Corporations

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The words in black are notes from book while those in red are what Burson said during lecture

MBCAModel Business Corporation Act DGCL-Delaware general corporation law Agency costsOfficers/employees have different incentives then owners Private ordering-Dont want Govt tell us how to order the affairs of our business and relationships Transaction costs a. Bounded RationalityBounds on rationality will limit accuracy of judgments Youre limited on what you can see in the future. You dont know how it is going to develop in the future b. Opportunism c. Team-specific investmentWhen a person or asset has a higher value in its current team use than its value in its next best use d. Default rules save transaction costs Discrete and Relational Contracting a. Discrete contractingParties w/ no preexisting obligations to each other negotiate a k that anticipates and provides a rule governing all contingencies b. Relational ContractingInstead of attempting to provide an answer to all contingencies at the commencement of the relationshipThey attempt to build a governance structure that will allow them to solve problems that arise Tailored, Majoritarian, and Penalty Default Rules a. TailoredDesigned to give contracting parties the exact rule that they would themselves choose if they were able to bargain costlessly over the matter in dispute b. MajoritarianDesigned to provide investors with the result that most similarly situated parties would prefer c. Penalty Default RulesDefined to motivate parties to contract around the default. Designed to force parties to specify their own rules ex ante, instead of relying on a default rule provided by law

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Agency
I. Generally a. PrincipalOwnership and control of the team in the hands of 1+ members i. Principal is bound due to Agent in tort because of vicarious liability b. AgentsOther team members employees c. Agency relationship is consensual in nature Definitions and Terminology d. 1.01 Agency DefinedAgency is the fiduciary relationship that arises when one person (a principal) manifests assent to another person (an agent) that the agent shall act on the principals behalf and subject to the principals control, and the agent manifests assent or otherwise consents so to act (Per BursonMemorize) e. 1.02 Parties Labeling and Popular Usage Not controllingAn agency relationship arises only when the elements stated in 1.01 are present. Whether a relationship is characterized as agency in an agreement between parties or in the context of industry or popular usage is not controlling f. 1.03 ManifestationA person manifests assent or intention through written or spoken words or other conduct g. 8.01-8.15Duties of Agent and Principal to Each Other

h. 8.01 General Fiduciary PrincipleAn agent has a fiduciary duty to act loyally for the principals benefit in all matters connected with the agency relationship II. Gay Jenson Farms Co. v. Cargill, Inc. a. Facts: Warren operated a grain elevator and purchased grain from farmers for resale. Cargill financed Warren for Warrens operations to the extent that both defendants names appeared on drafts that Warren dispersed. Cargill also had a significant amount of control over Warren, including approving any expenditure over $5,000, approving of any stock sale or dividends, and instructing Warren to explain the nature of any withdrawals on the account. The defendants also contracted into unrelated agreements that clearly established a principal-agent relationship. Warren also sold a majority of its grain to Cargill. Warren had financial problems that worsened until Plaintiffs began questioning the ability of Warren to make payments, and Cargill reassured Plaintiffs otherwise. Warren was forced to close, owing Plaintiffs $2 million. Plaintiffs brought suit against both, claiming Cargill was a principal of Warren. b. Issue: The issue is whether Cargill, through its control and influence over Warren, became liable as a principal over Warren? c. Held: Yes. Cargill consented to be a principal once Warren agreed to implement the changes and policies that Cargill suggested. Cargills subsequent interference in Warrens internal operations further established the relationship. i. Private ordering here failed ii. Difference b/t contract and agreement iii. Almost every er (principal)ee (agent) relationship is an agency relationship III. Agency Law and Relations with Creditors a. Third party who deals w/ an agent does so at his peril b. Agents actions will bind the principal only if the principal has manifested his or its assent to such actions c. Such manifestations of assent can take two forms: Actual authority or apparent authority (aka ostensible authority) i. Actual authoritywhen the principal manifests consent directly to the agent 1. 2 types of actual authority: express and implied a. Can be written/oral/implied from the conduct of the principal 2. If actual authority existsprincipal bound by agents authorized actions ii. Apparent authority (aka ostensible authority)When agent is w/ out actual authority, but the principal manifests his consent directly to the third party who is dealing with the agent a. *Cant have actual and apparent authority* b. Can be express/implied c. 3rd party will be able to bind principal only if 3rd party reasonably believed that agent was authorized iii. Agency by estoppel (rest. 205)A person has not made a manifestation that an actor has authority as an agent and who is not otherwise liable as a party to a transaction purportedly done by the actor on that persons account is subject to liability to a third party who justifiably is induced to make a detrimental change in position b/c the transaction is believed to be on the persons account, if: 1. The person intentionally or carelessly caused such belief; or 2. Have notice of such belief and that it might induce others to change their positions, the person did not take reasonable steps to notify them of the facts. d. Tort Actions i. Blackburn v. Witter

Facts: While employed by Walston & Company (D) and Dean Witter & Witter Company (D), long (D had acted as investment adviser for Blackburn (P). Long (D) had been a trustworthy counselor for Blackburn (P) until he persuaded her to invest in a nonexistent company by selling him some of her stock in exchange for his personal note. Although Blackburn (P) questioned Long (D) about discrepancies in the transactions, he allayed her concerns by telling her that he was acting for his employers and that the investment was recommended by their research. Wjen Longs (D) fraudulent action came to light, Blackburn (P_ filed this action to recover her losses. 2. Issue: Is a principal who puts an agent in a position that enables the agent, while apparently acting within his authority, to commit a fraud upon third persons subject to liability for the fraud? 3. Holding and Decision: Yes, A principal who puts an agent in a position that enables the agent, while apparently acting within his authority, to commit a fraud upon third persons is subject to liability for the fraud. a. If there is liability here, it must rest on the theory of ostensible agency since Long clearly had no authority as an employee of either Walston or Witter to borrow money for his personal use or to take money from a client and give his personal note rather than a security for it. Walston and Witter cannot accept the benefits of the sale of the stock by Long as their agent while at the same time denying liability for the fraudulent misuses of the money obtained by the sale of the stock. Further, Walston knew Long was drinking to excess, gambling heavily, and encouraging customers to buy and sell stock merely for the purpose of promoting volume so that this commissions would be greater, yet it did nothing to advise his customers of this ii. Sennott v. Rodman & Renshaw 1. Facts: Jordan started buying/selling stock for Sennott. Jordan was the son of a partner at Rodman (The brokerage agency). After doing a number of legitimate transactions for Sennott, Jordan fraudulently offered Sennott stock options for Skyline homes. Sennott paid Jordan, but did not receive stock. Issue: Was Rodman liable? 2. Rule: A partnership will not be vicariously liable for the actions of its partner if the partner did not knowingly assist and participate in efforts to defraud and the fraud victim did not rely on the apparent authority of the defrauder. 3. An alysis: Court said no apparent authority hereNo reliance on Rodman. Not only did the fraudulent representations never involve Rodman but both Sennott and Jordan actively sought to prevent Rodman from discovery the option transactions. Here Sennott relied on Jordan not Rodman (whereas in Blackburn customer relied on company not investment banker). iii. Rest. 2.01-2.06. 3.01, 3.03 e. Agent will be subject to principles of direction and control i. Must also maintain control to give interim instructionsThis is sometimes what separates an agency from independent contractor relationship f. Agency relationship can be express or implied and gratuitous g. 2.04 Respondeat SuperiorAn employer is subject to liability for torts committed by employees while acting w/ in the scope of their employment

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h. 7.07 An employee is an agent whos principal controls or has the right to control the manner and means of the agents performanceThe fact that it is performed gratuitously (w/ out money) does not relieve liability i. Restatement of Agency 220 (p.535)-Determining whether someone is a servant (employee) or independent contractorThe following factors are considered: i. The extent of control (by agreement) the master may exercise over the details of the work ii. Whether employed is engaged in a distinct occupation/business iii. Whether the work of the kind of occupation in the locality is usually done under direction of the er or by a specialist w/ out supervision iv. Skill reqd in the particular occupation v. Whether er or worker provides the tools, place of work, etc for the person doing the work vi. The length of time for which the person is employed vii. The method of payment, whether by the time or by the job viii. Whether or not the work is a part of the regular business of the employer ix. Whether or not the parties believe they are creating the relation of master and servant; and x. Whether the principal is or is not a business j. Cmt f 1.01Principals and agents contract with each other to determine how much control the principal will retain, and how much control will be given to the agent

The Corporate Form and the Specialized Roles of Shareholders, Directors, and Officers I. The corporate Form MBCA 2.06, 8.01,10.01-10.04, 10.20 DGCL 109,141(a) 142, 242
DCGL 141(A)Default RuleThe Business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate or incorporation

I. Overview Shareholdersprovide capital and elect directors owns a unit or multiple units of a corporation Directorsmake major policy decisions manage the corporationelected by the shareholders 1. By statute all corporate powers are exercised by the board of directors a. Under state corporate law, the board acts as a unit via majority rule, as do voting shareholders Officersexecute those policies and provide day-to-day managementDirectors hire the officers Employees II. Agency relationship b/t Director ? Directors/Officers??? Officers/Employees?? III. Directors Directors determine basic corporate policies, appoint and monitor the corporate officers, and determine when and if dividends are to be paid by shareholders Directors management power must be exercised collectively and by majority ruleindividual directors are not given general agency power to deal w/ outsiders

 Incentives for directors come from private ordering ex. Providing directors w/ share ownership.
Law also imposes fiduciary duties Judicial presumption that directors acted properly Inside directors serve as an informational link b/t the corporation and the board of directors IV. Officers Corporate law considers officers as agents and the corporation as principal (acting through its board of directors) and leaves it to the board to work out the oversight that it desires as to its agents Like directors, officers receive compensation for services they perform, but do not share in the corporations residual profit unless they also own shares Officer connotes a corporate employee who ranks above other corporate employees in a corporation s management hierarchy Corporate SecretaryCorporation must designate an individual to be responsible for keeping and verifying corporate records V. Shareholders Corporate ownership interest are represented by shares Shareholders collectively have the power to elect annually the corporations directors and approve fundamental changes in the corporations governing rules or structure SharesFreely transferrable Normally, shareholder has no obligation or liability to the corporation or its creditors beyond the amount she paid for the shares 1. Limited liabilityallows SH to risk only a predetermined amount of capital in each corporate investment, instead of potentially risking her entire wealth as would be the case if shareholders were personally liable for a corporations debts. Limited Liability reduces transaction costs. If SH were personally liable for corporation debts, a potential purchaser would require information about the wealth an investment decisions of other shareholders in order to assess the fully the risk of become a SH. Almost all state corporation codes now provide that the business of a corporation shall be entrusted to directors, except as otherwise provided in the articles of corporation. 1. Thus, original articles of incorporation can give shareholders a right to control, or participate in control of, ordinary business matters Most states do allow SH to initiate a change in the corporations bylaws. However, SH normally may not amend the bylaws to make ordinary business decisions or to est. corporate policies Directors management authority extends to chairing and controlling the agenda of shareholders meetingsmanagement normally may rule out of order an SH attempt to propose an amendment to the articles or bylaws that would intrude on management authority to make ordinary business decisions or to establish corporate policies. SH do have the right to suggest that the directors take a particular action or adopt a new policy CA, Inc. v. AFSCME Employees Pension PlanFacts: SH submitted a proposed bylaw to directors that would amend the current bylaw to reimburse SH for expenses in connection w/ nomination of candidates in a disputed election. Directors refused to include proposal in proxy materials. 1. Issue #1Is a proposal seeking to require a company to reimburse SHs for expenses incurred in the elections of directors a proper subject for inclusion in proxy statements as a 5

 141 (A) the business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.

matter of Delaware law? Held: Yes. Both the BOD and the shareholders of a corporation are empowered by law to adopt, amend or repeal the corporations bylaws. However, such power is not coextensive, b/c only the board has management powers. Delaware law provides that a proper function of bylaws is not to mandate how the board should decide specific substantive business decisions, but to define the process and procedures by which those decisions are made. Such bylaws are appropriate for SH action. a. Rule (1): A proposal seeking to require a company to reimburse shareholders for expenses incurred in the elections of directors is a proper subject for inclusion in proxy statements as a matter of Delaware Law 2. Issue #2Would the SH proposal, if adopted, cause directors to violate any DE law to which it is subject? Held: Yes. The bylaw would prevent the directors from exercising their full managerial power in circumstances where their fiduciary duties would otherwise require them to deny reimbursement. The challenged bylaw contains no language or provision that would reserve to CAs directors their full power to exercise their fiduciary duty to decide whether or not it would be appropriate in a specific case, to award reimbursement at all. a. Rule (2): A proposal seeking to require a company to reimburse shareholders for expenses incurred in the elections of directors, if adopted, would cause the company to violate any Delaware law to which it is subject. Following CA, Inc., Delaware enacted 112 and 113 specifying that bylaws can include provisions requiring a corporations proxy to include individuals nominated by SH (112) and providing for the reimbursement by the corporation of expenses incurred in connection with the election of directors (113). The statute is permissive, rather than mandatory. 1. Similarly, the MBCA enacted 2.06 that authorizes both shareholder-expense-reimbursement bylaws and share-holder-proxy access bylaws. DGCL 109(a) allows SH & BOD to adopt/amend/repeal corporation bylaws. Directors must initiate changes to the article of incorporation

II. The Formation of the Corporation and the Governance Expectations of the Initial Participants I. Where to Incorporate: State Corporation Laws as Competing Sets of Standard Form Rules Corporations incorporated in one state are recognized by other states Under traditional choice-of-law rules, termed the internal affairs doctrine, CTs look to the laws of the incorporating state to determine the basic rights and duties applicable to a particular corporation. II. Formation: The Articles of IncorporationMBCA 2.01-2.06 Delware B.C.L. 101, 102 Process to form a corporation: Participants complete the articles of incorporation and file them w/ the appropriate state official in the chose state, often a designee of the secretary of the state After articles are filedthere is usually an initial organization meeting at which directors are elected, shares are issued in exchange for consideration, and bylaws governing corporate procedures are adopted. III. Corporation I. Business Associations Public Corporation 6

1. Primary market when corporation first issues shares to the market. When they do that
money goes to capitalize a company;Stock is issuedShares are then traded on exchanges; 2. Secondary marketShares listed for Trade a. When you buy a share of stock on a secondary market who does that money go to? i. The money goes to who ever had the share before it ii. How does this help the company? 1. The company can own its own shares. They can go to a bank and borrow more against them. 2. Enterprise value of a company 3. Liquid 4. Developed in mid-later part of 1800s Closely held corporation 1. Small number of shareholders 2. Dont have liquidity of Public Corporation Professional Corporation (Not studying in this class)Physician/lawyerShield from liability Not for Profit (Not studying in this class)Dont generate profit that flows out to shareholders To get public to invest you need: (1) Limited Liability (2) Liquidity (3) Centralized Control Rights of a Corporation Constitutional rightsA corporation is a considered a person with 1st amendment rightsFree speech When corporation makes profit it has to pay taxes The shareholders dont have to pay tax when the corporation makes money Shareholders have to pay taxes when they get paid dividends This is Double Taxation Capital Structure terminology Authorized SharesShares that are specified in the articles of incorporation. Have to specify the number of shares the corporation can issue Outstanding sharesnumber of shares that company has sold but not bought back If the board of directors wants to have more sharescharter amendment Incorporation Process Governed by State Law Majority (over 60% of Fortune 500/50% listed on the NYSE) are incorporated in Delaware. 1. No minimal capital req 2. Only have to have 1 incorporator 3. Favorable franchise tax 4. No corporate income tax for companies doing business outside Delaware a. Can keep books etc. outside Delaware 5. Very dedicated court system to resolving corporate disputes Internal Affairs DoctrineNo matter where the claim or lawsuit arises-look to the state law of incorporation

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VII. Limited Liability MBCA 6.11Liability of Shareholders DELAWARE GENERAL CORPORATION LAW 102 (B)(6) Limited liability is a default rule and can be changed VIII. Formation: The Articles of Incorporation Participants complete the articles of incorporation and file them with the appropriate state official in the chosen state, often a designee of the secretary of state. (secretary of the state) iii. 103 (Delaware) Not in our supplementWhen your charter is filed the corporation comes into existence a. Filing takes place when the secretary of state stamps it as filing b. Can file it with a delayed filing date (Dont want it to become effective until such ____date) iv. Incorporator/promoter a. Incorporator i. 101DGCL/2.01 MBCA Person that basically fills out the certificate. ii. Often is a lawyer iii. Incorporator can become an officer of the corporation b. Promoter i. Someone who is acting on behalf of the to be form corporation 1. Such as the person that goes to the lawyer ii. MBCA 2.04Must be careful b/c not insulated from liability until incorporated iii. Hypo: If a promoter signs a lease, subsequently a corporation forms then a corporation can become a party to the lease by expressly adopting the contract (a novation) or if the corporation moves into the space they can ratify it by accepting the benefits of it 1. You can more explicitly put the other party on notice that youre not doing this personally so when the corporation comes into existence that it will take the promoter after it. a. Say Will Wilson for corporation to be formedThis puts them on notice Requirements: Corporations names, its registered office and a i. Agent for service of process, and the number of shares it is authorized to issue ii. After the articles are filed, there is usually an initial organizational meeting at which directors are elected, shares are issued in exchange for consideration and the corporation receives to undertake its business, and bylaws governing corporate procedures are adopted. IX. Determining Shares to Issue MBCA 6.01; DELAWARE GCL 151 1. Corporate norms specify that there must be a class of shares that carry authority to elect directors and exercise all other shareholder voting rights. 2. There must be a class that entitles the bear to receive the corporations net assets upon dissolution 3. Shares that combine both residual claimant status and voting rights are called common shares 4. Corporate norms contemplate that all shares of a given class will be fungiblethat is they will have identical rights, preferences, and limitations o This in turn supports a uniform expectation that minimizes transaction costs for a purchaser and bolsters the functioning of a national market for shares

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MBCA Sec. 2.02-2.06; Delaware G. C.L. Sec 101, 102

5. Preferred shares of the same class have identical rights, but preferred shares do not have identical rights across classes or from corporation to corporation o Accordingly, purchaser and sellers of preferred shares may be unable to rely upon national market valuation and instead may face research costs in ascertaining exactly what rights attach to shares. X. Determining Voting Rights: Using Articles and Bylaws to Change Legal Norms i. Most state corporation law norms take the form of default rules ii. The corporate law default rules can be changed by inclusion of the preferred rule in the articles of incorporation or bylaws iii. Articles are public documents that can be changed only by action of a corporations directors and shareholders. iv. Bylaws often can be changed by the directors alone and are not publicly filed documents Overview of Normal Rules of Shareholder Voting for Election of Directors: Straight Voting MBCA 8.04, 7.21, 7.28 Delaware G.C.L. 141(D), 212(A), 214, 216 1. Default rules governing shareholders ability to elect directors a. Directors are annually elected by plurality vote, according to votes cast on a one vote per share basis i. Alternatively Majority voting b. The number of directors is usually specified in the initial articles or bylaw 2. Cumulative Voting a. In a cumulative voting scheme, a shareholder can cast a total number of votes equal to the number of shares multiplied by the number of positions to be filled, and these votes can be spread among as many candidates as there are seats to be filled or concentrated in as few as one candidate. b. The purpose of cumulative voting is to permit some minority shareholders to have a place on the board c. The maximum voting power of a given block of shares (i.e., how many seats on the board of directors can be controlled by a given number of shares) can be determined by the following formula: i. To elect X number of directors (For X put in the number of directors you want to elect), a shareholder must have more than SX/(D+1) 1. S equals the number of shares voting and D equals the number of directors to be elected 3. Class Voting, Including Dual-Class Voting Schemes a. Normally, power to elect directors rests with the voting shareholders as a whole b. However, a corporation may, in its articles of incorporation, divide its shares into classes and permit each class to select a specified number of directors i. This allocates the right to elect directors between different sets of investors c. Dual Class common MechanismSeparates shareholders into two classes and gives one class disproportionate voting power as compared to their capital contribution to the corporation i. This might be desirable for a company going public ii. The dual-class voting schemes for companies already by publicly traded have been disfavored by the SEC and curtailed by stock exchange rules but are permitted in Delaware. A classified Board with Staggered TermsAdaptability Versus Stability MBCA 8.06; DELAWARE G.C.L. 141(D) 1. Almost all state corporation codes provide as a norm that directors shall be elected annually a. However, these laws expressly allow corporations to adopt longer and staggered terms for directors

2. If directors are divided into two groups, then each directors serves a three year term 3. The terms of all directors are staggered so that the term of only one group expires each year 4. Absent removal of directors having staggered terms means that two annual meetings would be required to replace a majority of the board of directors 5. Thus, shareholderseven a majority shareholdercannot easily change corporate policies simply by electing an entirely new board I. Looking Ahead: Shareholder Action After Electing Directors The annual Meeting and other forums for Shareholder Action MBCA 7.01-7.07, 7.21 DELAWARE G.C.L. 211-213, 216, 222, 228 a. Directors may be tempted to use their power to thwart shareholders voting rights b. To minimize the risk that directors will act unfairly, corporation statutes specify in detail the substance of shareholders voting and meeting rights, as well as the procedural rules that safeguard the shareholders exercise of these rights. The following are some of the more important rules: i. The annual meeting and election of directors 1. Most corporation codes protect the exercise of this right by specifying immutably that directors shall be elected at an annually held meeting of shareholders 2. Most corporation codes provide summary judicial procedures to ensure that a failure to hold a required annual meeting is quickly remedied. ii. Special Shareholders meetings 1. Address issues expressly identified in the meeting notice 2. In Delaware the directors or whoever may be listed in the charter can call a special meeting a. This blocks shareholder-initiated special meetings to oppose the current board 3. MBCA 7.02authorizes the holders of 10 percent or more of a corporations stock to call a special meeting iii. Action by Written Consent 1. Corporation statues provide a third forum by which shareholders can actwritten consent in lieu of a meeting 2. MBCA has the more restrictive rule of permitting action by written consent only by unanimity, which effectively limits its use to small corporations with a few shareholders, while Delaware permits written consent by the vote of the number of shareholders otherwise required by corporate actiona majority in many cases 3. This is default and can be changed iv. Hoschett v. TSI International Software, Ltd. 1. Facts: Hoschett (P) holds shares of common stock in TSI (D). TSI (D) is a privately held corporation. Pursuant to TSIs certificate of incorporation, holders of TSIs (D) stock, vote together on all matters, including the election of directors. TSI (D) has never hand an annual meeting for the election of its directors. Hoschett (P) sought an order requiring TSI (D) to hold an annual meeting of its stockholders for the election of directors and to make publicly available to shareholders a stock list. After the action was filed, TSI (D) received a written consent representing a majority of the voting power to the corporation that elected five individuals each to serve as a director of TSI (D) until his or her successor is duly elected and qualified.

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2. Issue: Does a stockholders written consent taken after the filing of a complaint and purporting to elect directors for TSI (D), satisfy the requirement to hold an annual meeting? 3. Held: No. Annual meeting and shareholder voting are central to corporate governance. Creating consent to designate directors in lieu of having an annual meeting does not produce a more practical and efficient system. The formality of notice to all shareholders and a meeting could have an effect on how the majority of shareholders vote. a. The annual meeting serves purposes other than the election of directors, including opportunities to bring matters before the shareholder body, such as oral reports, questions and answers, and in rare instances, proxy contests, and between shareholders and managers. The court concluded that "absent unanimous written consent," the corporation was obligated to convene an annual meeting of its shareholders to elect directors. 4. Rule: A consent action, which duly designates directors of a company, does not satisfy the corporations obligation to hold an annual meeting at which the companys directors are to be elected, in conformity with the certificate of incorporation. a. Important to have democratic form that enhances governance 5. After this case the Delaware legislature amended 211 DCGL a. 211 (B): as amended, now specifically permits directors of a Delaware corporation to be elected by a written consent in lieu of an annual meeting, unless the corporation's certificate of incorporation prohibits this action. However, if a corporation cannot get unanimous consent, the shareholders may elect directors by written consent of the majority of the shareholders entitled to vote for election of directors only if all of the positions to which directors could be elected at an annual meeting held at the effective time of the consent are vacant, and if the consent fills those positions. i. CMT if a corporation cannot obtain unanimous consent, then, in order to use a written consent instead of holding a shareholders' meeting, it will be required to remove all directors or have all directors resign before the effective time of the consent. The corporation does not need this resignation or removal of directors if it obtains unanimous consent. v. Record date: Determining shareholders entitled to vote 1. Shareholders who are entitled to participate and vote at a meeting are not necessarily the shareholders who own shares on the date of the meeting 2. State corporation codes provide that the shareholders entitled to vote are those owning shares on the record date specified by directors Piercing The Veil i. 102 (6)p.211; 6.22(b) Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that the may become personally liable by reason of his own acts or conduct 1. In practicethreatening to pierce the veil is a good tool to get settlements a. Alter ego theory b. Entity/enterprise theoryGoing after the collective asset as if its one enterprise

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ii. The law permits the incorporation of a business for the very purpose of enabling its proprietors to escape personal liability. Walkovsky v. Carlton 1. Respondent Superior was the basis for relief in this case iii. Introduction 1. Black letter law of piercing the corporate veil-The separateness of the corporate entity is normally to be respected. However, a corporations veil will be pierced whenever a corporate form is employed to evade an existing obligation, circumvent a statute, perpetrate fraud, commit a crime, or work an injustice. a. Such black letter formulations give judges little structure with which to approach the analysis of particular cases. 2. 3-part test to pierce the veil: a. (1) The parent completely control and dominate the subsidiary b. (2) The parents conduct in using the subsidiary was unjust, fraudulent, or wrongful toward the plaintiff, and c. (3)Plaintiff actually suffered some harm as a result 3. Most LLC statutes explicitly state that the liability shield does not protect a person from liability for his or her own tortious acts. Traditional Piercing Factors i. When a court pierces the corporate veil, it places creditor expectations ahead of insiders interests in limited liability. ii. Particular piercing factors seem more relevant even though no one factor emerges as determinative. It is generally believed that courts are more likely to pierce in the follow situations: 1. The business is a closely held corporation a. Courts pierce the corporate veil in closely held corporations or corporate groups. No reported case of piercing has ever involved the shareholders of a publicly traded corporation. b. B/c most publicly held corporations are not effectively controlled by shareholders, it seems unlikely that CTs would find it equitable or efficient to hold such shareholders personally liable for a corporations debts 2. The plaintiff is an involuntary (tort) creditor a. Courts often are less willing to pierce the corporate veil for creditors whose dealings with the corporation were voluntarysuch as suppliers, employees, customers and lenders. So long as they are not deceived, voluntary creditors usually can anticipate the corporations no-recourse structure and contract for personal guarantees, higher prices, or assurances on how the business will be conducted. b. Involuntary creditors---such as tort victims and retail customerscannot easily protect themselves contractually, nor do they knowingly assume the risk of dealing with a no-recourse business. c. Consumers Co-op v. Olsen (contract case) 3. The defendant is a corporate shareholder (as opposed to an individual) a. Many argue that CTs should be more willing to pierce the corporate veil to reach other corporations than to reach a real person b. Enterprise liability doctrine (In the correct place?)

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i. Courts sometimes use the enterprise liability doctrine to disregard multiple incorporations of the same business under common ownership. Doctrine pools together business assets to satisfy the liabilities of any part of the enterprise; the assets of individual owners or managers are not exposed. ii. Walkovsky v. Carlton 1. Facts: Carlton set up 10 wholly owned cap operations. Each corporation owned two cabs and employed its own taxi drivers. A taxi driver of one of the corporations ran over Walkovsky, who sued all of Carltons corporations and Carlton himself. Each cab corporation carried the requisite insurance required by statute, but no more. Walkovsky sued on 2 theories (1) Carltons whole taxi enterprise was liable, making all the affiliated assets available on an enterprise liability theory, and (2) Carlton was liable in his personal capacity. 2. Analysis: The CT accepted the enterprise liability theory since Carltons corporations, held out to the public as a single enterprise, were artificially separated into different corporations. But the court rejected the argument that Carltons use of multiple corporations or his minimal insurance coverage justified personal liability. CT remanded regarding Carltons individual capacity c. Parent-Subsidiary Piercing i. When a subsidiary incurs liabilities, creditors will often look to the parent corporations assets. But simply isolating business assets and risks in different corporations does not justify piercing. Instead, courts have required a showing that the parent dominated the subsidiary so that they acted as a single economic entity and recognizing corporate separateness would be unfair or unjust. ii. Thompsons study indicates courts pierce to reach corporate defendants (37%) less frequently than individual defendants (43 percent) 4. Insiders failed to follow corporate formalities a. Ex. holding shareholders and directors meetings, issuance of stock, election of directors and officers, passing resolutions authorizing payments, and keeping corporate minutes. b. In deciding to pierce, CTs sometimes refer to the failure to observe formalities on the theory shareholders have used the corporation as their alter ego or conduit for their own personal affairs c. Rationale: i. It could be argued that anyone who disregards the corporate form should not be allowed to claim the privilege of limited liability ii. It could also be argued that the failure to observe formalities may indicate that creditors have been confused or misled about whom they were dealing with iii. It could be argued that a lack of formalities suggests shareholders systematically disregard corporate obligations. That is, lack of formalities

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provides indirect evidence of shareholder commingling and siphoning of assets. 5. Insiders commingled business assets/affairs with individual assets/affairs a. When shareholders fail to keep corporate and personal assets separate. b. Ex. using a corporate bank account to pay for personal expenses c. The commingling of assets allows an inference that the participants disregarded creditor interests 6. Insiders did not adequately capitalize the business (Undercapitalization and Purposeful Insolvency) a. CTs state a willingness to pierce the corporate veil when a corporation is formed or operated without capital adequate to meet expected business obligations. i. Simply organizing or running a business that has little or no capital, standing alone is generally not sufficient to piece the corporate veil. To require that corporations be formed and operated always w/ adequate capital to meet all contingencies would add a significant burden to entrepreneurial activity b. Sometimes undercapitalization is purposeful, as when the corporation is run to always be insolvent. In general, creditors expect that a business with which they deal will be run to be profitable w/ reserves set aside to meet corporate obligations as they become due and payable. Purposeful insolvency resulting form a shareholders undisclosed siphoning of whatever corporate assets becomes available can justify piercing. 7. The defendant actively participated in the business a. Shareholders who are not active in the business and have not acted to disadvantage creditors are less likely to be personally liable than those whose actions resulted in a depletion of assets. See MBCA 6.22 (shareholder may become personally liable by reason of his own acts or conduct); De. GCL 102(b)(6)(same) 8. Insiders deceived creditors a. The most critical factor in piercing cases b. When corporate participants falsely create the appearance of sufficient business assets or otherwise mislead creditors, courts understandably refuse to enforce the usual nonrecourse understanding. iii. Distinguishing Direct Personal liability 1. Many cases that hold shareholders liable are not piercing cases at all a. If a shareholder has personally obligated herself for debts of the corporation, liability arises not from disregarding the corporate entity but from the shareholders personal guarantee b. Likewise, if a shareholder or corporate manager commits a tort in the course of corporate business, she is liable under traditional tort and agency ruels iv. Sea-Land Services, Inc. v. Pepper Source 1. Facts: Marchese was the sole shareholder of Pepper Source. Marchese was also the sole shareholder of several other corporations, and he was a co-owner of an additional corporation. Plaintiff asserted that the corporations were shells wherein Marchese shifted money around the different entities to avoid creditors collecting from the corporations.

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Evidence was presented that showed Marchese treated the corporate accounts as his own personal account, and he frequently shifted money around. 2. Issue: Whether Plaintiff can hold Marchese and each of his corporations liable for the uncollected debt? 3. Held: Plaintiff may be able to hold Marchese and his corporations jointly liable for the uncollected debt, but Plaintiff has yet to offer evidence to completely demonstrate that the corporate veil should be pierced. The court applied the two-part Van Dorn test (from Van Dorn v. Future Chemical and Oil Corp., 753 F.2d 565 (7th Cir. 1985)) which required a plaintiff to not only prove that there is a unity of interest between the individual and the corporation, but the plaintiff must also establish that the allowance of a limited liability would sanction a fraud or promote an injustice. In this case Plaintiff did not adequately offer evidence on the second point to be awarded a motion for summary judgment. 4. Van Doren test: The veil of limited corporate liability will be pierced when the plaintiff proves that 1) there is a unity of interest between the individual and the corporation, and 2) to allow the limited liability would promote an injustice or sanction a fraud.

Fiduciary Duty, Shareholder Litigation, and The Business Judgment Rule

I. Introduction to the Role of Fiduciary Duty and the Business judgment rule a. Overview 2 focuses i. The fiduciary duty of loyalty operates to constrain directors and officers in their pursuit of self-interest 1. It is an actionable wrong for an officer or director to compete with her corporation or divert to personal use assets or opportunities belonging to her corporation 2. This applies in a similar fashion to officer and directors of both closely held and publicly traded corporations ii. The second focus of corporate law fiduciary duty is directors official conduct in directing and managing the business and affairs of the corporation 1. Both statutory and judge-made law assigns to the directors the power, authority, and responsibility to manage the business and affairs of the corporation. 2. In this context, fiduciary duty broadens to include not only a duty of loyalty, but also a duty of care 3. Here much of the case law involves publicly traded firms iii. An essential element of the directors authority and power is the business judgment ruleA judicial presumption that the directors have acted in accordance with their fiduciary duties of care, loyalty, and good faith. 1. The protection provided by the business judgment rule lies in the much greater pleading and evidentiary burden that it places on plaintiffs seeking to hold directors liable for allegedly breaching their fiduciary duties while engaged in official conduct on behalf of the corporation 2. A party challenging a board of directors decision bears the burden of rebutting the presumption that the decision was a proper exercise of the business judgment of the board. a. This greater pleading and evidentiary burden deters frivolous lawsuits

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i. Ex. merely alleging that a decision has turned out badly, even very badly, does not state a cause of action NOTE To be protected by the Business Judgment rule, it must involve a business decision. Therefore it wont be applicable in the monitoring cases iv. In some circumstances, a directors fiduciary duty is owed directly to the shareholders. 1. Ex. directors owe shareholders a duty of disclosure when recommending that shareholders approve a merger favored by the directors. 2. A shareholder may enforce directly owed fiduciary duties via an individual action against the directors, of , if a class certification is appropriate, as a class action on behalf of all similarly situated shareholders. 3. Any recovery in these direct actions goes to the plaintiffs shareholders and not the corporation. 4. Often, a director (or officer) owes fiduciary duties to the corporation, and to the shareholders collectively. 5. A corporation may enforce fiduciary duties owed to it in two ways: a. An action brought by the corporation at the behest and under the direction of its directors; or b. A derivative action brought on behalf of the corporation by one or more of its shareholders i. Derivative actionAction against the directors by the corporation. However, the shareholders bring it. The recovery goes to the corporation. All the SH gets is good governance and possibly a better valuation of the stock 6. Normally it is the directors responsibly to instate litigation against an officer/director who violated a fiduciary duty 7. The derivative suit is an exception. CTs will allow shareholders to maintain a derivative suit only when convinced that the managers are unable to impartially and in good faith control a particular lawsuit. (ex. when it is obviously that a majority of the directors face a danger of being found liable to for breach of fiduciary duty). b. Discretion to determine general business policies i. Shelnsky v. Wrigley 1. Facts: Derivative suit against directors for mismanagement and negligence. Plaintiff is minority shareholder of defendant. Defendant owns the cubs. Plaintiff sought damages and an order that defendants cause the installation of lights in Wrigley field and the scheduling of night baseball games. Plaintiff alleged all of the MLB teams have night games which leads to higher attendance and better revenue. The cubs did not have night games and plaintiff pointed to the lack of night games for the low revenue. Defendant argued that this is a daytime sport and its bad for the neighborhood to have night games. This would lead to a lower property value 2. Analysis: Generally, the directors have great discretion in managing. However, surrounding that discretion are certain standards of conduct. Here, Wrigley (D) feels that it is reasonable to consider the long run impact of night games on the neighborhood and its subsequent impact on the corporation. Whether this is the best decision is a question for the board of directors, not the courts

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a. Shareholders have no power to make ordinary business decisions, w/ out this protection, directors would be perpetually 2nd guessed. 3. Rule: To overcome the presumption of business judgment, a stockholder derivative suit must rely on fraud, illegality, or conflict of interest c. Discretion to Consider Interests of Non-shareholder Constituencies i. Judges have traditionally granted business judgment rule protections only when directors act in the best interests of the corporation ii. The CTs of Delaware rested the conventional view. Directors may consider the interests of other constituencies if 1. There is some rationally related benefit accruing to the stockholders Revlon, Inc. ; or 2. If doing so bears some reasonable relation to general shareholder interests Mills Acquisition Co. 3. More than 30 states have added other constituency statutes. Most of these statutes provide that in determining the best interest of the corporation, directors may consider the interests of supplies, employees, customers, and affected communities. These statues do not necessarily require a change in the traditional interpretation of fiduciary duty. iii. Dodge v. Ford Motor Co 1. This case is a classic example of shareholder litigation seeking to change or obtain redress for corporate policies that are intended to bestow significant benefit on nonshareholder constituencies, arguably at great cost to shareholders. 2. Facts: Dodge (P) objected to Ford Motor Cos (D) election not to declare a special dividend despite large profits and a considerable amount of cash on hand 3. Issue: May a court of equity require the directors of a corporation to declare and pay a dividend? 4. Analysis/Held: Yes a. Ford (D) was enjoying immense profits and had a large cash surplus. b. Dicta: A business corporation is organized and carried on primarily for the profit of the stockholders. The powers for the directors are to employed for that end. c. It is proper for a corporation to behave charitably toward the public if it can do so without compromising the interest of its shareholders. d. Note this is a Michigan case, not Delaware. 5. Rule: A corporation may be compelled to declare a dividend if its directors failure to do so constitutes fraud, lack of good faith, or an abuse of discretion. iv. Some states have recently enacted other constituency statutes that permit, but do not require, directors to consider nonshareholder constituents (or stakeholders), particularly in the context of a corporate takeover. v. The ABA considered and soundly rejected any amendment of MBCA 8.30 to include other constituencies d. Corporate Social Responsibility (CSR) i. Although not required by law, many companies have voluntarily taken responsibility for their impact on customers, workers, communities, and other stakeholders, as well as the environment (ex. green initiatives or fair labor commitments) ii. Proponents see CSR as applied business ethics and a means more suited than regulatory compliance for companies and their decision makers to internalize externalities.

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iii. Critics claim that CSR is superficial window-dressing that companies use to divert attention from the harms they cause and to forestall government regulation. iv. Milton Freeman The Social Responsibility of Business is to Increase its Profits 1. A corporation is an artificial person and in this sense may have artificial responsibilities, but business as a whole cannot be said to have responsibilities, even in this vague sense. 2. In a free-enterprise system, a corporate executive is an ee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. II. The Fiduciary Duty of Care Duty of CareRequires directors to exercise the same care that ordinarily and prudent men would use in normal circumstances 1. Delaware nowhere sets out statutorily what a duty of care is or the business judgment rule is a. Policy Arguments for Limiting the Reach of the Duty of Care ii. MBCA 8.30(B) 1. In some states, including Delaware, the fiduciary duty of care is defined solely by judicial doctrine. 2. The most widely adopted definition is modeled after the pre-1998 version of MBCA 8.30(a)(2), and requires a director to carry out her duties with the care an ordinarily prudent person in a like position would exercise under similar circumstances 3. Liability for breach of the duty of care has always been rare, and has occurred in circumstances where the directors conduct was egregious. 4. CTs universally recognize that directors are presumptively not liable for breach of duty of care by applying the business judgment rule iii. Joy v. North (No Facts) (CT of Appeals) 1. Rule: A corporate officer who makes a mistake in judgment as to economic conditions, consumer tastes, or production line efficiency will rarely, if ever, be found liable for damages suffered by the corporation. a. First, SH voluntarily undertake the risk of bad business judgment b. Second, CTs recognize that after-the-fact litigation is an imperfect device to evaluate corporate business decisions c. Third, b/c potential profit often corresponds to potential risk, it is very much in the interest of shareholders that the law, not create incentives for overly cautious corporate decisions d. BJR does not apply in cases in which the corporate decision lacks a business purpose, is tainted by a conflict of interest, is so egregious as to amount to a nowin decision, or results from an obvious and prolonged failure to exercise oversight or supervision. 2. When does BJR not apply? a. Corporate decision lacks business purpose b. Conflict of interest c. So egregious to amount in no-win decision 3. NOTE:

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a. Ownership is divorced from control i. Tension between accountability and discretionIf the court is going to hold director accountable for everythingthen directors will be more risk adverse i. But we want risk in American business. Should not create incentives for overly cautious decisions 4. Delaware Chancellor Allen policy argument for limiting fiduciary duty of care a. The redress for failures that arise from faithful management must come from the markets, through the action of shareholders and the free flow of capital, and not from this Court. Should the Court apportion liability based on the ultimate outcome of decisions taken in good faith by faithful directors or officers, those decision makers would necessarily take decisions that minimize risk, not maximize value. b. Duty of Care in the Decisional Setting iv. Kamin v. American Express Company 1. The directors of American Express faced the choice of liquidating a bad stock investment at the corporate level (taking a corporate tax deduction for the loss) or distributing the stock to the shareholders as a special dividend (a taxable event for the shareholders). Although the choice seemed obvious, the board opted for the stock dividend and shareholder sued. The directors explained they were concerned liquidation at the company level would have adversely impacted the companys accounting net income figures. The court found the concern sufficient. That is, the court accepted that appearances could be more important than actual cash effects. v. Smith v. Van Gorkom 1. Facts: P and other shareholders of Trans Union Corp. (D) brought a class action suit to rescind a cash-out merger that had been approved by Van Gorkom (D) and other members of the board of directors and ultimately approved by an overwhelming majority of the stockholders. The CT held that the business judgment rule applied to raise the presumption that the action taken by the board was an informed one made in good faith in the honest belief it was in the corporations best interests. Renewed allegations that the board of directors acted w/ out sufficient information and that the stockholders were also not sufficiently informed prior to their vote of approval formed the basis for the appeal. 2. Issue: Must a decision made by the board of directors be an informed one in order for it to be protected by the business judgment rule? 3. Holding: Yes. The concept of gross negligence is the proper standard for making that determination. Here, it is evident the board did not make a deliberate determination whether to approve the merger. A director cannot abdicate his duty by leaving the decision to the shareholders alone, and even they were not adequately informed. 4. Rule: A decision made by a board of directors must be an informed one to be protected by the business judgment rule a. In other words, The failure of the members of the board to adequately inform themselves represented a breach of the duty of care, which of itself was sufficient to rebut the presumption of the business judgment rule vi. NOTE: 1. In Van Gorkom BJR presumption was rebutted because the duty of care was breached because the decision by directors was not informed

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2. A directors duty to exercise an informed business judgment is in the nature of a duty of care, as distinguished from a duty of loyalty 3. There is a duty of care difference b/t BJR and standard of liability a. The standard for breach of care is gross negligence b. Therefore in Van Gorkom, they were grossly negligent in informing themselves in making the decisionwhich rebuts the BJR 4. In Van Gorkom, the Duty of Candor was also breachedThis can be apart of the duty of care or party of the duty of loyalty 5. Del 141(E) Directors are fully protected in relying in good faith on reports made by directors a. In Van Gorkom, The CT held that it wasnt really a report he relied on b. Del legislature amended to say shall in the performance of such members duties be fully protected in relying in good faith upon the records of the corporation upon such information, opinions, reports, or statements presented to the corporation by the officers/ees 6. 141(i)specifically addresses teleconferences for board meetingsThey all need to hear each other Various Business Terms LBO/MBO Leverage buyout buyer uses the corporation itself as collateral to buy it. a. Uses the cash flow to service the debt. Critics say this strips or bleeds the company Lock Up An undesired third party is deterred from acquiring a major portion of the target company due to the very high value of the lockup option. Cash out merger- a merger in which the acquiring company buys the stock of the target company for cash, in effect cashing out the stock of the company being absorbed. This is a variation of a traditional merger in which shareholders of the target company trade in their stock for stock in the acquiring company. By paying cash, the acquiring company reduces its capital by the amount of the cash-out, but gains the assets of the target company. In a cashout merger, shareholders of the target company have no interest in the company that results from the merger. Mergers in p.265 of supplement a. Only directors can propose a merger b. Shareholders cant propose want but most vote to approve You must pay a premium when you buy a lot of shares because you are also gaining voting power CEOthe key central decision maker. Higher than the president. Ultimately responsible to the board and the performance of the company COODaily operations of the business CFO-broad management authority over the financial operations. Reporting requirements. Works with the outside auditors. Responsible for knowing what the clash flow is Controllerresponsible for internal controls of the company. Usually works under CFO vii. DGCL 141 (E) A member of the board of directors, or a member of any committee designated by the board of directors, shall . . . be fully protected in relying in good faith upon the records of the corporation . . .and . . . information, opinions, reports or statements presented to the corporation by any . . . officers or employees . . .or by any other person as to matters the member reasonably believes are within such other persons professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation. 20

a. To survive a Rule 23.1 motion to dismiss in a due care case where an expert has advised the board in its decision making process, the complaint must show: i. The director did not in fact rely on the expert, ii. The reliance was not in good faith, iii. They did not reasonably believe the experts advice was within their professional competence, iv. The expert was not selected with reasonable care, v. The subject matter that was material and reasonably available (the cost calculation) was so obvious that the boards failure to consider it was grossly negligent regardless of the experts advice, or vi. The decision was so unconscionable as to constitute waste or fraud. viii. (p. 384) As for plaintiffs contention that the directors failed to exercise substantive due care we should note that such a concept is foreign to the BJR. CTs do not measure, weigh or quantify directors judgments. We do not even decide if they are reasonable in this context. Due care in the decision making context is process due care only. Irrationality is the outer limit of the business judgment rule. Irrationality may be the functional equivalent of the waste test or it may tend to show that the decision is not made in good faith, which is key ingredient of the business judgment rule. ix. Entire Fairness: Under Delaware law, if the plaintiff carries his burden of proving that the directors acted w/ out requisite care in approving a merger or other major decision, the defendants then have the burden of proving that the transaction or decision was intrinsically or entirely fair to the corporation Cede & Co. v. Technicolor (Del) 1. A breach of either the duty of loyalty or the duty of care rebuts the presumption that directors have acted in the best interests of the shareholders, and requires the directors to prove that the transaction as entirely fair. 2. What must directors prove to establish the entire fairness of a transaction or decision if business judgment rule presumptions are lost? a. The concept of fairness has 2 basic aspects (Weinberger): i. Fair Dealingembraces questions of when the transaction as timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained 1. Fair dealing involves things like candor, COI 2. If you have a breach of duty of candor you cant have entire fairness ii. Fair pricerelates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and many other elements that affect the intrinsic or inherent value of a companys stock 3. However, the test of fairness is not a bifurcated one as b/t fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness. However, in a nonfraudulent transaction we recognize that price may be the preponderant consideration outweighing other features of the merger. Tri-Continental Corp. (Del) c. Statutory Exculpation Provisions (Delaware G.C.L. 102(b)(7) )

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x. Approximately 40 states have now enacted legislation allowing corporations to limit or eliminate directors liability for breach of fiduciary duty xi. DGCL 102(b)(7) A provision eliminating or limiting the personal liability for a director to the corporation or its stockholders for monetary damages for breach of fiduciary as a director; 1. Under 102(b)(7) Cannot limit liability: a. For any breach for duty of loyalty to the corporation b. For acts or omissions not in good faith or intentional violation of law c. Note this only exculpates for monetary damages They can still bring injunction actions d. For paying an unlawful dividend under 174; or e. For any transaction that the director derived an improper personal benefit 2. No such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective xii. When a corporation agrees to exculpate its directors, it is understood that the shareholders are contracting away any right shareholders might otherwise have to hold the directors liable for damages caused solely by the directors breach of the duty of care xiii. One can still bring an action for injunction; and duty of loyalty and bad faith cases are unaffected as shown above xiv. Malpiede v. Townson 1. SH of Fredricks of Hollywood (Fredericks) (P) contended that an exculpatory provision in Fredericks charter that precluded money damages for directors breaches of the duty of care did not bar their claim that the board was grossly negligent in failing to implement a routine defense strategy that could enable the board to negotiate for a higher bidder in a merger situation, or otherwise create a tactical advantage to enhance stockholder value. 2. Holding: P argues that the exculpatory provision should not bar their claim b/c the claim is very closely intertwined with, and therefore indistinguishable from, their duty of loyalty and bad faith claims. However, the SHs (P) do concede that if a complaint unambiguously and solely asserts only a due care claim, the complaint is dismissible once the corporations exculpatory provision is invoked. Ps complaint fails properly to invoke loyalty and bad faith claims, so the only claim left is a due care claim. 3. Holding: the Delaware Supreme Court held that where a corporation has such an exculpatory provision and the plaintiffs file a complaint that contains only a duty of care claim, the court will dismiss the complaint because the plaintiffs cannot recover monetary damages from the defendants. Or, stated another way, to survive a motion to dismiss, a complaint must allege a breach of the duty of loyalty or the duty of good faith. NOTE: 1. The key in this case is when does exculpatory provision kick in? 2. Always make sure your client has an exculpation clause 3. Exculpation clause must be plead as an affirmative defense 4. Burden for BJR is on the plaintiff. Then it goes to entire fairness (Weinberger). Its then the defendants (directors) burden to establish entire fairness. If they carry this burden, the ball game is over. If they do not carry this burdenLiability can be based upon breach of duty of loyalty or breach of the duty of care (the tort duty of carethe substantive duty of care) (Delaware CTS hardly ever get this far). a. This is when you plead 102(b)(7) for the duty of care portion

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i. Even with exculpatory clauseyou are fucked for duty of loyalty. b. The reason why it doesnt kick in earlier is because 102(b)(7) doesnt relieve the other party of the burden of proving entire fairness or that its only based on a duty of care? 5. The complaint must allege well-pleaded facts to support the breach of the duty of loyalty or bad faith. If all that survives the heightened pleading standard is a duty of care violation, the complaint will be dismissed. d. PROBLEM 47 (P.349) xv. Facts: five board members and one of them owns 30% of stock. This member wants to change the way the film studio is run (back to a 1930s style where they retain stars). They have to pay a lot of money to actors in order to get them to sign on. He tells other member they have to sign on by 6pm today. Everyone approvesthey dont look at contracts b/c they arent supplied to them. Then everyone dies on a plane crash. They didnt have insurance on the stars. 1. Analysis: a. 141(e) would probably not protect them here b. Three things were done here: Changed business modelSold film libraryEntered into the contracts w/ stars c. What did they not do? i. These are factors of whether they were grossly negligence (process violation) to rebut BJR 1. The board never questioned sums being paid 2. Board did not receive contracts 3. The board only met for an hour (Burson thinks they made a mistake in book by saying 13 hours) 4. No intrinsic evaluation of the library 5. Didnt protect their assets (failure to insure) a. This is the substantive kind of negligence that isnt covered b. This is not failure to inform. This would not be basis to rebut BJR 2. What if company goes bankrupt and they were fully informed but didnt protect their assets? This would not rebut the BJR. The substantive decision can be stupid and harm the company, go bankrupt etc. But if they engaged in the right process in getting thereThey are protected in BJR III. The Fiduciary Duty of Loyalty The core of this fiduciary duty is the requirement that a director favor the corporations interests over her own whenever those interests conflict As with the duty of care, there is a duty of candor aspect to the duty of loyaltyThere are situations where failure to be completely candid breach of the fiduciary duty of loyalty a. The Corporate Opportunity Doctrine i. (Wikipedia)The corporate opportunity doctrine is the legal principle providing that directors, officers, and controlling shareholders of a corporation must not take for themselves any business opportunity that could benefit the corporation. The corporate opportunity doctrine is one application of the fiduciary duty of loyalty ii. Northeast Harbor Golf Club, Inc. v. Harris (Maine)

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1. CT found corporate opportunity when country club president acquired for herself property adjacent to clubs golf course, which real estate agent had offered to her in capacity, as president on assumption club would be interested. a. Rule: Corporate officers and directors must disclose all relevant information prior to taking personal advantage of any potentially corporate opportunity. iii. Punctilio of honor (Justice Cardozo) Meinhard v. Salmon: 1. A trustee (i.e. fiduciary) is held to something stricter than the morals of the marketplace. Not honesty alone but the punctilio of an honor the most sensitive is then the standard of behavior... 2. The level of care and attention that a fiduciary must abide by in his conduct to an individual or firm he has fiduciary relationship. The courts have articulated two basic precepts of fiduciary conduct which define the contours of what Justice Cardozo referred to as the punctilio of honor standard: The duty of undivided loyalty by a fiduciary to those under his care; and the duty of a fiduciary to exercise the utmost of good faith towards his dependents. iv. The Delaware Approach 1. DGCL 122(17) Every corporation created under this chapter shall have power to: Renounce, in its certificate of incorporation or by action of its board of directors, any interest or expectancy of the corporation in . . . business opportunities that are presented to the corporation or 1 or more of its officers, directors or stockholders 2. Broz v. Cellular Information Systems (Delaware) a. Holding and Decision: Here, the totality of the circumstances indicates that Broz (D) did not usurp an opportunity that properly belonged to CIS (P). Broz (D) was entitled to utilize a corporate opportunity for the benefit of RFBC, his wholly owned corporation, instead of for CIS (P), for which he served as an outside directors because: (1) the opportunity became known to him in his individual and to corporate capacity, (2) the opportunity was related more closely to the business conducted by RFBC than to that engaged in by CIS (P), (3) CIS (P) did not have the financial capacity to exploit the opportunity, and (4) CIS (P) was aware of Brozs potentially conflicting duties towards RFBC and did not object to his actions on RFBCs behalf b. Rule: The corporate opportunity doctrine is implicated only in cases where the fiduciarys seizure of an opportunity results in a conflict between the fiduciarys duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity. 3. Steps to look at for corporate opportunity: a. DE Rule: i. A corporate officer or director may not take a business opportunity for his own if: 1. The corporation is financially able to exploit the opportunity; 2. The opportunity is within the corporations line of business; 3. The corporation has an interest or expectancy in the opportunity; and a. Difference between interest and expectancy i. If corporation had contractual right in land they have an interest in it

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ii. Expectancy suggests that it comes to the corporation in the ordinary course of business may not ever mature lease renewal 4. By taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position conflicting to his duties to the corporation. ii. A director may take an opportunity if: 1. The opportunity is presented to the director in his individual capacity; a. An outside opportunity lowers the burden 2. The opportunity is not essential to the corporation; 3. The corporation holds no interest or expectancy; and 4. The director has not wrongfully employed the resources of the corporation in pursuing the opportunity. iii. A directors right to appropriate an opportunity depends on the circumstances existing at the time it presented itself to him without regard to subsequent events. iv. Safe harbor: formally presenting an opportunity to a board avoids the possibility that an error in the fiduciarys assessment of the situation will create future liability for breach of fiduciary duty. 1. However, presentation to the board is NOT necessary in DE v. If the corporation has an existing expectancy in a business opportunity, the manager must seek corporate consent before taking the opportunity. 4. Guth v. Loft (Delaware) FACTS: Mr Guth was the President of Loft Inc, which made a cola drink. Loft's soda fountains purchased cola syrup from Coca Cola Ltd, but then Mr Guth decided it would be cheaper to buy from Pepsi after Coke declined to give him a larger jobber discount. As he went to enquire, Pepsi went bankrupt. Mr Guth bought the company and its syrup recipe, (which he then had Loft chemists reformulate) and then purported to sell the syrup on to Loft Inc. He was alleged to have breach his fiduciary duty of loyalty to the company by failing to offer that opportunity to Loft Inc, and instead appropriating it for himself. a. If there is presented to a corporate officer or director a business opportunity which the corporation if financially able to undertake, which is, from its nature, in the line of the corporations business and is of practical advantage to it, is one in which the corporation has an interest or a reasonable expectancy, and, by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of his corporation, the law will not permit him to seize the opportunity for himself." NOTE: i. Classic corporate opportunity case ii. A breach of the duty of loyalty will overcome the presumption of the BJR. In looking at the BJR, it is not a standard of liability. It is more of a pleading standard. But you still ultimately have to prove damages and liability. 1. The breach of the duty of loyalty can be a standard of liability? iii. What should he have done? Brought info to the board of Loft?

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b. Also if presented to director or officer in private capacity, not essential to the corporation, corporation holds no interest or expectancy c. If an element is missing, its not a corporate opportunity. b. Conflicting Interest Transactions i. Interested transaction is part of the duty of loyalty ii. Common Law: Transactions between a corporation and one or more of its directors were void or voidable simply because a conflict of interest existed iii. Modern view: By 20th century, most common law courts no longer viewed conflict of interest transactions as automatically void or voidable. Instead, COI transactions were voidable only if the transaction or the conduct of conflicted directors was unfair to the corporation. 1. Thus, a conflicting interest transaction would be voided if the substantive terms of the transaction were found unfair, or, even if such terms were found fair, if the benefiting directors had in any way breached their obligation to disclose fully all relevant facts to the corporation, including, the fact of their interest in the subject matter. iv. Globe Woolen Co. v. Utica Gas & Electric Co. 1. Facts: Maynard is Globes (p) chief stockholder, president, and a director. He was also a director of Utica (D) and chairman of its executive committee. Maynard wanted Utica (D) to supply Globe (P) with electricity, but only if Utica (D) could guarantee that if Globe (P) switched from steam to electricity Globe (P) would save money in operating costs. When the proposed contract was laid before Uticas (D) executive committee, Maynard did not speak about whether the contract was a profitable one for Utica (D) Maynard presided at the meeting, put forward the resolution to ratify the contract, but was excused from voting. Changes in how the mills would be operated were not taken into consideration when the contract was formed, and such changes led to losses for Utica (D). 2. Issue: Are the contracts voidable b/c although Maynard, a director of Globe (P) and chairman of Utica (D), did not vote to ratify the contracts he still crafted them to his benefit and Uticas (D) detriment and thus had a duty to warn Uticas (D) executive committee about he possible pitfalls for the contracts, prior to ratification, bud did not do so? 3. Holding/Decision: Yes. Maynard could not divest himself of his duties as a trustee for Utica (D) simply by refusing to vote and shifting the responsibilities to his associates and then reap a profit from the error. A trustee can be quiet if everything is fair; however, he cannot be quiet and must warn, if he knows of some oppression. A trustee can assert a dominating influence in other ways than voting. a. Maynard exerted persuasive influence over the transaction. Greenidge (other director) was subordinate to him and was trying to please him. Maynard wrote the contract, and all that remained when it came before the executive committee was ratification, a mere formality. The members of the committee knew that the contract, which they were looking at for the first time, had been drafted by Maynard, the chairman, and they relied on his faith and loyalty to assume that the contract was just and equitable. 4. Rule: The refusal of a chairman to vote at a meeting of the board of directors, held to ratify a contract, does not nullify any influence the chairman might have exerted without voting. Such a trustee has a duty not to take advantage of those in his trust but rather to warn those who trust him

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Note: The whole issue here was disclosure to the board. xvi. The Intersection of the Common Law and Conflicting Interest Statutes 1. Delaware G.C.L. 144 provides that no conflicting interest transaction shall be void or voidable solely by reason of the conflict if the transaction is: i. (1) Authorized by a majority of the disinterested directors; or ii. (2) Approved in good faith by the shareholders; or iii. (3) Fair to the corporation at the time authorized. b. In addition, 144 codifies the common law requirement for complete candor and fair dealing by making director or shareholder approval effective only if the interested directors has disclosed all material facts 2. Delaware 144 and similar statutes leave significant gapse.g. burden of proof, interests that constitute a conflict, standard of judicial review, and what constitutes disinterestednessthat must be filled by the courts xvii. 144 Interested directors: Quorum 1. (a) No transaction b/t a corporation and one of its directors/ officers, or another corporation in which a director/officer has an interest or is a director . . . shall be void or voidable just b/c the director/officer is present or participates in a board meeting which authorizes the transaction, or solely because any such director/officers votes are counted for such purpose if: a. (1) The material facts as to the director/officers relationship/interest to the transaction are disclosed or known to the BOD, and the board in good faith authorizes the transaction by a majority vote disinterested directors, even though the disinterest directors be less than quorum; or i. What is a quorum? 141(b)--? A majority of the total number of directors shall constitute a quorum . . . unless . . . the bylaws require a greater number. Unless the certificate of incorporation provides otherwise, the bylaws may provide that a number less than a majority shall constitute a quorum that in no case shall be less than 1/3 of the total number of directors except that when a board of 1 director ii. Good multiple choice question: Need majority b. (2) The material facts as to the director/officers relationship/ interest and to the transaction are disclosed or known to the shareholders entitled to vote thereon, and the transaction is specifically approved in good faith by vote of the shareholders; or c. The contract or transaction is fair to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee or the shareholders. 2. (b) Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors or of a committee which authorizes the contract or transaction. 3. NOTE: a. This is not the BJRbut works with it b. BJR applies if you go through these steps? c. If you satisfy (a)(1) or (2) The case d. Its directors burden to establish entire fairness at the time it was approved i. If they do prove thisGame over

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e. What if the deal needs to get done and a majority cant show up? Shareholders can vote in good FAITH f. Notice the word disinterested is not used in 144(a)(2), but it is in 144 (a)(1) i. Can use 141(i) with a telephone callIf you cant contact a board of director g. If you dont establish 1 or 2you go to fairness and dont est. BJR??? 4. Shapiro v. Greenfield (MD) a. Facts: Shapiro was the operating officer for College park. In 1961, College Park acquired 68 acres on which it constructed the 72,00 square foot Clinton Plaza shopping center. By 1991, Clinton Plaza was only 50% leased and generating insufficient cash flow. Shapiro subsequently developed a joint venture with Jaffe. The joint venture required the creation of three entices 1) Clinton Crossings Limited Partnership which was to own the redeveloped Clinton Plaza Shopping center; 2) Clinton Crossings, Inc., which was to be a one percent owner and the general partner of Clinton Crossings Partnership; and 3) TSC Clinton Associates Limited Partnership which was to own forty-nine percent of Clinton Crossings Partnership. b. Rule (1): When a directors involvement in a project demonstrates a conflict of interest but he does not capitalize on an opportunity that should have been presented to the corporation, there is no usurpation. c. Rule (2): When a director does not personally benefit from a transaction, the appropriate inquiry into determining whether a director is to be considered an interested director is to focus on the directors ability to exercise independent judgment and the expected influence of a particular relationship on the director. Note: This case is Maryland but they are kind of adopting Delaware law Here, Shapiro was on both sides of the transaction Why is this not a corporate opportunity? 1. The principles used to determine whether a director is interested or disinterested turn upon the involvement of the director in the contract or transaction to which the corporation is a party. A corporate opportunity typically presents the reverse factual situation: the non-involvement of the corporation in a contract or transaction in which it may have an interest. Simply stated, an interest director transaction statue applies where a director seeks to transact business with the corporation. Conversely, a transaction should be analyzed under the corporate opportunity doctrine where a director seeks to take an opportunity from the corporation. (CB p.316) 5. The enactment of Delaware G.C.L 144 limited the stockholders power in two ways. a. First, 144 allows a committee of disinterested directors to approve a transaction and bring it within the scope of the BJR. b. Second, where an independent committee is not available, the stockholders (Per Burson-must be disinterested) may either ratify the transaction or challenge its fairness in a judicial forum, but they lack the power automatically to nullify it. When a challenge to fairness is raised, the directors carry the burden of establishing . . . [the transactions] entire fairness, sufficient to pass the test of careful scrutiny by the courts.

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If the transaction is found to be unfair to the corporation, the SH may then demand recession of the transaction or, if that is impractical, the payment of rescissory damages. If however, the directors meet their burden of proving entire fairness, the transaction is protected from SH challenge. Weinberger. 6. Where evidence shows that a majority of the independent directors were aware of the conflict and all material facts, in satisfaction of factors 1 and 2 (as well as the duties of loyalty and care), but acted to reward a colleague rather than for the benefit of the shareholders, the Court will find that the directors failed to act in good faith and, that the transaction is voidable. In re Walt Disney Company Derivative Litigation 7. While there is little case authority, commentators assume that the requirement of a good faith shareholder vote in Delaware G.C.L. 144(a)(2) and similar provisions in other jurisdictions would be interpreted to preclude voting by a conflicted shareholder e. The Fiduciary Duty of Care xviii. In re Caremark International, Inc. Derivative Litigation 1. Facts: Defendant corporation, Caremark International, Inc., provides health care services and products to patients who are often referred to them by a physician. Since the business is reliant on referrals, there is a temptation by companies such as Caremark to compensate physicians. A federal law, the Anti-Referral Payments Law (ARPL) is in place to prevent such a system, and in 1991 the Department of Health and Human Services began investigating potential ARPL violations. The Department of Justice joined the investigation soon thereafter, and by 1992 Caremark instituted several new policies and procedures in attempt to find any internal wrongdoings. But in 1994, Caremark was indicted for violating the ARPL. Plaintiffs initiated this suit that year, alleging that the Board of Directors did not exercise the appropriate attention to this problem. 2. Rule: A board of directors has an affirmative duty to attempt in good faith to assure that a corporate information and reporting system exists and is adequate 3. Holding and Decision: Directors generally do not monitor day-to-day operations in a company. The duty of care implies that a board will make a good faith effort to ensure that the corporate information and reporting system is adequate. The board (D) appears to have been making structural changes all along to gain greater centralized control of the company and an ethics monitoring group was in place well before the settlement was reached. a. A duty to monitor does not require a board to be aware of all the details of corporate activity. In fact, such oversight would be physically impossible in a large company. The duty does, however, require the board to be aware of major activities and related issues that could pose a threat to the company. The choice of what structure to sue in information gathering is still subject to the safe harbor of the BJR; therefore, a claim that the duty to monitor has been breached is tremendously difficult to prove successfully. Note: ***Get standard from this case*** Will be on exam *** o The importance of this case has to do with the failure to monitor o Negligence not practical when looking at due care??? P. 366 FNT 16 Proximate cause not being an element of the process due of care

c.

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Stone v. RitterStated to flesh out what is the duty of good faith? This is a very controversial decision. The Delaware SC basically said there are only 2 fiduciary duties: care and loyalty. Good faith or a lack of good faith is a subordinate part of the duty of loyalty. You see this most applied in the duty to monitor cases Look at p. 370: o In order to show that the Caremark director breached their duty of care by failing adequately to control Caremarks ees, Plaintiffs would have to show either (1) That the directors knew or (2) Should have known that violations of law were occurring and, in either even, (3) That the directors took no steps in a good faith effort to prevent or remedy that situation; and (4) That such failure proximately resulted in losses complained of although under Technicolor this last element may be thought to constitute an affirmative defense o This is the back in standard of liability What is the liability of directors when they fail to take action when they dont know of anything wrong going on? What accountability is there for directors in that case? o Directors should have no liability in an absence of suspicion theres no duty of directors to put in a duty of espionage o This case is not about a directors decision but the absence of a decision o If you fail to make a decision Theres not a decisionDont get to the business judgment rulethen go to the fairness then the standard of liability o Ultimately the three fiduciary duties become standards of liability o So BJR doesnt apply in failure to monitor case xix. Stone v. RitterDelaware SC approved the Caremark doctrine 1. In Walt Disney Co. Deriv. Litigation a. A failure to act in good faith requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e. gross negligence) b. Disney identified the following example of conduct that would establish a failure to act in good faith: i. A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. 2. The third of these examples describes, and is fully consistent with, the lack of good faith conduct that the Caremark court held was a necessary condition for director oversight liability i.e. a sustained or systematic failure of the board to exercise oversightsuch as an utter failure to attempt to assure a reasonable information and reporting system exists. 3. In Walt Disney Co. Deriv Litig. CT held that Caremark articulates the necessary conditions predicate for director oversight liability: (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations. f. The Role and Nature of Substantive Review

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i. Waste The judicial standard for determination of corporate waste is well developed. Roughly, a waste entails an exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade. Most often the claim is associated with a transfer for corporate assets that serves no corporate purpose; or for which no consideration at all is received. Such a transfer is in effect a gift. If, however, judgment that in the circumstances the transaction is worthwhile, there should be no finding of waste. BJR does not protect against a claim of waste. ii. Brehm v. Eisner 1. Essentially, the waste doctrine allows courts to find directors liable where direct proof of lack of care or loyalty is lacking, but the substantive decision seems explainable only as a product of the directors failure to carry out their fiduciary responsibilities. 2. Facts: Disney hired Ovitz as its president. Ovitzs employment Agreement contained a large compensation package if he were to leave on a non-fault basis. Problems soon arose after Ovitz began to work, and Breham (P) alleged that these problems were sufficient to let Ovitz go for cause. Eisner (D) and Ovitz, however, agreed to arrange for Ovitz to leave Disney on the non-fault basis provided in the Agreement, and the New Disney Board (D) approved his decision. Brehm (P) alleges that the Old Disney BOD (D) breached its fiduciary duty in approving the wasteful Agreement; and the new Disney board (d) breached its fiduciary duty by agreeing to a non-fault termination of the Agreement, and that the directors (D) were not disinterested and independent. Brehm (P) alleged that the Old Disney Board (D) failed to properly inform itself about the total costs and incentives of the Agreement, especially the severance package. The Board (D) had relied on a corporate compensation expert in connection with its decision to approve the Agreement. The expert, however, had not quantified for the Board (D) the maximum payout to Ovitz under the non-fault termination scenario. The expert later stated that he should have done so at that time. 3. Rule: A complaint which is mostly conclusory does not meet the rules required for a stockholder to pursue a derivative remedy 4. Holding and Decision: a. Substantive Duty of Care i. Where there is no reasonable doubt as to the disinterest of or absence of fraud by the Board, mere disagreement cannot serve as grounds for imposing liability based on waste. 1. Almost an impossible standard to overcome: most often a waste finding is associated with a transfer of corporate assets that serves no corporate purpose; or for which no consideration at all is received b. Rationale: There were no facts alleged by Plaintiffs that would put into question the Boards independence other than conclusory statements that the Board was beholden to Eisner. It was also acceptable for the Board to rely upon the compensation expert who, at the time, endorsed the agreement. Plaintiffs would have to prove that the Board did not in fact rely on the expert, their reliance was not in good faith, or that the expert was not competent. NOTES:

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1. Strike price Normally the strike price will be the date the auction is granted. With back dating of options was about, they back date the strike price 2. Waste is outside the business judgment rule 3. Relying on the compensation expert would be under 141(E) g. Directors Duty of Good Faith Explicated i. In re Walt Disney Company Derivative Litigation 1. Facts: the directors (D) of Walt Disney Company (Disney) entered into an employment agreement (OEA) with Ovitz that provided he would receive millions of dollars in severance, foregone bonuses, remaining salary payments and stock options if he were terminated without cause. Ovitz had a left a very lucrative position with CAA to joining Disney. The board (D) terminated Ovitz without cause not long after entering the ODA because the relationship was not working for the parties, and Disney shareholders (P) brought suit claiming that the directors (D) breached their fiduciary duties of loyalty, good faith, and due care by entering into the employment agreement and then by terminating Ovitz without cause. a. Specifically, the shareholders contended that Disneys compensation committee directors (D) violated the fiduciary duties of due care and good faith by approving the OEA, which contained Non-Fault Termination (NFT) provisions that could potentially result in an enormous payout, without informing themselves of what he full magnitude of that payout could be. 2. Rule: a. (1) Directors do not breach their duty of care where, although they do not follow best practices, they are sufficiently informed about all material facts regarding a decision they make i. The SH claimed that the Courts decision was erroneous b/c the evidence showed that the compensation committee members did not properly inform themselves of the material facts, so they were grossly negligent in approving the NFT provisions of the OEA. b. (2) Intentional dereliction of duty, a conscious disregard for ones responsibilities is an appropriate legal definition of bad faith. i. The chancery Court did not err is using this definition, because there are at least three different categories of fiduciary conduct that can give rise to a bad faith claim 1. The first is subjective bad faith, which is fiduciary conduct motivated by an actual intent to harm 2. The second category involves lack of due care, which does not involve malevolent intent, but taken by reason of gross negligence a. Gross negligence by itself cannot constitute bad faith 3. The third category falls between the first two, and this is the category intended to be captured by the Chancery Courts definition a. The question is whether such misconduct is properly treated as a nonexclupable, non-indeminifable violation of the fiduciary duty to act in good faith; the answer is yes

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b. That is b/c fiduciary misconduct is not limited to selfinterested disloyalty or to gross negligence, but may lie somewhere in between these extremes c. Gross negligence may be exculpated, but acts not in good faith may not c. This case demonstrates, among other things, how the duty of directors to act in good faith is an independent duty that is on the same footing as the duties of care and of loyalty, and how that duty interacts with other independent duties. Although the duty to act in good faith has always been part of corporate governance jurisprudence, it has been only relatively recently that the duty has been viewed as an independent duty, rather than as a duty subsumed with the other fiduciary duties. ii. Stone v. Ritter 1. Facts: AmSouth paid civil penalties to resolve government and regulatory investigations pertaining principally to the failure by bank employees to file suspicious activity reports, as required by the federal bank secrecy act and various government regulations. These violations were discovered after a ponzi scheme, which was unwittingly aided by AmSouth branch employees, was uncovered. Although the corporation had in place an extensive, information and reporting system, in its investigation, the govt concluded that AmSouths compliance program lacked adequate board and management oversight. AmSouth SHs (P) brought a derivative action against the corporations present and former directors (D) based on these events, w/ out first making demand on the board. 2. Rule: A derivative action will be dismissed for failure to make a demand where alleged particularized facts do not crate a reasonable doubt that the corporations directors acted in good faith in exercising their oversight responsibilities. 3. Holding and Decision: The allegations made by SH (P) are a classic Caremark claim. Such a claim of directorial liability is premised on the directors ignorance of liabilitycreating activities. In Caremark, the CT ruled that directors will face personal liability only where there has been a sustained or systematic failure of the board to exercise oversight (such as an utter failure to implement a monitoring system). Here, SH (P) asserted that b/c it was likely the directors would face such personal liability, they could not be reasonably expected to exercise independent and disinterested judgment when faced with a pre-suit demand. However, AmSouths Certificate of Incorporations exculpatory provision will shield the directors (D) from liability as long as they acted in good faithso if they acted in good faith, demand would not be excused. Thus, it must be determined whether the directors (D) act in in good faith. Here, while it is clear with hindsight, that the organizations internal controls were inadequate there were also no red flags to put the board on notice of any wrongdoing. The directors (D) took the steps they needed to ensure a reasonable information and reporting system existed. Therefore, although there ultimately may have been failures by employees to report deficiencies to the board, there is no basis for an oversight claim seeking to hold the directors personally liable for such failures by employees; a bad (and very costly) outcome does not per se equate to bad faith. 4. Analysis: The CT in this case makes a point of clarifying doctrinal issues related to the duty of good faith. First, the CT emphasizes that the failure to act in good faith is a condition to finding a breach of the fiduciary duty of loyalty and imposing fiduciary

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liability. The CT explains that a failure to act in good faith is not conduct that results, ipso facto, in the direct imposition of fiduciary liability. The failure to act in good faith may result in liability b/c the requirement to act in good faith is a subsidiary element, i.e. a condition, of the fundamental duty of loyalty. It follows that b/c a showing of bad faith conduct ... is essential to establish director oversight liability, the fiduciary duty violated b the conduct is the duty of loyalty. Second, and as a corollary, the duty to act in good faith does not establish and independent fiduciary duty that stands on the same footing as the duty of care and loyalty. A failure to act in good faith gives rise to liability only indirectly. Further, as a corollary, the fiduciary duty of loyalty is not limited to financial or similar conflicts of interest, but also encompasses cases where a directors has failed ot act in good faith. iii. Gantler v. Stephens (p. 397)Per Burson look at

Derivative Actions
IV. Special Aspects of Derivative and Direct Litigation a. Derivative Litigation and the Demand Requirement i. SH derivative suit, where SH could commence and manage fiduciary litigation on the corporations behalf. ii. In a classic form, a derivative suit involves two actions brought by an individual shareholder: 1. An action against the corporation for failing to bring a specified suit; and 2. An action on behalf o the corporation for harm to it identical to the one which the corporation failed to bring iii. Joy v. North 1. Given the policy reasons for the BJR, why would a SH be able to institute a derivative action on behalf to the corporation if, in fact, the directors are able and willing to make decisions concerning such legal action in the best interests of the corporation? 2. The compromise reached in most jurisdictions revolves around the demand requirement. a. If the board reaches a decision not to pursue the claim via litigation, the SH may challenge the directors decision as a breach of fiduciary duty, but has no right to directly pursue the original claim that was the subject of his demand, unless the directors action in refusing to institute litigation is found not to be protected by the BJR. b. Delaware excuses SHs from making pre-suit demand in circumstances where demand would be futile, for example, when the directors lack the independence to impartially consider a demand. In these jurisdictions, the demand futility exception becomes the initial battleground in derivative litigation. Defendants quickly move for dismissal on the grounds that the SH-plaintiff wrongfully failed to make demand. NOTES: Whether its a stockholder claim is direct or derivative o Who suffered harm? The corporation or shareholders? o Who received the benefit of any recovery or remedy? FRCP 23.1Delaware has identical rule o That the plaintiff was a SH or member at the time of the transaction of which the plaintiff complains or that the plaintiffs share or membership thereafter devlolved on the plaintiff by operation of law.

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In other words***You have to have been a shareholder at the time the action was complained of *** o Complaint has to be verified! Any derivative action has to be sworn to o Demand utility The complaint shall also allege with particularity the efforts if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for the plaintiffs failure to obtain the action or for not making the effort Strike suitLawyer will round up a bunch of SH and even if the claim is not substantialsue the corporation/derivative action and look for a settlement 1. Three common law branches a. Demand refused i. Board rejects the demand after due deliberation, preceded by investigation of the facts ii. Board can conclude that: 1. The law has not been violated, or 2. Pursuing the corporations rights would not be in the corporations best interest 3. Gets BJR protection iii. Board notifies shareholder iv. Shareholder files suit v. Board motions for SJ bc of the BJR 1. By submitting to the Board, the shareholder tacitly acknowledges the absence of facts to support a finding of futility 2. The only issues for the Court to consider are lack of diligence in investigation and lack of good faith (base motive dominates). b. Demand accepted i. Board notifies shareholders that intends to take action ii. Board decides to go ahead with lawsuit or settle 1. Settlement may pose a problem that it may just be a slap on the wrist iii. Once the board accepts demand, the shareholder no longer has any rights in the litigation c. Demand excused i. Shareholders attorney proceeds directly to court ii. DE and other jurisdictions excuse demand in several instances: 1. Closely held corporation 2. When corporation has not responded after extraordinary amount of time 3. When demand is made and corporation takes no position on the issue 4. When demand is excused as futile iii. MBCA (ALI principles) requires demand 1. Justified bc exceptions to pre-suit demand impose excessive additional litigation costs 2. Only remedy here is if directors refuse to commence litigation after demand is made iv. Aronson v. Lewis 35

1. Facts: Fink, a director of Meyers, owned 47% of Meyers stock. Fink entered into an employment contract with Meyers where he received many benefits including a large salary. Lewis (P), a SH, challenged the entire arrangement as grossly excessive and a waste of corporate assets. However, Lewis (P) did not make a demand on the BOD to correct the alleged wrong due to a belief that the directors, chosen by Fink, could not make an untamed decision. Lewis (P) filed a derivative action. 2. Holding and Decision: a. To protect the managerial discretion of the board, the law requires that a SH demand action from the board to correct a wrong to the corporation before filing suit. However, where demand would be futile, the SH need not seek redress before filing suit. Mere board approval of a challenged action does not prove that the demand requirement would be meaningless. To show demand futility, particular facts must raise a reasonable doubt that the directors are independent. If such a doubt cannot be raised, then definite facts must raise a reasonable doubt that the transaction was otherwise a valid exercise of a business judgment. i. Here, no facts show he wasnt independent. Fink owns less than a majority of stock, so he is not in total control of the corporation. Even majority stock control does not strip directors of the presumption of independence. 3. Rule: A SH must make a demand upon the BOD to redress a wrong prior to the filing of a derivative suit, unless he can allege facts, with particularity, which creates a reasonable doubt that he directors action was entitled to protections of the business judgment rule. 4. E&E The Delaware Supreme Court has stated a party challenging a business decision must show the directors failed to act (1) In good faith, (2) In the honest belief that the action was in the best interest of the company, or (3) on an informed basis. Aronson v. Lewis NOTE 1. The decision in this case has also affected cases where a demand was made on the board. In cases where demand has been made, the Plaintiff is deemed to have tacitly conceded that the board is independent. Thus, the only inquiry left to be made when the demand is refused by the board rests on the analysis of good faith in the boards inquiry into the matter. 2. Issue of Demand futility: Where officers and directors are under an influence which sterilizes their discretion, they cannot be considered proper persons to conduct litigation on behalf of the corporation. Thus, demand would be futile. i. The demand futility is inextricably bound to issues of business judgment, but stated the test to be based on allegations of fact, which, if true, show that there is a reasonable inference the business judgment rule is not applicable for purposes of a pre-suit demand. ii. In determining demand futility must decide whether, under the particularized facts alleged, a reasonable doubt is created that: 1. The directors are disinterested and independent and 2. The challenged transection was otherwise the product of a valid exercise of business judgment. a. This is the substantive nature of the challenged transaction and the boards approval thereof

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NOTE: Test under Aronson applies at the time of the transaction Court will not really allow discovery if you bring a derivative action. CTs stay recovery. Once you can get to discovery you have a good chance of settlement Disjunctive Test to establish demand utilityRaising a reasonable doubt is enough to Get Rails testapplies when fail to monitor ? reasonable doubt as to independence of the board as of the time . v. Notes and Questions 1. What distinguishes a derivative suit form a direct suit? i. Who suffered the alleged harmthe corporation or the suing stock holder individually; and ii. Who would receive the benefit of the recovery or other remedy? b. Thus, the relevant inquiry is the nature of the wrong alleged, not merely the form of words used in the complaint NOTES Derivativeis in the name of the corporation by the SH o Recovery goes to corporation o Lawyers are the ones who are sure to make money off derivative actions 2. Pleadings for derivative suits are not satisfied by conclusory statements or more notice pleading. However, the pleader is not required to plead evidence. What the pleader must set forth are particularized factual statements that are essential to the claim. 3. Once the defendant files a motion to dismiss for failure to make demand, certain to occur quickly after the derivative complaint is filed, the court will normally stay discovery until a decision on that motion. How can the plaintiff discover the necessary particularized facts without being able to conduct discovery? Pleadings may well have the tools at hand to develop the necessary facts for pleading purposes 4. If a SH makes pre-suit demand, what course of action may the shareholder pursue if the directors either refuse the demand, or simply take no action? a. Law not well developed. Although Delaware does not require demand in every case b/c Delaware does have the mechanism of demand excusal, it is important that the demand process be meaningful. A SH who makes a serious demand and receives only a peremptory refusal has the right to use the tools at hand to obtain the relevant corporate records, such as reports or minutes in order to determine whether or not here is a basis to assert that demand was wrongfully refused. In no event may a corporation assume a position of neutrality and take no position in response to the demand. Kaplan b. If a demand is made and rejected, the board rejecting the demand is entitled to the presumption of the BJR unless the SH can allege facts with particularity creating a reasonable doubt that the board is entitled to the benefit of the presumption. If there is reason to doubt that the board acted independently or with due care in responding to the demand, the SH may have the basis ex post to claim wrongful refusal. The SH then has the right to bring the underlying action w/ the same standing which the SH would have had, ex ante, if demand had been excused as futile. Grimes. 5. Plaintiffs meet their burden of demonstrating the futility of making demand on the board by showing that half of the board was either interested or not independent.

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a. Is 6 a majority of 12? No its only 50% b. In the context of the limited companyIf you can show either half were independent or interested then you have established what you need to create a reasonable doubtThis only applies where you have an even number of board of directors. So if you have 13 it takes 7 c. AaronsonIt has to be a majority of the board. Have to show a majority of the board is interested 6. Rales a. A court should not apply the Aronson test for demand futility where the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit. This situation would arise in three principal scenarios: i. Where a business decision was made by the board of a company, but a majority of the directors making the decision have been replaced; ii. Where the subject of the derivative suit is not a business decision of the board; and iii. Where the decision being challenged was made by the board of a different corporation b. Instead, it is appropriate in these situations to examine whether the board that would be addressing the demand can impartially consider its merits without being influence by improper considerations. Thus, a court must determine whether or not the particularized factual allegations of a derivative SH complaint create a reasonable doubt that, as of the time the complaint is field, the BOD could have properly exercised its independent and disinterested Business judgment in responding to a demand. If the derivative plaintiff satisfies this burden then demand will be excused as futile. c. Where there is no conscious decision by the BOD to act or refrain from acting, the BJR has not application b. Fiduciary Duty and Aronsons First Prong i. In re the limited, Inc. Shareholders Litigation 1. Facts: SH of the Limited Sued the Company (D) and its BOD (D) for committing waste and breaching their fiduciary duty of loyalty and due care. 2. Issue # 1: Have the SH (P) met the pre-suit demand requirements? a. Holding and Decision # 1: Yes. When a (P) initiates a shareholder derivative action w/ out first making a demand on the companys board, the complaint must allege with particularity the reasons justifying the plaintiffs failure to do so. The SHs (P) have alleged sufficient particularized facts to raise a reasonable doubt as to the disinterestedness of at least six of the twelve directors. i. Ones position as a director for a number of years, the receipt of directors fees, or receiving revenues form The Limited (D) that are not material, are not facts which raise a doubt as to independence. An individuals receiving material compensation from principle employment at The Limited (D) or its subsidiary; material consulting fees from The Limited (D); and gifts given from Wexner (D) to a university b/c of that individuals solicitation raises a reasonable doubt as to that individuals independence from Wexners (D) will.

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3. Issue #2: Have the SH (P) stated an actionable claim for breach of fiduciary duty a. Holding and Decision # 2: Yes, SH have stated an actionable claim for breach of the duty of loyalty b/c 6 out of 12 directors (D) who approved the transactions were interested. B/c the challenged transactions were not approved by a majority of independent and disinterested directors, the complaint states a loyalty claim. 4. Issue #3: Have the SH (P) failed to state an actionable claim for corporate waste? a. Holding and Decision # 3: To constitute waste, the transactions must be shown to have served co corporate purpose. Since the stocks under the Agreement couldnt have been sold until 7 years after The Limiteds (D) announcement of rescinding the Agreement, it is unknown whether The Limiteds (D) stock would have continued to rise in value, and it is mere speculation to say what benefit the Company (D) may have enjoyed. SH (P) also failed to allege that the self-tender was waste b/c it was not so one-sided that no business person of ordinary, sound judgment could conclude that the Corporation had not received adequate consideration. Furthermore, no breach of the duty of care b/c the complaint does not allege gross negligence. NOTES Look at the way the court goes about determining the lack of independence in the board members c. Demand Futility Under Aronsons Second Prong or Under the Rales Test i. Ryan v. Gifford 1. Facts: (P), a SH alleged that Maxims directors (D) breached their duties of loyalty and care by approving or accepting backdated options. As a result of the backdating, P asserted that Maxim received lower payments upon exercise of the option than it would have received in absence of the backdating, and that Maxim suffered adverse effects. 2. Issue #1: Does a complaint that alleges the deliberate violation of a SH approved stock option plan, coupled with fraudulent disclosers, sufficiently allege bad faith to rebut the BJR presumption and survive and dismissal? a. Holding and Decision #1: Acts taken in bad faith breach the duty of loyaty. The allegations here state a claim for bad faith, because if ture, they involve disloyalty to the companys best interest. There would not be an instance where the deliberate violation of a SH approved stock option plan,and false disclosures, intended to mislead SHs, would be anything but an act of bad faith. Therefore, well-pleaded allegations of such conduct are sufficient to survive dismissal. b. Rule: A complain that alleges the deliberate violation of a SH approved stock option plan, couple with fraudulent disclosures, sufficiently alleges bad faith to rebut the BJR presumption and survive dismissal 3. Issue #2: Does a SH have standing to bring a breach of fiduciary action based on the backdating g of options that occurred while he was not a SH? a. Holding and Decision #2: No. DGCL 327 clearly provides that a SH seeking to bring a derivative action must have been a SH at the time of the complained-of transaction or acquired his shares by operation of law. b. Rule: A SH does not have standing to bring a breach of fiduciary action based on the backdating of options that occurred while he was not a SH. d. Dismissal of Derivative Litigation at the Bequest of an Independent Litigation Committee of the Board

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i. A corporation can appoint a committee made up of directors who are not involved in the first suit and assert for this committee the right to claim the boards power to control derivative litigation. ii. Zapata Corp. v. Maldonado 1. At the time Maldonado (P) instituted a derivative suit against Zapata (D), he was excused from making a prior demand on the BOD because they were all defendants. The board had changed membership when, four years later, it appointed an independent Investigation Committee, composed of two new directors, to investigate the litigation. The committee recommended dismissing the action, calling its continued maintenance inimical to the companys best interests. 2. Rule: Where the making of a prior demand upon directors for a corporation to sue is excused and a SH initiates a derivative suit on behalf of the corporation, the BOD or an independent committee appointed by the board can move to dismiss the derivative suit as detrimental to the corporations best interests and the court should apply a two-step test to the motion (1) Has the corporation proved independence, good faith, and a reasonable investigation? (2) Does the court feel, applying its own independent business judgment that the motion should be granted? 3. Holding and Analysis: the fact that a majority of the board may have been tainted by self-interest is not per se a legal bar to the delegation of the boards power to an independent committee composed of disinterested board members. The moving party should be prepared to meet the normal burden of showing that there is no genuine issue as to any material fact and that it is entitled to dismiss as a matter of law. If the CT determines either that the committee is not independent or has not shown reasonable bases for its conclusions, or if the court is not satisfied for other reasons relating to the process, including but not limited to the good faith of the committee, the CT shall deny the corporations motion. It must be remembered that the corporation has the burden of proving independence, good faith, and reasonableness. If the CT is satisfied that the committee was independent and showed reasonable bases for good-faith findings and recommendations, the CT may proceed, in its discretion to the 2nd step. The CT should determine, applying its own independent business judgment, whether the motion should be granted. This second step is intended to thwart instances where corporation actions meet the criteria of step one, but the result does not appear to satisfy the spirit or where corporate actions would simply prematurely terminate a stockholder grievance deserving of further consideration in the corporations interest. Of course, the CT must carefully consider and weigh how compelling the corporate interest in dismissal is when faced w/ a nonfrivolous lawsuit. It should, when appropriate, give special consideration to matters of law and public policy in addition to the corporations best interests. NOTE This special judicial review is only when theres a special litigation committee iii. DGCL 220(b) Any stockholder . . . have the right . . . to inspect . . . and to make copies and extracts from: (1) The corporation's stock ledger, a list of its stockholders, and its other books and records; and (2) A subsidiary's books and records, to the extent that: (a) The corporation has actual possession/control of such records of such subsidiary; or (b) The corporation could obtain such records . . . as of the date of the making of the demand. e. Indemnification and Insurance i. DGCL 102(b)(1), 145

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1. Insurance and indemnification are mainstays in the arsenal of devices that limit directors risk of bearing personal financial losses as a result of serving on a board. 2. Under general agency law principles, a principal is required to indemnify an agent either: (Rest. 3rd of Agency 8.14) a. (1) Pursuant to the terms of their indemnity agreement, if any; or b. (2) Whenever the agent suffers a loss that, because of the relation, should fairly be borne by the principal. ii. Directors and officers indemnification rights are generally determined by provisions in either indemnification contracts or corporate by-laws The DGCL not only authorizes indemnification but also places significant statutory limits on corporate power to indemnify officers and directors iii. While most indemnification is a matter of contract, in certain circumstances directors and officers may have a CL or statutory right to indemnification. Delaware (DGCL 145(C)), requires a corporation to indemnify its officers and directors if they are successful on the merits or otherwise in defense of any action, suit or proceeding related in any way to their service as an officer or director. The Delaware version has been held to require indemnification for partial success. iv. First insurance policies designed to protect directors and officers from unwarranted apprehension of liability initially were written on a policy form having two parts: 1. Corporate Reimbursement LiabilityCovered a corporations liability to indemnify its employees, whether such liability arose from contract or was imposed by law. 2. Director and Officer LiabilityInsured named officers and directors against insurable acts for which the corporation did not provide indemnification. Specifically excluded from the k were uninsurable acts such as willful misconduct, dishonest acts, or actions involving receipt of improper personal benefit. Current insurance is similar in content to the original policy, but insurance companies have developed a variety of forms that deviate from the 2 part structure. Coverage afforded by part 2 is still referred to D&O insuranceregardless of the actual terminology of a particular policy

The Limited Liability Company

I. Introduction a. An LLC is formed by filing a chartering document, usually termed articles of formation or articles of organization with the statecertificate of organization is very simple b. A separately adopted and nonpublic agreement, commonly termed an operating agreement, specifies in detail the ownership rights, duties, and obligations of those who will own and manage the LLC c. Members have residual claimant status. Members like shareholders in a corporation, share ratably in the profits of the firm, but only after all other claimants and needs of the firm have been satisfied. Most LLC statutes permit an LLC to be member-managed or manger-managed, usually providing membermanagement as the default rule if the operating agreement does not provide otherwise. d. Member-managed LLC Not only are members the firms residual claimants, but they also, collectively, have authority to manage the LLCs business and affairs. Further, each member owes fiduciary and contractual duties to the LLC in the carrying out of this management role. e. Managers and manager-managed LLC LLC statutes provide that the sole proprietors ownership functions may be allocated to one or more managers, who may but need not be members of the LLC. 41

The members, as members, have no management authority or fiduciary responsibilities. Instead, the persons designated as managers are responsible for managing the business and affairs of the LLC. f. Limited Liability Neither members not mangers are personally liable for the LLCs obligations. g. Delaware has greater willingness than other states in an LLC context to permit members to contract around the fiduciary duty of loyalty and waive their right to petition a court for dissolution. NOTE LLC is the fastest growing preferred business organization LLC puts a premium on private ordering Benefits of a corporationLimited liability but double taxation is an issue Disadvantage of a partnershipDo not have limited liability Development of LLCs was driven by the tax code Preference is giving to the ex-ante contract h. Elf Atochem North America, Inc. v. Jaffari i. Rule 1: Because the policy of the Delaware LLC Act is to give maximum effect to the principle of freedom of contract and to the enforceability of LLC agreements, the parties to such agreements may contract to avoid the applicability of those provisions of the Act that are not prohibited rom being altered. ii. Rule 2: An LLC agreement is binding on an LLC where only its members have signed the agreement iii. Facts: Elf (P), a manufacturer of solvent-based maskants and Jaffari (D) who had developed an alternative to the solvent-based maskants agreed to undertake a joint venture that would be carried out using a LLC as the vehicle. Malek LLC (D) was formed in Delaware. However, Malek (D) was not a signatory to the agreement detailing the governance of the new company. The agreement contained an arbitration clause and a forum selection clause providing CA courts would have jurisdiction over any claims. Elf (P) later sued Jaffari (D) for breach of fiduciary duty. iv. Issue 1: Because the policy of the Delaware LLC (Act) is to give maximum effect to the principle of freedom of contract and to the enforceability of the LLC agreements, may the parties to such agreements contract to avoid the applicability of those provisions of the Act that are not prohibited from being altered? 1. Holding and Decision: Yes. Only where the agreement is inconsistent with mandatory statutory provisions will the members agreement be invalidated. Here, the parties specifically agreed that no action could be brought, except in CA. This provision is consistent with Delawares policy of encouraging alternate dispute resolution mechanisms, and does not otherwise violate a mandatory provision of the Act. Thus, there is no reason why the parties could not alter the Acts default jurisdictional provisions and contract away their right to file suite in Delaware. Additionally, even though 18-109(d) of the Act does not expressly provide the parties may agree to the exclusive jurisdiction of a foreign jurisdiction, b/c that section is otherwise permissive and does not expressly prohibit such action, the parties may contractually agree to such jurisdiction. v. Issue 2: Is an LLC agreement binding on an LLC where only its members have signed the agreement? 1. Holding and Decision: Yes. Here Malek (D) was simply the parties joint business vehicle, so that Maleks (D) failure to sign the agreement does not affect the members rights thereunder or the agreements validity.

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i. Shortly after Elf Atochem, Delaware amended 18-109(d) to read as follows: In a written LLC agreement, a member who is not a manager may not waive its right to maintain a legal action or proceeding in the courts of the State of Delaware with respect to matters relating to the organization or internal affairs of a LLC. II. Planning for the Limited Liability Company a. Delaware LLCA 101, 304, 306, 401-403, 503, 504, 505(C), 601-604 b. At a minimum, the Operating Agreement should specific the basic economic and management arrangements that will govern the firm. Additionally, the Operating Agreement should specify the rules or processes that will determine how major changes in the relationships between and among members and managers will take place, and what rights exist to exit from the relationship and withdraw invested capital. c. If the operating agreement is silent on a key issue, then statutory default rules will govern d. Olson v. Halvorsen i. Rule: An oral LLC operating agreement will be enforced where it has not been superseded and there is no evidence that the parties have intended to depart from the agreement. ii. Facts: Olson (P), Halvorsen (D) and Ott (D) cofounded Viking. The cofounders reached an oral agreement that all earnings were to be paid out annually, with no deferral of compensation, and that a departing member was to only receive his accrued compensation and the balance of his capital account. Written but unexecuted agreements for some of the operating entitled reflected this arrangement, as did executed written short=form agreements. Olson (P) later proposed that upon departure from Viking a founding member would be paid an earnout, through a new entity to be called Founders. Olson (P) worked with lawyers to draft an operating agreement for Founders, the other two members never agreed to its terms. At Olsons (P) direction, Founders was incorporated and certain amounts of the founders residuals earnings were run through Founders for bookkeeping purposes. Even though the earnout concept was on the management committees agenda for a while, issues surrounding it were never resolved. Olson was later terminated and paid the amount specified in the oral agreement. Olson (P) brought suit against Halvorsen (D) and Ott (D) claiming that he was entitled to the fair value of his interests in those entities. iii. Issue: Will an oral LLC operating agreement be enforced where it has not been superseded and there is no evidence that the parties have intended to depart from the agreement? 1. Holding and Decision: Yes. NOTE: Get the statute of frauds analysis here (its in the commercial case briefs) CT said LLCs are subject to the statute of frauds CT here looked to 18-101(7)Limited Liablity company agreement means any agreement written, oral or implied, of the member or members as to the affairs of a LLC and the conduct of its business. o But CT saidthis was subject to the statute of frauds In July 2010they amended 18-101(7) that a LLC agreement is NOT SUBJECT TO STATUTE OF FRAUDS With LLC, in Delaware (18-1101) you can contract around fiduciary duties except for the duties of good faith and fair dealing e. Notes and Questions i. The RULLCA allows a member to dissociate at will, but such dissociation neither dissolves the firm, nor provides a fair-value buyout. As a result, if the Operating Agreement does not vary the

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LLC statutory default rule, minority members may find the value of their membership interest locked in with no ready market to provide liquidity. ii. Under Delaware LLCA 604, unless the LLC Agreement otherwise provides, upon resignation any resigning member . . . is entitled to receive, within a reasonable time after resignation, the fair value of such members LLC interest iii. LLCA 693 provides that [a] member may resign from a LLC only at the time or upon the happening of events specified in a LLC agreement and in accordance with the LLC agreement III. Fiduciary and Contractual Duties a. Generally i. Delaware LLCA 1101 (C)-(e) ii. Delaware permits elimination of all duties other than duty of good faith and fair dealing iii. Most other states do not allow elimination of the duty of loyalty, or allow curtailment of the duty of loyalty to a lesser extent than Delaware. iv. Jurisdictions differ on whether the LLC is member-managed or manager-managed 1. RULLCA 409(a)A member in a member-managed firm owes to the company and . . . the other members the fiduciary duties of loyalty and care . . . a. However, in some states, absent contrary agreement, members in member managed LLCs do not owe fiduciary duties to each other v. LLC (compared to corporations) statutes allow greater deviations from the standard governance structure so as to emphasize freedom of contract. vi. Users of manager-managed LLCs commonly craft specialized fiduciary duty regimes, but there is no corporation law like uniformity in the contractual devices used to accomplish this tailoring. vii. Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC 1. Rule 1: A duty of good faith and fair dealing may be implied from an LLC operating agreement and imposed on the LLCs managing member and its owner for the benefit of the LLCs members where the operating agreement provides the managing member with broad authority to manage the LLC. 2. Rule 2: On a motion to dismiss, an LLC agreement, which provides for traditional fiduciary duties as well as for no duties among members unless expressly included will be interpreted asp providing for traditional fiduciary duties. 3. Rule 3: The owner or an affiliate of an LLCs managing member may be held liable for breaches of fiduciary duties where the owner or affiliate controls the LLCs assets and uses that control for personal gain. 4. FACTS: Bay Center LLC (P) formed Emery Bay (D) with PKI (D) (which was owned and managed by Nevis (D)). Emery Bays (D) LLC Agreement gave PKI (D) considerable power and authority to manage the affairs of t Emery Bay and also contemplated that PKI (D) would be responsible for managing the Project, but the parties defined those responsibilities through a separate agreement, the Development Management Agreement. PKI (D) did not sign the Development Management Agreement, but had one of its affiliates, ETI (D) sign it. a. Dealing may be implied from an LLC operating agreement and imposed on the LLCs managing member and its owner for the benefit of the LLCs members where the operating agreement provides the managing member with broad authority to manage the LLC?

FRIENDLY MERGERS AND HOSTILE TAKEOVER ACQUISITIONS

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I. The Statutory Template a. Mergers b. DGCL 251(merger), 253(short form merger), 259-261 i. Statutory merger transaction where two + corporations are combined into one of the corporationsusually referred to as the surviving corporation ii. When the merger is effectedLegal existence of all constituent corporations other than the surviving corporation ceases. iii. Assets and liabilities of constituent corporations pass to the surviving corporation and the outstanding shares of stock in the disappearing corporations are canceled iv. In a consolidation the surviving entity is not one of the constituent corporations but a newly created consolidated corporation v. Statutory template for a merger (DGCL 251) establishes core requirements: 1. In the archetypical merger, SH of the disappearing company receive shares of the surviving corporation in exchange for their disappearing shares. Must be a plan or a agreement of merger b/t the constituent corporationsPlan must specify: a. Which corporation will be the surviving corporation; and b. The consideration to be provided in the merger 2. Directors of each constituent corporation must adopt the plan 3. Merger must be approved by the Shareholders 4. Approved plan of merger must be filed with a state official such as the corporations commissioner for the merger to become effective as set forth in the merger plan 5. DGCL 262 sometimes provides SH a right to judicial appraisal (valuation) in lieu of amount provided in the merger agreement vi. Merger is one of the few corporate actions that the directors cannot do by themselves. vii. SH normally does not have the right to get cash from the corporation in exchange for their shares viii. Most states now require approval by only a majority of shareholders, although it usually must be an absolute majority of all shares entitled to vote, not just a majority of votes cast at a particular meeting. 1. This governance model (must have approval by SH of both parties to a merger) is built on certain key assumptions: a. SH can make an informed decision to approve/reject mergerSH in the decisionmaking process adds value for corporation and SH i. Assumes management will be able to provide SH with sufficient, digestible, and unbiased info about pros/cons of merger 2. Lawmakers must believe that it will not be unduly burdensome for corporations to await the decision of their SH before beginning the critically important and costly process of integrating their assets and personnel II. Dissenters Rights a. DGCL 262 (appraisal rights) b. If SH dissents when asked to approve a merger or other covered transaction, and if the transaction nonetheless obtains the requisite SH approval, the dissenting SH may demand that his shares be repurchased by the corporation for fair valueCommonly called dissenters rights or appraisal rights c. If dissenting SH and corp. cant agree on price w/ in time and procedure in statute-fair value will be determined in judicial proceeding.

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d. SH will receive judicially determined fair value, plus interest, even if that amount is less than the corporation offered to SH as part of the terms of the merger. Moreover, the court is empowered to assess the corporations expenses against the dissenting shares if equitable. (DGCL 262_ e. MBCA Approach. Do we need to know? i. Req corp to make payment to dissenter as soon as corp action is completed Payment must reflect corps good faith judgment as to the fair value of dissenters shares If court finds higher fair value in appraisal proceedingdissenter will receive the difference ii. Corp usually required to pay cost of appraisal. Dissenter charged costs only if acted arbitrarily or not in good faith in demanding payment or exercising his appraisal rights. CT apportions attorneys fees if equitable f. When should appraisal rights be available? i. W/ respect o mergers most statutes provide that appraisal rights exist only when voting rights exist 1. EXCEPTION: SH of a corporation merged out of existence via a short-form merger will receive appraisal rights ii. Delaware denies appraisal rights for most publicly traded shares, if the merger consideration received in exchange is also publicly traded stockMBCA differs here g. Weinberger Approach i. Weinberger v. UOP, Inc. NOTE This was a freezeout merger Restored the appraisal remedy Created a much more contemporary way of determining value/appraisal Signal had directors on both sides of the fence (former ees on the other side) Per Burson ***read Weinburger** again ii. In Rosenblatt Getty sought to cash out the minority SH in its controlled subsidiary, Skelly. To avoid structural problems pointed out in Weinbeger, the members of Gettys negotiating team resigned from the Skelly board. Del. held that Getty satisfied its fiduciary obligations. h. Appraisal and Entire Fairness Review After Weinberger i. DGCL 262(h) ii. Cede & Co. v. Technicolor iii. The overwhelming trend in modern cases is to reject minority and marketability discounts III. Lynch Claims and the Siliconix Transaction: The Impact of the Common Law on Deal Structuring a. 2 options for Controlling Shareholders seeking to taker their corporation private: i. Long-form cash-out merger ii. Second option involves two steps 1. Step 1: A tender offer whereby the corporation offers to buy the sock held by a majority of SH, such offer being conditioned on enough stock being tendered to give the controlling SH at least 90 percent equity of the outstanding voting; 2. Step 2: A short-form, cash-out merger iii. In re Cox Communications, Inc. Shareholders Litigation b. Delaware strictly limits the appraisal action to issue of valuation c. In determining whether breach of fiduciary duty claims may be raised in an appraisal proceeding, CTs distinguish b/t claims that the corporation nor its officers and directors breached fiduciary obligations in connection w/ the merger, and claims the corporation as damaged by breaches of fiduciary duty unrelated to a merger.

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i. It is settled law that a breach of fiduciary duty claim arising from the merger, such as entire fairness, must be brought as a separate action directly challenging the merger. However, breach of fiduciary duty claims that do not arise from the merger are corporate assets that may be included in the determination of fair value. ii. In Delaware for long-form mergers, where the statute is silent on exclusivity or contains an exclusivity requirement with a general exception for unlawful or fraudulent conduct, court have rule the appraisal is not exclusive. iii. Justice Berger stresses two points that are essential if appraisal is o fulfill its role as an exclusive remedy for minority SHs who are involuntarily forced out of the enterprise at a price set unilaterally by the majority: 1. Frist, If the merger was timed to take advantage of a depressed market, or a low point in the companys cyclical earnings or to precede an anticipated positive development, te appraised value may be adjusted to account for these factors 2. Second, Even though Glassman insulates parent corporations and their fiduciaries from entire fairness claims arising out of short-form mergers, the duty of full disclosure remains and minority SHs must be given all the factual information that is material to that decision (to accept the merger consideration or seek appraisal). d. Litigating Entire Fairness- Lynch claims i. Kahn v. Lynch Communications SystemsCT held that entire fairness remained the std. for review in controlling SH dominated cash-out mergers even if the interests of minority SHs were represented by a committee of independent, fully informed directors. Subsequently, so-called Lynch claims became the preferred litigation mechanism (instead of an appraisal action) for minority SHs disappointed w/ the terms of a cash-out merger. The Glassman case eliminated Lynch claims in the context of short-form mergers, but lynch claims remain prevalent (and generally preferable from the plaintiff standpoint to appraisal actions) in the context of controlling SH-dominated long-form cash-out mergers. If conditions of inrecox not metyou go bck to lynch. Lynch is good law if you dont meet in re cox. ii. In re Emerging Communications, Inc. Shareholders Litigation iii. When the standard of review is entire fairness, ab initio, director defendants can move for summary judgment on either the issue of entire fairness or the issue of burden shifting iv. If entire fairness is the std of review ab initio, would it be appropriate for the trial ct to grant a summary judgment motion on exculpation grounds in favor of an independent director whose conduct clearly involves, at most, a breach of the duty of care? 1. When entire fairness is the applicable std for judicial review, CT has held that injury or damages becomes a proper focus only after a transaction is determined not to be entirely fair. A fortiori, the exculpatory effect of sec. 102b7 provision only becomes a proper focus of judicial scrutiny after the directors potential personal liability for the payment of monetary damages has been established. Although 102b7 may provide exculpation for directors against the payment of monetary damages that is attributed exclusively to violating the duty of care, even in a transaction that requires the entire fairness review standard ab initio, it cannot eliminate an entire fairness analysis by the Court of Chancery. Emerald Partners a. The CT of chancery should address the 102b7 provision only if it makes a determination that the challenged transaction was not entirely fair. Director defendants can avoid personal liability for paying monetary damages only if they

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have est. that their failure to withstand an entire fairness analysis is exclusively attributable to a violation of the duty of care.

Federal Regulation of Tender Offers

I. The Williams Act a. In a tender offer, an acquiring company offers to purchase part or all of a target companys shares directly form the SH of the target. b. The acquiring companys purchase of target stock for cash is w/ in the usual authority of its BOD and requires no lengthy corporate proceedings by the acquiring company. c. If an acquiring company issues its own stock as consideration for the shares to be acquired, that issuance is regulated by the securities Act of 1933. i. For cash considerationno similar regulation existed b/f 1968 d. Furthermore, if control of the target is sought by proxy solicitations, the target SHs receive substantial disclosure as reqd by the rules and regulations under 14 of the Securities Exchange Act of 1934 e. Williams Act added 13(d)-(e) and 14(d)-(f) to the 1934 Act. f. 13(d) requires certain disclosures if a person acquires more than 5 percent of the stock of a company whose stock is registered under the 1934 Act g. 14(d) requires similar disclosure when a bidder makes a tender offer for the stock of such a company. h. Disclosure i. Securities Exchange Act of 1934 13(d), 14(d) and (e); Schedules 13(D) and 14(D) ; SEC 13d-5 ii. 14(d) requires that the tender offeror provide each security holder and the SEC with the information specified in 13(d) as well as any additional information required by the Commission. iii. The 13(d) disclosure, which is made only to the SEC, includes info on the background and identity of the offeror or 5 percent owner, the source and amount of funds or other consideration used in making the purchase, and, if the purpose is to acquire control, and plans the purchaser has to liquidate, merge, or make major changes. iv. Prudent Real Estate Trust v. Johncamp Realty, Inc. v. NOTE: 1. The issue as to who must make disclosure under the Williams Act has arisen more frequently as to the definition of groups. The statutory definition in 13(d)(3) of a group as an aggregation of persons or entites who act as a group for the purpose of aacquriing, holding or disposing of securities has been given fairly broad interpretation by the courts. Rule 13d-5(b) states that a group cannot wiatuntil it makes its first coneted acquisition or disposition of shares but ust file immediately upon fomraiton of the group vi. Securities and Exchange Commission v. Amster & Co. vii. The Williams Act provides no express private cause of action

Changes In Control: Hostile Acquisitions

I. The Market for Corporate Control a. If the motivation of the acquisition is to replace inefficient management, there will be concern that the current directors will exercise their gatekeeper function in an opportunistic fashion. b. Direct dealings b/t SHs and potential alterative management teams are one way to counter this opportunistic behavior c. A potential acquirer who seeks control / out the consent of the current control group can 48

i. (1) Make a tender offer seeking to buy sufficient shares to gain control of the board; or ii. (2) Launch a proxy fight seeking the authority to vote sufficient shares to gain control of the BOD. d. In addition to requiring disclosure, the Williams Act provides certain procedural protections to shareholders faced with a tender offer. For ex., a tender offer must remain open for 20 days, blocking a bidders effort to force a hasty decision by SHs. SEC Rule 143-1(a). If more shares are tendered than the bidder sought to purchase, the bidder must buy a pro rata portion from each SH. This preents use of a first-come, first-served strategy to pressure SHS to tender. 14(d)(6). Also, the bidder must pay the same price for all shares purchased, and if the offering price is increased b/f the end of the offer, those who have already tendered must receive the increased price. NOTES: In most of these casesthe board is not interested in cooperating which is what distinguishes these case Concern of the court(1) whether these directors are just throwing up defenses to protect themselvesnot necessarily for the interest of the company or its constituents; and (2) Inherent conflict when the takeover bid is made with the directors What is the resistance to these defenses? SHs oftenb/c it can devalue the stock Combination of these things that make them power e. Glossary of Takeover Tactics i. An acquiring company is referred to as a bidder (or raider). ii. A bidder such as Maremont in Cheff v. Mathes would be portrayed as engaging a bust-up takeover, seeking to break up the target and sell it off in pieces. iii. Financing for many raiders during the 1980s was provided by issuing junk bonds, a term that refers to bonds that are higher risk and therefore bear a higher interest rate iv. The company sought to be acquired is a target. v. white night 2nd bidder, thought to be friendly to target management, who makes an offer to rescue the target from a hostile bidder. vi. White squire A friendly party who does not acquire control but acquires a large block of target stock with the acquiescence of target management. vii. Arbs or arbitragersregular market participants who seek to make money by short-term purchases or sales of stock. viii. Front-end loaded tender offerThe consideration in the tender offer is worth more than the consideration in the second-step merger. Such tender offers are viewed as coercive b/c shareholders who do not tender in the first step will be forced to accept less for the untendered shares. The transaction becomes even more coercive if the consideration is junk bonds or illiquid securities. ix. Golden parachutesThe lucrative compensation and fringe benefits given to target management to ease their descent if they are fired after a hostile takeover. Parachutes are promoted as a means of keeping needed executives when a company is in play. Contracts extended to a large number of lower-level employees are sometimes referred to as tin parachutes. 1. Triggered when there is a change in the companyoften will include accelerated vesting of options + a multiple of two or there year of salary x. Greenmailpejorative term for a targets repurchase of its own shares from a raider where the target pays a premium for the shares to induce the unwanted suitor to go away. Can be taxes on repurchase some corporations have passed charter provisions forbidding the payment of greenmail.

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xi. Lock-ups and termination feesA white knight may be reluctant to bid or to continue bidding, b/c of the substantial unreimbursed expenses and opportunity costs incurred if the bid is unsuccessful. 1. Contractual provisions (or deal provisions) include termination fees or stock options at a bargain price designed to compensate the white knight for serving as a stalking horse in the auction contest. 2. Lock up option gives the white knight a right to purchase the corporations most valuable assetsits crown jewels. Such options make other bids unlikely b/c many of the key assets are now promised to the white knight. a. Lock-up options create value if they induce a white knight to make a final bid that the knight would otherwise be unwilling to make, unless the lock-up prematurely forecloses the auction, preventing another bidder from presenting an even higher bid. xii. A friendly agreement may also include contract clauses to protect the purchaser, such as MAC (Material adverse changes), which permit the purchaser and out if certain conditions occur. Reserve termination fees also protect the purchaser xiii. Poison pillsRefers to stock rights or warrants issued to a potential targets SHs prior to a takeover. These rights lie unused and almost worthless until triggered by a hostile acquisition. 1. Some versions of the pilltarget SHs get the right to redeem their shares in the target company for a price well above market price well above market price or the target SHs get the right to purchase shares of the acquiring company at a reduced price after a folloup merger b/t the two companies. typically exclude any shares of the target crowned by the acquiring company. Acquiring company finds itself w/ a target corp depleted of assets or filled w/ new obligations. NOTES: Triggering Eventtriggers rights in the SH to rightsrights are the right to convert to have shares issued to a person for a much reduced value Dilutes the stock that the acquirer is trying to purchase Flip-over pillgives right to acquire rights in bidders shares at a discount Look at 160 xiv. Recapitalizations and leveraged buyouts (LBOs) by management (MBOs). Target mgmt. may seek to respond to the bidders offer by provide SHs a rearranged financial package that offers SHs an immediate cash payment for their sharesoften financed by huge additional borrowings by the corporation. This may take the form of a tender offer backed by mgmt. as an alternative to the initial tender offer by a hostile bidder. xv. Shark repellent amendments (or porcupine provisions) to the corporations charter and/or bylaws (above defensive tacticsusually taken by BODs w/ out participation by SHs). Some defensive tacticsinclude SH approval and invoke a different kind of judicial review 1. Supermajority amendments Raise the vote required to effect a merger or similar transaction from the simple majority or 2/3 normally required by corporate law to a figure as high as 90 percent. 2. Fair price amendmentsLike the supermajority provisions, focus on second-step transactions that may follow the acquisition of control by a raider. These provisions build on the supermajority concept in that they waive the supermajority vote if the second-step transaction offers a fair price as defined in the provision.

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3. Staggered board amendments (aka classified board)Most used shark repellantPrevents a raider from removing the other defenses right away. If you could come in and replace the entire boardyou could get the company to remove the poison pill. Combination of position pill and classified board can be almost undefeatable 4. Dual-class capitalizationMgmt can gain insulation beyond their actual share ownership if their shares have multiple votes per share or the public shares have factional votes per share. f. Judicial Review of Tender Offer Defenses i. Traditional View 1. Takeover defenses essentially involve the directors efforts to prevent SHs from exercising their power to vote or sell in the unfriendly takeover context. 2. Directors attempt to employ takeover defends that will be protected by the BJR 3. Cheff v. Mathes NOTE: Why do we not just say BJR? BRJ is not used in these situations burson just calls it the enhanced business judgment rule a. This is a conflict but it doesnt arise to the level of a pecuniary interest (i.e. a selfdealing transactionGo to entire fairness or go through 144 steps in this situation) So instead the burden shifts to the board to show theres a reasonable danger to corporate policyct says this standard is established by good faith and reasonable investigation b. The prospect of entrenchment creates an inherent conflict (read p.842) g. The Enhanced Scrutiny Framework i. The Unocal Doctrine 1. Unocal Corp. v. Mesa Petroleum Co. (front loaded tender offer) NOTES First stepoffer cash for steps; second stepoffer junk bonds so that forces the remaining that didnt trade for cash in the first step to have incentive to take in the firstThis is coercive Precluding Pickens from participating in the offer (the exclusivity) is what is being questioned here. Enhanced duty here that comes b/f the BJRThere is an enchaned duty which calls for judicial examination at the threshold b/f the protections of the BJR may be conferred a. in the face of this inherent conflict directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed b/c of another persons stock ownership i. This where you show good faith and reasonable investigation. ii. This is all a restatement of Mathes 1. A majority of outside independent directors on the board meets that standard b. NEW ELEMENT: If a defensive measure is to come within the ambit of the BJR, it must be reasonable in relation to the threat posed i. Examples of such concerns may include: inadequacy of the price offered, nature and timing of the offer, questions of illegality, the impact on constituencies other than SHs (i.e. creditors, customers, ees, and perhaps

51

even the community generally), the risk of nonconsummation, and the quality of securities being offered in the exchange. ii. Corporate enterprise is whats being protectednot just the SHs iii. The threat to the SHs here was a coercive offer 2. 14d-10 promulgated under Williams act in response to Unocalprohibited selective tender offers. 3. Several states have statutes rejected the heightened Unocal test in favor of the traditional BJR. h. Poison Pills i. DGCL 141, 151, 157, 160 ii. Poison pillname for various rights given to SHs entitling them to additional securities of the company upon the happening of certain events. 1. Flip-in plandirectors cause the corporation to issue certain rights to all current SHs, often issued as a dividend to these SHs. At the time of issuance, the rights have little current value; rather, these rights flower upon a triggering event. The sting or poision of the plan is that acquirers are excluded from the right so that a successful raider will find shares in the target diluted a. These rights usually can be redeemed by the BOD prior to the triggering eventthus, theres an incentive for a raider to come to the Bod b/f crossing the threshold. 2. Flip-over works on the same principlesbut rights given to the SHs are to purchase shares (again at a discount in any company into which the target company is merged. A raider could thus avoid this pill by continuing to operate the target as a separate company, an option that is feasible but one that most acquirers find to be financially unattractive. iii. Moran v. Household International i. The Revlon Rule i. Revlon, Inc. v. MacAndrews NOTES: What moved this from the UnoCal standard to best value of SH? You can consider other constitutenciesif it furthers the SH But should really only look to the best valueof the SHs Once you deicide company is going to be sold, broken up, or change of controlThe standard changes to maximizing SH value Key to this case is that Time convinced the Ct it wanted a continuing enterpriseResponse was not disproportionate to the threat o Non o Revlon duties triggered Change of control Break up of corporate entity/mission j. Refining Revlon and Unocal i. (The Time Case) Paramount Communications v. Time NOTES: Time wanted to preserve their corporate culture and journalistic integrity WB stockholders would have 62% of the merged companyIsnt this a change of control? CT says ii. QVC Case (paramount v. QVC) 52

NOTES: iii. Notes and questions 1. QVC decision makes clear that the Revlon duty applies only to a subset of acquisition transacitons

Burden is on directors to prove they met their enhanced duties We have looked at the BJR as a shield against director liability. Most of these cases are for injunctions not director liability. Its a defense of the directors actions. So we are not talking about director liability here Chef v. Mathes Then BJR kicks in CTS are most worried about entrenchment in these cases Unocal (T Boon pickens) o Front loaded 2 tiered tendercoercive b/c front was ntice and back-end was junk bonds o T boone wasnt allowed to participate in the counteroffer made to the SH he couldnt be allowed to be held out now o This court gave the second step to enhanced bJR 1st step Burden goes to the directors to est. reasonable grounds to belief theres a threat to corporate policy Satisfied by showing good faith; and reasonable investigation The actions must be reasonably related to the threats posed They showed ability to consider other constitutencies. Burden is on the directors Poison pills had a redemption feature. These are particularly needed if you have a white Knight. Allows the board to redeem the pill at a highly redeemable price. If you want to get the company sold to a white night. In Unocal the parties had adopted powision pill b/c of the takeover environment in general.

151 g and 157 are the power to create rights How flip over pill works Hypo: net assets: 1k, Stock price: $10, Shares outstanding :100 o Target company issues a right to their SHs that issues rights to 100 dollars a share at $5 a share. o

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Insider Trading
I. The Common Law Foundation for Rule 10 b-5 a. 10-b5 is the primary regulator of insider trading today, even though theres no specific reference to insider trading in the staute. b. 16)b_of the Securities Exchange Act of 1934 specifically regulates insider trading by requrign officers, directors, and 10 percent SHs to disgorge any profits made on a purchase and slae during a six=month period c. One common law approach has focused on fiduciary duty of trustees and agents owned to the coproation and the unjust enrichment of the indiser. i. Diamond v. oreamunoa person who acquires special knowledge or info by virtue of a confidential or fiduciary relationship w/ another is not fee to explit tht knowledge or information for his own personal benefit but must account to his principal for any profits derived threform. Rule 10b 5 as a regulator of Insider Trading a. Cady, Roberts & Co A corporate insider who has material nonpublic information about the enterprise is under a duty either to abstain from trading or first to disclose the nonpublic information. b. In Texas Gulf Sulphur the 2nd Circuit further refined this duty c. Texas Gulf Sulphur Co d. Insider trading as contributing to an efficient market. Insider trading permits mother changes in stock prices than would occur w/ out insider trading. In situations where information cannot credibly be disclosed to the market (b/c of competitive fears or b/c it is soft information), insider trading conveys some of this information to the market. e. Harms from permitting trading on inside information i. Delayed DisclsoureLess information available to the market if insiders hold back in order to profit trades, thus impairing the efficiency of the market ii. Corporate injury trading will adversely affect a corporation producing the info if the inside info is used to purchase ctock in a company tha the first company is seeking to take over and the trading leads the price of the target to increase iii. Investor injuryTraders on the other side will be harmed iv. Loss of Public Confidence in the MarketsRegulation of insider trading is oftenlinked to resotring public confidence in the market (after 1929 crashSE Act of 1934 is a product of)

II.

One disadvantage of lynch is that its shareholder by shareholder Securities Exchange Act. Of 1934 Historically federal laws have been focused on disclosure. 10k and 10Q are reports that companies have to make and reveal all the risk they can foresee about someone buying their stock. Securities Exchange Act. Of 1934 governs tender offers. A tender offer is a public offer made to purchase the shares from the stockholders. It doesnt require target companies board of approval. Proxy constests were subject to federal and state law. Williams Act passed in 1968. At the Heart of the Williams Act is disclosure. Why do you have disclosure? B/c benefit to target SH to make decision whether to tender their shares or not. Very often a tender offer is condition on the tender qureiing a certain number of shares 13(D) Reports by Persons Acquiring More than Fiver Per %

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Securities and Exchange Act13(D)(p. 827) and 14(D) are the primary sections looking at here. 13(D)When somebody aggregates 5% of the shares of the target, their obligations under 13 (d) are triggered.-->10days to file? Under 13(d) only disclosures you need to make are to the SEC and companies board. 13(D) is for someone trying to acquire 5% of the company thats all. 14(d) is if the owner wants to make a tender offer for more than 5%. 13(D)(3) If members aggregate holdings can exceed 5%. Ex. 1 person has 2%, another has 1%, and another has 2%. People in the group have to have some connection to each other. Look at case on p. 1082 about disclosure. Disclosure as to the purposes

Notes: The board has to initiate a merger and the shareholders (w. one excpetion) vote to approve the merger When 2 companies mergeThe effect of the companu loses all of its identity. Everything is passed by law to the surviving company. It takes not only all the assets but the liability as well Look at 259 (a)Tells you the consequence of a merger 1. 251(b)Where you start for a merger a. T (target) and A (acquiring) boards adopt merger agreement (both boards have to adopt) b. 251(b)(3): As charger can be amended at this point c. 251(b)(5): Allows cash and securities in addition to acquirer common as consideration 2. 251(C) a. SH vote at A and T: majority of shares entitled to vote threon 3. 251(C) a. file articles of mergermerger effective at this point 4. It takes a majority vote of SH to approve the mergerTakes a vote of the majority of the outstanding shares of those entitled to vote. Look at 251(C) to expand on this 5. Short form Merger 253 Asset Sales DGCL sec. 271 Statutory sale of assests is much more complicated o As a result, the mechanics of transferring control and consideration are more complex o Asset salehave to do title searches and have each piece of title transferred Tax consequences of asset sale o Double taxation of asset sales; Tax at the corporate level based on difference in the depreciated tax book value of the assets sold and the sum of the purchase price and the liabilities assumed Tax at the SH level (assuming liquidation) based on the difference b/t the tax basis of the SHs stock and the liquidating distribution. o More flexibility in strucing tax-free reorganization in merger than asset sale o 40% equity and 60% cash for tax free reorganization in merger as contrasted w/ 80% equity for asset sale tax free reorganization Successory liability In a merger, Get this

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SH voting and appraisal in Std merger Approval o both companys boards o both companys Shareholders Appraisal o Available to SH of both corporationyou cant seek appraisal rights under 262 if you dont agree w/ merger o SH voting and apprialal in asset sale 271 requires approval of a sale of substianlly all the corporations assets by the boar and SH of the selling corporation o SH approval must be by a majority of the outstading shares Delaware doesnt require tha thte SHof the purchasing corporation approve the transaction. Only the board of the bpurchains corpaiton get the rest of this slide Triangular Transactions (triangular mergers) Provides the transaction cost-minimizing advantage of an asset sale, while also providing the advantages of a merger o Ex. buyer company provides the transaction cost=minimizing advantages of an asset slae, while also providing the advantages of a merger. Buyer sets up a shell subsidiarycall it new co Capitalize newco with consideration to be paid target SH in the qquisiton-cash or debt or equity securities of the buyer o Target then merges with Newco Forward triangular merger***get slides on these examples** What happens to old Target SHs? Target company goes out of businessSHs end up with cash (cash out merger)They can also end up with securities. .. Freeze out mergerWhere you hold a majority o fhte shares of the subsidiary but you dont own 90%, you own 50%. You then use a subsequent merger (2 second stage merger) to force out the reminaing SHs.->You usually see this when you have a tender offer. Tender offers come in when you want to bypass the board Difference b/t short form merger statutotry merger will you own 90% or more (253?); and freeze outnot statutory (Weinberger)if majority wants to acquire balance of shares. b/c minority cant stop it. Its the second stage of a 2 part merger. The first part is the acquisition

Sinclair Oil Corp v. Levin this case talks about the fiduciary duty of parent to minority shareholders of subsidiary Inhereit interested transaction here where BOD are the same on both companies (company and subsidiary). Here BJR not applied b/c transaction is inherently self-serving So you donthave to rebut the BJR. So first thing you look at is intrinsic fairness of the transaciotn.

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Deaing with a controlling SH on both sides of the transactiontheres a inherently conflict of interestso BJR not needed.Entire fairness is the standard not BJR at this point. Look at paragraph on p. 724 the paragraph that starts with A controlling Long form merger Have to have the cooperation of the other board w/ a negotiation for long form merger With tender You can go over their head Smith v. van gorkomcash-out merger Shortform doesnt require a vote (you have 90%) Weinberger is all about the remedy Feeze out mergercontroling sh has majority they either negotiate a takeover of the rest of the stock or make a tender offer. The minority stockh are frozen out and cant prevent it. Siliconix Lynch Entire fairness is the standard: Fair dealing and Fair price up to Weinberger basically had controlled freezoutsyou basically had class actions b/c cases developed such that a business purpose was required the apprisial remedy was very narrow. Why want class action instead of seeking an appraisal? Bc cost can be spread out over lots of parties. Apprasial is sh by sh. Weinberger overruled lynch v. vicors oil (?)(awarded recissory damages for conduct) in terms of the nature of the damages but also in the sense that you can have a class action if you allege breach of duty or fraud 1) Basically said whether an allegation of breach of duty or pricethe std of liability is fair dealing and fair price 2) You resolve this through the appraisal processThis is where the relief is *If the price is fair then you wont get anything Good faith is used separately in a 102(B(7) but still a subset Entire fairness is the standard of liability. If you dont have this,then you will be subject to minority stockholders thorugh an appraisal remedy or class action (unless you have an exculpatory clause) have to let directors know youre going to take appraisal remedy prior to SH vote.

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Look to 262(h) Freeze out is usally is connection with cash out merger b/c freeze out is the second part of cash out How do you privatize? You buy all the shares (Cox) Cox Dakota? Cota coto? o But still do have BJR protection if: o entitled to BJR (or majority SH) if : Have independent committee of directors that recommend the transaction (whether a tender or not) Majority of the minority that recommends ether the tender offer or transaction: IF you have those 2 components then you should get the protection of the BJR Changed???by some spring Delaware case o Unified st.d of in re cox. BJR applies when freezout condtion on affirmative rcommendation on special committee

Technicolor: 2 step merger. Issue: When is the company valued? o After the first stepmajority SH begins to implement a different business plan o The second step of the merger (actual merger) occurs about 2 months later o Argument was the appraisal value should exclude the work Perlman did from revitalizing company from time he became majority SH to time of merger. It should be valued as of the time he became majority owner CT said no. Cant do cost/cash flow projections to come up with a hypo value. But you can get the benefit of anything done from time he became majority SH to time of merger. Rapkin v. Hunt (p. 754) o First stage: paid 25 dllars a shareslets more than a year goes by and pays significantly less than that after offered 25 a share a year later. Sues for bad faith. o Youre not limited to your appraisal remedy. Weinberger said if issue is only the price. Then appraisal is your only remedy. However, if fair dealing is your issuethen you can have a class ation Glassman v. Unocal (p. 755) o When you have a short form merger (253 merger) you have no fiduciary duties. But you do have a duty to tell a choice about the merger (candor). Apprasial is the only remedy in a short form merger No fiduciary dutyexcept candor SolomonIf I accomplish my 2-step merger in the following way I make a tender offer and get up to 90% of the shares. The only remedy that majority SH can have is an appraisal. Not subject to intervention for breach of fiduciary duty Con v. Lynch (p.769) For long form merger route Even if you have a majority of the minority and an independent committee. The Std. is still entire fairness. You still have to meet the std of entire fairness. P. 776-77 read this. Roadmap of how the CT looks at this entire fairness issueApply this analysis on the test. The person that did this last year booked the class.

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If conditions of inrecox not metyou go bck to lynch. Lynch is good law if you dont meet in re cox.

BursonUnless you have lots of confidence in the board you dont make demand

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The test for determining demand futility was stated in Aronson v. Lewis, , as a two prong test under which the plaintiff must create a reasonable doubt that: (1) the directors are disinterested and independent; and (2) the challenged transaction was a valid exercise of business judgment.
NOTE: Grimes v. Donald (Per BursonRead this p.410Expert) SH made demand then directors rejected it. o Standard for establishing wrongful refusal. Does the court ever see the merits of the case? No! Directors receve presumption of BJR in refusing demand. If you can overcome BJR as of the time they refuse the demandThen you might be able to establish wrongful refusal. BursonNot sure how this would happen o The way the rules have evolvedits almost malpractice to make a demand

DERIVATIVE LITIGATION 1 Choice: If direct you sue

st

If Derivative: 2nd choice: FRCP 23.1 and Delaware chancery rules 23.1 basically say the same thing o Have to state with particularity why you havent made demand If you set forth your reasons and they are adequate then demand can be excused rd 3 Choice: Make Demand If board accepts demandThey sue If demand is refused Is it refused wrongly? o StandardHave you created a reasonable doubt whether the wrongful refusal meets the three part criteria If refusal is wrongful then you go forward with your suit

When you file your suit 1st thing that happens in the suit File a motion to dimiss for failure to state a claim 12(B)(6) process duty of care here? If you lose your motion to dismiss as a plaintiffCan make demand If refused you have a period of discovery? Then file rule 56summary judgment based upon business judgment rule What if defendants lose the motion for summary judgment? Board must show that the decision was fair Then you go to liability

Two different standars AaronBoard that made the decision Rail std->look at board in place at the time of filing the complaint 60

Read last paragraph of p. 403 Elements of BJR being informed (gross negligence), good faith Disinterested and disjunctive

If board rejects demand (Board rejecting demand is entitled to presumption of BJR)Can file for wrongful refusalYou have to raise reasonable doubt that the board acted wrongfully, disinterested Look at p. 935in Rhales takes for BOD resposnding to demand is a 2 step process (1) and (1) board must weigh

Read bottom of 437 to 437

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