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AGENCY

Whos An Agent; When Authority

3 kinds of issues: 1) whats an agent, looking at the restatement of agency 2) whats theaffect of an agent on legal relationships of principal 3) agents duties to principal

To create an agent/principal relationship, you dont need to formerly say I will be youragent. The agreement also does not absolutely need to be in writing.

Parties contracting with the agent are liable to the principal.

A principal is also subject to liability on contracts made by the agent on behalf of theprincipal.

For a principal to liable for the actions of the agent: a) the agent must be aservant/employee of the principal master. b) the tortious action must have been done

within the scope of the agents service/employment.

Sect 1 of Rest. defines agency. Agency is the fiduciary relation which results from a) themanifestation of consent by one person to another that b) the other shall act on his behalfand c) subject to his control and d) consent by the other so to act.

Sec. 2 of Restatement says the master is a principal who controls or has the right tocontrol the physical conduct of the agent.

Court stretches to say a jury could find a principal/agent relationship where a teacherlends a car to a coach to drive students to the game and the coach gets in an accident

(Gordon v. Doty)

Court finds sufficient control by grain dealer to establish that a grain elevator was theagent of a grain dealer, such that farmers could sue the grain dealer for the grainelevators failure to pay. (Jensen Farms v. Cargill)

Someone will be viewed as a subagent of a principal if the principals agent had express,implied, or apparent authority to hire the subagent.

Apparent authority (sec. 5) deals with whether Sam thought Bill had the authority toemploy him, while implied authority deals with whether Bill had the implied authority to

employ Sam.

Court finds that Bill had implied authority to hire Sam on behalf of the church, because itwas implied that Bill would get help painting the church. Therefore, Sam was a subagentof the church. (Mill Street Church v. Hogan)

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Court finds that supervisor had apparent authority to hire the plaintiff on behalf of thecompany, because plaintiff reasonably believed that the supervisor was authorized tomake such a sweet deal. (Lind v. Shenly Industries) (check on result)

the principal is liable for all the acts which are within the authority usually confided toan agent of that character. This is similar to, but not quite apparent authority. This

principle the Court put forth is called inherent authority. Court finds manager of hotelhad inherent authority to purchase cigars from the plaintiff on the hotels behalf.(Watteau v. Fenwick)

To find apparent authority, we need to find conduct by Arco that truck stop owner couldhave interpreted as giving employee authority. Inherent authority would bind Arco if it isusual for an employee negotiating with the truck stop owner to be able to give discounts.To show this inherent authority, the normal customs of the trade with respect to thepower of an employee to negotiate discounts would need to be demonstrated. Inherentauthority thus seems to be a looser form of apparent authority. (Nogales SC v. Arco)

Ratification requires intent to ratify with full knowledge of the material circumstances. Itseems unlikely that the wife was aware of the full material circumstances of the leasewith the option to purchase, so therefore she could not have ratified it. (Botticello)

Ratification is usually used as a means of protection of 3rd parties, not the principal.

Woman buys clothes from man in department store who was in fact an impostor. No realor inherent authority cuz the guy wasnt an agent. No apparent authority either cuz thedepartment didnt really do anything to manifest that the guy had authority. Thealternative theory the court uses is authority by estoppel, under which the Court requiresthe woman to show acts or omissions, intentional or careless, by the department store,

which created the appearance of authority in the impostor. There has to be a good faithreliance on the appearance, and a change in position. (Hoddeson v. Koos Brothers)

Liability in Contract & Tort

Humble andHoover deal with the level of control necessary to establish tort liability.Not a bright line rule but one of degree.

Court found lack of control by Holiday Inn over the details of the day to day operationsof the hotel, so that Betsy-Lenn was not a servant-type agent. Therefore, Holiday Inn notliable for accident. (Murphy v. Holiday Inn)

Actual authority, implied actual authority, apparent authority, inherent authority, orauthority by estoppel can create duties of principal to third person by way of agent.

With respect to creating liability in principal for actions of agent, not any old agent whodoes something negligently will make the principal liable. The agent needs to be aservant type agent, not an independent contractor type agent.

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Also, you cant make a master liable for the actions of the servant if the servant is actingoutside the scope of his employment.

Old Restatement guidelines: conduct of servant is within scope of employment if andonly if the action is 1) of kind he is employed to perform 2) takes place within time andlocation space limits 3) is motivated in part by a purpose to serve the master 4) not using

force intentionally against someone else.

Even though drunken coast guard sailor does not seem to be motivated by a purpose toserve the master when turning on the valves at a dock at which his ship is docked, courtemploys new foreseeability approach to say, the govt cannot justly disclaimresponsibility for accidents which may fairly be said to be characteristic of its activities.Another way of saying this is that if the actions by the sailor are reasonably foreseeableby the government, the government should be liable. This conception relies on notions offairness. (Bushey)

The Restatement says that certain acts which are intentional torts may be within the scope

of employment but the action must be of the same general nature as that authorized, orincidental to that authorized. Orioles found liable for actions of pitcher whopurposefully pegged a heckling fan. (Manning v. Grimsley)

Gas station employee uses racial epithets against customer following dispute over a creditcard. Court says question of fact whether the employee was acting within the scope ofemployment, since the racial epithets were made while at work, while checking creditcards. And the employee may have been motivated to act in the interests of theemployer. (Arguello v. Conoco)

Govt hires independent contractor to do construction work, and contractor mistakenly

damages a neighboring building, so neighboring building owner sues govt. There are 3circumstances in which govt might be held responsible for independent contractorsaction: 1) (didnt hear) 2) when the government negligently hires a negligent contractor3) when the activity involved is a nuisance per se or inherently dangerous. Court findsthat knocking down a building in an urban area like this is an inherently dangerousactivity, such that the government can be liable. (Majestic Realty v. Toti)

Fiduciary Obligations of Agents

A few fiduciary duties of agents to their principals include obedience, care, loyalty.

Agents cannot make secret profits from misuse of his position if he does, he must turnthem over to the principal. Therefore, soldier violated fiduciary duty when used hisposition to smuggle goods. (Reading v. Regem)

Employee believes his company cannot do work for a client, so on his own refer theclient to another company, earning himself referral fees. Court says employee violatedhis fiduciary duty to the company by not informing the company that the client tried toplace an order with the company. Therefore, employee must give referral fees to hiscompany. (General Automotive v. Singer)

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Default rule is that when people create a partnership, each person has the same votingpower.

As for profit sharing, after each partner is repaid his contribution, the default rule is thateveryone shares equally in annual profits.

If one of the partners acts negligently, the entire partnership is liable for the wrongful actof the individual partner. Moreover, if the assets of the partnership dont cover theexpenses of the suit, the individual partners can also be liable for the negligent actions ofanother partner. So partnerships have joint and severable liability.

If one of the partners wants to leave the partnership, the default rule is that you canalways dissolve the partnership. Even though it might destroy economic value, he has theright to just call it quits and get bought out.

Case law helps to distinguish partners from a) employees (Fenwick) b) lenders (Martin v.Peyton) c) contractors (Southex Exhibitions)

Owner gave receptionist deal in which receptionist would get fixed salary plus 20% ofthe profits. Despite the fact that the agreement said they were partners, the court saidthey were not partners because she did not have to put up any capital, she would not sharein any losses, and she did not have any control or management rights. Element ofco-ownership is completely lacking. So the element ofprofit-sharingwas present andrelevant, but not enough. (Fenwick)

PPF loans KNK some money. In addition to profit sharing, PPF has some control rights,unlike the receptionist in Fenwick. The Court says this is what lenders do, so PPF wasnot a partner in KNK. (Martin)

Can Cargill case in which party exercising control was found to be principal bereconciled with Martin, where party exercising control was found not to be partner?

Southex and RIBA run homebuilding show together. Although there was profit sharing,Southex bore all the risk of loss, Southex seemed to have more of the control of the show,and the contracts they had were for fixed 5 years terms that could be renewed. Therefore,court said it seemed more like a service contract than a partnership. Therefore, RIBA hada right to dissolve the relationship with Southex, so that Southex was not entitled to anydamages for RIBA hiring another company to run the show. (Southex Exhibitions)

UPA 16(1) Partnership by estoppel if A has represented to C that it is a partner with Bor consented to B representing to C that A and B are partners, and then third party givescredit to apparent partnership on the faith of such representation or just gives credit, ifthe representation was public, then C may sue A on a theory of partnership by estoppel.Court finds insufficient evidence of partnership by estoppel between Price WaterhouseUS and Price Waterhouse Bahamas. (Young v. Jones)

Fiduciary Obligations of Partners

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Salmon, partners with Meinhard in lease of building, goes around Meinhard, toward theend of the building lease, to lease the entire block where the building is located. Courtsays Salmon violated fiduciary duty, because Joint venturers, like copartners, owe to oneanother, while the enterprise continues, the duty of the finest loyaltyNot honestlyalone, but the punctilio of an honor the most sensitive, is then the standard of behavior.So what exactly is the standard of conduct required of Salmon? It was not just enough

that he didnt lie; he had an affirmative duty to disclose to Meinhard of the opportunityfor leasing the block. (Salmon v. Meinhard)

103(b)(3) a partnership agreement may not eliminate the duty of loyalty under 404(b),but the agreement may identify specific types or categories of activities that do notviolate the duty of loyalty, as long as those conditions are not manifestly unreasonable.

So yes, you can bargain as to specific requirements of duty of loyalty, but may not doaway with the duty altogether.

Once a partner retires, he is no longer part of the partnership, so that the managers of the

firm had no fiduciary duty of care to him. (Bane)

Violation of duty of care is very hard to prove and win on.

Negligent mismanagement is not sufficient to create a violation of fiduciary duty underthe business-judgment rule. The business-judgment rule under corporations law says thatjust making a bad, negligent decision is not enough to make a business manager liable.The manager must have done something really, really bad or committed intentionalmisconduct in order for the manager to be liable for a business decision. (Bane)

Two partners leave law firm and take some associates and clients with them to start new

law firm. They breached their fiduciary duty because 1) they lied months earlier bysaying they were not going to leave the firm 2) bad process of soliciting clients, forexample by delaying informing the other partners of what clients they wanted to takewith them and 3) the prejudicial content of the letter to the clients in contrivance of theABAs ethical guidelines written in footnote 15. (Meehan v. Shaugnessy)

So whats ok and whats not ok when leaving a law partnership? They can leave apartnership, they seem to be able to take associates with them, and may be able to takeclients if the process is right, though they cant do things like dragging out cases so thatthe case is settled after they leave the firm instead of before.

Law partnership expels partner with history of alcohol abuse. Court finds that a firm firmdoes have a duty of good faith and fair dealing for expulsion under UPA 31(1)(d), whichcannot be contracted out of, though that duty was not violated here. Very difficult underCourts analysis to find a violation of duty of good faith. (Lawlis v. Kightlinger)

Partnership Property; Capital; Management

Woman sells half her interest in company to Shoafs; it is later discovered accountant hadembezzled money so that after recovering money from him, partnership was worth more

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than previously thought. She claims she should recover all the money, not just half of it.Court said that Mrs. Putnam did not have an ownership interest in any of the specificproperty. The partnership owned the property and she simply had an interest in thepartnership. So the only thing she could and did transfer to Shoaf was her interest in thepartnership. She had no specific interest in the property of the partnership. Therefore,the Shoafs get the other half of the money from the bookkeeper. (Putnam v. Shoaf)

What does a partner own and whether & how can it be transferred? UPA 24 saysproperty rights are 3 fold:

1) rights in specific partnership property (sec. 25), which means only possessoryrights for partnership purposes only and those possessory rights are not assignableby an individual. The possessory rights are only assignable by the partnership.

2) Interest in the partnership. (sec. 26). Interest in the partnership means thepartners share of profits & surplus. This interest in the share of profits & surplusis personal property and is assignable under sec. 27.

3) Management rights: these are equal, unless otherwise agreed (18e). Thesemanagement rights are not assignable by an individual partner. (See 18g on hownew partners get in by consent of other partners)

Management-type rights include various collateral powers. Individual partners cana) act as agent of partnershipb) bind partnership by admissions, knowledge, wrongful acts, breach of trustc) the bundle of such rights cannot be sold by the individual partners

Two partners in store. One tells Nabisco the partnership wont buy from it, but the other

partner then buys from Nabisco. Nabisco demands payment. Court says partnership canonly prevent a partner from taking an action on behalf of the partnership if there is amajority vote. There is no majority vote here since there are only two disagreeingpartners. Therefore, partner had right to buy from Nabisco and the partnership must payNabisco. (Nabisco v. Stroud)

If there had been a majority vote and the partnership notified Nabisco not to sell, then thepartnership would not have been liable to Nabisco for its sell of bread to Freeman, butthere was no majority here, so the partnership is liable.

1st partner hires an employee even though 2nd partner disagrees. 1st partner pays the

employee and then sues 2nd

partner for half the employees compensation. Court sayssince there was no majority vote on hiring the employee, partnership is not responsiblefor one partner hiring the employee. (Summers v. Dooley)

Why the difference between Nabisco and Summers? Perhaps because in Summers, it isan internal partnership dispute, whereas in Nabisco, if court ruled that the partnership didnot have to pay Nabisco, then Nabisco, a third party that had nothing to do with theinternal partnership dispute, would be left in the lurch.

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So in short, when 3rd party rights are affected, agency power trumps the deadlock.(Nabisco). When 3rd party rights are not affected, the deadlock trumps agency power.

Guy rejoins firm as partner and chairman of DC office. Firm then merges with anotherfirm so that the guy then becomes only co-chairman of DC office. He claims there was amisrepresentation and fraud by the partnership because they said that no partners will be

worse off due to the merger. He claims he is worse off by becoming co-chairman insteadof just chairman. Court disagrees, saying that the partnership agreement has no specialclause guaranteeing him chairmanship of the DC office, while other lawyers do havespecial clauses form themselves. Therefore, he had no contractual right to be chairman.Firm could have removed him at anytime. Plus, even if this knowledge that he was notguaranteed the chairmanship would have caused the guy to change his vote on themerger, it doesnt matter because his vote would not have affected the outcome of themerger vote. (Day v. Sidley & Austin)

Mother who is partner brings her child to work and child gets injured. Father of childsues. Court decides that the mother was acting as partner in the ordinary course of

business when she negligent, so that the partnership is responsible for the mothersnegligence, and the partnership cannot recover from the mother. (Moren v. JAX)

In real life, a principal can try to collect against an agent, so why cant a partnership sue apartner? UPA says otherwise for partnerships, giving individual partner the right torecover from the partnership for negligent actions they committed while in the ordinarycourse of business.

Partnership Dissolution; note on LPs

A partner can dissolve the partnership at any time he likes, though of course he may pay

damages if its in violation of the partnership agreement, but the fact remains he still candissolve the partnership. (this is in stark contrast to a shareholder not being able todissolve a corporation or his relationship with it).

According to Sec. 38, the rights of partners to partnership property differs dependingupon whether the dissolution is in contrivance of the partnership agreement or consistentwith it.

That is why plaintiff in Owen v. Cohen asked the court to dissolve the partnership basedon the defendants action rather than just dissolve the partnership himself before the termof the partnership was up, in potential contrivance of the partnership agreement.

Main themes:

1) Partner X can dissolve or dissociate from partnership at any time.

2) But consequences depend on wrongful/rightful distinction, and on other factors.

3) If dissolution wrongful, Xa) does have the right to be paid off at her interest, but

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b) perhaps paid over time or in future; with offset for damages; & otherpartners have right to continue partnership business.

See UPA 38 and RUPA 701, 701.

4) If dissolution rightful, X is bought out at value of his interest. Partnership iswound up and partners all get payment in cash. Unless - there are many issues

of implementation, waiver, agreement, and courts may assert equitable powers.

5) Default rule distinction between partnerships at will v. those for a term or specificundertaking.

-dissolve former -> rightful; dissolve latter-> wrongful (unless term over)

-There are other triggers of dissolution, e.g. death, unlawful business and someothers, e.g. court decrees about impossible partner may lead to wrongful dissolutionremedies (Owen v. Cohen)

5) Default rules about who can dissolve rightfully under what conditions and howdissolution is carried out can be changed by contract between partners.

Partner wants to get out of 30 year partnership, claiming mismanagement by his partner.Court disagrees, saying there was no mismanagement, so the partner can dissolve only incontrivance of the agreement, with all its consequences, eg potential damages. (Collins)

partnership is a partnership at will, so you can dissolve the partnership at any time, BUTthe partners have a fiduciary duty of good faith in the dissolution and winding up of thepartnership. So if the one brother decides to dissolve the partnership, but then opens upanother linen business and has a lot of the same old clients, this would be a dissolution in

bad faith, violating his fiduciary duty to his partner. If he dissolves in bad faith, the Courtwill make the dissolving partner compensate the other partner. (Page v. Page)

A partner may not dissolve a partnership to gain the benefits of the business for himself,unless he fully compensates his co-partner for his share of theprospective businessopportunity.

Loss sharing by partners default rule: share losses same way as profits.

Court says default doesnt apply when one side supplies all the capital and the othersupplies all the labor. In that case, in the absence of agreement, the partner who supplies

all the capital must pay for all the loss, while the partner who supplies the labor/servicesdoes not have to pay for the loss. (Kovacik)

The reason they make this rule is that the services providing partner is in a sense alreadylosing the cost of his labor, so its only fair that the capital providing partner should bearthe capital losses.

Kovacik rule has been rejected by RUPA, which says the partners should split the lossesequally.

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Partners file a suit to dissolve partnership and buyout a drug-using partner. The drug-using partner then dies. Question whether filing the suit created dissolution becauseestate of drug-using partner will be compensated differently depending upon whether ithas to be a buyout after dissolution or a buyout after death of partner. Court saysdissolution was not caused by the filing of a lawsuit; dissolution only comes with a

judicial decree. (G&S Investments)

Question of how partners leaving law firm should compensate the old firm for takingclients. If they took the clients ethically, then they compensate based on the partnershipagreement. If they took the clients unethically, then they have to disgorge all profits theymake off these clients to the old firm, such that it would be as if the partners continued towork for the old firm on these client matters. (Meehan v. Shaugnessy)

NATURE OF THE CORPORATION

Why Corporations

1) Investors have limited liability in corps, whereas partners liable for actions ofpartnership and often vice versa.

2) More restrictions on transferability of interest in partnership than interest incorporation

3) Each partner can kill a partnership. The corporation is perpetual and can only bedissolved by majority vote

4) Managerial power partnership model is all for one, one for all. Corporate model

of management is director primacy; power of corporation is mostly in the board

Limits of Limited Liability - Piercing the Vail and Related Doctrines

Cab injures man, but cab is owned by corporation, which is owned by Carlton. Thecorporation has minimum liability insurance and minimum capital legally allowed,Carlton owns 10 of these cab corporations, and when capital accumulated, Carlton wouldwithdraw assets as dividends as fast as he could. Injured man therefore wants to piercethe corporate veil and sue Carlton, claiming the corporation is a dummy corporation thatis Carltons alter ego. Court doesnt see much wrong with setting up corporations tominimize corporate liability, because isnt that the basic idea of corporations? It

therefore refuses to pierce the corporate veil. So the key seems to be whether Carltonseems to operate the corporation in his individual, personal capacity, or only as thedirector of the corporation. (Walkovsky v. Carlton)

Marchese uses lots of corporations with minimal assets similar to Carlton above to avoidliability. Plaintiff seeks to pierce the corporate veil. Court expounds piercing thecorporate veil test:

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1) such unity of interest and ownership such control that separate personalities nolonger exist

The factors we look at here are i) failure to have records or formalities ii) commingling offunds or assets iii) undercapitalization iv) treating corp assets as shareholder assets, ie amessy relationship

2) under the circumstances, adherence to the fiction of a separate entity wouldsanction fraud or promote injustice

On remand, court allows piercing corporate veil as well as reverse pierce of the otherfirms that Marchese owns. (Sealand Services v. Pepper Source)

Fraudulent Conveyance Law - its ok to be pay dividends and such, but not when you areinsolvent or when the dividend leaves you with an unreasonably small amount of capital.Then, it will be looked at as a fraudulent conveyance of money to which creditors have aright.

Piercing the corporate veil is a somewhat looser form of this fraudulent conveyance law.

Question whether corporate veil of MEC could be pierced to sue its sole shareholder,Bristol, in breast implant products liability dispute. Court uses totality of thecircumstances test to determine whether Bristol had substantial domination of MECwhich made the wholly owned subsidiary the alter ego of the parent company.

Some of the important factors are that they have common directors and officers, thecompanies filed consolidated financial statements and tax returns, the subsidiary operateswith grossly inadequate capital, Bristol represents that the breast implants are its

products, etc. Based on this, corporate veil may be pierced at trial. (Silicone Gel)

Limited partners in a partnership no liability for partnership but in exchange for noliability, they must not be involved in management decisions.

Limited partners have gotten around problem of having to choose between no liabilityand management power by setting up a corporation to be liable partner of the corporation,but with them heading the corporation. But they do not technically participate inmanagement and control of the limited partnership as themselves, but as agents of thegeneral partner corporation. Therefore, they can run the partnership but not be liable.Court upholds this scheme, so that limited partners are not personally liable. (Frigidaire)

Shareholder Derivative Actions

On direct v. derivative distinction Eisenberg v. Flying Tiger Line

On the demand requirement Grimes v. Donald, and Marx v. Akers

On special litigation committees (SLCs) Auerbach v. Bennett, Zapata Corp v.Maldonado, In re Oracle Derivative Litigation

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Eisenberg sues in a direct action, not derivative action, because if he files a derivativesuit, he would need to post security for expenses of the corporation This requirement forposting security is used in order to prevent frivolous strike suits. Court says Eisenbergcorrectly filed a direct suit. (Eisenberg)

Direct action brought by the shareholder in his or her own name. Cause of actionbelongs to the shareholder in his individual capacity. Arises from an injury directly to theshareholder. Monetary recovery of other benefit goes to shareholder.

Derivative action brought by a shareholder on corporations behalf. Cause of actionbelongs to the corporations as an entity. Arises out of an injury done to the corporationas an entity. Monetary recovery goes to corporation.

When shareholder wants to bring a derivative action, the directors are often able to refuseto take action under the business judgment rule.

In that situation, the shareholder would have to first make a demand on the directors inthe derivative suit. (unless demand can be excused)

Corporation could either agree to the demand and take over the case. Or the corp couldalso say no, they wont sue, after examining it. That would probably be the end of thecase because it would be hard to show wrongful refusal of the demand.

Demand will be excused where the board has a material financial interest and cannot betrusted to make a fair business judgment. Also demand can be excused where theplaintiff shows with particularity that the board did not engage in the minimallyinformed, adequate process worthy of BJR protection.

In a direct action, no need to make demand on directors nor argue about businessjudgment, nor post security for expenses.

In response to a derivative action or not, a board can create a special litigation committeewith the power to investigate the transaction and offer a recommendation.

If ones voting rights are injured, it is a direct action.

Plaintiff in derivative suit makes demand on board, which refuses. He then claimsdemand is futile, but Court says you cant claim demand would be futile after you make

demand; you can only claim demand futility before you make the demand. (Grimes)

When demand is made and refused, the legal standard for judging the refusal is the BJR.

Delaware Demand Fulility Test:

Plaintiff must allege particularized facts (using tools at hand before discovery) creatingreasonable doubt that board is capable of making a good faith decision on the suit.Plaintiff could show:

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Majority of board has material financial or familial interest in transactioncomplained of

Majority of board is dominated/controlled by alleged wrongdoer or interestedparties OR

Underlying transaction not product of valid exercise of business judgment (thisleaves some discretion with the court)

New York test (Marx v. Akers):(1) Director interest/domination(2) Good process, esp. info gathering(3) so egregious test

Delaware standard for reviewing special litigation committee recommendation ofdismissal? (Zapata v. Maldonado)

(1) inquiry into independence/good faith of committee; inquire into bases supportingcommittees recommendations

(2) court may go on to apply its own business judgment as to whether case is to bedismissed.

Corporation has burden of proving independence, good faith, and reasonableinvestigation by the special litigation committee.

Key general issue: who counts as independent director for purposes of getting judicialrespect for special litigation committee recommendations? Directors who are universityfaculty members when defendant directors and officers have made modest gifts touniversity and have considered making very major ones? (Oracle Derivative Litigation)

In sum, shareholders usually cant just bring a derivative action, they usually must make

a demand first upon the board to take an action. If the board refuses, it is very difficultfor the shareholders, who want to sue, to overcome that refusal. The shareholders have toallege with particularity some facts that create a reasonable doubt that the directors weredisinterested and independent, or that the boards decision was way beyond any rationalbusiness judgment.

Derivative suits often have little success, and the success they did have has been modest.Recently, there has been a shift to class action suits, rather than derivative suits.

Role and Purposes of Corps

Charitable contributions are allowed if the directors judge that they will contribute to theprotection of corporate interests. Court therefore says the corporation was allowed tomake the charitable contribution to Princeton. (Barlow)

Other states have different allowances for corporate donations eg California and NewYork corporate code gives corporations the power to make donations, regardless orirrespective of specific corporate benefit.

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Power to declare dividends is in the board of directors of alone, and courts will notinterfer UNLESS it clearly appears they are guilty of fraud or misappropriation, or therefusal to declare dividends amounts to such an abuse of discretion as to constitute fraudor breach of good faith that the directors are bound to exercise. Court finds Henry Fordbreached this standard by limiting dividends to shareholders and using the money tobenefit employees and consumers of Ford cars (up-front stakeholderism or constituency

approach to corporate purposes). (Dodge v. Ford Motor)

Part owner of Cubs sues, claiming refusal of Wrigley to have Cubs night games is bad forbusiness and motivated by concern for the neighborhood, not profit maximizing. So likein Ford case, this is another assertion of primary corporate purpose and an attack onmanagerial assertion of stakeholderism. Why does Wrigley win but Ford loses? TheCourt here uses a standard of showing of fraud, illegality, or conflict of interest in orderto side with the plaintiff, whereas the standard in the Ford Motor Company case was thatthere had to be a breach of good faith by the directors. There are no statements in thiscase by Wrigley which are like the statements of Henry Ford that he is looking out for theinterests of workers and consumers. Because there are no statements like this, the Court

is willing to assume that Wrigley is exercising his business judgment that being nice tothe neighborhood is good for business, even if that business judgment is wrong.(Shlensky v. Wrigley)

Corporate charitable giving is in legal in almost every state.

matters of conscience exception allows corporations to cease participating in legal butseriously unethical business activities (ie involvement in apartheid, genocide, etc.)

FIDUCIARY DUTIES OF OFFICERS ET. AL.

Duty of Care

Three important Delaware opinions: Van Gorkam case (in merger context), Brehm v.Eisner case (in executive compensation context), Caremark opinion (dealing withproactively set up systems for dealing with legal violations)

Plaintiffs sue claiming decision to give dividends in subsidiary as opposed to sellingsubsidiary a waste of corporate assets that violates the boards fiduciary duty of care. theCourt holds that it wont interfere with the directors discretion just because the decisionappears mistaken. The Court says it will only interfere if there is fraud, illegality, self-dealing by majority of the board, bad faith, or nonfeasance. This is a strong statement of

the business judgment rule by the Court. (Kamin v. American Express)

Mother shareholder pays no attention as her sons fleece the corporation by having thecorp give loans to themselves. Court find she violated fiduciary duty of care. This casecan be distinguished from Kamin in that here the wife made no business judgmentwhatsoever, whereas at least in Kamin a business judgment, though perhaps bad one, wasat least made. (Francis v. United Jersey Bank)

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So the lesson of the case is that the business judgment rule doesnt protect a director fromnonfeasance. A director has to take some minimum level of action to undertake herduties as director.

Affirmatively: director must know rudiments of business, keep informed, attendmeetings, do general monitoring. Must basically go through basic motions of being a

director. If not, can be liable for duty of care violation.

So these two cases taken in conjunction suggest that as long as the directors go throughthe basic motions, they will be safe under the business judgment rule.

Board rubber stamps decision of CEO to merger with another company. Court findsboard violated duty of care, saying the process by which the board approved the mergerwas wholly inadequate, because the board spent very little time analyzing the mergeragreement, and in fact approved it sight unseen. Also, the board never hired aninvestment bank to analyze the fairness of the proposal. (Smith v. Van Gorkom)

Key legal point of Van Gorkom: The directors breached their fiduciary duty of care totheir stockholders 1) by their failure to inform themselves of all information reasonablyavailable to them and relevant to their decision to recommend the Pritzker merger.

Notice here the Court requires the directors to get allinformation reasonably available,not just all materialinformation reasonably available.

As a result of this case, Delaware and other states passed statutes saying that corporationsmay pass charter amendments which eliminate monetary damage of directors forviolations of duty of care (statute doesnt apply to violations of duty of loyalty or acts notin good faith and statute only applies to directors, not officers). Virtually all Delaware

corps have adopted this charter provision shielding directors.

Disney gives large severance package agreement to Ovitz, and then terminates himwithout cause, resulting in much larger severance than if they terminated with cause.Court ruled these board decisions were acceptable under BJR so that there was noviolation of duty of care. (Brehm v. Eisner)

Key legal holding of Eisner: Substantive due care concept is foreign to the businessjudgment rule in Delaware. Due care in the decisionmaking context is process due careonly. Irrationality is the outer limit of the business judgment rule.

Directors can protect themselves by relying on experts.

Ratchet phenomenon all the children are better than average. So with respect toexecutive compensation. Companies want to pay their executives better than average,which causes a great ratcheting up of executive compensation.

Derivative suit against board for failing to properly monitor actions of company, whichresulted in company breaking law and having to pay major fines. Suit settled forattorneys fees and better oversight procedures in the future. Question whether

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settlement is fair and reasonable, because once settlement is approved, all shareholderslose right to sue directors on this matter. Court says board of directors have duty of careto attempt in good faith to assurea corporate information and reporting system, butthe level of detail appropriate for the required info system is a question of businessjudgment, though there does need to at least be some legal monitoring system Courtapproves settlement as fair and reasonable because under this conception of the duty to

monitor, it would be unlikely for the plaintiffs to succeed, so it makes sense for thesettlement to be modest. (Caremark)

No duty to monitor the personal activities of one of its employees. Therefore, thedirectors committed no breach of duty to monitor in failure to monitor Martha Stewartstrading activities. (Martha Stewart Litigation)

The Delaware Supreme Court approved the Chancerys decision, but on differentgrounds, saying that the plaintiffs failed to demonstrate demand futility since the majorityof the directors were independent, despite friendships with Martha.

Duty of Loyalty - Interested Director Transactions and Corporate Opportunity Doctrine

Key Legal Principle - The Court, citing a SCOTUS case of Pepper v. Litton from 1939,said that when an interested-director transaction is challenged, the burden is on thedirector not only to prove the good faith of the transaction but also to show its inherentfairness to the corporation. So the duty of loyalty seems a lot stronger than the duty ofcare, which is diluted in large part by the business judgment rule.

Directors pass this duty of loyalty test when they are sued for hiring the wife of the CEOto perform on a radio show sponsored by the company. (Bayer v. Beran)

Shareholder sues, claiming directors are using one corporation for the benefit of anothercorporation for which they are directors in violation of their duty of loyalty. Court saysthat because this is a conflict of interest situation, the business judgment rule does notapply. And the burden is on the directors to show that the lease was fair and reasonableto the corporation. Court find directors fail to satisfy this burden, as they never attemptedto figure out fair rent and acted as if the corporation existed solely for the benefit of theother corporation. This is a classic example of self-dealing by directors. (Lewis v. SLE)

Corporate opportunity doctrine: If business opportunity is presented to D or O which

1) corp is financially able to take

2) is in corps line of business3) is one in which corp has an interest or a reasonable expectancy4) taking by the Do or O will bring his self-interest into conflict with corps interest

then law will not permit him to take it.

Director of company takes an opportunity to buy something. His company wasntinterested in that thing, but the corporation that was trying to buy his company was alsotrying to buy that thing. Court found the director did not have to take the interests of this

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acquiring corporation into account in determining whether to buy the thing. (Broz v.CIS)

In re Ebay corporate opportunity doctrine violated

Duty of Loyalty Dominant Shareholders and Stockholder Ratification

Sinclair has its subsidiary Sinven give out big dividends, which plaintiffs claim is used bySinclair to expand its operations abroad, but that Sinvens profits should have been usedto expand Sinvens operations. So the claim is that Sinclar took Sinvens corporateopportunities.

If self-dealing, intrinsic fairness rule applies with burden on Sinclair, if no self-dealing,then business judgment rule applies and burden on plaintiffs.

Court finds self-dealing with respect to a contractual claim, but not with respect tocorporate opportunity claim as the plaintiffs have shown no opportunities that came to

Sinven, which Sinven lost to Sinclair. (notice this difference with the later Broz case thatdidnt requires that the opportunities independently come to CIS) (Sinclair Oil)

Dispute over redemption of certain types of stock. Court finds controlling shareholder,who appointed a majority of the board, had a fiduciary duty to fully inform Class Ashareholders of the value of the firm when it calls Class A shares, so that the Class Ashareholders can decide whether to convert instead. (Zahn v. Transamerica Corp.)

What is important for ratification is not whether a majority of shareholders generallysupported the transaction, but whether a majority of the disinterested shareholderssupported the action. So, since a majority of the disinterred shareholders did not support

the purchase, any issues of self-dealing by the directors had not been cured. Because theself-dealing nature of the transaction had not been cured, the intrinsic fairness standardneeded to apply and burden was on the directors to show the intrinsic fairness. (Fliegler)

Easier to claim self-dealing decision by directors was not ratified if there was not fulldisclosure to the approving stockholders.

3 standards of review, and then the effect of shareholder ratification:

1) for arms length transaction? Business judgment rule with burden on plaintiff

2) for interested director transactions? burden on defendant to show inherent fairness oftransaction, unless there is ratification by disinterested directors and shareholders, inwhich case the burden is on the plaintiff to show a violation of the BJR.

3) For controlling shareholder-arranged mergers? Intrinsic fairness (stronger thaninherent) needs to be shown and burden on defendant, but if there is ratification, then theburden is on the plaintiffs to only show that the deal is not fair (doesnt need to showviolation of BJR). So when there is a controlling shareholder-arranged merger rather

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than an interested director transaction, it is easier for plaintiffs to win. This was the casein Wheelabrator.

Disclosure: registration of securities

Whats a security? (Great Lakes)

Whats a public offering? (Doran)

Public offerings of securities must be registered with SEC. The purpose is to mandatefull disclosure and deter fraud; not substantive regulation

Section 5 rules of the road:a) Dont offer securities for sale before registration statementfiled. What

is an offer is broader than you think.

b) Dont sell securities until registration statement is effective. Usually

effective when SEC says so.

c) Deliver statutory prospectus to each buyer before sale.

Great Lakes buys company from Monsanto. Great Lakes sues, alleging that there werematerial mistakes and omission (MMOs) in the sale of security to Great Lake.

There was nothing wrong with registration statement, because Monsanto made noregistration statement to the SEC, because this sale doesnt seem like a public offeringwhich would require registration with the SEC. Case turns on whether the company wasa security under 33 or 34 of 1934 Securities Act. (Great Lakes)

Security is any note, stock, treasury bond, evidence of indebtedness, and some openended categories like investment contract. General partnership interest is not a security.

Five factor test on p. 410 of what are the common features of stock: a) dividend rights b)negotiability c) right to pledge/hypothecate 4) voting rights 5) ability to appreciate invalue.

Investment contract: 3 elements: a) investment of money b) in a common enterprise c)with profits to come solely from the effort of others

Horizontal v. Vertical commonality see p. 413

Doran claims that there was no registration statement, so that the sale of the limitedpartnership interest to him violated Sec. 5, so that he says he should be able to rescindunder 12(a)(1). Defendant claims it is exempt from registration as private placementunder 4(2).

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Consider four factors in determining whether this a private placement 1) number ofoffeeres & relationship to issuer & each other 2) number of units offered 3) size ofoffering 4) manner of offering.

Court says this is a private placement under latter 3 factors, but 1st factor is the mostimportant. To satisfy 1st factor, the defendant must show that all offerees were financially

sophisticated plus had access (either access because of actual disclosure or because ofactual access to the offerors information). And not just Doran had to be sophisticatedand have access, but every offeree did. (Doran)

There is now a private placement exemption safe harbor under Regulation D if you areoffering interests that under certain values.

Court found MMOS in registration statement filed by company. Directors then sued. Forexpertised parts of the registration statement, the directors just need to show they had noreasonable belief that the statements were false. For non-expertised parts, they have toshow they had a reasonable belief that the statements were true. Court found defendant

failed to satisfy these due diligence defenses. (Escott)

Later opinions have taken a more understanding approach to reasonable investigations.

If director found guilty of this sec. 11 violation, it doesnt mean he was negligent, justthat he was unable to prove due diligence, which makes it likely he will be able to beindemnified by the company and by insurance.

Rule 10b-5

Even though merger negotiations were ongoing, Basic repeatedly denied that negotiations

were taking place. Soon after, merger completed. Shareholder who sold before mergerwas announced, saying Basics false denials depressed the stock price. Court said thatthe existence of negotiations could be material before an agreement in principle had beenreached. (Basic v. Levinson)

The principle of materiality that a misstatement or omission is material if there was asubstantial likelihood that a reasonable investor would consider it important in decidingwhether to buy or sell. Very fact dependent standard

Basic should have just said no comment, as court says that omission by silence is ok aslong as there is no duty to disclose, and there is no duty to disclose merger discussions.

Can plaintiffs show reliance on misstatements by invoking the fraud on the market(FOM) theory? Fraud on the market theory is that in an open and developed securitiesmarket, publicly available (mis)information will affect the market price. This seems tobe a soft version of the efficient capital markets hypothesis.

The Supreme Court accepts this theory, such that there is a rebuttable presumption thatthe denial of the mergers affected the market price, so that it is therefore not necessary for

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the individual plaintiffs to show that they read and relied on the merger denials in sellingthe stock. This holding allows plaintiffs to bring class actions based on misinformation.

Under the fraud on the market theory, onlypublicly available (mis)information will affectthe price. In this case, the misinformation was only privately available, so there will beNO rebuttable presumption of reliance based on the FOM theory here. (West)

Court concludes two misstatements were material: 1) that company had a patent, whereasthey were only in the process of getting the patent 2) merger agreement was imminent,whereas the deal was not even close to being completed. (Pommer v. Medtest)

Majority shareholder seeks to buy out rest of shares of company. Some minimumshareholders sue under Rule 10b-5, claiming price offered was wholly inadequate. Butthe statue did offer minority shareholders the opportunity to get a reappraisal in theDelaware Courts. Court dismisses the case, saying that an action under 10b and Rule10b-5 requires deception or manipulation., such as a MMO, but none alleged here. Onlyallegation is that there was a low-balled appraisal. (Sante Fe Industries)

Key point is 10b and 10b5 only apply to manipulation and deception.

Rule 10b5 covers options, so buyer of option has standing under 10b5 to sue corporationand officers for MMO. (Deutschmann)

Rule 10b5 MMO Actions: Overview of Elements

Implied private right of action? yes

Jurisdictional prerequisite? Easy to satisfy use of mails, instruments of interstate

commerce

Must plaintiff be actual buyer or seller of security? Yes, see blue chip stamps case.(SCOTUS, 1975)

Must plaintiff show bad mental state of defendant? Yes, Ersnt & Ernst. (SCOTUS, 1976)Scienter (includes recklessness)

Must plaintiff show deception and manipulation? Yes, Santa Fe Ind. (SCOTUS, 1977)

Standard of materiality? Basic Inc. (SCOTUS, 1988) formulation

Proof of reliance? Actual or, if appropriate, FOM

Proof of loss causation? Needed, See Dura (SCOTUS 2005)

Loss Causation a causal connection between the material misrepresentation and the loss

Dura claims it was going to get FDA approval, but FDA later disapproved. Investorswho bought stock before the FDA disapproval sue. Simply showing that the investor

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bought at an inflated price is not enough to prove loss causation. To prove loss causation,you have to prove other facts that nothing else was affecting the price at that time. Also,members of class who bought after Duras statement will also have to have sold after theFDA disapproval was announced.

How does one prove that the price went down after the FDA disapproval because of the

FDA disapproval? And how does one prove that the price was inflated due to the overlyoptimistic statement by Dura? Court didnt specify exactly how you go about provingloss. (Dura Pharmaceuticals)

Inside Information

Old case - Director of company buys more company stock based on inside knowledge.Man who sold stock to him sues the director. The Court said the directors do not have afiduciary duty as trustees to the corporations shareholders. They only have a duty to thecorporation as an entity. If there was a personal relationship between the buyer and the

seller, then perhaps there would be a duty to disclose the inside information, but this wasan impersonal trade through a broker, so there was no duty to disclose here. (Goodwin)

SEC sues directors for insider trading on info about potentially massive copper discovery.The Courts main holding is that, under Rule 10b5, if the insiders had material nonpublicinformation, they either had to disclose the information or abstain from trading. This isthe famous disclose or abstain rule. So this ruling basically says that Rule 10b5outlaws insider trading. (Texas Sulpher)

Information is material if the information would affect the decision of a reasonableinvestor about whether to buy the stock or not. Two part test: 1) would a reasonable

investor think this is important 2) and this encompasses any fact that in reasonablecontemplation mightaffect the value/price of the stock. Court says information onpossible copper discovery is material here.

Reasons for disclose or abstain rule: 1) Congressional purpose that all investors onimpersonal exchanges have relatively equal access to material info. 2) insiders access tomaterial nonpublic information is for corporate purpose, not for personal benefit nosecret profits reasoning found in fiduciary law generally.

When you are in arms length market transactions, there are no fiduciary relationships

Dirks, a broker, finds out about massive fraud at a company, so he tells his clients to selland he also tries to get the Wall Street Journal to publish a story about the fraud. SECsues Dirks, claiming the tippee inherits an insiders disclose or abstain obligationwhenever he receives inside information from an insider

Court says the tippee inherits the duty when the insider breaches his fiduciary duty to theshareholders by tipping and the tippee knows or should know the insider is breaching.The breach depends on the insider getting a personal benefit. If the insider does not get apersonal benefit from tipping, then he has not violated a fiduciary duty to the

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shareholders. The insider didnt breach duty by disclosing, since he got no personalbenefit, so that Dirks inherited no duty himself. (check on this)

Dorsey & Whitney lawyer, working for Grand Met on tender offer it is going to make toPillsbury, trades Pillsbury stock based on this secret information which he was supposedto keep secret. Even though the lawyer was not an insider of Pillsbury or even

Pillsburys lawyer, Court used the misappropriation theory to find the lawyer guilty ofviolating Rule 10b5 insider trading. (OHagan)

Misappropriation theory, p. 503 a person commits fraud in connection with asecurities transaction, and thereby violates 10b and Rule 10b5, when he misappropriatesconfidential information for securities trading purposes, in breach of a duty owed to thesource of the information.

So here, the lawyer is misappropriating confidential information from both Dorsey &Whitney, and Grand Met, in breach of a duty owed to both of them.

Court also relies upon another theory to find liability, called 14b3, which specificallyprevents certain people, such as the lawyer, from trading in a companys stock in advanceof the company receiving a tender offer. It is clear that the lawyer violated 14b3.

Section 16(b)

Directors or officers or those who own more than 10% of a class of equities areconsidered insiders. Under 16b, if these insiders both buy and sell a firms stock within asix-month period (the order is irrelevant), all those profits most go to the corporation.

10b5 applies to trading in bonds and notes, not just stock, so 10b5 is much broader than

16b. 16b applies to only 34 Act filers. Contrast this with Rule 10b5.

If there are multiple sales & purchases within the 6 month period, the sales & purchaseare matched so as to maximize profits, and thereby maximize the amount that has to bepaid over to the corporation. The rule is pretty brightline.

The remedy for violation is by private derivative actions.

A director or officer is caught if he has this status either at the time of purchase or at thetime of sale. He need not be a director or officer at both times. But if you are an insiderby virtue of owning more than 10% of the stock, you must own more than 10% at the

time of both purchase and sale.

Go over p. 523 16(b) questions before exam.

Indemnification & Insurance

Competing policy considerations want to deter fiduciaries from breach of their duties,but want not to deter prudent talented people from serving as fiduciaries.

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Sources of protection:

a) exculpation provisions in charters Cf. 102(b)(7)b) Indemnification statutes, eg DGCL sec. 145c) contractual promises to indemnify in bylaws, charters, etcd) D & O Insurance

Indemnification under DGCL Sec. 145. Overview of subsections:

a) Corp power to indemnify expenses, ie legal fees, and amounts paid in 3rd partysuits if person acted in good faith & with reasonable belief, etc.

b) Corp power to indemnify expenses only (no damages) in derivative actions ifperson acted in good faith & with reasonable belief and person not adjudgedliable to corp (except)

c) Corp obligated to reimburse expenses if defendant is successful on the merits or

otherwise.

To cover situations in which the corporation cannot indemnify directly the employee, thecorporation will often buy D & O insurance, which will indemnify the employee instead.

Chance that director or officer may not be able to be indemnified if he loses, but that hewill be able to be indemnified if he settles, thereby encouraging him to settle lawsuits.

Rules that regulate advance of legal fees by corporation.

Dispute over whether corporation has to indemnify employee who settles lawsuit. Courts

says despite corporate charter requirement to indemnify in absence of finding of goodfaith, there is still a good faith indemnity requirement under 145(f) that must be followed.

Also, in suit against both corporation and employee, which settles, the corporation has topay a lot of money to the plaintiff but the employee doesnt have to pay anything. Courtagrees that the employee was therefore technically successful in the suit, and should havehis legal fees paid for accordingly.

Company sues employee for 16(b) violation. Court says company has to advance legalfees even though the company would not have to pay legal fees if the employee settles orloses. But he hasnt settled or lost yet, so until then, he has a right to an advance of the

legal fees. If he does settle or lose, then he would presumably have to pay back the legalfees. (Citadel Holding)

SOX AND RELATED REFORMS

Major sources of corporate governance changes:Federal Sarbanes-Oxley Act of 2002 (SOX)1) NYSE corporate governance rules added to listing requirements in mid-20032) Governance rating systems by independent agencies (the GRAs)

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3) Stricter tone in state case law (e.g. Oracle, Disney)

SOX-related corporate governance changes 4 main themes:1) fix audit process2) change board of directors3) improve disclosure

4) empower shareholders?Audit-related changes (reducing conflict):

1) limit auditors non-audit services:

a) prohibit some (info tech consulting, valuations, actuarial services, helpdoing internal audit work, etc.)

b) Disclose size of non-audit & audit fees (which can affect governanceratings)

c) GRA (government rating agencies) campaigns to limit non-audit work.

2) Shift power to hire, fire, pay the auditors (from management or board to auditcommittee and audit committee members have to have greater independence)

3) Reduce personal bonding between auditors and the audited (by mandatorypartner rotation and limits on hiring audit firm employees such as with coolingoff period)

Audit related changes (inducing action):

1) Require internal controls, eg making sure the company has documentedprocedures to make sure that numbers are input properly and not falsely

(hundreds of little rules in this regard), and Sec. 404 attestations.

Notice that what has happened is that we told accounting firms that they cantdo all this extraneous non-auditing work, but now they have to do all thiswork under Sec. 404 to ensure that the internal controls and processes areadequate, so there is a question whether the accounting firms have in factbenefited from SOX despite the limits on what kind of work they can do.

2) Financial literacy and expertise (in audit committee members)

3) New regulator: PCAOB (Public Company Accounting Oversight Board) (the

regulations they pass are supposed to improve the quality of audits)

Board-related Changes (conflict-reducing standards):1) majority of independent directors (IDs)2) stricter definitions of independence3) ONLY IDs on key committees.4) Must have key committees: audit, compensation, nominating committees.5) Supermajority of IDs?6) Independent chairperson of board

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7) Regular executive sessions

Board related changes (action-inducing standards):1) financial literacy and expertise2) limits on over-boarding (how many boards certain people can sit on, in order to

make sure people have the time and ability to do an adequate director job)

3) director stock ownership (governance ratings agencies want this in order to alignincentives of directors with that of shareholders)

4) governance guidelines & codes of ethics5) self-assessments

What do boards do? Management and monitoring. Management depends on collegiality,but monitoring depends on impartial policeman attitude.

The Big Questions: The SOX-related corporate governance changes all shift the Boardsrole from the management to the monitoring side. How seriously does this hurt theboards managerial role?

Transparency enhancements: More and faster public disclosures

Shareholder Empowerment - Some boost from SOX-related changes:

1) shift from staggered boards to annual election of all directors2) shareholder nomination of directors (proposed SEC rule)3) movement for majority vote requirement in director elections (ongoing)

Whats a majority vote? A majority of the shareholder votes cast, or a majority of thetotal possible shareholder votes?

The vast territory of unchanged governance: Areas still under same state and federal lawsthat existed before SOX:

1) substantive corp law on self-dealing, executive compensation, private benefitsof control, etc.

2) substantive corp law on mergers, takeovers, other large transactions3) substantive corp law on basic allocation of power among officers, directors,

shareholders4) law on private enforcement of the above (derivative suits, etc.)

Post-SOX Corporate Governance Changes

Major legal change depends on a bandwagon effect. BUT, bandwagon-generatedreforms may be very sub-optimal or even perverse. Therefore, what is necessary isreform as a continuing work in progress.

Big issues today are executive pay, eg pay for performance, and director elections, egmajority voting, among others.

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Big issue is that the Federal rules say that a corporation, when faced with a different slateof directors, can either mail the challenging partys proxy statement out or give them ashareholder list. However, the challengers want the list so they know who the owners ofbig chunks of stock are and concentrate on them. Knowing this, the corporation rarelywill give out the list under the Federal rules. Many state rules require corporations togive out the list, though.

PROBLEMS OF CONTROL

Shareholder Voting Control

Court says non-dividend bearing shares representing a negligible investment amount canbe considered shares for voting rights purposes. (Stroh v. Blackhawk Holding)

Illinois allows shares to be considered shares if (1) right to participate in control of acorporation, (2) in its surplus or profits, OR (3) in the distribution of its assets.

The Illinois constitution (and many states) now allow for different voting shares fordifferent classes of stock.

Voting rights may be limited within a class of stock as well as between stocks.(Providence &. Worcester)

Corporation holds open polls during shareholder meeting because its resolution will lose.It then holds another meeting later, for which it had solicited certain shareholders to comeand vote for its resolution, and at this meeting it wins the resolution and closes the poll.In order to determine whether there was a breach of duty of loyalty by adjourning themeeting without closing the polls on proposal, there is a two-part test:

1) Plaintiff must establish that the board acted for the primary purpose ofthwarting the exercise of a shareholder vote/stockholders are not given a full andfair opportunity to vote. If so

2) Board then has burden to demonstrate a compelling justification for its actions.

Court found the primary purpose was to thwart the exercise of a shareholder vote and thatit was doubtful there was a compelling justification to do so, but it said the record neededto be developed further in this regard. (SWIB v. Peerless Systems)

Proxy fights; Private actions re Proxy Rules

Corporations have to have meetings every year for the election of directors and for votingon other important issues. Some companies have all directors up for election each year,others have a staggered board. A lot of this depends on state law. Certain notice rulesand quorom requirements have to be met for these annual meetings.

Many people cannot attend these meetings, and its not worth them to do so since theyown so little stock. These people can have someone vote for them by proxy. See 14a 7-9

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Proxy fight over MGM. Directors of MGM pay for the proxy fight expenses for thedirectors upcoming election. Court says this was ok, because these expenses wereundertaken in an open and obvious manner, and these expenses were reasonable. Plus,these expenses are undertaken in a fight about key policy decisions of the company. Theresult might be different if the proxy fight was a personal dispute between incumbents

and challengers. (Levin v. MGM)

May successful insurgents get their proxy-fight expenses reimbursed by the corporation ifthey are successful? Yes, with stockholder approval. Do incumbent directors and officersneed to get stockholder approval for proxy-fight expenses? No, apparently the businessjudgment rule applies. Note that the expenses need to be linked to the dispute aboutbusiness policies, not just personnel disputes. (Rosenfeld v. Fairchild Engines)

So incumbents can make reasonable expenses, but insurgents on the other hand only getreimbursed if they win and shareholders approve.

Case makes false proxy statements regarding a merger. 14a says it is unlawful for anyperson to solicit proxies in contrivance of rules adopted by the SEC to protect investors,such as those prohibiting false and misleading proxy statements. Court said under Sec.14(a) and Rule 14a-9, there is an implied private right of action to enforce this rule.(Case v. Borak)

Material misstatement in proxy statement regarding a merger. Shareholder sues. Inexamination causation, lower courts looks at preponderance of probabilities to seewhether the MMO affected the voting result. In doing that, it considers the fairness of themerger terms, on the assumption that the shareholders would have voted yes anyway ifthe merger was fair.

SCOTUS overrules, saying, if it is found that a) there was a material defect in the proxystatement and b) the proxy statement was an essential link in the accomplishment of thetransaction, there is sufficient showing of causation of a legally cognizable injury, ie noneed to show the particular defect was an essential link. This is a pretty liberal view ofcausation.

SCOTUS said merger could be unscrambled as a remedy, though thats pretty radical, soinstead damages should be granted to the extent the merger caused injuries. (lower courtfound merger fair, so no injuries and no damages. (Mills v. Electric Auto-Lite)

14a7 on mail-or-give-list rule (mainly an issue with proxy fights), 14a8 on shareholderproposal rule, and 14a9 on antifraud rule. Implied private right of action under 14a9antifraud rule. Oral and written falsehoods are covered by antifraud rule.

Shareholder Proposals; Inspection Rights

Court says a qualified stockholder may inspect the corporations stock register toascertain the identity of fellow stockholders for the avowed purpose of informing themdirectly of its exchange offer and soliciting tender of stock. Qualified stockholders under

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NY law have owned more than 5% of stock for over 6 months. The requestingstockholder must sign an affidavit that the inspection is not desired for a purpose otherthan the business of the corporation and that the petitioner has not been involved in thesale of stock lists within the past 5 years. Court says a desire to convince people to selltheir stock does involve the business of the corporation. (Crane v. Anaconda)

Bottom line: in Delaware and in NY, making a tender offer qualifies as a proper purpose(Del) or in the interest of the business (NY) in order to get access to a shareholder list.

Shareholder wanted shareholder list and corporate records so that he could tellshareholders that they should stop the company from selling munitions for the war inVietnam. Court held that this does not constitute a proper purpose germane to hisinterest as a shareholder, as a proper purpose means an economic interest. (Pillsbury)

To prove proper purpose to see shareholder list, the corporation must show thatshareholder does not have proper purpose.

To prove proper purpose to see books and records, the shareholder seeking disclosurebears the burden of showing proper purpose.

Compare this to rules under 14a-8 with proxy statement, in which you can have a non-economic interest to get something on the proxy statement. Why the difference? The costof throwing in one more proposal in the proxy statement is not very much. But the costsin inspection are much more

Can NY state law and US constitution require an out-of-state corporation doing businessin NY to provide resident shareholders with shareholder record where the requestingshareholders could not obtain such lists under the laws of the state of incorporation? Yes,

it does not violate the commerce clause, as its an exception to the internal affairsdoctrine. (Sadler)

Several exceptions under 14a8 that allow a company to refuse to send out a proxystatement of a shareholder proposal. For example, there is a requirement that theshareholder proposal deal with something more than just ordinary business.

Some shareholder proposals are cast as requests, rather than orders, that can be moreeasily passed.

The power of stockholders to change bylaws cant be taken away.

Shareholder submits resolution for proxy-statement about pate from force-fed geese.Company seeks to exclude. Law says resolution can be excluded if it involves less than5% of the companies business or is not otherwise significantly related to the corpsbusiness. Court says that although pate makes up less than 5% of company sales, theissue is otherwise significantly related to the corps business due to its ethical and socialsignificance and the fact that it does implicate significant levels of sales. So Courtdefines corps business more broadly than just economic matters. (Lovenheim)

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Shareholders seeks to have resolution on proxy statement regarding examining federalhealth reform proposals and their effect on the company. Company seeks exclusion,claiming it has an insignificant relationship to its business. Court disagrees, saying thatdue to spiraling health care costs, health care does have a significant relationship to itsbusiness. Court also disagrees with company claims that the proposal may be excludedas beyond the registrants power and by the ordinary business operations exception.

(NYCERS v. Dole Food)

Employee shareholders submit resolution proposing that employees be allowed to retireafter 30 years of service regardless of age. Company seeks to exclude the proposal fromthe proxy statement. Court says it can be excluded under ordinary business exception,because this is an ordinary business issue that can be worked out in collective bargaining.

Since the proposal can be excluded under the ordinary business exception, the Courtdoesnt get to personal grievance exclusion, which says that a proposal can be excludedwhich seeks benefit for proponents that would not be shared by shareholders at large.(Austin v. Con-Ed)

Control in close corporations

Shareholders make pooling agreement whereby they agree to pool their shareholdervotes. If they disagree, an arbitrator tells them how to pool the votes. Eventually oneshareholder refuses to vote the way arbitrator tells him, claiming the pooling agreement isagainst public policy. Court disagrees, saying shareholders are allowed to make poolingagreements, so that the complaining shareholder breached the agreement.(Ringling Bros.)

Three large shareholders in NY Giants baseball team make agreement to electedthemselves and directors and choose themselves as officers. Against the contract, 2 of

the 3 decline to continue McQuade as director and officer. McQuade sues, but Courtsays a shareholder voting contract that precludes directors from changing officers isillegal and void, as directors have an independent fiduciary duty to do whats best for thecompany, even if that means appoint different officers. (McQuade v. Stoneham)

Only two shareholders of corp, one majority, one minority. They make agreementwhereby majority SH, Dodge, agrees to keep minority SH, Clarke, as direct and managerin exchange for Clarke giving Dodge a secret formula. Dodge breaks the agreement, andClarke sues. Court found the shareholder agreement valid, ordering Dodge to specificallyperform it. Court distinguishes the case from McQuade in that all the shareholder hadsigned this agreement, nobody was harmed by the agreement, and there was no attempt to

sterilize the board, in that the agreement says Clarke can be removed as officer by theboard for incompetence, inefficiency, etc. (Clarke v. Dodge)

Closed corps are different from regular corps, including because investors are likely toinvest a great deal more of their wealth in the corp and because shares of a closed corpare more difficult to sell, so a shareholder should have greater flexibility to protect hisrights through a shareholder agreement. As long as all shareholders agree, or minoritySHs do not object, these agreements are ok. Therefore, Court rules shareholder

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agreement, which gives widow of shareholder certain rights, enforceable. Court notesthere is no harm in the agreement to shareholders, creditors, or the public. (Galler)

Court says, under Cali law, vote pooling agreements on election of directors are notillegal. So under agreement whereby shareholder must sell his shares at certain price tothe majority if he breaches the pooling agreement, the Court orders breaching shareholder

to sell his shares. Court says voting agreement valid even if corp was not a statutoryclose corporation. (Ramos v. Estrada)

Abuse of Control

Close corporation relationships are more akin to partnerships than at will employmentrelationships regarding duties of loyalty and good faith to each other. In closecorporations, shareholders do have fiduciary duties to each other. So shareholders inclose corp liable when they leave one of the shareholder employees off the salary list anddont reelect him as director, ie freeze him out. (Wilkes v. Springside Nursing Home)

Shareholders in close corporations owe on another substantially the same fiduciary dutiesthat partners owe one another. That fiduciary duty is of the utmost good faith andloyalty. (Donahue v. Rodd)

Court in Wilkes applies this Donahue standard with a two step test:

1) when minority SH sues majority SH under this standard, the majority SHcan try to show a legitimate business purpose for their action, eg firingSH/employee for incompetence. This was not shown in Wilkes.

2) If majority SH does show legitimate business purpose, the minimum SH

can then try to show that the legitimate business purpose could have beenachieved by a less harmful alternative course of action.

Ingle hired as a sales manager of a car company, and then becomes a shareholder in thebusiness. He is eventually fired, and majority SH exercises right of repossession ofshares at a specified price, per the shareholder agreement. Court finds this action ok, asthe written contract in this case allowed for termination of employee for any reason, sothat Ingle has no right as a minimum SH in a close corporation against an at-willdischarge by the majority SH. Plus, there is not a total freeze out here as Ingle wascompensated at price specified in agreement. (Ingle v. Glamore Motor Sales)

Court seems to see Ingle more like a hire hand than one of the founding partners, so theCourt might think that his reasonable expectations should be less than in Wilkes.

Majority SH refuses to employee minority SHs in a closed corporation, does not pay outdividends, and gives himself a very large salary. He then offers to buy out minority SHsshares at a low price. Court found a freeze-out, ruling for the minority SHs. Courtextends strict duty approach to situations involving more subtle freeze-outs fromfinancial benefits that SHs in close corporations ordinarily expect to receive.(Sugarman)

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Lesson is that courts especially like to find a fiduciary duty in a closed corporation wherethe majority freezes out the minority shareholders.

Closed corporations has 4 equal shareholders, but bylaws give each a veto power overcompany actions. 1 shareholder refuses to give dividends (presumably out of personal

tax consequences to him), resulting in the company paying extra tax to the IRS. OtherSHs sue him to recover this lost extra tax money. Court finds he had a Donahue-typefiduciary duty when he used his veto power, so that he violated his fiduciary duty here.(Smith v. Atlantic Properties)

Courts should give deference to shareholder agreements and not interfere to give SHsrights that were not protected in the shareholder agreements. (Nixon v. Blackwell).

Employee of company, who owns some stock in the company decides to switch jobs. Aspart of employee agreement he must sell back his shares to the company. When heresigns, the company doesnt tell him that it is in merger negotiations, which would

vastly increase the value of the shares. Employee later sues, claiming he would havestayed at the company had he known of the merger. Court says his claim survivessummary judgment. (Jordan v. Duff and Phelps)

Control, Duration, and Statutory Dissolution

Two equal shareholders in LLC agreemetn start feuding. The LLC agreement calls for abuyout at fair market value, but it did not provide for a transfer of the liability on themortgage, so one of the guys sues for a dissolution, because he doesnt want to be boughtout and have to remain liable. Delaware statue says a court may order dissolution of anLLC whenever it is not reasonable practicable to carry on the business in conformity

with the LLC agreement. Basically, if there is a reasonable alternative exit mechanismbesides dissolution, then the court will not grant a dissolution to break the deadlock. Thecourt rules the buyout provision is not a reasonable alternative exit mechanism, becausethe plaintiff would still be liable under the mortgage. Therefore, the court ordersdissolution. (Haley v. Talcott)

Woman as part of divorce gets 1/6 of shares in closed corporation. The othershareholders pay themselves director salaries, but do not pay out any dividends, so shegets nothing frm her ownership. She sues. Court views dissolution of company as toodrastic a remedy, so instead it orders that a buyout of her shares at fair market value beordered if she can show at trial that the other owners acted in an illegal, oppressive, or

fraudulent way, or acted wastefully. (Alaska Plastics)

Dispute between majority and minority SH. Minority SH asks for buyout at fair price.Court said dissolution or a buy-out could be ordered if the reasonable expectations of theminority SH, regarding participation in management or employment with the company,were violated. The reasonable expectations must be based on understandings, express orimplied, among the shareholders. (Meiselman)

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Three brothers each own 1/3 stock in closed corporation. One brother, Alfred, findsaccounting discrepancy resulting in fight with other brother. The other brothers placeAlfred on mandatory leave of absence, telling employees he had nervous breakdown.Court found breach of fiduciary duty as the two brothers did not act openly, honestly,and fairly. Court also says Alfred should get lost wages because he had a reasonableexpectation that his employment was not terminable at will, but that there was a lifetime

employment agreement. And because the two brothers did not act in good faith, attorneyfees should be awarded to Alfred. (Pedro v. Pedro)

Disputes arose between majority SH and minority SHs about future of furniturecompany. Frustrated that their concerns were not being addressed, the minority SHsstopped attending meetings, but continued to receive large dividends. Majority SHrefused to buy their shares out, so they sued for dissolution. Court says involuntarydissolution will be granted where liquidation is reasonably necessary for the protectionof the rights or interests of the complaining shareholders. Court found that there was nobad faith conduct by the majority SH, so that liquidation was not necessary to protect therights of the minority SHs. (Stuparich)

Key differences among cases: a) Alaska Plastics minority SH not told about meetings,and did not get dividends, so found for plaintiff b) Pedro minority SH fired fromemployment, and lies told to employees as to why minority SH fired, so found forplaintiff c) Stuparich minority SHs received large dividends, themselves chose not toattend meetings, and merely disagreed as to business judgment of majority SH, so foundfor defendant.

Transfer of Control

Two possible reasons for paying a premium 1) to get the private benefits of control by

taking more money from the company as a salary for running it 2) because the buyerbelieves that it can make the company worth more if it has control.

Conventional case law doctrine is that sale of control block at a premium is not wrong perse, and seller doesnt have to share premium with minority SHs, unless sale is 1) to alooter 2) diverts a corporate opportunity 3) is fraudulent. 4) or involves other misconduct.

Selling a controlling block at a premium is not wrong in and of itself without anymisconduct. (Zeitlin v. Hanson Holdings)

Wilport buys Feldmans controlling shares of Newport in order to guarantee itself supply

of steel, as this takes place during the Korean War when there is a price control on steel.Feldman is receiving a premium in essence for guaranteeing supply to Wilport whichmight have been guaranteed to Wilport had Wilport agreed to make an advance purchaseof steel from Newport. So this case can sort of be analogized to the corporateopportunity doctrine, in that Feldman took an opportunity that was available to thecorporation by taking personal advantage of the fact that Wilport was desperate toguarantee a supply of steel. (Perlman v. Feldman)

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-avoid getting vote of acquiring company shareholders-but get technical efficiencies of merger-and keep liabilities of the target company in separate corporate entity from theacquiring company

c) stock purchases

d) tender offer for all shares, or some percentage of shares.

e) proxy contest characteristic of hostile acquisitions

De Facto Merger Doctrine

Smaller company absorbs stock of larger company and then liquidates it. The reasonthey do this is because based on choice of law considerations, the acquired companyshareholders will not have appraisal rights under a sale, while if the big company

absorbed the small company, then there would be appraisal rights for the acquiredcompany. So this is done to avoid appraisal rights. Court says, though, that this is a defacto merger. This is structured as an asset acquisition but you get the net result of amerger. Therefore, merger, not simple sale rules apply, such that the shareholders of thebig company will get appraisal rights. (Farris v. Glen Alden Corp)

The lesson here is that some courts will try to extend/recharacterize transactions as defact mergers because of public policy; other courts will refuse to extend merger rules tode facto mergers.

Loral attempting to acquire Arco. The way they do it is like a simple sale, except that

Loral, the acquiring company, is paying not with cash, but with stock in itself. Court sayssale of assets statute and merger statute are independent of each other, with equal dignity.So if you do a sale you dont get appraisal, and if you do a merger, you do get appraisal.So no de facto merger doctrine in Delaware. (Hariton v. Arco Electronics)

Freeze-out Mergers

Big corporation seeks to acquire smaller company. The key danger of this merger is thatthe parent company owns a significant part of the target company, and some of thedirectors of the target company are also officers and directors of the parent company, sothey have a conflict of interest. Because of this conflict, court does not apply BJR to

decision of the target companys board to accept the merger offer at $21 per share.

Court says plaintiff initially must allege specific acts of fraud,misrepresentation, or other items of misconduct, indicating unfairness &demonstrate some basis for invoking entire fairness obligation. If plaintiffdoes this, then majority SH then has burden of proof to show entirefairness, which means showing that there was fair dealing and it was a fairprice. But if the defendant majority SH can show that the merger wasapproved by an informed vote of the majority of the minority

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shareholders, then the burden will shift back to the plaintiff to show thatmerger was not fair. Court finds burden did not shift back to the plaintiffs,though, because the vote was not informed. (Weinber