agreement did not allow for such a form of dissolution. The agreement was for the partnership to be permanent and not to be terminated or dissolved except upon mutual approval of both aprties. Meersman then locked all the doors and kicked Dale and all of his stuff. ii. Rules and Reasoning: i. When a wrongful dissolution occurs, partners who have not wrongfully caused the dissolution shall have the right to continue the business in the same name and to receive damages for breach of the agreement. ii. Partnership agreement controls, except when there is: i. 1. a breach of a strong fiduciary duty or

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2. partners agree to something that involves and harms the interests of non-present 3rd parties.

iv. Sharing of Losses 1. General Principles i. 1. in the absence of an agreement to the contrary, the law presumes that partners and joint adventurers intended to participate equally in profits and losses irrespective of any inequality in the amounts each contributed to the capital employed in the venture, with the losses being shared by them in the same proportion as they share the profits. ii. 2. Compensation for Services i. default rule = no one gets compensated for services unless the PA says so, but partners do get a share of the earnings. 2. Kovacik v. Reed i. Facts: i. Kovacik is the money man, and Reed is the hands-on expert in contracting. They form a partnership which is done orally. The idea is that they will remodel kitchens in the SF area. They agree to share the profits on a 50-50 basis, but the money is to come from Kovacik. After 9 months, Kovacik says that the venture is losing money and that he wants to dissolve the K, and he tells Reed that he wants payment for some losses ii. Rules and Reasoning: i. General Rule everyone shares profits and losses at the same proportion i. Exception Where, However, as in the present case, one partner or joint adventurer contributes the money capital as against the others skill and labor, all the cases cited, and which our research has discovered, hold that neither party is liable to the other for contribution for any loss sustained. Thus, upon loss of the money the party who contributed it is not entitled to recover any part of it from the party who contributed only services. v. Buyout Agreements 1. Definition i. A buyout agreement is an agreement that allows a partner to end her or his relationship with the other partners and receive a cash payment or series of payments, or some assets of the firm, in return for her or his interest in the firm. i. Remember that all of the cases that we have dealt with could be resolved if they had a proper buy-sell agreement in place. 2. Key Issues: i. 1. Triggering Event: i. when someone wants to get out of a business i. 1. when somebody dies ii. 2. when somebody gets disabled iii. 3. by will of any partner ii. 2. Valuing the Business i. In order for the agreement to work, it must be known what the parting persons share is worth i. 1. outside appraisal ii. 2. formula iii. 3. book value iv. 4. price per year v. set it according to duration iii. 3. Obligation to buy vs. option i. 1. Firm

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ii. 2. Other Investors iii. 3. Consequences of refusal to buy iv. 4. Method of Payment i. Cash ii. Installments G&S INVESTMENT V. BELMAN i. Facts: i. G & S sought judicial dissolution of their limited partnership with N after he began using cocaine and starting making irrational decisions. They sought judicial dissolution and the right to carry on the business and buy out Ns interest as permitted by 38. N died after filing of complaint and G & S sought to amend complaint invoking right to continue and acquire Ns interest (under articles 19 of their Articles of Limited Partnership- they had all drafted). This PA allowed them to buy a deceased partners interest at book value. B, an executor of Ns estate claimed that the mere filing of the complaint acted as a dissolution (that they were wrongfully dissolving partners), requiring the liquidation of the assets and distribution of the net proceeds to the partners. This argument does not win- they may have been wrongfully dissolving partners if they had just terminated it (31), but by going to court they protected themselves. ii. 2 Critical Issues i. 1. Whether the surviving general partner, G&S is entitled to continue the partnership after the death of Nordale ii. 2. How the value of Nordales interest in partnership property is to be computed. iii. Rules and Reasoning: i. Partnership buyout agreements are valid and binding even if the purchase price agreed upon is less or more than the actual value of the interest at the time of buying or selling

III.

CORPORATIONS

Types of Corporations o All of these are defenses to individual liability and argue against piercing the veil. o 1. Corporation De Jure all steps have been taken to form a corporation o 2. Corporation De Facto there was a good faith attempt to file in accordance with the valid state law but not legally perfect. 1. tried to set it up in good faith 2. legally authorized to set up the corporation 3. acted as if you were a corporation o 3. Corporation By Estoppel 3rd party will be estopped from suing you individually if they thought all along that they were dealing with a corporation. Key Distinctions between Corporations and Partnerships o Corporation 1. 3 documents involved 1. certificate of incorporation o single page document filed with secretary of the state. 2. articles of incorporation o sets out the rules by which the corporation will function 3. by-laws o detailed rules of the corporation

2.

3.

4.

o LLC

5. 6. 7.

In a partnership, there is no such requirement for formality in documents. Longevity Corporations can exist in perpetuity Partnerships, at least under the old rule had to be reformed every time a partner was gone. Taxation Corporations are double taxed, but can be avoided in 3 ways o 1. pay no dividends, and only high salaries to the owners o 2. form it as an S-corporation gives you the right to be taxed in the pass-through fashion as a partnership o 3. dont pay dividends to stock holders. Limited Liability Corporations have limited liability for all of its owners Partnerships have no limited liability for all its owners, and that is why people opt for the LLC rather than the Partnership. Management Corporations have a centralized management Perception Corporations are sexier Cost Corporations cost more to set up

Documents needed: 1. Articles of organization 2. Operating Agreements Promoters of Corporations o Promoter = person who sets up the corporation ID a business opportunity and puts a deal together, forming a corporation as a vehicle for investment by other people. Promoters have responsibilities and legal liabilities as they are doing things on behalf of the corporation. o Fiduciary Duty: Promoters have a FD to each other and to the corporation Promoter = Agent for Corporation There is a fiduciary obligation to the corporation There is a fiduciary obligation to 3rd parties for pre-incorporation commitments. o Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc Facts: Before Southern-Gulf was incorporated (known as a company to be formed), Barrett, the president of Southern Gulf, entered a K with Camcraft, which required Camcraft to build a ship. Barrett informed Camcraft by letter that it had incorporated in different location than originally planned. Camcraft president (Bowman) signed written acceptance and agreement to the letter. Camcraft defaulted and SG brought suit for specific performance. Camcraft (D) sought to escape liability for breaching due to legal status of the plaintiff (they argue that the business was not incorporated when Barrett signed the K so it is invalid- that Barrett cannot sign on behalf of corp. if it is not formed yet). It was valid. Rules and Reasoning: Corporation by Estoppel - One who Ks with what he acknowledges to be and treats as a corporation, incurring obligations in its favor, is estopped from denying its corporate existence, particularly when the obligations are sought to be enforced. o Where a party has contracted with a corporation, and is sued upon the K, neither is permitted to deny the existence, or the legal validity of such corporation. Note you can always sue the promoter and thus promoter is personally liable to the corporation because he is one who signed his name on the K.

UNLESS the corporation was filed before any K was entered into. In this case, the K will only bind the corporation and not the promoter. The corporation is not automatically liable on promoters K made for its benefit before it came into existence o Instead, a newly formed corporation may accept or reject all preincorporation Ks. Generally corporate adoption of a K releases the promoter from further liability only if the parties expressly agree that the corporation will take over the rights and responsibilities of promoter (novation). The Corporate Entity & Limited Liability o Background Information Piercing the Corporate Veil thereby eliminating the limited liability shield 2 types of cases where this issue of piercing will come up o 1. closely held corporation case characteristics 1. few shareholders 2. all or most of the shareholders are active in the management of the business 3. no public market for its shares 4. shares are subject to 1 or more contractual restrictions on transfer 5. never registered a public distribution of shares under the federal or securities acts. o 2. parent/subsidiary case A parent corporation may be held liable for its subsidiaries obligations if it fails to maintain a clear separation between parent and subsidiary affairs. Conduct which may lead to parental liability 1. referring to subsidiary as a department or division of the parent 2. mixing business affairs o using parents stationary o having common officers o mixing assets Law permits the incorporation of a business for the very purpose of escaping personal liability General Rule: Piercing the Corporate Veil The courts will disregard the corporate form, or pierce the corporate veil whenever: o 1. the corporation is not clearly run as a separate corporation, OR o 2. if it is necessary to prevent fraud or achieve equity. o Closely Held Corporation Cases Walkovszky v. Carlton Facts: o Walkovsky (W) was run down by a cab owned by SC Corporation (SCC). SCC was one of ten cab companies of which Carlton (C) was a shareholder. Each cab corporation has two cabs registered in its name and each carried minimum liability insurance ($10K). It was alleged that these corporations were operated as a single entity. This structure is designed to limit Carltons liability. W wants to sue all of these companies because liability insurance for each is not enough to cover his claims. The case failed because of deficiency in complaint, later amended to allege more facts of mingling and he won. Rules and Reasoning: o Piercing the Corporate Veil Requirement to Pierce the Veil 1. show that the corporation is the alter-ego of the person who owns it o cant separate person from the corporation

2. generally fraud, or injustice o fraud misrepresentation o injustice subjectivity involved in the analysis Whenever anyone uses control of the corporation to further his own rather than the corporations business, he will be liable for the corporations act upon the principle of respondeat superior applicable even where the agent is a natural person. Liability will extend to reach assets beyond those belonging to the corporation When a corporation is a fragment of a larger corporate combine which actually conducts the business, the corporation may be treated as an agent and the corporate veil pierced in order to reach the principal. Only the larger corporate entity will be financially responsible and not the stockholder. When a corporation is a dummy for its individual stockholders who are in reality carrying on the business in their personal capacities for purely personal rather than corporate ends the corporation may be treated as an agent and the corporate veil pierced in order to reach he principal Stockholder will be personally liable. o The corporate form may not be disregarded merely because the assets of the corporation and its liability coverage are insufficient to cover s claim. Sea-Land Services, Inc v. Pepper Source Illinois Piercing the Corporate Veil Requirements Facts: o SL could not collect on bill owed by PS since PS had been dissolved and had no assets. SL field lawsuit against M (the sole shareholder of PS and other corporations) and five business entities he owns seeking to pierce PSs corporate veil and hold M personally liable for the judgment owed to SL, and then to reverse pierce Ms other corporations so that they would also be responsible. It was alleged that all of these corporations were alter-egos of each other and hidden behind the veils of alleged separate corporate existence for the purpose of defrauding. Rules and Reasoning: o PCV Requirements in Illinois 1. Unity of Interest (lack of separation between corporation and the individual or other corporations), AND unity of interest and ownership that the separate personalities of the corporation and individual (or other corporations) no longer exists o 4 factors 1. failure to maintain adequate corporate records or to comply with corporate formalities 2. commingling of funds or assets 3. undercapitalization 4. one corporation treating the assets of another corporation as its own. 2. adherence to the fiction of a separate corporate existence would permit a fraud or promote injustice the wrong must be beyond a creditors inability to collect since that is something that is in every veil piercing action. Parent/Subsidiary Cases In Re Silicone Gel Breast Implants Products Liability Litigation Facts: o MEC was incorporated in Wisconsin and manufactured breast implants. After review that included information about defects in implants, Bristol, a Delaware corporation purchased MECs stock. MEC became a Delaware corporation wholly

owned by Bristol. Bristol expanded by purchasing from the Cooper Companies two other breast implant manufacturers YSS Inc. and AC. Though executed in the name of MEC and the Cooper Companies, the purchase was negotiated between Bristol and the Cooper Companies and the purchase price was paid from a Bristol account. MEC board consisted of Bristol VP, another Bristol executive, and MECs President. Bristol set the employment policies and wage scales that applied to MECs employees. Before hiring a top executive MEC had to get Bristol approval. Bristol provided various services to MEC. Some of Bristols in house counsel acted as MECs attorneys. Bristol is the sole shareholder of MEC but has never manufactured or distributed breast implants. At trial it could be shown that many of these factors had been proven- Bristol was liable. Rules and Reasoning: o A parent corporation is expected to exert some control over its subsidiaries, but when a subsidiary corporation is so controlled as to be the alter ego or mere instrumentality of the parent corporation, the corporate form may be disregarded in the interests of justice. Totality of the Circumstances must be evaluated in determining whether a subsidiary may be found to be the alter ego or mere instrumentality of the parent corporation All jdxs require showing of substantial domination o 1. P&S have common D&Os o 2. P&S have common business departments o 3. P&S file consolidated financial statements and tax returns o 4. P finances the S o 5. P caused the incorporation of the S o 6. S operates with grossly inadequate capital o 7. P pays the salaries and other expenses of the S o 8. S receives no business except that given to it by the P o 9. P uses the Ss property as its own o 10. Daily operations of the 2 corporation are not kept separate o 11. S does not observe the basic corporate formalities, such as keeping separate books and records and holding shareholder and board meetings. Delaware Does not require a showing of fraud if a subsidiary is found to be the mere instrumentality or alter ego of its sole stockholder Furthermore many jdxs that require a showing of fraud, injustice, or inequity in a K case does not in a tort situation. o Courts are reluctant to pierce the corporate veil in K cases Party seeking relief is presumed to have voluntarily and knowingly entered into an agreement with the corporate entity and is expected to suffer the consequences of limited liability since it could have insisted on assurances that would make the parent also responsible. o Tort cases are different The injured party had no such choice, the limitations on the corporate form were non-consensual. Tax Shelter Investments o TSI = investments that show losses for tax purposes even though they may be successful economically. The tax advantage of the use of the limited partnership form of organization was that the investors were able to claim their pro rata share of the (economically artificial) losses of the partnership on their

individual tax returns, which is not possible for tax-shelter type investments if the corporate form is used. NEW VARIATION: a limited partnership with a corporation as the sole general partner no individual was liable for the debts of the partnership. o Frigidaire Facts: Frigidaire entered a K with CI, a limited partnership. M & B were limited partners of CI and also served as officers, directors, and shareholders of Union Properties (UP) (the only general partner of CI). M & B controlled UP, and through that control they exercised day-to-day control and management of CI. CI breached the K with Frigidaire and F sued UP and M & B. [Here the limited partners (M & B) own shares of the general partner (CI) and so they control the general partnership- similar to Escamilla in that they are acting like general partners] It is argued that M & B should incur general liability (lose their limited liability) for the limited partnerships (CI) obligations because they took a part in controlling the business of Commercial. There is no reason to find that M & B incurred general liability. Rules and Reasoning: Limited partners do not incur general liability for the limited partnerships obligations simply because they are officers, directors, or shareholders of the corporate general partner. o CONTROL = important factor If the officer, director, or shareholder is controlling the limited partnership in his corporate capacity, he will not incur general liability, BUT If the officer, director, or shareholder is controlling the limited partnership in his direct or personal capacity, then he may incur general liability for those personal affairs. o JUST FORM AN LLC everyone will get limited liability without the hassle of organizing this way. Shareholder Derivative Actions o Background Information 1. When shareholders sue on behalf of the corporation for the wrongdoing of officers, directors, or managers of a corporation. 2. Although the suit is brought by individual shareholders, it is on behalf of the corporation and the corporation as a whole gets the money if the suit prevails. 3. There are 2 types of fiduciary duties: 1. duty of loyalty 2. duty of care. 4. Direct vs. Derivative Suit: derivative whereby all shareholders were equally affected and therefore the suit is brought on behalf of all shareholders. 5. Laws with cover derivative suits 1. DE law 2. NY law 3. MBCA Model Business Corporation Act o Demand required every time. o Introduction Under the Erie doctrine state substantive law should be applied and federal procedural rules. Cohen o State statute requiring the posting of a bond for derivative suits was held to be a substantive, and not a procedural law, and thus it was proper for corporations to require shareholders bringing derivative actions to post a bond for expenses and attorneys fees in the event that he lost the case. o Federal Court sitting in diversity jdx must apply a state statute providing security for costs if the sate court would require the security in similar circumstances. o Requirement of Demand on the Board of Directors Background Information

Once the makes a demand, he waives his right to contest the independent of the board (i.e. that demand would be futile). Policy of demand requirement = process helps to deter costly, baseless suits by creating a screening mechanism for merely suspicious claims. Grimes v. Donald Delaware Law Rules and Reasoning: o General Rule: Before a lawsuit is filed, you must demand that directors fix the problem or file a lawsuit. If the demand is rejected, the board is entitled to rely on the BJR unless the stockholder can allege facts with particularity creating a reasonable doubt that the board is entitled to the benefit of the presumption. If the demand is waived, then the lawsuit can proceed. o But most likely, the demand will be refused. o A stockholder filing a derivative suit must allege either that: 1. the board rejected his pre-suit demand for the board to assert the corporations claim, OR 2. allege with particularity why making demand would be futile why he was justified in not having made a demand at all. o Demand is futile (and thus excused) if it is alleged that: 1. a majority of the board has a material financial or familial interest that will be affected 2. a reasonable doubt exists as to whether the board is capable of making an independent decision to assert the claim if demand were made 3. the underlying transaction is not the product of a valid exercise of business judgment, and in which case, you must plead with particularity that shows violation of the BJR o BJR Business Judgment Rule Reasonable and Informed business decisions will not be disturbed by the courts Marx v. Akers New York Law Rules and Reasoning: o General Rule: Same as Delaware, except the futility test o Demand on the BoD is futile if a complaint alleges with particularity that: 1. a majority of the directors are interested in the transaction, or 2. the directors failed to inform themselves about the transaction to a degree reasonably necessary under the circumstances, or 3. the directors failed to exercise their business judgment in approving the transaction. o Courts have held that a COA for excessive salary raises will not stand alone unless, wrongdoing, oppression, or abuse of fiduciary position is also demonstrated. Role of Special Committees Background Information Standard Procedure: o 1. wrongful behavior occurs o 2. behavior is discovered by the or his attorney and a decision regarding demand has to be made. If he decides demand will be futile litigation begins If he decides to make a demand Corporation can accept or refuse the demand, and normally, will always refuse the demand.

3. If futility is claimed, then a showing as it is required by a particular state will be required. o 4. If the demand is waived, the Corporation will now have the option form a SLC to determine whether to go on with the litigation SLC are appointed by the Board to decide whether or not it is the best interest of the corporation to pursue litigation once it has been filed. o Only created when the litigation has been filed. If a lawsuit has been filed, the corporation may challenge the litigation on 2 grounds o 1. if no demand that the demand was not excused o 2. create SLC to make a determination as to the merits of the litigation. Important Note: o The demand requirements and SLC information are only relevant to derivative lawsuits. If there is a direct lawsuit from an individual, then neither of these are applicable. Auerbach v. Bennett New York Law Facts: o GTE sells telecommunication equipment and sometimes, they pass little money under the table to foreign officials. In other words, bribery. A bribery of corporate officials is unlawful anywhere and a violation of US law. Board of Directors created a SLC and the SLC determined that it would not be in the best interests of the corporation for the present derivative action to proceed. Rules and Reasoning: o A court may not review the substantive decision of the SLC (on the merits), as that decision falls within the BJR and courts are ill-equipped to evaluate business judgments. The BJR, however, does not foreclose inquiry by the courts into the disinterested independence of those members of the board chosen for the SLC. THUS if a court determines that the members of the SLC are not disinterested and independent then the court may review the decision of the SLC. Extremely deferential approach to corporate boards. Zapata Corp v. Maldonado Delaware Law Facts: o This time, the SLC does not work to foreclose any further litigation Rules and Reasoning: o When determining whether or not to honor an SLCs recommendation, the court should: 1. inquire into the independence and good faith of the SLC, and 2. apply its own business judgment to the facts at hand. This test is more favorable to shareholders and much tougher on corporations o Corporation has the burden of proving the independence and good faith of the SLC Oracle Delaware Law Facts: o Software company and there were 4 indiviudals who were alleged to have been involved in insider trading. Insider trading means that you have insider information to your advantage to buy or sell stock. This particularly case involves a

shareholders suit against the CEO, CFO, and 2 other key directors and that this was a breeach of their fiduciary duty. Suit began, demand was futile, and suit is under way. Oracle sets up a SLC. SLC consists of newly appointed directors but the result was different. Rules and Reasoning: o Same Role and Purpose of Corporations o AP Smith Mfg. Co. v. Barlow Facts: CEO has his corporation give 1500 to Princeton University. Shareholder brings derivative suit saying that you dont have the authority to do that. Rules and Reasoning: The purpose of a corporation is to make money for its shareholders, but a corporation may under appropriate circumstances donate money to various organizations. o Dodge v. Ford Motor Co. Facts: Ford was making so much money that they accumulated a surplus. Profits that were undistributed. He wanted to use that surplus to make his own steel plant. Dodge brothers were original investors in his corporation. They owned 10% of all shares in Ford. They saw how well Ford was doing and they decided to make their own car company. When Henry Ford decided to stop paying special dividends (which are extraordinary dividend paid beyond the ordinary dividend), Dodge brothers were upset Rules and Reasoning: Generally decisions pertaining to dividends (to pay or not to pay) and the amount to be paid to the shareholders are left exclusively in the hands of the board of directors. o Court of Equity will not interfere unless it is clearly shown that the directors are guilty of fraud or misappropriation of the corporate funds, or where they refuse to declare a dividend when there is a surplus of net profits and it would not be detrimental to the corporation to divide such amount among its shareholders, but only if such refusal amounts to such an abuse of discretion as would constitute fraud or breach of good faith owed to shareholders. o Most cases will be thrown out under the BJR o Shlensky v. Wrigley Rules and Reasoning: BJR The judgment of the directors enjoys a presumption that it was formed in good faith an d was designed to promote the best interests of the corporation they serve. o Unless the conduct of the s borders on fraud, illegality, or a conflict of interest, then the court should not interfere. o Important Note: When a party brings a claim against a corporation, the claim will be a breach of the duty of care. The BJR is then sued as a defense to the claimed violation of the duty of care. IV. LLC a. Background Information i. LLC = alternative form of business organization that combines certain features of the corporate form with others more closely resembling general partnerships. b. Characteristics i. Investors of LLC = members ii. LLC provides liability shield for members iii. More flexibility in developing rules for management and control than corporation iv. LLC may be managed by all members v. LLC has advantageous tax treatment: pass through taxation

vi. Formation: 1. Some paperwork which must be filed with a state agency i. 1. articles of organization filed with the secretary of state ii. 2. operating agreement 2. Imposition of fees and taxes c. LLP = Limited Liability Partnership i. Formation: 1. Filing of a document with state official ii. Used for law firms and accounting firms only d. Formation e. WATER, WASTE & LAND, INC D/B/A WESTEC V. LANHAM i. Facts: 1. Lanham and Clark are employees of the LLC known as Preferred Income Investors, LLC, but when Lanham and Clark do business with Westec on behalf of the LLC, it hands out a business card that leaves out the LLC part. Westec doesnt get paid after providing its services. So they try to go after Lanham and Clark individually. ii. Rules and Reasoning: 1. An agent is liable on a K entered on behalf of a principal if the principal is not fully disclosed. i. In other words, an agent who negotiates a K with a 3 rd party can be sued for any breach of the K unless the agency disclosed both the fact he or she is acting on behalf of a principal and the identity of the principal. 2. Members of an LLC are not excused from personal liability on a K if the other party did not have notice that the members were negotiating on behalf of an LLC i. Partially disclosed principal from agency rules applies f. Piercing the LLC Veil i. Kaycee Land and Livestock v. Flahive 1. Rules and Reasoning: i. Same Rules as in Corporations i. There is no reason in either law or policy to treat LLCs differently than we treat corporations. i. If the members and officers of an LLC fail o treat it as a separate entity as contemplated by statue, the should not enjoy immunity from individual liability for the LLCs acts that cause damage to 3rd parties. g. Fiduciary Obligations i. McConnell v. Hunt Sports Enterprises 1. Facts: i. Involves 2 business persons Hunt and McConnell. ii. Venture to bring Hockey to Ohio through LLC. They sign an operating agreement that says various things. They cant get the hockey going in Columbus without a place to play and there is no hockey arena so they start negotiating with an insurance company to build an arena. Hunt negotiates on behalf of the LLC but they cannot come to terms. Nationwide links up with McConnell and he says that he will accept Nationwides terms and they reach an agreement. The deal is sealed. iii. LLC was formed in order to start a hockey team in Columbus, and now McConnell has taken it away. 2. Rules and Reasoning: i. Fiduciary Obligations can be altered by the operating agreement. i. A member of an LLC does not breach a fiduciary duty to the company by directly competing against it where the operating agreement expressly permits competition.

h. Dissolution i. New Horizons Supply Cooperative v. Haack 1. Facts: i. Haack contended that the trial court erred in denying her defense that because the debt was incurred by Kickapoo Valley Freigh LLC, she was not personally liable for the cooperatives claim. ii. Haack signed an agreement in which the patron would be responsible for payment of any fuel purchased with the Cardtrol Card issued under the agreement by New Horizon. i. Patron = Kickapoo, LLC. ii. Signed by Haack i. No indication as to whether signature was given individually or representatively. iii. Kickapoo was arrears. i. Upon being contacted, Haack told them that she would start paying 100/month on the account. ii. No payment made, and then upon another contact, Haack informed New Horizons that Kickapoo had dissolved, that she was a partner, and that she would assume responsibility of payment iv. Her Defense account was with business name, and she was not personally liable for debts of the LLC 2. Rules and Reasoning: i. A member or manager of a LLC is not personally liable for any debt, obligation, or liability of the company only if the member or manager follows statutorily prescribed formalities of LLC incorporation, dissolution, and creditor notice. i. A dissolved LLC may dispose of known claims against it by filing articles of dissolution, and then providing written notice to its known creditors containing information regarding the filing of claims.

V.

DUTIES OF OFFICERS, DIRECTORS AND OTHER INSIDERS a. Duty of Care i. Overview 1. The board of directors manages and oversees the corporations business and affairs. Judicial review of board decision-making and oversight is governed by the duty of care, which in turn is confined by the business judgment Rule. 2. Very easy for corp to win duty of care case i. Look at whether the board held meetings to discuss the decision ii. Look at whether the corp shopped the price around to get the best price. ii. Business Judgment Rule 1. The Corporation will cite the BJR in defense. The business judgment rule shields directors from personal liability and insulates board decisions from judicial review. It has two aspects: one substance and one procedural. 2. Rationale: i. Encourages Risk Taking -- W/o BJR, directors might exercise moribund caution. ii. Avoids Judicial Meddling Judges are not business experts. Derivative suit plaintiffs and their lawyers may have incentives that are at odds with the corporation. By filling lawsuits, shareholders would be able to easily second guess corporate decisions. iii. Encourages Directors to Serve Business people detest liability exposure. This way qualified persons serve as directors and take business risks w/o fear of being judged in hindsight. 3. KAMIN V. AMERICAN EXPRESS COMPANY NO VIOLATION

The directors adopted a decision which they knew would cause the company to lose valuable tax savings. AmEx acquired stock 29m, and then years later when they wanted to dispose of it, it was only worth 4m. The board decided to distribute the 4m because the co. would avoid having to show a 25m loss and having people lose confidence in AmEx. ii. Shareholders wanted AmEx to sell the stock and use the capital gain to offset other taxable income, which would have been a 12 m benefit. iii. No Violation The decision may have been bad, but the directors could show some rationale. i. The board held a special meeting to weigh a potential distribution versus selling the stock at a loss iv. Under the BJR, the court do not inquire into whether a decision was substantially good or bad. The court only looks to the process of the decision and American Express appeared to consider all of its options. v. If the process the board of directors took to arrive at the decision was a reasonable one or taken in good faith, then the decision is protected by the business judgment rule. iii. Overcoming the Business Judgment Rule 1. When a board decision is challenged, courts place the burden on the challenger to overcome the business judgment presumption by proving: i. Fraud, bad faith, illegality or a conflict of interest (lack of good faith) ii. The lack of a rational business purpose (waste) (Disney) iii. Failure to become informed in decision making (gross negligence Van Gorkan) iv. Failure to oversee the corporations activities Francis v. United States 2. Failure to Become Informed in Decision Making i. Courts have held that a decision that was so hastily made and ungrounded in facts may not deserve BJR protection. Directors have a duty to have a least a reasonable amount of information prior to making a decision. ii. The standard of proof that plaintiffs are required to meet for showing the director failed to adequately inform herself is a high one. iii. SMITH V. VAN GORKOM -- VIOLATION (Not Procedurally Sound) i. Shareholders sued to directors after they agreed to sell the company. The CEO contemplated selling company in a leveraged buyout. He offered to sell the company for $55 a share. Five days later, Pritzker agreed to buy the company at $55 a share. The sale just need approval from the board. ii. The board received no information about how the $55 a share figure was determined. Yet, the board, after a twenty minute presentation by Van Gorken, and without reviewing any merger documents, agreed to sell the company. iii. Court held BoD violated duty of care the boards acceptance of the offer of $55 a share w/o gathering more information was at a minimum grossly negligent. iv. Rule: Directors are not entitled to the BJR, unless there is some evidence that they were reasonably informed prior to making the decision. v. Important: case stands for prop that procedural haste and the failure to diligently to it step by step may be deemed by the court to be a lack of duty of care. One way to violate duty of care is to not be procedurally sound. iv. But see CINERAMA INC -- NO VIOLATION (Fair Price) i. It is safe to assume that in response to the Van GOrken decision, the court did not want Van Gorken to be interpreted narrowly and wanted to leave to company a lot of discretion to do these types of deals.

i.

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ii. So in Cinerama, similar to Van Gorken, the CEO sold his company to pearlman w/o shopping around to any other company. iii. But unlike in the Van Gorken case, where Mr. Prisker offered 55 dollars per share and that is what they agreed to, here the CEO forced the buyer to offer more, the buyer offered one amount, and the CEO was tenacious bargainer for getting the buyer to raise his price and get the company 100% premium over current stock market of the shares. Got the best bargain for the company. iv. So even if the procedure was inadequate, if the price is fair, then there is no violation. v. How Can Corporations Protect Themselves i. This is one sure way you can defend yourself against allegations of breach of fiduciary duty. if you shopped it around you are almost asure to be protected, Failure of Oversight i. FRANCIS V. UNITED STATES JERSEY BANK VIOLATION/No Oversight --SUIT BROUGH BY CREDITORS i. When directors failed to exercise any oversight, they are not protected by the business judgment rule ii. In this case, two directors (sons) of a family held re-insurance brokerage had loaned themselves more than $12 million of corporate funds. The third director (mom) didnt know about the misdirected funds. She was director in name only, after husband left interest to her and sons. HE told her sons were conniving. She did not read any of the companys financial reports and had little idea what the company did. iii. The sons run the company to the ground and file bankruptcy. Creditors file derivative suit. iv. Rule: Directors may not shut their eyes to corporate misconduct and then claim that because they did not see the misconduct, they did not have a duty to look. ii. IN RE CARMARK i. Health Care Industry Suit involves claims that the members of Caremarks BoD breached their fiduciary duty of care to Caremark in connection with alleged violations by Caremark employees of federal and state laws and regulations applicable to health care providers. ii. Where a claim for director liability (breach of duty of care) is based upon the failure to discover the existence of liability creating activities, only the systematic failure of the Board to exercise oversight such as failure to attempt to ensure that a reasonable information and reporting system exists will establish the lack of good faith required for liability. iii. In order to show that the directors breached their duty of care by failing adequately to control employees, must show: i. directors knew or ii. should have known that violations of law were occurring, and in either event iii. that the directors took no steps in good faith effort to prevent or remedy that situation and iv. that such failure proximately resulted in the losses complained of. Irrational and Wasteful Decisions i. Another exception to the BJR occurs in cases in which the board of directors decision can be shown to have no relationship to the firms interest. ii. Such decisions are wasteful, irrational, or otherwise outside the firms interest.

b. Duty of Loyalty i. Overview 1. 2. Burden of proof on D to show that the transaction/conduct was fair. ii. Directors and Managers 1. BEYER V. BERAN Opera Singer Case i. Plaintiffs, Bayer et al., filed a derivative shareholder action against Defendant directors, Beran et al., contesting their decision to pay for radio advertising that employed a directors wife. Plaintiffs also argued that Defendants needlessly renew the employment contract of Dr. Henri Dreyfus. ii. The radio agreement and the employee contract both withstand the scrutiny of analysis under the duty of loyalty standard. The radio advertising made sound business sense. There was nothing exorbitant about the amount paid to Camilles wife iii. He should have left it up to the board to decide if wife was qualified to sing. An even better way of insulating himself would have been if the CEO had left the outside directors to decide the issue and not have the inside directors participate. BEHIHANA OF TOKYO i. Section 144 of the Delaware Corporation Code provides a safe harbor for interested transactions. A transaction shall not be voided solely by reason of the conflict if: i. the material facts as to the director's relationship or interests as to the contract or transaction are disclosed or are known to the board of directors, and the board in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors; OR ii. the material facts as to the director's relationship or interests as to the contract or transaction are disclosed or are known to the shareholders entitled to vote, and the K or transaction is specifically approved in good faith by vote of the shareholders; OR iii. The contract or transaction is fair as to the corporation at the time it is authorized, approved, or ratified by the board of directors, committee or shareholders. ii. Section 144 reverses the burden of proof and P must show it was unfair. iii. Corporate Opportunities 1. Rule: The duty of loyalty requires that a director or officer put the interest of the corporation before self- interest. Generally, a director or officer cannot take for themselves opportunities presented to them in their corporate capacity that: i. The corporation is financially able to take advantage off; ii. Are within the corporations line of business and is of practical advantage to it; and iii. Is one in which the corporation has an interest or expectancy. 2. However, the officer is permitted to take advantage of the opportunity if the corporation consents. The plaintiff has the burden of proving the existence of a corporate opportunity. 3. BROZ V. CELLULAR INFORMATION SYSTEMS -- NO VIOLATION (Broz is Prez of RFBC and Director of CIS, both cell phone providers. FCC license offered to RFBC for purchase, and Broz bought it. CIS did not want, and could not afford license. But PriCellur bought it, and it wanted it and could afford it. No Violation because Broz acted in good faith: he asked CIS at a time when PriCelluer did not own them and they said no) CIS is not financially able to take opp. Not same line of business, CIS moving out of cell industry 2.

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No interest or expectancy getting out of cell industry

IN RE EBAY, INC. SHAREHOLDER LITIGATION -- VIOLATION (CEO has relationship with Goldman Sachs; GS worked on other co.s IPOS and would spin some of the IPO investments to Ebay execs gave them first dip at stock at lower prices, then when it goes public, stock worth 3xs, shareholders bought derivative suit Violation because only reason CEO got the opp to get preferred price is because she is an officer of Ebay. i. D argued no expectation cuz Ebay not in business to buy stock, but court said it often bought stock buy stock in other corporations for its own accounts. ii. This harms shareholders because instead of deciding investment banker based on quality of work, Ebay will choose based on who is giving favorable stock buying options. iii. Meg should have disclosed the opportunity to the board, and have independent/outside directors decide the issue. 5. Remedies: A director who usurps a corporate opportunity without consents must share the fruits of the opportunity as though the corporation had originally taken it. Remedies include: i. Liability for profits realized by the usurping manager ii. Liability for lost profits and damages suffered by the corporation 6. Rationale: The corporate opportunities doctrine seeks to strike a balance between the right of directors or officers to take advantage of business opportunities and the need to protect a corporations opportunities to expand and maximize profits. iv. Dominate Shareholders Parent/Subsidiaries 1. Issue i. In some cases where the conflicting transaction involves a controlling shareholder, getting a vote of a majority of interested, fully informed shareholders is impracticable a dominant shareholder has too much control. ii. When you have shareholders who own so much stock that he/she is deemed to be able to control the board, the courts will impose some fiduciary duties on some shareholders for two reasons i. Controlling shareholders can control the board. ii. Some corporate actions require a direct shareholder vote. Where a controlling shareholder uses that vote in a manner the court considers unfair, a court may find violation. iii. In these cases, the self-interested transaction might not create liability for directors under duty of loyalty if the director can show that the transaction was fair to the corporate entity. Del. Corp. 144(b)(3) 2. Rule: In general, transactions between controlling shareholder and the corporation are subject to an intrinsic/entire fairness test. Under it, the controlling shareholder has the burden of proving that the transaction was fair to the corporation. The test applies only when a potential for self-dealing inheres in the arrangement when the controlling shareholder can receive something at the expense of the corp or rminority. 3. SINCLAIR OIL CORP V. LEVIEN Fair Because All Shareholders Benefited i. Sinclaire owned 97% of Sinven, its subsidiary. Sinclair caused Sin-ven to make a distribution to shareholders of the Sin-Ven. ii. 1st Duty of Care Sinclair paid dividends instead of reinvested i. Burden of proof on Plaintiff to rebut BJR ii. This is protected under business judgment rule. iii. 2nd Sinclair Received Dividends breach of DoL? i. Burden of Proof on Defendant to show Transaction was Fair

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ii. The 3% Sin-ven shareholders claimed this violated the DoL because, as a majority shareholder, Sinclair was the beneficiary of the decision to call for the distribution. Is this self-deal? iii. The test in parent-subsidiary cases, is one of intrinsic fairness. iv. The Duty of Loyalty does not apply in cases in which the shareholders stand to gain equally from the alleged self-interested transaction. the material facts as to the director's relationship or interests as to the contract or transaction are disclosed or are known If all shareholders will gain, that establishes that there is good evidence that the transaction is intrinsically fair. v. Duty of Loyalty excludes cases where ALL shareholders benefit equally. Duty of loyalty would only be implicated when the parent made a distribution to itself to the exclusion of other stockholders. Here, minority shareholders also received their pro rata share of the distributions. iv. Advice: i. Pay on time, disclose the conflict, and ask if they have any objection to this, and if they dont then that might protect you, you can also work out late payment/interest fees and that might have worked. ii. To eliminate this conflict, they could have bought all the stock and could have done anything they want because they own all of it, although this would be appealing to the board because they wanted v. 4. ZAHN V. TRANSAMERICA Conflict Among Classes of Stock Holders i. Transamerica owned a controlling block of the Class B shares and dominated the management of Axton Fisher. Transamerica had elected majority to board. Zahn owned Class A common stock in Axton Fisher. Transamerica had interest in both. Upon liquidation, the division of assets was 2:1, in favor of Class A. Zahn didnt convert shares because he didnt know the value was underrepresented. ii. Here, since the transaction was dominated by the majority, dominating board has to prove fairness. Majority has fiduciary relationship toward minority. The court says that AFs call to redeem the class of stock is voidable in equity. Most states will say that a share is a contractual right and fiduciary duty doesnt go further. iii. Transamerica was controlling shareholder. The corp charter gave the BoD the right to call a redemption of the Class A stock, but in this case the BOD was controlled by Transamerica, which owned the Class B (Voting stock) and would benefit form a decision to redeem the Class A stock. The board is therefore not disinterested. Duty of Good Faith 1. Directors also have an obligation, of emerging importance, to perform their duties in good faith, though the contours of the duty are still largely inchoate. Bad faith conduct is manifested in cases in which the director deliberately or intentional acts to undermine corporate interests. 2. A directors violation of the obligation is determined under a subjective standard. It is an inquiry into the directors motivation for the decision to act or not act, not an objective standard. 3. If the director believes that the decision is in corporate interest, the act is said to be taken in good faith, regardless of whether this belief is not objectively reasonable. But if the director makes a groslly negligent decision because she is motivated by a desire to harm another faction of the board, such conduct might violate the duty. ii. Compensation 1. IN RE THE WALT DISNEY COM.

Disney hired guy to be #2 exec. After a year, he was fired and given $140 mm severance package, which came from stock options that he negotiated as part of his employment. ii. Shareholders filed a derivative suit against Disney Execs. for agreeing to pay that. 2. JONES V. HARRIES 3. Case Where Corp didnt Pay Per Contract breached known duty to act (pa on K) iii. Oversight 1. STONE V. RITTER NO VIOLATION i. Shareholders brought a suit against the individual directors of a large bank for failing to prevent a money laundering scheme. Court ruled in favor of the directors. ii. Rule: A director breaches the obligation of good faith anytime such director consciously disregards her obligations: iii. Imposition of liability requires a showing that the directors knew that they were n of discharging their fiduciary obligation. Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach duty of loyalty by failing to discharge that obligation in good faith. iv. Duty of good faith a sub species of duty of loyalty. This does not create an independent basis for recovery. d. Disclosure and Fairness i. Is It a Security? 1. Knowing whether a particular type of instrument or investment is a security is important because i. It tells you whether the registration requirements of the Securities Act apply; and ii. It relates to the antifraud provision in the Acts. Plaintiffs have easier time brining suit under securities laws than under state common law fraud. 2. 2(1) of Securities Act: i. 2 categories: i. list of specific instruments i. stocks ii. notes iii. bonds ii. list of general, catch all phrases i. evidence of indebtedness ii. certificate of interest iii. investment Ks iv. voting trust certificate v. any instrument commonly known as a security. ii. Key Characteristic i. It involves a passive investment simply in expectation of earning a profit from the investment. 3. ROBINSON V. GLYNN Need Passive Ownership = Security i. This involves LLC. Glen has LLC and convincing Robinson to make major investment. He pays 15 mm and is given of the shares and a position on the board. He is not a controlling member but he is an officer/Treasure. He had ability to select external financial and legal consultants, to review status reports, ect. He later sues arguing that he was misled by deceiving statements when he made the investment. Issue is whether his ownership interest was an LLC ii. Court said it was not. Whether an ownership in an LLC is a security depends on how active or passive the ownership is. His membership and participation in the

i.

corporation was active. He didnt buy an investment, he bought active ownership. iii. Note: In a Limited Partnership, the limited partnership interest may be a security because they have no control over running the company, only general partners do. ii. The Registration Process 1. The Securities Act prohibits the sale of securities unless the company issuing the securities has registered them with the SEC. Specifically Section 5 requires: i. A security may not be offered for sale through the mails or by use of other means of interstate commerce unless a registration statement has been filed; ii. Securities may not be sold until he registration statement has become effective iii. The prospectus (a disclosure document) must be delivered to the purchaser before a sale. 2. Because of the cost and delay in the registration process, many issuers work hard to find ways to sell securities w/o registering them. There are two types of exemptions to the registration requirement: i. Exempt Securities need never be registered ii. Exempt Transactions one time exemptions; Introduction Securities Act prohibits the sale of securities unless: o The company issuing the securities has registered them with the SEC. 5 of SEC 3 basic rules o 1. a security may not be offered for sale through the mails or by use of other means of interstate commerce unless a registration statement has been filed with the SEC must give the Commission extensive information about its finances and business. Primary inquiry whether the statement contains the disclosures required by the statute and whether the information appears to be accurate. o 2. securities may not be sold until the registration statement has become effective, and o 3. the prospectus (a disclosure statement) must be delivered to the purchaser before a sale. 2 types of exemptions to the registration requirement o 1. Securities Entirely if a security is exempt, it need never be registered either when initially sold by the issuer or in any subsequent transaction o 2. Some transactions in securities which are otherwise not exempt this is a 1 time exemption. Doran v. Petroleum Facts: o Lawyers will go to great lengths to avoid registration with the SEC because it is such an expensive process. In this case, it was limited partnership shares and they were securities. Even as a security, they had a possibility that they were exempted from registration because it was a private offering Rules and Reasoning: o Private Offering Exemption If a transaction involving the offering of securities is not a public offering it may be exempted form registration under this exemption. 4 factors in determining whether an offering qualifies for the exemption 1. # of offerees and their relationship to each other and the issuer

# helps understand the magnitude of the offering relationship is important in determining knowledge of the offerees o there must be a sufficient basis of accurate information upon which the sophisticated investor may exercise his skills. o must demonstrate that all offerees had available the information a registration statement would have afforded a prospective investor in a public offering. 2. # of units offered o the less the #, the more like a private offering. 3. Size of the offering o more like a private offering if $ value of each unit is minimal and the total monetary value of the offering is insubstantial 4. Manner of the offering Understand that this an affirmative defense and must be raised by the . o Regulation D Provides 3 safe harbor exemptions that an issuer may use so that it can come within the private-placement exemptions, and thus avoid the registration requirements Exceptions: 1. less than 1 million dollars o if an issuer raises less than $1 million through the securities it need not register them 2. less than 5 million dollars o if an issue raises less than $5 million through the securities and there are no more than 35 buyers, then it need not register them, or 3. greater than 5 million dollars o if an issuer raises more than $5 million through the securities and there are no more than 35 qualified buyers then it need not register them qualified buyer = experienced and professional investor Caveats 1. even if you fall within Regulation D, you may still be subject to blue sky laws, which are the securities law of the states, and 2. this exemption only applies to the initial sale Escott v. BarChris Construction Corp. Facts: o BarChris was in deep financial trouble so some of the people who had invested in BarChris were looking for someone to sue for their now worthless bonds. They looked to 11 of the 1933 Act 11 allows you to sue people responsible for a prospectus if there is something misleading or false in the prospectus. You can sue auditors, anyone who signed the statement, any person who was a director, underwriters. Rules and Reasoning: o On the main issue of liability, the questions to be decided are: 1. did the registration statement contain false statement of fact, or did it omit to state facts which should have been stated in order to prevent it from being misleading? If it did, you can sue anyone who signed the registration statement Everyone who was a director of the issuer

o o

And any person whose profession gives authority to a statement made by him And every underwriter. 2. if so, were the facts which were falsely stated or omitted material within the meaning of the Act? Materiality those matters as to which an average prudent investor ought reasonably to be informed before purchasing the security registered. 3. are there any affirmative defenses? Due Diligence - 11(b)(3) and 11(c) o All s, except the issuer, may assert this defense as an affirmative defense to a suit alleging material misrepresentations or omissions. o Under this defense, experts and non-experts are treated differently and are thus held to different standards in the pursuit of the defense. Non-Expert must be shown that they conducted a reasonable investigation (done by a prudent man in the management of his own property) as to the registration statement and as a result of that investigation had reasonable grounds to believe that the statements were true and that there was no omission to state a material fact. Expert must be shown that they conducted a reasonable investigation (expert must verify all of the information in the registration statement that was made or prepared by him) as to the statements purportedly made under their authority as an expert and as a result of that investigation had reasonable grounds to believe that the statements were true and that no material omission had been made. As for the non-expert portions of the statements, the expert is held to the same standard as a non-expert. Note on Integrated Disclosure and Regulation S-K There are 2 disclosure systems created by both Acts 1933 Securities Act disclosures with respect to particular transactions, such as the new issue of stocks or bonds to the public 1934 Securities Exchange Act system of periodic disclosures on certain companies most importantly, the obligation to file annual and quarterly reports. Integrated Disclosure System 1. Under the Exchange Act o all publicly traded companies, as well as some large close corporations are required to file Exchange Act Reports. Register with the SEC by filing an initial Form 10 need only be filed once with respect to a particular class of securities 2. Form 10-K o Corporation thereafter must annually file a Form 10-K, which contains audited financial statements and managements report of the previous years activities and usually also incorporates the annual report sent to shareholders. 3. Form 10-Q o 3 quarterly filed formed will contain unaudited financial statements and managements report on material recent developments

4. Form 8-K o filed within 15 days after certain important events affecting the companys operations or financial condition It was because all of these filings were so duplicative that Regulation S-K was created. o An issuer planning a registered offering first looks to the various registration statement forms to determine which form it is eligible to use The forms then direct the drafter to Regulation S-K for the substantive disclosure requirements o Requires disclosure of 2 basic types of information: 1. information about the transaction and 2. information about the issuer (Registrant) Form S-1, the basic registration statement form requires detailed disclosure about both categories. BUT, Form S-3 only requires disclosure about the transaction. o In order to use Form S-3: 1. issuer must be large and 2. seasoned

e.

Rule 10b-5 i. 10(b) of the Exchange Act and Rule 10B-5 provide a private right of action in securities law. 1. 10(b) 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 national securities exchange< i. (b) to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. Rule 10B-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 of any facility of any national securities exchange, i. (a) to employ any device. Scheme or artifice to defraud, ii. (b) to make any untrue statement 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 iii. (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 with the purchase or sale of any security. 3. Important Note: Rule 10B-5 actions are almost never derivative actions since the whole corporation is hardly even harmed. ii. A private plaintiff must show the following elements to recover damages under Rule 10b-5: 1. Fraudulent Conduct i. eg. Material misstatement or making a material omission ii. A statement or omission is material if there is a substantial likelihood that a reasonable investor would consider it important in making her investment decision. iii. Scienter: To be fraudulent and actionable under 10b-5, the conduct complained of must have been undertaken with intent to deceive, manipulate or defraud. i. Ernst & Ernst v. Hochfelder Scienter (Duty) i. Accounting firm cant be sued because they were not the primary actor. You need some type of gross negligence on the part of the accounting firm otherwise they are not liable. If they 2.

2.

were merely negligent and overlooked information that should have been revealed, thats not enough. ii. Scienter - In order for there to be liability for the issuance of a false or misleading statement, there is a requirement of proof of a state of mind. iii. Person making the false statement must have made it with an intent to deceive, manipulate, or defraud. iv. BASIC V. LEVINSON Materiality i. During merger discussions, the volume of trading for Petitioners stock increased and the price was increasing, seemingly due to rumors of a potential acquisition. Petitioner publicly refuted the rumors of a merger. Shortly thereafter Petitioner requested to suspend trading because of merger talks. Respondents sold their shares before the suspension but after the public denials of merger discussions. Therefore Respondents claimed that Petitioners violated Section 10(b) of the Securities Exchange Act and of Rule 10b-5. ii. Materiality: An untrue statement or the omission of a statement must be material to be actionable under Rule 10B-5. i. Material = there is a substantial likelihood that a reasonable investor would consider it important to his investment decision iii. Materiality with respect to contingent or speculative information or events: materiality will depend upon the balancing of both the indicated probability that the event will occur, and the anticipated magnitude of the event in light of the totality of the company activity i. Probability vs. magnitude test a. 1. relevant factors to assessing probability i. indicia of interest in the transaction at the highest corporate level b. 2. relevant factors to assessing magnitude i. size of the 2 corporate entities. iv. Timing: i. The falsity of the statement is determined at the time it was made, and not if it were to come true later. a. A statement materially false when made does not become acceptable because it happens to become true. In connection with the Purchase or Sale of a Security by Plaintiff i. BLUE CHIP STAMPS V. MANOR DRUG STORES Standing for s i. Standing protections of Rule 10B-5 only extends to purchasers and sellers of a corporations securities. ii. So if you are going to bring suit on behalf of plaintiffs, they must have been people who bought and sold. ii. DEUTSCHMAN V. BENEFICIAL CORP iii. In this case, some people bought calls of beneficial stock and they sued alleging that officers of the beneficial corporation owned stock and that they falsely understated the problems in order to maintain price of stock and call options. They wanted to make sure the price didn't fall so they issued false information about the corp. The issue was whether the holders of the options have standing to sue. iv. People who own options are entitled to protection under 10b5. v. Question: Managers owe fiduciary duty to shareholders. DO the officers have a fiduciary duty to option holders? No. If you have put option, you have the opposite interest since a put option is betting that the corporation will lose value. If you impose a duty on officers of the corporation to do this, how would they

3. 4.

resolve conflicting interest? People who own options are not owners, they do not own stock, have no right to vote, so probably the better argument is that the fiduciary duty are not owed to them vi. Drunken Widow Case managers are owed duty to creditors when corporation is teetering on bankruptcy. The fiduciary duties may go to creditors. Interstate Commerce Reliance i. In a non-disclosure cause, reliance is presumed. The plaintiff need not prove reliance on undisclosed information. ii. In a misrepresentation action on securities sold in a well-defined market (national stock exchange), reliance on any public misrepresentation may be presumed based on the fraud on the market theory. i. Under fraud on the market theory, an investor who buys or sells stock at the price set by the market does so in reliance on the integrity of the stock, which in turn is based on publically available information ii. Thus, a plaintiff will only have to prove reliance if the stock was not sold on an exchange. iii. The presumption of reliance may be rebutted if the D can show: i. that the plaintiff would have acted the same way even with full disclosure ii. The price was not affected by the misrepresentation; or iii. That the plaintiff did not trade in reliance on the integrity of the market iv. WEST V. PRUDENTIAL SECURITIES, INC. Reliance (Fraud on the Market) (Causation) i. Jefferson Savings and Hoffman. He is going around and telling people that JS is likely to be acquired by someone else at a substantial premium. His clients go out and buy the stock. The price of JS stock goes up $5 during this period when he is telling his clients that JS is about to be acquired. ii. s bring a class action suit on behalf of all shareholders who bought or sold JS stock during this period i. They want to rely on the fraud on the market presumption, but the court doesnt allow it. iii. Reliance is required under Rule 10B-5 for the claim to be actionable since it provides the causal connection between the s misrepresentation and the s injury. i. An investors reliance on any public (press release) material misrepresentation may be presumed under Rule 10B-5 when the claim is part of a class action (based on the fraud on the market presumption). a. This presumption may be rebutted by the b. Oral fraud, which is not public will not be allowed to proceed as class actions. ii. However, when an individual is suing, the presumption of reliance is not applicable and it must be actually shown that he relied on the material misrepresentation. v. BASIC V. LEVINSON i. Reliance FOR A CLASS you can use the fraud on the market theory and that creates a reputable presumption of reliance. Damages i. A private plaintiff must show that the defendants fraud caused the plaintiff damages

5.

f.

iii. SANTA FE INDUSTRIES NO Fraud 1. Sante Fe wants to acquire the last 5% through short form merger. In a short form merger, minority shareholders are granted appraisal rights. The appraisal came out to $125/share. The corporation offered $150/share and the minority shareholders were unhappy. Their argument is if the corporation were liquidated, the value of the liquidated assets would amount to $649/share. They bring action for fraud under 10b5. 2. Supreme court said this is not fraud under 10b5 i. This may be fraud if someone offers you substantially less than what the shares are actually worse, but it is not the type of fraud covered by Rule 10b5. ii. 10b5 requires full disclosure, and there is no evidence that he corporation didnt disclose. iii. The fact that the price is unfair is not the type of fraud 10b5 protects against. iv. No corporation is obligated to break up solely because it will have a higher value it if breaks up versus if it dissolves. 3. This case draws yet another line around 10b5 litigation and says we dont want to expand federal law. The concern: if you allow fraud to be interpreted broadly, it could undermine state corporation law. Inside Information i. Overview 1. Rule 10b-5 greatest impact is to prohibit most instances of trading securities on the basis of inside information. 2. Early insider trading cases focused on the duty of the trader to disclose or abstain from trading. 3. Now, it is clear that a person violates rule 10-b5 fi he breaches a duty of trust and confidence owed to: i. The issuer ii. Shareholders of the issuers; or iii. In the case of misappropriates, another person who is the source of the material nonpublic information. 4. Insider trading under state corporation law: i. If CEO bought shares from shareholders for his personal account based on nondisclosed information, he violates the duty of loyalty. So you dont need federal law to go after the insider trading violation, because under state corporation law, the CEO is guilty. 5. Should Insider Trading be Illegal? i. Why it should be legal i. Helps keep accurate price ii. Great way of compensating meritorious employees iii. For example, in Texas Sulfer case, some of the employees were geologists who were doing valuable work for the company, and they bought stock and profited insider trading in this respect rewarded their efforts ii. Why it should be illegal i. Erodes public confidence in the markets ii. May inflate market prices based on speculative corporate activities or finds iii. For example, insider trading on speculation of merger causes stock price to rise, but the merger may never happen. So the price reflected speculation and not the companys true value. ii. GOODWIN V. AGASSIZ NEED Privity 1. Plaintiff is a resident of Boston and owns 700 shares of a mining corporation. He tells his stock broker he wants to sale, broker finds buyer. The buyer is an officer of the mining company. A recent geology report shows that the land they have been exploring has rich deposits of valuable minerals. The plaintiff shareholder does not know this. So he sells

his shares, and then the information comes out in the public that there are mineral deposits. He is upset and brings suit alleging that the officers who bought the stock breached a fiduciary duty, arguing under state law (since Rule 10b5 doesnt exist yet). 2. Court said there is no breach of duty it wasnt certain that the mineral deposits would increase the value of the corporation; they were still taking a chance. i. Unlike the CEO in F4 above, where there was privity because there was no face to face dealings with the shareholders, he dealt with a broker so there was no privity. ii. Plus the mining company had no obligation to disclose. It had a major financial incentive not to disclose because they wanted to acquire the surrounding land at the lowest possible price. 3. Remember from Basic v. Levinson, the issue is at what point the information becomes material. How certain will it be that the minerals will be found and how important will it be for shareholders to know? Ask these questions. 4. Court said as long as it is done anonymously, then it is okay, no violation. But if there had been face to face contact and the company had not disclosed it to the seller, privity, then there is a violation. iii. Insider Theory 1. An insider is anyone who breaches a duty not to use inside information for personal benfit. Typical securities insiders, such as directors, officers, controlling shareholders, and employees of the issuer are deemed to owe a duty of trust and confidence to their corporation which is breached by trading on inside information. 2. SEC V. TEXAS GULF SULPHUR -- Violation i. Another mining case. They keep finding information that the land is rich in minerals. i. Nov 15: drilling shows something interesting, looks positive ii. Dec. 13: They do chemical tests and they turn up positive iii. March 31: They complete the land acquisition, after they found out land has minerals, they start buying up surrounding land iv. They dont disclose anything publically this whole time. Meanwhile, employees and officers are buying stock and call options like crazy because insiders how something big is in the works and you can see it from the rise in the stock price v. April 12: issue press release (doesnt disclose the full extent of the discovery) vi. April 16: Issue a corrected press release ii. Defendants still traded between April 12 and the announcement. Defendants claimed that the information was not material to the value of the company and therefore did not feel obligated to publicly disclose the information. They also argued that any trading after they released the news at midnight of April 16 was legitimate because technically the news was disseminated to the public. iii. Court said violation, the insider who has the information has a fiduciary duty that requires them either to disclose or to abstain from trading. i. They had two choices: disclose or abstain from trading ii. But court said they faced a dilemma because if they disclosed, it would have violated state corporation law because they couldnt disclose that information until he corporation had a chance to buy the surrounding land. iii. So the only option left was not to trade, and the insider here did not observe that. iv. Tipper/Tippee Liability 1. Tipper Liability: Where an insider gives a tip of inside information to someone else who trades on the basis of that inside information, the tipper can become liable under Rule

2. 3.

4.

5.

10b5 if the tip was made for any improper purpose (in exchange for a kick back, gift for a family members benefit, reputational benefit, ect). Tippee Liability: The tippee can be held liable derivatively if (1) the tipper breached a duty AND (2) the tippee knew that the tipper was breaching the duty. DIRKS V. SEC NO Violation i. An insider that worked for Equity Funding of America told Dirks, a stock analyst that the company was overstating their assets and that Dirks, who was an officer that provided investment analysis for a broker-dealer firm, should investigate the fraud. He tries to get WSJ to expose it, but they dont. During this time, Dirks told investors and clients about the fraud, and they reacted by selling their stake in the company. Then WSJ published the story. SEC filed suit against Dirks claiming insider trading. ii. The SEC wanted a brightline rule saying that anyone who knowingly traded on the basis of inside information violates 10b5. iii. Justice Powell said there is no violation i. Tippees must get the information inappropriately, and Dirk did not. ii. Seacrest, who gave Dirk the information, did not use the information improperly; Seacrest did not disclose the information to Dirk for a purpose to gain from the purchase or sell of stock, he was trying to expose it. iii. So the chain of disclosure was improper; since he disclosed for a proper person, then Dirks disclosure was proper too. iv. Rule: You need an unbroken chain of improper disclosure for tipper/tippee liability. As soon as you have proper disclosure, then anyone after that break in the chain is off the hook. The SEC tried to get around the Dirks case Regulation D i. SEC wanted a brightline rule and they didnt get, so they promulgated Regulation D. ii. Regulation D stands for the proposition that whenever an officer or insider is talking to an outsider about corporate developments that would affect stock price, the insider is obligated to make the call accessible to the general public. iii. This means you either have to make a conference call where all analysis of all brokerage firms are allowed to listen, or you have to post the conversation on the internet, but you cant have private conversations. iv. With this, the SEC is saying that although we cannot make what Dirk did illegal, we can require greater transparency. v. Downside: This burdens everyone because you have to hire more people to minotir the calls. SEC did not think about this when implementing Reg D. ITSFEA i. In 1984 and 1988 Congress passed ITSFEA, Insider Trading Securities Federal Enforcement Act. ii. This act provides informers with cash awards, allows individuals who claim damages to file suit, and encourages companies to implement improved internal controls. iii. What it Does i. This created a private right of action for people who were injured by insider trading available to anyone who is a contemporaneous trader. i. So someone who is in the market at the same time, selling when they are buying, or buying when they are selling. ii. You would have cause of action for your damages. ii. It also gave the SEC the right to get up to 3 times damages from the insider trader.

iii. It put an obligation on law firms and other professional services firms to monitor their employees to make sure they are not engage in securities trading. i. SO if secretary or messenger working for a lw firm reads documents relating to merger, for example, they law firm is liable under IFSFEA, if the employees trade on the information, unless the law firm has monitoring in place to control employees ii. Requires firms to train employees and administration stff not to use the information for insider purposes. iv. This is further evidence that Congress has spoken on the issue; it is not just the SEC and the Courts. v. By enacting this law, Congress made it clear that they think insider trading should be unlawful. v. Misappropriation Theory 1. Under the misappropriation theory, the government can prosecute a person under rule 10b5 for trading on market information in breach of a duty of trust and confidence owed to the source of the information; the duty need not be owed to the issuer or shareholders of the issuser. 2. A person will be deemed to owe a duty of trust and confidence in a misappropriate case when: i. The person agrees to maintain information in confidence ii. The person communicating the information and the person with whom it is communicated have a history of sharing confidences so that the recipient of the information should that the person communicating the information expects the recipient to remain confidentiality; or iii. When the person receives the information from a spouse, child, parent, or sibling (unless the recipient can prove that he had no reason to know that the information was confidential) 3. CHIARRELA NO Violation i. The defendant is an employee of printing company, print documents for law firm, some of these docs include merger documents. He works on the printing press and he sees some of the documents that are going to be made public. The law firm was very careful and cognizant of their obligation so they left the name of the corporation of the documents out and they weren't going to fill that in until the last instance tit went to print. But Chirella found out through other information in the docs who the company was, so he went out and bought that company's stock. The SEC went after him civilly and criminally ii. SCT said no violation i. Chiarrela didnt have a fiduciary duty to the corporation, he just worked for the printer. ii. He wasnt a insider, wasnt even a temporary insider. iii. Dissent: i. Justice Burger said this was violation under the misappropriation theory. Under that theory, if you misappropriate information that you owe to the employer, not to the issuer of the stock, then violation. ii. He did have obligation to his employer, the law firm, but the court didnt get into that theory because it hadnt been properly raised by the government. 4. Sidenote: When should you buy stock if you are a insider? Within the days the 10K and 10Q reports are filed. As long as the reports are accurate, then that is when everything is disclosed and the public is up to speed and officers and directors can trade. 5. US V. OHAGAN

g.

Respondent was a partner in a law firm, Dorsey & Whitney, which was representing a company that was potentially tendering an offer for common stock of the Pillsbury Company. Respondent was not personally involved in the representation, but he was aware of the transaction enough to know that if he purchased Pillsbury securities now that they would increase in value once the offer went through. He asked the partners to put him on the case, they said no, but he still got the info. Respondent was going to use the profits from this transaction to replace money that he embezzled from the firm and its clients. After the offer went through, he made a $4.3 million profit. The SEC investigated Respondents transactions and claimed he violated Section:10(b) ii. Gov went after him on a Misappropriation theory, not Dirk Theory i. In Dirk you have to show breach of fiduciary duty to the ISSUING company. So the SEC would have to show that OHagan breached a duty he owed to Pillsbury ii. But the law firm didnt work for Pillbury, they worked for the other company in the transaction. iii. The SEC also tried out a new statute, 14e3, which doesnt require fiduciary duty. i. This would not apply to Dirk because it only applies to tender officers, not to fraud discovered. ii. The statute doesnt say that insider trading is illegal., but because of its breath, and because insider trading is a form of fraud, the government uses it when it wants to go after a person criminally. 6. Avenues for Liability i. Civil First Three Theories ii. Criminal Use Mail Fraud iii. Private Cause of Action -- ITSFEA Short Swing Profits i. Rule 16(b) provides that any profit realized by a director, officer, or shareholder owning more than 10% of the outstanding shares of the corporation from any purchase, and sale, or sale and purchase, of any equity security of his corporation within a period of less than six months mus be returned to the corporation. ii. Requirements 1. Purchase and Sale or Sale and Purchase Within Six Months i. Where there is uncertainty, the test applied to determine whether there is a purchase or sale is whether this is the kind of transaction in which abuse of inside information is likely to occur. 2. Equity Security i. The term covers convertible debt, but not other bonds or debentures. ii. If convertible debentures (bonds), then what? bonds are not covered under 16b, unless they can be converted into stock. If person owns 5K convertible debtunres, then 16(b) applies. 3. Officer, Director, or More than 10% Shareholder i. Officer/Director i. purchase or sale made by person before becoming an officer are excluded because person does not have access to the inside information sought to be protected from abuse under 16b. ii. But purchases or sales made within 6 months after ceasing to be an officer or director can come within section 16(b). ii. More than 10% Shareholder i. A person is more than 10% shareholder if he directly or indirectly owns more than 10% of any class of equity of the corp at at the time immediately before both the purchase and the sale. 4. Profit realized.

i.

i. This includes profits and losses avoided. iii. Compared to Rule 10b5. 1. More narrow than 10b5 because if you wait 6 months and one day, then sell the stock you bought, you are fine. 2. Broader than 10b5 because it doesnt require trading on the basis of inside information. iv. Policy 1. The purpose of section 16(b) is to prevent unfair use of inside information and internal manipulation of price. This is accomplished by imposing strict liability for covered transactions whether or not insider information was relied on. 2. Isnt this overkill on top of 10b5? 3. Older prohibition established in 1934. v. Who Enforces 16(b) 1. Any stockholder can bring a derivative action to enforce 16(b). 2. Dont need to make demand under 16(b) because 16(b) is a federal statute. 3. Attorneys bring these suits because they read 16(a0 reports, which require corporations to disclose trades and stock of their own corporate officers, directors and 10% shareholders, so these are publically available reports on Edgar. 4. If shareholder wins, the money the offending person profited goes back into the corporate treasury and the attorney gets attorneys fees. vi. Examples 1. Bill is CEO of Corporation. 1 million shares are outstanding, he purchases 200K for $10 share and on May 1, he sales 200K for $50/share. Is he liable under 16b. Yes. He made $8 million. / 2. CEO Bill buys 200K for $10/share on jan 1. On May 1, he sales 110 shares for $50/share; On May 2, he seels 90 shares for $50/share; Is he still liable. Both purchases are still within 6 months, the liability is exactly the same. Still liable for 8 milli 3. Bill is CEO with 1mm issued. On Jan 1 he buys 200K at 10/share. May 1 he seels 110 shares at $50/share. Then resigns. May 2, he sells 90 shares at $50 shares. 4. Renee is neither officer nor director, she owns 200 of corp stock, there is 1mm outstanding. On jan 1 she sells all her shares for 50 share, on may 1 buys 50K for 10 a share and then buys 110 more at the same price. Is she liable? She is only liable if 10% owner at start of sale and the purchase/sell. Niether the may 1 or may 2 transaction qualify because she wanst a 10% shareholder at hte start of those transaction. So she has zero liability. h. Indemnification and Insurance i. Under what circumstances is a corporation required to reimburse an officer or director? ii. 145 Indemnification of Officers, Directors, Employees and Agents (Delaware Law) 1. (a) A corporation shall have the power to indemnify any person who was or is a party to any suit by reason of the fact that the person is or was an officer, director, employee, or an agent of the corporation against expenses, judgment, fines and amounts paid in settlement in connection with such action if the person acted in good faith and in a manner the person reasonably believed to be in the best interests of the corporation. 2. (b) A corporation shall have the power (discretionary) to indemnify any person who was or is a party to any action by or in the right of the corporation to procure a judgment in its favor by reason of the fact that the person is or was an O, D, E, or A of the corporation against expenses incurred by the person in connection with the defense or settlement of such action or suit if the person acted in good faith and in a manner the person reasonably believed to be in the best interests of the corporation, and except that no indemnification shall be made when the person has been adjudged to be liable to the corporation unless the court determines that person to be entitled to indemnification. 3. (c) When a present or former director or officer of a corporation has succeeded on the merits or otherwise in defense of any action referred to in subsections (a) and (b), that

person shall be indemnified (required not discretionary) for expenses incurred in connection therewith. i. Success does not require vindication, thus where claims against a director or officer are dismissed without any payment or assumption of liability by him, despite the fact that the corporation has paid $ in settlement of the claims, he is deemed to have been successful under the language or otherwise. Thus, he is entitled to indemnification of his legal fees incurred in defense of the suit. ii. Escape from an adverse judgment or other detriment, for whatever reason, is determinative. 4. (d) Any indemnification under subsections (a) and (b) shall be made only upon the determination that indemnification is proper in the circumstances because the person has met the standard of conduct set forth in those sections, but when the person entitled to indemnification is a director or officer at the time, such determination shall be made by majority vote of the directors who are not parties to such action. [This section authorizes discretionary reimbursement by majority vote of directors] (e) Expenses incurred by an officer or director in defending any action may be paid (discretionary) by the corporation in advance of the final disposition of such action upon receipt of an undertaking by or on behalf of such director of officer to repay such amount if it is ultimately determined that he is not entitled to indemnification by the corporation. [This subsection allows a corporation to advance the costs of defending a suit to a director] i. Ex. Under the statute this authority is permissive, but an agreement carrying the same language as this provision but exchanging language may be paid in statute for shall be paid in agreement makes the corporate duty to advance payments mandatory. The use of the word shall was deemed to reflect the parties intention to provide expanded protection Citadel Holding Corporation. This obligation is subject to a reasonableness requirement, thus the corporation is not required to advance unreasonable expenses but is required to advance reasonable ones. This interpretation also limits the advancement to expenses for related legal proceedings, not unrelated legal proceedings. (f) The indemnification provided by other subsections shall not be deemed exclusive of any other rights to which those seeking indemnification of expenses may be entitled to under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise. i. While it is true that a corporation may provide indemnification rights that go beyond the rights provided by the substantive subsections of 145, it is also true that any such indemnification rights must be consistent with the substantive provisions of 145. Ex. Where it was argued that a corporation could indemnify a director under its Article Ninth even if he acted in bad faith, the court held that 145(f) does not permit a corporation to bypass the good faith requirement of 145(a), as such a bypass would be inconsistent with the substantivizes of that provision- Waltuch. Under this if there is no insurance coverage and the d is found liable and must pay money back to the crop, the corp cannot reimburse the d without the approval of the court, and the court must decide if it is appropriate to do so. When indemnification is discretionary, who authorizes it? 145(d). A vote cannot include those who are going to be reimbursed because of conflict of interest. If no directors, then i. directors w/ no conflict ii. independent legal counsel iii. vote of shareholders What does the D have to do to get the advance? YOu have to sign and agree to repay the amount if it is determined that you were acting in bad faith. You can get advance

5.

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reimbursement but you have to sign statement that says if it turns out you werent entitled to reimbursement you agree to repay the amount. 9. Idemnification is discretionary see 145(b) iii. WALTUCH V. CONTICOMMODITY SERVICES Succesful on the Merits 1. Sold things at spike before the price plummeted. The action against the corporation and against Waltuch as individual. Corporation settles the suit by paying 35 million dollars. But then there is a separate proceeding. He wants the corp to pay legal fees for both proceedings, which totals 2 million. The corporation countered that Section: 145 of Delawares General Corporation Law prohibit indemnification when there is no indication of a corporate officers good faith. 2. Court divides in two parts i. Can he get reimbursed for 1.2 mm for defending himself on the suit that was settled? Yes. i. Court held that Plaintiff was successful on the merits. Section: 145(c) affirmatively requires companies to indemnify officers when the successfully defended themselves. ii. As long as the charges were dismissed, Plaintiff should be considered vindicated. Therefore Plaintiff was entitled to the $1.2 million spent on private lawsuits. ii. Can he get reimbursed expenses for the subsequent proceedings? No, he was not in good faith. He ended up having to pay 100K fine. i. There is a separate provision that gets in this fight and that is 145(f) and that is the key issue between Waltuch and the corporation because he wasn't in good faith, he admitted it, he didnt contest his good faith, but claimed that he was still entitled to indemnification under this. ii. So waltuck and his attorneys says 145(b) says you need good faith, but 145(f) says that nothing here prevents additional indemnification from granting indemnification so 145(f) reads "good faith" out of the statute. iii. Court doesnt buy it, the talk about consistency. iv. What does 145(f) do if it cant trump the good faith requirement. Court says it still has teeth because good faith under 145 b is discretionary. So what 145 does is that it makes something discretionary mandatory. so when you are in good faith they can always guarantee to pay back. It still has meaning but it doesnt go as far as to trump the good faith requirement. 3. A corporate director or officer who has been successful on the merits or otherwise vindicated form the claims asserted against him is entitled to indemnification from the corporation against reasonably incurred legal expenses iv. CITADEL HOLDING CORP V. ROVEN 1. Plaintiff served as the director of Defendant company from 1985 to 1988. In 1987, Plaintiff requested, and Defendant agreed to, an amendment to strengthen his indemnification rights. The amendment provided for advancement to Plaintiff for legal expenses he may incur for litigation stemming from his position with the company. Defendant brought an action under Section: 16(b) of the Securities Exchange Act after Plaintiff purchase shares of Defendant stock. Plaintiff then sought an advance for the legal expenses, but Defendant refused, arguing that the indemnification agreement was not meant to include Section: 16(b) actions. The trial court ruled that Defendant should advance Plaintiff the money but did not force Defendant to pay the accrued interest. 2. A corporation may advance reasonable costs in defending a suit to a director even when the suit is brought by the corporation. 3. The Supreme Court of Delaware held that Defendant was required to advance Plaintiff the cost of the legal expenses, and is now responsible for the interest that has accrued. The issue is not whether Defendant is indemnifying Plaintiff, but rather whether the

VI.

agreement requires Defendant to advance the costs of Plaintiffs attorneys fees. The plain language of the agreement does not exclude Section: 16(b) litigation. PROBLEMS OF CONTROL a. Proxy Fights i. Proxy fights result when an insurgent group tries to oust incumbent managers by soliciting proxy cards and electing its own representatives to the board. ii. Proxy fights are subject both to the 1934 Securities Exchange Act and to state corporate statutes. iii. Strategic Use of Proxies 1. Levin v. MGM i. Proxy fight for control over MGM. Levin wants an injunction to tell MGM that they cant use corporate funds to fight to keep current director Bryant in. Levin wanted to be CEO. Since the board elects CEO, the only way Levin can be CEO is if his people are elected to the board. ii. Where a proxy fight revolves around policy differences rather than personality differences, incumbent directors may use corporate funds and resources in a proxy solicitation contest if the sums are not excessive and the shareholders are fully informed as to the nature of the costs involved. 2. Rule 14a-7 i. When an insurgent group wants to contest management and solicit proxies, this rule gives the insurgent group a right to have proxy solicitation mailed to shareholders. ii. Management then has a choice: i. provide insurgent group with a list of shareholders, or ii. mail the proxy solicitation for the insurgent group and charge the group for the cost of mailing. iv. Reimbursement of Costs 1. The incumbent board members can rely on the firm for expenses, if reasonable and not related to personality contest. Meanwhile the challenger normally has to pay for their own proxy expenses. Challengers may only recover their expenses after a challenge if they succeed. Further, their recover will also depend on shareholder approval. 2. Rational: i. Rule requiring challengers to cover their own expenses initially makes some sense insofar as it prevents frivolous challenges. 3. Limits i. The board is limited to making expenditures that are related to a firm interest. ii. The expenditures must be reasonable. 4. Rosenfeld v. Fairchild Engine and Airplane i. Atty owned 25 shares of corp and brings suit to challenge reimbursement of various parties in proxy fight. The corp reimbursed: ii. In a contest over policy, corporate directors have the right to make reasonable and proper expenditures from the corporate treasury for the purpose of persuading the stockholders of the correctness of their position and soliciting their support for policies that the directors believe, in all good faith, are in the best interests of the corporation. i. A new BoD may reimburse the old board for expenses incurred in their unsuccessful defense, as long as the expenses incurred were reasonable. ii. The successful contestants (new board) may reimburse themselves for expenses incurred, as long as those expenses are reasonable and the shareholders approve the reimbursement iii. A group that is unsuccessful in its challenge to an incumbent board is not entitled to reimbursement for expense sincurred. ii. Current board member 106K to defend his position.

Court said this is okay because it is reasonable amount and not personality contest. ii. Why isnt this a conflict of interest the board is paying itself to keep its job. Wrinkle in the law: this is not duty of loyalty violation. The controlling law says you can always pay yourself to keep your job. iii. Old board received 28K from new board i. This is okay. Of the three, there is no conflict of interest here. iv. New board paid itself 130K. i. Conflict of Interest? Yes. ii. But they received majority of shareholder votes. 5. Even if the expenses are reasonable, the board is not required to reimburse an unsuccessful challenger. i. If he loses proxy contest, chances of reimbursement are slim to none. ii. If he does win, before he has the board pay his expenses, he may want to have the shareholders ratify it first by voting and approving it improves chances it wont be challenged AND reverses the burden of proof. v. Shareholder Proposals 1. Shareholders might communicate with their co-investor by making a proposal that concerns business issues. ahreholders to put initiaives on the ballot for the annual shareholder meeting, and shareholder can do this at no expense to themselves. 2. Rule 14a-8 i. Eligibility to submit a proposal: i. Shareholder must hold: i. 1. at least $2K of stock at market value, OR ii. 2. 1% of the companys securities for at least 1 year. ii. Form: i. If the shareholder notifies the issuer of his intention to present a proposal for action at an upcoming meeting, the issuer shall set forth the proposal in its proxy statement. iii. Exemptions: i. In a few circumstances, the company may be permitted to exclude the proposal through various exemptions. i. Private Grievances ii. Ordinary Business Affairs iii. 5% Rule (insignificant relationship) matters that do not involved 5% of the corporations earnings or assets. ii. Corporation bears the burden of showing that a proposal fits within an exception. 3. When the Corp can Exclude a Shareholder Proposal i. Insignificant Relationship Rule 5% Rule i. Todays Rule = you can exclude the shareholders proposal if it is less than 3% of assets or net earnings at the end of its most recent fiscal year, OR $10 million in earnings, whichever is lower; and so long as it is not otherwise significantly related to the companys business. i. If a proposal fails to meet the % requirements, but is otherwise significantly related to the companys business, it cannot be excluded from the proxy statement. ii. Lovenheim v. Iroquois Brands a. Facts: i. Lovenheim sought an injunction barring IB from excluding from its proxy statements a proposed

i.

resolution he intended to offer at the upcoming shareholders meeting. b. Holding Exception to the Exclusion i. A shareholder proposal can be significantly related to the business of a securities issuer for noneconomic reasons, including social and ethical issues, and therefore may not be omitted form the issuers proxy statement even if it relates to operations which account for less than 3% of the issuers total assets. ii. Ordinary Business Affairs Exception i. Rule = A corporation may exclude a shareholder proposal from a proxy statement if the proposal deals with a matter relating to the companys ordinary business operations. i. This exception is used to omit proposals that do not involve any substantial policy or other considerations. HOWEVER, if the proposal touches on daily business matters, but involves a significant strategic decision as to those daily business matters, it may not be excluded. iii. Dealing with Policies Beyond the Corporations Power to Effectuate i. Rule = A corporation may exclude a shareholder proposal from a proxy statement if the company would lack the power or authority to implement the proposal.

vi. Shareholder Inspection Rights 1. Overview i. In addition to being able to request proxy lists under 14a-7, shareholders could also request corporate documents. ii. Courts are a little bit more reluctant to provide shareholders unlimited access to corporate documents, since shareholder could turn the corporation upside down rifling through its documents. Because of the more intrusive nature of this inquiry and potential to disrupt corporate operations, burden on plaintiff to show proper purpose. 2. Crane v. Anaconda NY Law Proper Purpose i. Crane Company, a stockholder demanded access to Anacondas shareholder list for the purpose of informing other shareholders of a pending tender offer. Anaconda said no because Crane is not a stock holder. ii. Crane buys 5% of stock then Crane requested a copy of Anacondas shareholder list for the purposes of informing other shareholders of the tender offer, and to rebut misleading statements disseminated by Anaconda. iii. Court says it is permitted because he had a proper purpose. Tender offer should be permitted access to the companys shareholder list if: i. Shareholder has held shares for 6 months OR has 5%; and ii. The list is sought for an objective adverse to the company or its stockholders, that is an improper business purpose. iv. Corporation has the burden of showing that the purpose is improper. 3. Pillsbury Delaware Law i. Plaintiff sought to inspect corporate records to identify other shareholders for the purpose of informing them of Respondents involvement in the Vietnam War. ii. Court said no improper purpose. iii. They would need to make a case that by making war bombs you will alienate a certain percentage of America and will hurt bottom line and will lose customers

and will money if they continue to make these bombs. maybe they wouldn't have won, but it wouldn't have been a been a stronger basis. 4. Sadler v. NCR Corporation i. NCR incorporated in MD, ATT goes to court in NY and tries to apply NY law, brings case in Sadler name. ATT wants: i. NoBU List Non Objecting Beneficial Owner List i. IF person bought stock through broker, they are beneficial owner, they get dividends or stock. ii. As long as he didnt object, he and every other NOBO shareholder would be on the list and its a more extensive list and would reveal every shareholder except those that objected to their name being disclosed iii. NCR argued that NY statutes says shareholder who owns stock for 6 months or 5% is entitled if proper purpose. NCR says ATT doesnt meet this requirement and they cant use a proxy or agent to get around. ii. CEDE List If ATT objective is to find out who the large shareholder are, then this list is adequate. But if you want direct contact with all of the shareholders, then you ask for NOBU list.l ii. Court orders that NCR produce both lists. iii. NOTE: MD state law didnt allow shareholders to get shareholder lists. ATT would not have qualified under MD law, and this is Maryland Corp So how did Court rule in favor of ATT? iv. Doctrine of Internal Affairs i. When there is a fight between constituencies of the corporation, then the law of the state wherein the corporation is incorporated controls. ii. In Sadler, court ignores this doctrine because MD law should control. iii. They ignore it partly because the court says as long as this is not inconsistent with the other state, then its allowed. iv. MD law says there is no right of shareholder to get shareholder lists, but the court said that MD did not say that you could not get it in some other way under some other states law. artificial definition of inconsistency. b. Shareholder Voting Control i. A corporation may prescribe whatever restrictions or limitations it deems necessary in regard to the issuance of stock, provided that it NOT limit or negate the voting power ii. Stroh v. Blackhawk Holding Corp 1. Blackhawks articles of incorporation provided for the issuance of 3 million shares of Class A stock and 500K shares of Class B stock. Each share was entitled to 1 vote. In the case of liquidation, shares of Class B stock were not entitled to dividends. 2. A corporation may prescribe whatever restrictions or limitations it deems necessary in regard to the issuance of stock, provided that it not limit or negate the voting power of any share. c. Control in Closely Held Corporations i. Background Information 1. Characteristics of CHC i. not publicly traded ii. owners are typically officers of the corporation. 2. Ways to maintain control of a CHC: i. Unlike a public corporation, where management is likely to maintain control and continue status as officers by using the proxy process, in closely held corporations the public is not involved so voting agreements/trusts among members are common and legal.

ii.

Voting Trusts i. each person in the trust appoints a trustee and gives their shares to that trustee to vote. The trustee acts as a fiduciary to the owner of the shares. i. Usually used to maintain control of a corporation by a family or a group when there is fear that some members of the family or group might form a coalition with minority shareholders to shift control. ii. You have to make sure you file the trustee agreement so that the corporation can know who is voting on your behalf. iii. Pooling/Voting Agreements i. agreements by which the shareholder simply commits to electing themselves, or their representatives, as directors, are generally considered unobjectionable, and are NOW expressly validated in many jdxs because they do not interfere with the obligations of the directors to exercise their sound judgment in managing the affairs of the corporation. ii. Tougher Situation = where agreements require the appointment of particular individuals as officers or employees because such agreements deprive the directors of one of their most important functions. ii. Pooling/Voting Agreements 1. Ringling Bros. v. Ringling DE Law -- OKAY i. Facts: Editch Ringling and Aubrey Haley entered into a voting trust agreement binding them to act jointly in all matters relating to their stock and ownership interests in Ringling Bros Circus. The K further provided that in the event that the parties failed to reach a joint conclusion in respect to the exercise of their voting rights, the issue would be submitted to an arbitrator. ii. Holding: A group of shareholders may lawfully K to vote in any manner they determine. i. Result = the votes that were case in contravention of the pooling agreement are invalidated and do not count. iii. Advice: They should have specified in detail how the agreement was enforceable; it should have spelled out what would happen if someone refused to vote in accordance witht eh agreement. They could have said the violating party will lose right to vote for 5th person and only Ringly will be able to elect fifth officer. McQuade v. Stoneham NY Law Handcuffed the Board NOT OKAY i. Facts: Stoneham owned a majority of shares in the NEC, also known as the NY Giants. McQuade and McGraw each purchased 70 shares of Stonehams stock, and entered into a shareholder agreement to preserve themselves as directors and officers of the corporation. The agreement further prohibited the amendment of salaries, shares, or bylaws of the corporation except with unanimous consent of the 3 parties. The BoD consisted of 7 men including all 3 men. McQuade was later discharged from the corporation as both an officer (treasurer) and as a director. ii. Holding: A shareholder agreement prohibiting the BoD from changing officers, salaries, policies, or retaining individuals in office, is illegal and void absent express contractual consent. i. An agreement that insures one a continued position may not be enforceable if there exists the potential form harm to non-participating minority shareholders (those not party to the agreement.) ii. We are concerned if the shareholder agreement binds people while they are on the board. The board of directors is the controlling body w/ a

2.

3.

4.

fiduciary duty to act in the interest of shareholders. If they are bound by agreement to vote in a certain way, then they cant carry out fiduciary duty to shareholders. Clark v. Dodge NY Law OKAY i. Facts: Corp w/ two shareholders. Clark has 25%. He had a trade secret idea and agreed to reveal to corporation in exchange for K with corporation with Dodge who owned 75%. Clark was to get 25% of profits and would be general manager. Dodge fires him and Clark sues. Is the agreement enforceable if only between two shareholders? ii. Holding: Where the directors are also the sole stockholders of a corporation, a K between them to vote for specified persons to serve as directors is legal, and not in contravention of public policy i. Reason = there is no potential harm to non-participating minority shareholders. iii. Contrast to McQuade i. there is no evidence in the McQuade case that there were any qualifications, they said we will keep you in official position and there was no way out of the agreement. ii. Here, Mr. Clark had to remain competent, so the additional qualification made it easier for the court to say we are not worried about this because if Clark was no longer faithful or competent there would have been grounds to get him out. iv. So a shareholder voting agreement will likely be enforced where (1) all the shareholders were party to the agreement and (2) there were qualifications. v. The more specific you can be about how profits are going to be calculated the better. You want liquidated damages. vi. Buy Sale Agreements How to Protect Client if they are Terminated? i. Anytime you set up a corporation or LLC, or any entity owned by more than two parties, you should recommend to party that they have a buy sale agreement. ii. Two things we should negotiate on behalf of our client: (1) employment K and (2) buy sale agreement. iii. So if the K is terminated or not renewed, then client will have rights under the buy sale agreement. If they are terminated, then the company is forced to buy out the persons shares at a fair price. Galler v. Galler IL Law OKAY i. Facts: Ben and Isadore Galler, partners who each owned an equal share of stock in Galler Drug Co, entered into a shareholder agreement providing for the support and maintenance of both their families. The agreement further bound the shareholders to elect as directors Isadore, Ben, and each of their spouses. Ben transferred his shares into his wife, Emmas possession as trustee. Isadore sought to have Emma modify the shareholder agreement, and remove herself as director. She refused and initiated suit. ii. Holding: Shareholders in a CHC are free to K regarding the management of the corporation absent the presence of an objecting minority and threat of public injury. i. Reason = without a shareholder agreement, specifically enforceable by the courts, insuring him a modicum of control, a larger minority shareholder might find himself at the mercy of an oppressive or unknowledgable majority. i. Shareholder agreement is necessary for the protection of those financially interested in the CHC

5.

6.

Shareholder in CHC cannot sell his shares on the public market and so he needs to protect himself. iii. Advice: Since 2/2 on the board, a good idea was to have some provisions explaining how to break a deadlock. They also could have done a buy sale agreement and that would have been helpful too. LLC would have been a better recommendation to them. Ramos v. Estrada - CA Law -- OKAY i. Facts: Broadcast Group and Ventura 41 combined to form TV for the purposes of establishing a tv station. Broadcast Group owned 50% by the Ramos, and the Estradas and 4 other couples each owning 10%. The shareholders of BG entered an agreement to vote their shares in TV in accordance with the majority view. In addition, the K placed restrictions on transfer, and treated a shareholders noncompliance with the voting provision as an election to sell his shares. So if someone did vote according to the agreement, they would be forced to sale shares back to the broadcast group. Estrada voted in opposition to BGs majority and declared the agreement void. Ramos sued Estrada for breach of K. ii. She relies on McQuade that you cant handcuff the board into choosing officers. iii. When Did She violate the Agreement? i. Did she violate the agreement when she voted against Ramos? NO. ii. She was supposed to support certain candidates that she agreed to support. They got together as shareholders, selected candidates, and she was supposed to vote who they agreed to vote for by majority and she didnt thats when she violated the agmt. iv. Compared to Other Cases i. Technically shareholder agreement okay here we agree to work together to support the same group or director (like in Ringling) ii. Unlike McQuade --> where people agreed to support certain people as officers. Here there was no agreement to support certain people as officers, only an agreement support the same group of directors. v. Holding: Voting agreements binding individual shareholders to vote in concurrence with the majority constitute valid Ks vi. In CA, shareholders voting agreements are expressly authorized by statute so long as the corporation is designated a CHC at the time of incorporation. vii. Note: i. Look for the actual moment of breach of the agreement. ii. Here the breach was not when Estrada was a Board member and voted against Estrada. It was when she was taken off the board and then voted herself in contravention. Overview i. McQuade You can go too far in limited discretion of the board you will get in trouble. ii. Ramos the shareholder agreement was a good way of getting around McQuade because it allowed the broadcast group to punish Ms. Estrada for not voting w/o directly contravening the law of McQuade.

a.

VII.

Abuse of Control a. Abuse of Control i. Background Information 1. In CHC dividends are most likely not paid. Rather, the majority may be given compensation by a job position and a salary. The minority could be frozen out in a CHC. 2. Buy Sell Agreements Remember that most of these problems could ii. Wilkes v. Springside Nursing Home Freeze Out

Wilkes, Riche, Quinn, and Pipkin joined forces to purchase a building and operate it as a nursing home. The formed a corporation in which ownership of the property was vested. Each invested and received an equal share in Springside. Wilkes is contractor and in charge of building maintance. However, as relations among the parties became strained, Wilkes notifies Springside of his intention to sell his shares. The board ceased Wilkes salary and did not reelect him as director or officer. Wilkes sued for damages based on breach of the fiduciary duty owed him by the other shareholders. 2. A close corporation is much like a partnership. Hence, the Massachusetts courts impose on shareholders in close corporations a fiduciary duty that approximates the duty that partners owe to each other. Shareholders owe each other utmost good faith and loyalty. They cannot act of out variance, expediency, or self interest in derogation of their duty of loyalty to the other stockholders 3. When minority stockholders in a CHC bring suit against the majority alleging a breach of the strict good faith duty owed to them by the majority, the court will analyize the action take by the controlling stock holders in the individual case: i. Shareholders in close corporations owe each other a duty of strict good faith. ii. If challenged by a minority shareholder, a controlling group in a firm must show a legitimate business objective for its action. iii. A plaintiff minority shareholder can nonetheless prevail if he or she can show that the controlling group could have accomplished its business objective in a less oppressive manner. something that would have harmed is or her interests less. 4. Application i. Wilkes shows he was fired from the job, isnt getting benefits and cant sale his shares. ii. Majority could show he was not doing his job competently, so they had legitimate reason to fire him. iii. But Wilkes could show, even if he was doing a crappy job, they could have paid his dividends or offered to buy his shares at a fair price, so that he at least gets some benefit. 5. Violation of Duty of Loyalty? Yes i. Wilkes was fired from the board ii. The three owners still on the board vote for their own salary and Wilkes doesnt ratify this iii. He is the only person w/o a conflict of interest in voting for their salary. iii. Ingle v. Glamore NO VIOLATION EMPLOYMENT AT WILL 1. Ingle owns 40% of corp and Lamor owns 60%. Ingle functions as general manager, including guaranteeing a loan for the corporation. As Lamors sons grow, he wants them to get involved in the business so he fires Ingle. There is a K agmt that requires Ingle, if he is no longer employed by the corp, to sell shares back to Lamor. Ingle does and he doesnt object to the price. He brings suit asking for a Wilkes claim I was a minority investor and by firing me you violated Wilkes duty that you owed to minority investor. 2. Court says no not the same as Wilkes i. This is an employment at will claim ii. Unlike Wilkes, he was an employee before he bought the shares. He bought the shares knowing that if he was terminated he would have to sell them. iii. Critical difference from Wilkes He knew from the beginning that he would sell the shares back if he left the employment. 3. Rule: A minority shareholder in a CHC, who is also employed by the corporation, is not afforded a fiduciary duty on the part of the majority against the termination of his employment. 4. Advice Should have got an employment K, he could have had some rights, liquidated damages, ect., if he was ever terminated.

1.

iv. Brodie v. Jordan What is the Proper Remedy for a Violation of the Wilkes Doctrine? 1. Shareholder is voted out as president and as officer. He gets no dividends, although he gets consultation fee for a year. He later dies, while the other two owners continue to benefit. Widow sues, claiming under Wilkes, there was a less oppressive means to get rid of him. The lower court agreed, finding a violation of Wilkes duty and gave her a court ordered buyout as a remedy. 2. Held: There was a breach of the Wilkes duty, but the remedy (court ordered buyout) was improper. i. The court ordered buyout created an artificial market for the buyout, said this is more than she could have reasonably anticipated. ii. The best result would have been just to do the buyout and come out with a fair price. 3. Advice: i. Brodie: Should have had a buy sale agreement at the time they set up the corporation. Agree in advance how to unwind the corporation. You can minimize the risk of litigation and provide a fairer result. He could have gotten one later on, even if he didnt do it when the corporation formed. ii. Other Two Shareholders: They should have just paid the woman her dividends and she wouldnt have felt excluded and she wouldnt have been motivated to bring suit. v. Smith v. Atlantic Properties When the Minority Violates Wilkes Duty 1. Smith, Wolfson, Zimble, and Burke formed Atlantic for the purposes of acquiring real estate. All 4 held an equal amount of shares. A clause in the articles of incorporation had the effect of giving to any one of the 4 original shareholders a veto in corporate decisions. Wolfson wanted warnings devoted to making building repairs while the other 3 wanted a declaration of dividends in order to avoid penalty taxes. Wolfson refused to vote for any dividends. 2. Stockholders in a CHC owe one another the same fiduciary duty in the operation of the enterprise that partners owe to one another. i. Abuse of control claim may arise from the acts of a minority shareholder and this is simply an extension of the Wilkes doctrine vi. Jordan v. Duff and Phelps Jordan, a securities analyst employed at will by Duff purchased stock in the company at book value. After informing Duff that he was resigning, Jordan stayed on until the end of the year in order to receive book value for his stock as of the end of that year rather than the prior year. The manger did not tell him that there was a merger in the wind and that the price of shares would go up. The book value now was 23K, but if he waits, it would be 400K After leaving, Jordan was started to learn of a pending merger between Duff and another company. Jordans stock would have been worth a great deal more. 2. Posner (Majority i. Views this as an at will employment. Even if they told him about the merger, he cold have still fired him and he would have had to take the 23K, and that would have left him with no rights under 10b5 3. Easterbrook i. Jordan did have 10b5 rights. 4. This is like the Car Dealership Case under 10b-5 Fraud b. Control, Duration and Statutory Dissolution i. This section, just like the one before deals with the minority shareholders claim that the majority shareholders have treated them unfairly. HOWEVER they are now invoking statutory provisions allowing the courts to order dissolution. ii. Dissolution 1. Sell off the corporation and pay creditors, then split the remaining money 1.

iii.

iv.

v.

vi.

This is a tool available to the minority shareholders being mistreated Two ways to achieve dissolution i. Selling the Business as a While ii. Piece Meal iii. OR Court Ordered Buyout 4. California Specific: California Corporations Code i. Petition for Dissolution 1800 i. CHC -> if there are 35 or fewer shareholders, anyone can petition. ii. If not a CHC, then 1/3 of the shareholders must petition iii. The petitioner must show that (1) dissolution is needed to protect their interests; or (2) majority has treated the minority shareholders unfairly ii. Automatic Dissolution 1900 i. If you have 50% or more of the shareholders backing you, or you own 50% or more of the shares, then you can seek dissolution for any reason. ALASKA PLASTICS No Dissolution 1. Couple gets divorced, the wife received 1/6 of shares issued by Alaska as settlement. Alaska subsequently failed to notify her of annual shareholder meetings, paid her no dividends, and did not allow her to participate in the business, and later offered her 15K for her shares, which was very low. She was iced out, so she sued. 2. Court does not find for dissolution. 3. From the point of view of a dissatisfied shareholder, the most successful remedy is likely to be a requirement that the corp buy his or her shares at fair value. The bottom line is that there is a sufficient showing that they were treating her unfairly. Court talks about a lesser included remedy. Alaska allows dissolving for fraud or injustice, but the court has the power to order a lesser remedy: a court ordered buyout. 4. Court does not find for dissolution. HALEY V. TALCOTT 1. They form an LLC, and Haley and Talcott are the owners. The LLC owns the building. Haley has K that gives him the right to manage the restaurant and 50 percent of the profits of the restaurant. The LLC agreement said that the non-departing member can buy out the departing member, but it didnt spell out land guarantees, ect. When the LLC bought the land, they both signed guarantees for the bank. Under this provision. 2. Generally DE loves contracts because they like the freedom to contract. But under the agreement, if Haley departed, he would still be a guarantor of the loan and court said it will not enforce that because its not fair. 3. The bank is not a party to the litigation, so the court has no authority to make the bank change the loan terms. Pedro v. Pedro 1. Fight between brothers. There is embezzeling. Accountant brought in, but it is unresolved. Alfred continues to believe his brothers are up to no good. They push him out. Book value wont compensate him. He wants to dissolve the corporation. But instead the court orders a court order buyout on terms that arent fair. Under 2. In determining whether to order equitable relief, dissolution, or a buy-out, the court shall take into consideration the duty which all shareholders in a CHC owe one another to act in an honest, fair, and reasonable manner in the operation of the corporation and the reasonable expectations of the shareholders as they exist at the inception and develop during the course of the shareholders relationship with the corporation and with each other. 3. Stuparich v. Harbor Furniture CAL 1. Each family member holds 1/3 of shares. But B4 parents passed control, they gave son a majority of the voting share. So although they get equal dividends, the son is in control. There is disagreement between the sisters on one hand and the brother on the other. They

2. 3.

2.

3. 4.

5.

brother employs his wife and son in business and they are salaried. The sisters want to get rid of furniture aspect of business and focus on mobile park, but the son does not. So the sisters sue under CA law to dissolve the corporation. In order to do this, they need a third of the shares. This seems easier than the raud/oppression statute that MN and Alaska has. They couldnt argue freezeout because they were receiving meaningful/significant dividends. You may or may not be able to dissolve a corporation even under the more generous CA standard. You can get into court by showing 1/3 of the shareholders want to dissolve, but you wont win unless you are able to show a total freeze out. Holding: The sisters were not able to show total freeze out because they were still getting 33K a year.

c.

Transfers of Control Selling the Stock i. Overview 1. When a shareholder sells part ownership of corporate entity to someone up, the issue of control premium arises. 2. Shares owned by a controlling shareholder command a premium over the other shares because they represent the power to control the business, to designate the corporate officers, to establish salaries, and ect. 3. Issue: i. A is 30% controlling shareholder. A sells to B, who wants control. B doesnt need 50%. If he can get A to sell 30% and have his directors resign and replace with Bs directors, then he can use the proxy process and 30% ownership to guarantee that he will control the corporation. ii. The market for As shares is $50, but B wants control so he offers $80 on the condition that professors directors resign. He is paying a premium, and the $30 premium, flows to A, the CEO, rather than to the shareholders, is this fair? ii. FRANDSEN V. JENSEN 1. Jensen family owns 52% of a corporation and controls. The agency owns a majority of the shares in First Bank of Grantsburg. Frandsen then buys 8%. He figures if he gains control of Jensen, then he can eventually get control of the bank. 2. Jensen negotiates two other agreements with Jensen: i. Right of First Refusal: i. If stock is being offered for sale, that stock must 1 st be offered to existing shareholders for the same price and upon the same terms. ii. So Jensen sells their shares, they have to give Frandsen first right to buy the shares at the offer price. ii. Take-Me Along Agmt: i. If the offer to sell the stock is rejected or declined by the one having the first right of refusal, then the corporation has the obligation to buy remaining shareholders shares at the same price at which the offered shares were sold. ii. If Frandsen declined the offer, then Jensen had to buy Frandsens shares at the same price at which it sold its own shares. 3. First Wisconsin, a bank, came along and wanted to buy Jensen stock. This doesnt work because Frandsen exercised his right of First Refusal. To get around this, since Jensen owns stock in First Bank of Grantsburg, Jensen just sold those assets directly to First Wisconsin. 4. The effect of this was that the stock of the Corporation were not sold, just its assets which did not trigger the right of first refusal or the take me along agreement.

Frandsen argued that it was triggered because by offering to sale shares of the corp, it was a merger. He argues that the results of a sale and merger are the same: IF you merge, the stock ends up being sold, its part and parcel of the merger procedure. 6. Analysis i. But Posner said a merger isnt the same thing as acquiring stock. ii. A merger is a separate statutory procedure that isnt the same as offering to buy stock. iii. Frandsen was sophisticated so he should have known his agreement would not have covered merger. iv. But Prof thinks that even a sophisticated business man would not have understood Posners arcane position iii. ZETLIN V. HANSON 1. Controlling group owns 44% of shares and sales to someone for premium price of $15/share, when the market price was $7.38. The remaining shareholders are upset because they are only to sell their shares at the market price when the other guy sold for 15. They argue that the control premium should be shared with everyone. 2. Zetline/American Rule: A controlling stockholder is free to sell, and a purchaser is free to buy, the controlling interest at a premium price, and keep the premium i. This rule creates a greater incentive who has control to sell it because he realizes that he gets all the premium, so greater incentive to sale. ii. Under this rule, it is easier to get change of ownership. iii. On the other hand, if your motivation is to perks, then you want to buy in at the lowest possible costs because you dont expect to make profits for the company, just want to personally benefit. in this way the American Rule promotes the guy who wants to cheaply buy and then take advantage. So may the Zetlin rule is not efficient and just promotes the wrong type of takeover. iv. Zetline rule controlling in most states in US. 3. Canadian Rule: When a shareholder sales shares for a premium, you have to share the premium with the rest of the shareholders. i. Prof likes this version. ii. U, 4. Federal Rule i. Public Sales: if you make a tender offer for publically traded firm, you have to share the tender with all shareholders, the Canadian Rule applies. ii. Private Sales: When you make a private offer, the Zetlin rule applies. iv. ESSEX UNIVERSAL CORPORATION V. YATES 1. Yates owns 28%, compared to 44% in Zetlin. He contracted to sell his interest to Essex. The K called for the transfer of Yates shares, 28% of voting rights, and also called for the resignation of a majority of Republic Board, to be filled by individuals of Essexs choice. i. But if the prior board resigns all at once, then the remaining members could vote for anyone and not Essex risks not getting control of Board. ii. When there is a vacancy on the board there is no stockholder election, board members are elected at yearly intervals, and remaining people vote to fill the vacancy. iii. The better way to do this is to have one board member resign at a time, so each time there is a still a majority to support the Essex regime. Sequential resignations 2. Yates wanted to get out of the deal and argued that the clause calling for immediate transfer of control was illegal and violated the K illegal transfer of control i. Board members have a fiduciary duty to shareholders to act reasonably consistent with the business judgment rule when picking officers, including the

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CEO. So if the CEO wanted to sell his position without a shareholder vote, that is contrary to state corporation law. 3. A provision in a contract for the sale of majority share control in a corporation that calls for the immediate transfer of control of a board of directors to the buyer is not illegal even if the buyer cannot convert that share control into operating control immediately. However, control of a corporation may not be sold absent the sale of sufficient shares to transfer such control. i. Plaintiff was receiving a sizable portion of the shares which would have eventually entitled them to elect representatives to the board. The agreement only accelerated that process. It was also acceptable for the majority shareholder to obtain a premium for selling the control of the company in this case because Judge Friendly personally would void a contract that gave controlling majority of management to a company that held less than fifty percent of the shares. If you dont have 50% plus 1, you cannot sell control for premium. But he wanted the state of New York to be able to determine what policy they would follow on their own.

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VIII.

5. v. Classified Board and Staggered Board 1. Difference i. Classified: Different classes of stock who have the power to name different directors ii. Staggered: You stagger the elections so not all the directors are elected at the same time 2. Why You Might Want a Staggered Election i. Takeover Defense Mechanism i. A staggered board of directors drags out the takeover process by preventing the entire board from being replaced at the same time. The terms are staggered, so that some members are elected every two years, while others are elected every four. Many companies that are interested in making an acquisition don't want to wait four years for the board to turn over. In these situations, the remaining board will use this as leverage to get a golden parachute we see you want control, but that will take you two years, if you buy us out we will resign today. ii. Cumulative Voting in Corporate Charter i. Cumulative voting is a way to cumulate votes on one person that guarantees a minority stockholder will get elected to the board. ii. Staggered voted nullifies the effect of cumulative voting. MERGERS, ACQUISITIONS AND TAKEOVERS a. Acquisitions: i. There are three ways to acquire another company (1) acquire the assets, (2) acquire the stock, (3) merger. ii. Acquire the Stock/Stock Acquisition 1. If A wants to buy Microsoft, he can put out a public tender offer for $150 per share. If A is successful, she will own enough stock an take control. iii. Acquire the Assets 1. A would need to negotiate with Microsoft to buy the assets. The sale would include patents, technology, copyrights, and A could come in and run corporation and give it a new name. 2. There are two ways to pay for stock or assets: (1) cash or (2) stock in the corporation. Most common way is to acquire stock for other stock. Corp would still have to answer for its debt. b. Merger i. Overview of Merger

Characteristics i. End up with 1 corporation ii. Combining of 2 organizations iii. Terms of the merger are spelled out in a doc called a merger agreement 2. Statutory Procedure i. Shareholders of both companies involved have to approve the merger by majority as well as the BoDs of both corporations ii. Must grant appraisal rights to shareholders who do not go along with the merger. 3. Merger is a statutory procedure where only one company survives. The terms of how the merger happens is set forth in corporate statutes of every state. ii. General Merger iii. Cash Out/Freeze Out Merger 1. Situation in which you already bought control through having a majority of the shares, but are attempting to acquire the rest of the stock. 2. Rationale: i. If person thinks the company is profitable, she will want all of the profits ii. Avoids conflict of interest situations. Sinclair. 3. WEINBURGER V. UOP, INC. i. The Signal Companies, , acquired, through both market purchases and a tender offer, a majority interest in UOP. Signal paid $21/share. Signal later decided to acquire all shares in UOP. A report generated by 2 directors of both corporations concluded that a share price of up to $24 would be a beneficial deal for Signal. Signal announced to minority shareholders in UOP that it was offering $21/share to acquire all shares in UOP. At the annual shareholder meeting of UOP, a majority of the minority shareholders approved the sale, which resulted in a forced sale of all shares. Weinberger, a minority shareholder that had voted against the sale, filed an action seeking to enjoin the merger. ii. A freeze-out merger approved without full disclosure of share value to minority shareholders is invalid. i. For a freeze-out merger to be valid, the transaction must be fair i. To be considered fair: 2 conditions must be met a. 1. shareholders must be informed of all relevant facts prior to their vote, and i. when important information is withheld from minority shareholders, their consent to the merger cannot be informed. b. 2. the price given must be fair. iii. When directors are on both sides of a transaction, or where a controlling stockholder eliminates the minority interest in a corporation, they are required to demonstrate the inherent fairness (entire fairness) of the transaction i. 1. Fair Dealing/Procedure i. timing, initiation, structure, negotiation, disclosure, and how approval was obtained. ii. 2. Faire Price/Value i. economic and financial considerations (assets, market value, earnings, future prospects, and anything else that affects the inherent and intrinsic value of the stock) iv. Delaware does not require a proper business purpose for the freeze-out merger. v. Remedies: for a violation of the inherent fairness test i. 1. appraisal proceeding, OR

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ii. 2. any form of equitable and monetary relief that may be appropriate. vi. Advise: Have independent people on the board hire their own investment banker to do the research and come up with a recommendation, then vote as a minority, then have entire board ratify it. iv. Short Form Merger 1. If A owns 90 percent or more of the shares, A can acquire remaining 10 percent without shareholder approval. 2. Shareholders have appraisal rights. i. Court appraises the shares and gives shareholders fair market value. ii. Weinburger Case iii. Sante Fe Industries 3. Under DE law, when you do this, the shareholders who are being bought out against their will have appraisle rights, this means if they do three things they can go to court and get the court to independently appraise what their stock is worth: (1) refuse to tender their shares, (2) bring suit and bear the expenses of the suit, and (3) rely on ht corporation for any information proving value. v. LLC Mergers 1. VGS, INC. V. CASTIEL i. The LLC is owned by Castiel (63%), Sahagen (25%), and Calypso(11%). The governing board of the LLC has three members, Castille, Sahagan and Castilles ally, Quinn. Castille didnt like the way LLC running, so Quinn and Sahagan vote to merge LLC with corporation. After the merger, incidentally, Sahagan controls a majority of the shares of the corporation. After the merger, Castiel was relegated to the position of a minority shareholder and was no longer CEO. ii. Plaintiff corporation, VGS, Inc., brought this action to validate its merger with the LLC after two of the three managers of the LLC, without notifying the third majority shareholder, voted for the merger. iii. DE Default Rule When LLC Involved in Merger: Unless the parties agree otherwise, an LLC cannot merge unless 100% of the equity holders approve the merger iv. But the operating agreement said: Board of managers has majority vote. Thus, the parties trumped the majority rule and said the LLC can merge if the majority of the board of managers approves the merger. v. The Court found that the merger was invalid. The Court derives duty of loyalty from partnership case like Salomon v. Meinheart and finds that the duty was violated here. S vi. The court held that the merger is invalid. Members have a duty of good faith and loyalty to each other, and therefore cant fail to give notice of a transaction to a member because you know that with that notice, he will block it. vii. Analysis i. Although Plaintiff is correct that there was only a requirement of the majority of LLC managers to vote for the merger, Sahagan and Quinn violated their fiduciary duty to Castiel by not informing him of the vote. A minority interest has a duty of loyalty to the majority interest, even if it means that the majority interest will thwart the vote by removing Quinn. The fact that Castiel may have been a poor performer does not exempt the other members of their duty to inform him in advance of the meeting. Takeovers i. Introduction 1. Takeovers are a good way of putting fear of god into management easiest way to displace management. 2. Absolute power corrupts absolute.

Takeover activity has been greatly reduced from the 1980s and 1990s, there were more hostile takeover. 4. But now with combination of state anti-takeover statutes like India and poison pills, which are lawful, management has the upper hand and we will see takeovers attempted ii. Defenses Against Takeover 1. There are several ways to defend against a hostile takeover. The most effective methods are built-in defensive measures that make a company difficult to take over. 2. Green Mail (Black Mail) i. Green mail is the practice of purchasing enough shares in a firm to threaten a takeover, thereby forcing the target firm to buy those shares back at a premium in order to suspend the takeover. ii. This is controversial because it deprives the person of value. iii. The takeover person loves it because they make a lot of money in a short period of time, but the rest of the shareholders do not receive anything and the value of their shares is diluted. iv. Example, if takeover firm bought shares at $50/share, to block the takeover, the corporation will offer to buy back shares at $80/share, a $30 premium. 3. Lock in Option i. When an acquiring bidder wants an initial stake in the firm ii. (Van Gorken case -- the corp allowed the firm to buy extra shares before the shares went public, it doesn't lock them in per se, but it gives them an advantage in future takeover activity. Prisker knew that he was going to be offering more, if someone outbid him he would be able to turn around and sell 1 mill shares at a nice profit. He can't lose and if he wins he gets control of the control, if he doesn't win in that way then someone outbids him and he gets to sale lock in shares for a nice profit. 4. Crown Jewel Defense i. The crown jewels defense - Sometimes a specific aspect of a company is particularly valuable. For example, a telecommunications company might have a highly-regarded research and development (R&D) division. This division is the company's "crown jewels." It might respond to a hostile bid by selling off the R&D division to another company, or spinning it off into a separate corporation. ii. You sale your most valuable assets to someone else so that the person who wants to take you over says omg the cmopany isn't what it isued to be. If GM was subject to takeover and they sold chevy division to someone else so that the value was going to go down drastically, it might cause acquiring firm to lose interest. 5. PacMan Defense i. With the Pac-Man Defense, a target company thwarts a takeover by buying stocks in the acquiring company, then taking them over. ii. THe companies would be combined so why does it matter which is which? CONTROlL, who gets to control the merged company. iii. This defense shines a light on the selfish motives of management in these takeover battles. you think the management is just acting in the intertest of the shareholders. yes and no, they are acting in their own interests, they want control. Poison Pill i. A Poison Pill is a strategy used by corporations to discourage hostile takeovers. With a poison pill, the target company attempts to make its stock less attractive to the acquirer. ii. Shareholders do not like poison pill because they deter takeovers, which are events that allow shareholders to make a lot of money (price goes up and

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shareholders get premium). Shareholders go to great lengths to get rid, even put in 14a8 initiative. Since shareholders do not like poison pill, corporate management adopts it by having a by law amendment, which only needs the approval of the board. iii. There are two types of poison pills: i. Flip in i. A "flip-in" allows existing shareholders (except the acquirer) to buy more shares at a discount in the event of a takeover attempt. The provision is often triggered whenever any one shareholder reaches a certain percentage of total shares (usually 20 to 40 percent). ii. The flow of additional cheap shares into the total pool of shares for the company makes all previously existing shares worth less. iii. Exampel: So an example would be, if GE acquires 20 percent of thshares of GM, then the poison pill if kicked in would allow all old shareh9oldes, not the 20 percent new guy, would be able to buy stock at 2 for 1 price adn that dilutes the value of other shares., and so GE all there shares would be diluted in value. ii. Flip Out i. Flip out provisions are triggered by mergers and allows stockholders to buy the acquirer's shares at a discounted price after the merger ii. Example: If GM is being taken over, the acquiring firm would first acquire it stock. When they reach a certain threshold, iv. Effect of Poison Pill i. Poison pills deter merger because they offer discounted stock to the old shareholders but not tot the new acquires. This is a very effective threat because no one wants to invest a lot of money to be halved in value over night, that is really very poisonous. ii. Golden Parachute to Waive Poison Pill Because poison pills are so effective, the acquiring firm will bend over backwards not ho have the poison bill triggered, so they go to management and they promise them golden parachutes. we will give you 20 million payment if you will have your board waive the poison bill. 7. White Knight: i. The White Knight is a common tactic in which the target finds another company to come in and purchase them out from under the hostile company. There are several reasons why they would prefer one company to another -- better purchase terms, a better relationship or better prospects for long-term success. 8. Golden Parachute: i. The Golden Parachute is a provision in a CEO's contract. It states that he will get a large bonus in cash or stock if the company is acquired. This makes the acquisition more expensive, and less attractive. Unfortunately, it also means that a CEO can do a terrible job of running a company, make it very attractive for someone who wants to acquire it, and receive a huge financial reward. iii. UNOCAL v. MESA Business Judgment Rule 1. Mesa Petroleum had made a front-end loaded two-tiered hostile bid for Unocal in which the front end was $54 in cash, and the back end of the deal was $54 in junk bonds. Because most shareholders would prefer to receive the cash instead of the bonds, shareholders were expected to tender their shares into the deal, even if they did not think $54 was a fair price. If a shareholder declined to tender, that shareholder risked being cashed-out for $54 dollars in risky debt instruments instead of cash.

In response, Unocal wanted to deter TBP from succeeding from taking over company. Thus, in response to the Mesa tender offer, Unocal made a self-tender at $72 for all but the Mesa shares. The Unocal board attempted to launch a self-tender offer to combat an unsolicited tender offer by Mesa Petroleum (Mesa). The self-tender offer would be triggered upon Mesa acquiring sixty-four million shares of Unocal, and would mean that Unocal itself would buy-back 49% of the outstanding shares of Unocal - but none of the shares to be bought-back could be shares held by Mesa. This would dilute the value of TBD shares that he acquired for a lesser amount. It also deterred shareholders from even tendering since if they waited, they could get a better deal. 3. The Court allowed this on the rational of the business judgment Rule i. In order to save the company, they were allowed to take this drastic measure even at the risk of a substantial loss ii. Even though they acted selfishly in trying to keep control, their response was proportional. $54 was too low and the TBD two tier front end offer is coercive. This put the squeeze on shareholders to quickly tender their shares in the first tier because they knew they would get lesser value in the second tier. This justified Unocals actions. iii. In essence, the Unocal court feared that a board may use takeover defenses to impermissibly prevent threats to corporate policy or to the board's control over the corporation. As a result, there was a need for "an enhanced duty" on the board, so as to ensure that their decisions in this area were meant only to further the welfare of the corporation and its shareholders. Therefore, the court ruled that in order for the board to be allotted the protection of the business judgment rule, the board must demonstrate that it was responding to a legitimate threat to corporate policy and effectiveness, and that its actions were "reasonable in relation to the threat posed." iv. After Unocal Case 1. New BJR Test Unocal Test i. People started to call this a BJR, but its not really. ii. Under the BJR, management gets a lot of discretion and their decisions are only questioned if their actions were unreasonable. iii. But the Unocal Test requires weighing the threat posed by the takeover person against the corporate defensive action. iv. If they feel like the defensive action is disproportionate to the threat posed, then the court will likely find managements actions illegal. 2. SEC Decision i. Unocoal was state law provision, but prompted decision from SEC. Both Unocal and Mesas actions are no longer lawful under securities law after this case. SEC also responded after this case and it didnt like self tender or the front end offer. ii. Now, if you make a tender, you have to make it available equally to all shareholders. So, whereas Unocal only made their self-offer to non Mesa shareholders, the SEC said that the tender cannot be on a non discriminatory basis. v. REVLON INC. V. MACANDREWS & FORBES HOLDINGS 1. Pantry Prides CEO approached Revlons CEO and offered a $40-42 per share price for Revlon, or $45 if it had to be a hostile takeover. The CEOs had personal differences, and the court noted this as a potential motivation for Revlon to turn elsewhere. Revlons directors met and decided to adopt a poison pill plan and to repurchase five million of Revlons shares. Pantry Pride countered with a $47.50 price which pushed Revlon to repurchase ten million shares with senior subordinated notes. Pantry Pride continued to increase their bids, and Revlon decided to seek another buyer in Forstmann. Revlon offered $56.25 with the promise to increase the bidding further if another bidding topped

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that price. Instead, Revlon made an agreement to have Forstmann pay $57.25 per share subject to certain restrictions such as a $25 million cancellation fee for Forstmann and a no-shop provision. Plaintiffs, MacAndrews & Forbes Holdings, Inc., sought to enjoin the agreement because it was not in the best interests of the shareholders. Defendants argued that they needed to also consider the best interests of the noteholders. Court said Revlons action were in violation of their fiduciary duties i. What they did early on was okay, but what they did in connection with Forstmann was not okay. ii. Once they have an offer for sale, they have an obligation to sale to the highest bidder and any one of the three would have been inconsistent with his obligation

Once it becomes inevitable that the company is going to be sold, the duty of the BoDchanges from preservation to the maximization of the companys value at a sale for the stockholders benefit. i. A board may have regard for various constituencies in discharging its responsibilities provided there are rationally related benefits accruing to the stockholders. i. Primary & Dominant Fiduciary Duty is owed to the shareholder. ii. This case does not hold that an inevitable dissolution or breakup is required for the change in duty, but the case can apply where there is a pending sale of control, regardless of whether or not there is to be a breakup of the corporation. iii. Understand that the lock-up provision, the no shop provision and the cancellation fee are not per se illegal, but under the balancing test, they were here because of the change in duty. vi. State and Federal Legislation 1. It is common for one corporation to try to take over another corporation. The federal Williams Act and state control share acquisition statutes have been devised to protect shareholders of the corporation from being acquired. 2. There are two sides to takeover legislation: (1) corporate management and (2) investment banking community. 3. Williams Act i. Overview i. A tender offer is an offer to shareholders of a corporation asking them to tender their shares in exchange for either cash or securities. ii. When this Act came out, Congress could either be strict or easy. i. Corporate Management would want to be on strict side so that it makes it harder to change corporate management. Corporate management doesnt like hostile takeovers because they can get outsted from their lucrative positions. Law firms lobbied for corporations. ii. Investors like takeovers because their services are needed and they make a lot of money iii. The Williams Act represented a compromise between these competing interests ii. Williams Act Requirements i. Disclosure Requirement i. When someone gets 5% or more of stock, they have to file a report containing disclosures the SEC within 5 days of acquiring 5% in shares. ii. The disclosure must include why they are acquiring it/purpose. But when you get over 5%, there is a strong suspicion that you

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are trying to acquire for more than an investment possible takeover. iii. Sometimes by the time the target company receives the report, the takeover person has already acquired more than the 5%.. ii. Regulation of Terms of Tender Offer i. Tender offers must remain open for 20 business days ii. A tender offer must be open to all security holders of the class of securities subject to the tender offer; iii. Shareholders must be permitted to withdraw tender shares while the offer remains open iv. If the offer is overproscribed, the bidder must purchase on a pro rata basis from among the shares deposited during the first 10 days; v. If the tender price is increased, the higher price must be paid to all tendering shareholders. iii. Buy Tendered Stock in Equal Proportions i. If a person makes an offer to buy 50% of a companys stock, and 100% of the stock is tendered, she has to buy equal proportions 50% of everyones stock. ii. The Act prohibits discrimination against shareholders. iii. In the days of Unocal, the rule was first come first serve, if you are the first to tender your shares, then a buyer could purchase them. iv. Now there is no pressure on shareholders, they can wait until the end of the twenty day period, be the last to tender their stock to see if a better offer comes along, and then tender. iv. Same Price for Everyone Who Tenders i. Old Rule: If you offered $50/share, and then later you raised tender offer, you could pay different prices. ii. New Rule under Act: If you make tender offer during takeover, you have to offer that price to everyone. iii. Effect of the Williams Act i. The Williams Act represents the desire to make sure takeovers are done in a fair and even handed fashion, but also to make way for them. The Williams Act does not operate to discourage takeover. ii. Under the Williams Act, there is no way that a controlling shareholder can get a premium that the other shareholders wont get This is more like the Canadian rule in the sense that everyone is treated equally. CTS CORPORATION V. DYNAMICS CORPORATION OF AMERICA i. Appellee owned 9.6% of Appellant, CTS Corporation and announced a tender offer to increase their ownership to 27.5%. Six days before their announcement, an Indiana law, Indianas Control Share Acquisitions Act, came into effect. The Act allows for disinterested shareholders to hold a shareholders meeting to discuss the merits of a tender offer for controlling shares. The would be takeover company did not want the Indiana law to control and argues that the Act is preempted by a federal law, the Williams Act. ii. The takeover companys argument was that the Williams Act says you have to keep it open for 20 days, but the Indian statute gave corps 50 days to hold shareholder vote to decide whether to give bidding company voting rights or not. So the argument that was made was that the Williams Act says 1 month and Indiana is extending that and giving corp 50 days to even decide just a vote iii. Court said no.

i. The Indiana Act is not preempted by the federal law because entities can comply with both federal and state law without frustrating the federal law. ii. The state law furthers the federal laws goal of protecting shareholders from tender offer abuses but does not tip the balance between management and acquirers. Instead, the rights of shareholders are strengthened in a situation where many believe shareholders are traditionally at a disadvantage. iii.