CORPORATIONS

BROUGHMANN

FALL 2014
 Table of Contents
PART 1: AGENCY
Conceptual View of the Corporation ....................................................................................................
Agency Law ............................................................................................................................................
Creation of Agency Relationship ........................................................................................................................
Liability Under Contract ......................................................................................................................................
Authority and Ratification .............................................................................................................................................

Principal and Agent Liability on Contract ............................................................................................

Principal Liability .................................................................................................................................................
Agent Liability .....................................................................................................................................................
Servants and Independent Contractors...............................................................................................

PART 2: CORPORATE FORMATION + BASIC CONFLICTS

Corporate Formation (1) ........................................................................................................................
Basic Steps .........................................................................................................................................................
Promoter and Corporate Charter .................................................................................................................................
De facto Corporation ....................................................................................................................................................
Corporation by Estoppel ..............................................................................................................................................

Corporate Formation (2) ........................................................................................................................

Where to Incorporate ..........................................................................................................................................
Choice of Entity ...................................................................................................................................................
Limited Liability and Piercing the Corporate Veil ...............................................................................
Limited Liability ...................................................................................................................................................
Piercing the Corporate Veil .................................................................................................................................
The Problem: Agency Conflict ..............................................................................................................
Separation of Conflict and Control ......................................................................................................................
The Role and Purpose of Corporations ..............................................................................................................
Business Judgment Rule ....................................................................................................................................

PART 3: FIDUCIARY LITIGATION AND SUITS

Solution 1: Fiduciary Litigation ............................................................................................................
Direct Lawsuits ...................................................................................................................................................
Derivative Lawsuits .............................................................................................................................................
Demand on the Directors ....................................................................................................................................
Special Litigation Committees ............................................................................................................................
Fiduciary Suits .......................................................................................................................................
Duty of Waste .....................................................................................................................................................
Duty of Care ........................................................................................................................................................
Duty of Loyalty ....................................................................................................................................................
Directors and Managers...............................................................................................................................................
Corporate Opportunities Doctrine ................................................................................................................................
Dominant Shareholders ...............................................................................................................................................
Obligation of Good Faith ..............................................................................................................................................

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 PART 4: SHAREHOLDER VOTING + GOVERNANCE
Solution 2: Shareholder Voting and Governance ..............................................................................
Proxy Voting .......................................................................................................................................................
Shareholder Proposals .......................................................................................................................................
Shareholder Inspection Rights ............................................................................................................................
Control Rights in Closely Held Corporations ......................................................................................................

PART 5: MERGERS AND TAKEOVERS

Solution 3: Mergers and Takeovers ....................................................................................................
Mergers and Acquisitions ...................................................................................................................................
Hostile Takeovers ...............................................................................................................................................
Side Payments ....................................................................................................................................................
Securities Regulation ............................................................................................................................
False and Misleading Statements .......................................................................................................................
Insider Trading ....................................................................................................................................................
 
 

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 Conceptual View of the Corporation and its Constituents

I. Intro to Corporations
A. Four Key Concepts

B. Three conflicts of Corporate Law

i. *Conflicts between managers and shareholders*
ii. Between controlling and minority shareholders
iii. Between shareholders as a class and non-shareholder constituencies of the firm such as creditors and employees
C. Two types of Corporations

D. Businesses have broad freedom to specify the terms of their corporate charter. Most of
corporate law is based on default rules that can be contracted out of as opposed to
mandatory rules.
i. Huge businesses have small charters. They are often default to state law.
Amending a charter requires a shareholder vote, which takes a lot of effort. More
likely that a small business will have a larger charter
ii. Why do publically held firms rarely opt out of default rules?
1. High transaction costs
2. Network effects compel standardization
E. Sole Proprietorship is the most common form of business in the US
F. Corporate law does not directly concern employees
G. Corporate law is designed to find protections for minority shareholders
H. When a person buys stock in a corporation, they consent to the charter

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 I. Debt and Equity
Debt Equity
Priority Paid first when firm is Paid last when firm is
sold/liquidated sold/liquidated
Type of claim Fixed claim Residual claim
Primary legal protection Contract (and bankruptcy) law Corporate law

J. Corporate Charters:
i. Each corporation files a charter (Cert. of Incorporation) with the state of
incorporation
ii. Each corporation also drafts a set of bylaws that govern internal affairs of the
business.
iii. Charter + Bylaws = private constitution
iv. When a person buys stock in a corporation they consent to the terms of the
Charter/Bylaws.
K. Corporate Law: providing the charter you always wanted to write, but never had time to
i. Corporate law provides gap fillers, when charter is incomplete
L. Terms
i. Creditor – someone who lends money. Promise to pay back loan principle +
interest. Dole protections comes from a well drafted contract
ii. Default rules – Also known as an enabling rule. What most of corporate law is
based on. If you don’t specify otherwise, this is what you get. Can be contracted
out of. (majority rule of voting procedure)
iii. Mandatory rules - you can’t contract out of (need BoD, duty of loyalty)

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 AGENCY LAW

I. Restatement of Agency
[M] the manifestation of consent by P to A that;
[B] A shall act on P’s behalf;
[CL] subject to P’s right of control; and
[CT] A’s consent to act
II. While you don’t need a contract to have an agency relationship, you do need
consent
a. Gorton v. Doty (football coach/car crash): An agency relationship results when one
person allows another to act on their behalf and subject to their control.
b. A. Gay Jenson Farms v. Cargill (grain dealer takes on debt): A creditor who assumes
control of his debtor’s business may become liable as principal for the acts of the debtor
in connection with the business.
i. “There must be an agreement, but not necessarily a contract between the
parties”
III. Types of Agency Relationship

To have tort liability, you need to be in the

left. On the right, the independent contract
agent generally cannot bind the principal to
tort liability. The line in the middle is pretty
fuzzy.
 

IV. Agency Conflict vs. Agency Relationship

a. Law (P/A Relationship)
i. A acts “on behalf” of P. A is under P’s control. Extending rights and obligations to
3rd parties
b. Economics (P/A Conflict)
i. A has different interests that P, and P does not control A. P does not control A.
Viewed from P’s perspective
c. Application
i. Are corp. directors or managers “agents” of the shareholders?
1. Law: no
2. Econ: yes
V. ACTUAL AUTHORITY RST 3rd § 2.02(1)
a. From the agents perspective
b. Designated or implied OR necessary or incidental
to achieving the principal’s objectives as the agent
reasonably understands
c. The agent can act against P’s interest and still have
authority
d. A WOULD ALWAYS RATHER HAVE ACTUAL AUTHORITY
e. If you have actual express authority, you have implied

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 f. Case: Mill Street Church v. Hogan (brothers paint, one gets hurt): The party alleging
agency has the burden of providing the agency relationship. A person possesses
implied authority as an agent to hire another worker where such implied authority is
necessary to implement the agent’s express authority. Clear from the nature of the
project Hogan reasonably would need to hire help.
VI. APPARENT AUTHORITY
a. From the third parties perspective
b. 3rd party has to relatively believe the communication
would authorize
c. Manifestation has to be made from P to the 3rd party
d. Manifestation could be made through a reliable
Intermediary (even the public) to 3rd party
e. In limited situations, manifestation could come through
A’s communication to 3rd party
f. Cases
i. 370 Leasing v. Ampex (sell computer equipment w/o boss approval): A
salesperson binds his employer to a sale if he agrees to that sale in a manner
that would lead the buyer to believe that a sale had been consummated.
ii. Mill Street Church v. Hogan (brothers paint, one gets hurt): It must be determined
whether A reasonably believed that P wished him to act a certain way. Clear from
the nature of the project Hogan reasonably would need to hire help. A person
possesses implied authority as an agent to hire another worker where such
implied authority is necessary to implement the agent’s express authority.
VII. RATIFICATION
a. RST § 4.01
i. “the affirmance by a person of a prior act which did not bind him but which was
done or professedly done on his account”. P. 26
ii. A person ratifies an act by:
1. Manifesting assent that the act shall affect the person’s legal relations
2. Conduct that justifies a reasonable assumption that the person so
consents
b. No authority of agent at the time of execution of the contract but principal later assumes
liability. Can be express or implied
c. Does not occur unless:
i. Act is ratifiable
ii. Person ratifying has capacity
iii. Ratification is timely
iv. Ratification encompasses the act in its entirety
d. Ratification rules
i. you can’t ratify after the 3rd party backed out
ii. can’t ratify after material change in circumstances that would make it inequitable
to bind third party
iii. can’t ratify after a specific time that determines whether a third party is deprived
of a right or subjected to a liability
e. Ratification retroactively creates the effects of actual authority.
f. Case: Botticello v. Stefanovicz (tenant in common farm/married couple): Ratification
requires acceptance of the results of a prior act with an intent to ratify, AND with full
knowledge of all the material circumstances.
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 VIII. INHERENT AGENCY POWER
a. Power of an agent derived solely from the agency relation and exists for the protection of
persons harmed by or dealing with a servant or other agent
b. If you have a hidden principal, you can even without a manifestation, have a contract. It’s an
extension of apparent authority in settings where you can’t see the principal. IAP is a way to
put the principal on the hook.
c. Two primary versions of IAP
i. Hidden principal
1. In General:
a. A doesn’t inform 3rd party about existence of P (3rd party thinks she is
contracting solely with A)
b. Inequitable result would happen if P not liable.
2. Hidden Principal Liable if:
a. (1) A was a “general agent” for an undisclosed P
b. (2) The transactions in question were usual or necessary in such a
business
c. (3) A was acting on P’s “account” (i.e., in P’s interests), although
contrary to directions of P.
ii. General agent
1. In General:
a. A acting as general agent for P
b. A’s actions consistent with or incidental to transactions that this type of
agent usually allowed to conduct (i.e. authority comes from the agent’s
position).
c. 3rd party has no reason to believe A lacks authority
2. Disclosed P liable for A’s unauthorized acts, even absent actual/apparent
authority, if:
a. A is acting as general agent;
b. A’s acts usually accompany or are incidental to transactions which this
type of agent (i.e. based on title / office) would usually be allowed to
conduct;
c. Third party has reason to believe that agent is authorized and has no
notice to the contrary
IX. RST Third says inherent agency power doesn’t exist. A lot of jurisdictions still have this thought.
X. Cases
a. Watteau –When one holds another as A, that A can bind the P on matters normally
incident to such agency, even if he was not authorized for a particular type of
transaction.

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 PRINCIPAL AND AGENT LIABILITY ON CONTRACT

à P IS NOT LIABLE
I. Restatement § 144: A principal “is subject to liability upon contracts made by an agent acting
within his authority”
II. If Principal is liable under principles of agency, agent’s exposure is more limited (but not
completely vitiated):
a. Disclosed P:
i. A is (essentially) not liable to 3.
ii. A negotiates the contract in the name of P and A is not a party to the contract. The
parties’ intent is that P be bound
b. Undisclosed/Partially-Disclosed P:
i. Undisclosed Principal
1. A is liable as guarantor on the contract.
2. An A acting on behalf of an undisclosed principal is personally liable on the
contract itself
ii. Partially Disclosed Principal
1. Rule generally applies to partially disclosed principals too
2. Atalantc Salmon v. Curan (sells fish w/diff. business names): They thought
there was some sort of corporation. An A who makes a contract on behalf of
a partially disclosed P is personally liable on the contract. To avoid personal
liability, A must disclose the id of the P and that he is acting in representative
capacity. Not the duty of 3rd parties to seek P’s identity.
III. If Principal is not liable under principles of agency, agent (or “Non-agent”) may be liable to
the third party on one of two bases:
a. Common Law Fraud/Deceit (hard to prove)
i. Non-agent willfully/recklessly misrepresents fact of agency; existence of agency is
material; third party justifiably relies on misrepresentation; misrepresentation actually
induces third party to enter contract.
b. Warranty of Authority (Rest. 2nd of Agency § 329) (easier to prove)
i. Non-agent who purports to enter contract of Principal thereby becomes subject to an
implied warranty of authority, unless agent manifests that he does not make such
warranty or the other party knows that the agent is not so authorized.

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 SERVANTS AND INDEPENDENT CONTRACTORS

I. Respondeant Superior Liability

a. (1) Prove the tort and whatever elements there are in the tort
b. (2) Then you have to show there was a master/servant relationship between P and A
c. (3) And that A was acting within the scope of that relationship
II. Definitions
a. Servant = “an agent employed by a master to perform service, whose performance is
controlled or is subject to the right of control by the master.”
b. Scope of Employment: Conduct of a servant is within the scope of employment if, but only
if:
i. (a) it is of the kind he is employed to perform;
ii. (b) it occurs substantially within the authorized time and space limits; and
iii. (c) it is actuated, at least in part, by a purpose to serve the master …
c. Independent contractor = “a person who contracts with another but who is not controlled
by the other nor subject to the other's right to control with respect to his physical conduct in
the performance of the undertaking. He may or may not be an agent.”

Factors of Control over Physical Conduct

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 III. Vicarious Liability
a. “A master is subject to liability for the torts of his servants committed while acting in the
scope of their employment.” Restatement (Second) § 219(1)
b. Two elements:
i. 1) Master-servant (employer-employee) relationship
ii. 2) Acting in the scope of their employment
IV. Significance of Master/Servant Relationship
a. M is liable for all S’s torts WITHIN SCOPE of his/her employment.
b. M is liable for S’s torts OUTSIDE SCOPE if:
i. M intended the conduct/consequences, or
ii. M himself/herself was negligent or reckless, or
iii. The conduct violated a non-delegable duty of M, or
iv. S purported to act or to speak on behalf of the principal and there was reliance upon
apparent authority, or he was aided in accomplishing the tort by the existence of the
agency relation.
c. Cases
i. Humble Oil v. Martin - A party may be liable for a contractor’s torts if he exercises
substantial control over the contractor’s operations. Master-servant where
Humble is master. Humble had a great bit of control over the station. Here there
is a master-servant relationship, not a contractor relationship. “The agreement
required Schneider in effect to do anything Humble might tell him to do.”
Schnieder was Humble’s servant.
Hoover v. Sun Oil - The test is whether
the franchisee retains control of the day-
to-day operations of the business.
“Barone’s contacts and dealings with
Sun were many and their relationship
intricate... he alone assumed the overall
risk of profit or loss in his business
operation.” Sun had no control over the
details of Barone’s day to day operation,
therefore no liability can be imputed to
Sun  
 

V. Apparent Agency: Even in the absence of actual agency, a purported principal may be
vicariously liable for the tortious conduct of its apparent agent.
a. Franchises: Many franchisors own and operate some of their retail units and franchise
some.
i. The problem is that the public will often not know which are owned by the
company and which are franchised by it.
ii. The trademark, uniformity, and standardization that undergirds a brand name
product or service may also support a belief that the retail unit selling that product
or service is operated by the principal company rather than operating as an
independently owned franchise.

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 b. Miller v. McDonalds Corp - McDonald's had the "right to control" the way in which the food
was prepared. Thus, there is evidence that defendant had the right to control the part of its
business that resulted in plaintiff's injury.
c. Murphy v. Holiday Inns - Yes. The regulatory provisions did not give defendant control
over the day-to-day operation of Betsy-Len’s motel. While Holiday Inn had the power to
regulate the architectural style of the buildings and their furnishing, they did not have the
power to control the daily maintenance of the premises. The regulatory provisions of the
franchise contract did not constitute control within the definition of agency.

SCOPE OF EMPLOYMENT
One of the requirements is that the actions were in the scope of the employer/employee relationship.
Conduct of a servant is within the scope of employment if, but only if:

Vicarious Liability: Scope of Employment

¨ A master is subject to liability for the torts of his servants committed while acting in the scope of
their employment.” Restatement (Second) § 219(1)
¤ Two elements:
1. Master-servant (employer-employee) relationship
2. Acting in the scope of their employment

Restatement 2nd Section 228

q Conduct of a servant is within the scope of employment if, but only if:
q (a) it is of the kind he is employed to perform;
q (b) it occurs substantially within the authorized time and space limits; and
q (c) it is actuated, at least in part, by a purpose to serve the master …
q § 229(2) lists additional factors

IRA Bushey & Sons v. United States – (Coast Guard go cray) The level of foreseeability in a respondeat
superior issue is not the same as foreseeability in a negligence case. For purposes of respondeat
superior, it is only required that an employer would perceive that harm could flow from actions of their
employees, whether or not employer takes all precautions.

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 Exam Attack Strategy for Agency Law

• Contract
o Focus on the specific event / contract.
o Did A have authority (AEA, AIA, ApA, …) to enter into the
transaction / contract on P’s behalf.
• Tort
o Focus on the relationship
o Did P have sufficient control over A that the relationship falls into
the M/S category.
o General definition of agency relationship matters
o Need to have P-A relationship + extra emphasis on control for it to
qualify as M-S relationship (cat. 1).
o Apparent Agency creates tort liability for P even though M-S
relationship does not exist. Apparent agency π must prove:
§ all the elements of the tort,
§ principal represents that another is his servant, and
§ such representation caused π justifiably to rely upon the
apparent agent.
o Vicarious Tort Liability
§ Normal Rule (not apparent agency) π must prove:
§ all the elements of the tort,
§ the existence of a P-A relationship,
§ sufficient “control to classify as M-S type, and
§ action within scope of employment

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 CORPORATE FORMATION

I. Highly “statutized” area of law. Significant amounts of statutory interpretation. Most

corporate law rules are default rules (it can be costly/difficult to contract out of default. Our
focus will primarily be on Delaware (DGCL)
II. Basic Steps to form a Corporation

a. Get a plan
b. Pick a state to incorporate in
c. File “Certificate/Articles of Incorporation/Charter” with the Secretary of State of that state
i. Publicly available document
ii. Filed with the Sec. of State
iii. Have required disclosures (DGCL § 102(a))
1. Name of the corporation
a. Must include: association, company, corporation, club, foundation,
fund, incorporated, institute, society, union, syndicate, or limited
2. The address of the corporation’s registered office in the state
3. The nature of the business or purpose (“any lawful act or activity”)
4. If authorized to issue only 1 class of stock, the total shares of stock the
corporation shall have authority to issue and the par value of such shares
5. Name and mailing address of the incorporator or incorporators
6. If the power of the incorporator is to terminate upon the filing of the certificate,
the names and mailing addresses of the persons who are to serve as
directors
iv. Optional Information (DGCL § 102(b))
1. Any provision for the management of the business and who has what power,
provision limiting the duration of the corporations existence, etc.
d. Draft bylaws
e. Organizational meeting where you elect a preliminary board
f. Adopt bylaws
g. Issue stock
i. What happens if a company has multiple classes of stock?
1. § 102(a)(4). You need to start issuing the pecking order and the financial
rights that apply to the additional classes
h. Appoint Officers

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 III. The Promoter and the Corporate Charter
a. Once the charter is filed, does the corporation become a party to the contract?
i. Yes, but not automatically. The corporation must “adopt” the contract. Can be
effected:
1. o Expressly (typically by a novation)
2. o Implicitly (ratification by acceptance of benefits)
b. Once the charter is filed, is the promoter liable in the corporation braches the contract?
i. Yes. MBCA 2.04: “All persons purporting to act as or on behalf of a corporation,
knowing there was no incorporation under this Act, are jointly and severally liable for
all liabilities created while so acting.”
c. What if the corporation adopts the contract? Does this release the promoter from liability?
i. Not necessarily. Promoter can only be released from liability by other party to the
contract.
d. If the charter is never filed, is the promoter liable on the contract? DEFINITELY!
e. If the charter is not filed or is defectively filed, can the defectively formed entity (or
individuals) enforce the contract?
i. A third party who dealt with the firm as though it were a corporation and relied on the
firm, not the individual defendant, for performance is estopped (Southern-Gulf
Marine v. Camcraft).
ii. Two ways to get around this rule: (i.e. treat unincorporated firm as a valid
corporation):
IV. De facto Corporation and Corporation by Estoppel
a. Often seen as overlap but one way to distinguish:
i. De facto based on good faith effort of entrepreneur + mistake
ii. Estoppel based on other party’s perception
b. De facto Corporation

Grant shareholders limited liability as though in

a de jure corporation if the organizers:
1. in good faith tried to incorporate
2. had a legal right to do so
3. acted as a corporation.

c. Corporation by Estoppel

Grant shareholders limited liability as though in

a de jure corporation – as against only contract
creditors – if the person dealing with the firm:
1. thought it was a corporation all along
2. would earn a windfall if now allowed to
argue that the firm was not a
corporation

V. Cases
a. Southern Gulf Marine v. Camcraft After a party has given its promise to do something, they
should not be permitted to escape performance by raising an issue as to the character of
the organization to which they contracted with, unless its substantial rights might thereby be
affected. A third party who dealt with the firm as though it were a corporation and relied on
the firm, not the individual defendant, for performance is estopped.
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 WHERE TO INCORPORATE

Why does Romano refer to the choice of incorporate as a “competition”? They want the franchise tax
revenue!

The top means – good for

shareholders

The bottom – a law that is

good for management,
possible shareholders
 

WHY DO COMPANIES
WANT TO INCORPORATE
IN DELAWARE?

Competition, market forces, and contracts force managers to act in their own general interest.

Internal affairs doctrine says when you incorporate in a state, that state you incorporate in binds
what law you should apply.

  16
 CHOICE OF ENTITY

This is a corporations class

Two primary business form (plus a couple of variations)
• Corporation or Partnership, here are the basics:
Corporation Partnership
- Pro: limited liability - Pro: Pass through Taxation
- Con: Entry level tax treatment No double tax penalty
Better treatment of business losses

- Con: Unlimited Liability

Personally liable for partnership obligations
Each partner has authority to bind the partnership

I. Partnership vs. Corporation

In partnership contract, generally
hard to transfer/sell partnership
interests. Think about how weird
that would be. One benefit of
partnership is decentralized
management. You don’t have to
comply with level of formality.
 

Partnership Variations Corporation Variations

General Partnership (GP) C Corp – entity taxation
S Corp – pass through taxation
Limited Partnership (LP) - Cannot have more than 100 owners
-General partners (bear full liability) - Can only issue one class of stock
-Limited partners (passive investors, limited
liability) Hybrid: Limited Liability Company (LLC)
- Pass through tax treatment that partnership has
Sole Proprietorship + limited liability protection that the corporation
- A one person partnership has.
- Can’t take it public. Just a few have gone public
as a LLC

Other Alternatives: Social Enterprise/Nonprofit

Traditional non-profit entity
• Mission statement + IRS filing (501(c)(3) status)
• No owners
“Benefit” corporations (B Corp) (Ex. Etsy) & low-profit limited liability corporation (L3C)

  17
 • Has owners and can make profit, but explicit statement that business may pursue other goals
Cooperatives
• Business owned by the users of its service

II. Source of Law

Partnership (based in common law)
• Most states have a general partnership and limited partnership act (primarily default terms)
• Can be modified by partnership agreement
Corporation
• State code (primarily default terms)
• Can be modified by charter/contract
LLC
• First LLC statute created in 1979, not available all states
• Lots of freedom – you can do a lot with an LLC. Just modify with an LLC operating agreement (maximum
contractual flexibility)
o Operating agreement very important to taking advantage of the LLC form (required in many states, but not
Indiana)

III. LLC Operating Agreement

• Drafting an effective operating agreement (partnership agreement) can make LLC (partnership) more costly than
Corp.
o LLC statutes often do not provide good default provisions.
o Cost of forming an LLC has gone down substantially with automated operating agreements: Legal Zoom
(operating agreement)
§ Encourage you to look at sample documents
Formation/Disclosure
Why is nothing required here?
A: don’t want to create unnecessary
regulatory burden. Also, no need to warn
rd
3 parties that they are dealing with a
limited liability entity.

Limited Liability

How  could  you  protect  

general  partner?  

Pay for insurance. Have the

general partner not be a
person (make them a
corporation/LLC).
 

  18
Management and Control

Member-­‐managed  is  similar  

to  Partnership
Manager-­‐managed  is  closer  
to  Corporation    

Transferability of Ownership
In a family owned
Taxatation businesses why would
you not want a free
transferability of
shares? Small close knit
relationship, you don’t
want something
imposed like this.
 

TAXATION
Corporate Tax is
Complicated (& not subject of
this course)

  19
 PIERCING THE CORPORATE VEIL AND LIMITED LIABILITY

a. General Overview of Limited Liability and Veil Piercing

General Rule: Limited Liability
- Shareholders not personally liable for
corporate debts
- Policy rationales: costs and benefits of LL
- Voluntary creditors vs. Involuntary creditors
Exceptions:
Two part test: (i) alter ego, and (ii) promotes
fraud/injustice
- Vertical Piercing (conventional)
- Horizontal Piercing (enterprise liability)
- Reverse Piercing (corporate shareholders
may be at greater risk)
 
b. Limited Liability
i. Butler says it’s more important than steam. Why is it thought to be so important? It
encourages investment! The idea is to get people to take risks and get big
businesses off the ground. It encourages innovation.
ii. MBCA § 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 he may become personally liable by reason of his own acts
or conduct”
b. Asset Protection
i. Owner-Shielding
• standard account of limited liability
• It protects the owner’s personal assets from business liabilities
• THE NEMESIS OF THIS IS VERTICAL PIERCING
ii. Entity-Shielding
• If you did not have this, problems would arise
• Protects the business assets from personal liabilities of individual shareholders
• THE NEMESIS OF THIS IS REVERSE PIERCING
c. Case: In re Silicone Gel Breast Implants Products Liability: A parent corporation is expected
to have some control over its subsidiary. But “when a corporation is so controlled as to be
the alter ego or mere instrumentality of its stockholder, the corporate form may be
disregarded (pierce the corporate veil) in the interest of justice.
d. Is corporate limited liability a good idea then?
PROS ✓ CONS ✕
Encourages entrepreneurship and economic Decreases shareholders incentive to monitor
growth management

Facilitates a developed trading market for Exposes third parties to unfair/inefficient

ownership externalities

Improves shareholders ability to diversity portfolio

Improves creditors incentive to monitor corporate

managers? Mabes

  20
 c. Piercing the Corporate Veil
a. VEIL PIERCING WORKS BY FAR THE MOST OFTEN IN COMPANIES THAT HAVE A
SINGLE SHAREHOLDER.
b. Test for Piercing (either vertical or horizontal)
i. (a) Unity of interest and ownership (Alter Ego)
1. Lack of corporate formalities
2. Commingling of funds and assets
3. Severe under-capitalization
4. Treating corporate assets as one’s own
ii. (b) Refusing to allow piercing would either
1. (i) encourage fraud or
2. (ii) promote injustice.
c. Vertical Piercing (conventional)
i. Allows one to reach the shareholders assets
ii. Basic Q: did the SH transgress SH-Corp boundaries
iii. Case
i. Sea Land v. Pepper Source: A corporate veil may be pierced
if 1) there is such unity of interest and ownership that the
separate personalities of the corporation and individual no
longer exist and 2) saying there are two separate
corporations would be fraud/promote injustice

d. Horizontal Piercing (enterprise liability)

i. Allows one to reach the sister corp’s assets
ii. Basic Q: did the sister corp transgress Corp-Corp boundaries?
e. Reverse Piercing
i. Creditor goes after CEO, CEO says I don’t have any money, so Creditor goes after
corporation’s assets. (If CEO has blurred the boundaries, creditor may be able to get it).
f. Cases
i. Walkovsky The corporate form may not be disregarded
merely because the assets of the corporation, together with
the mandatory insurance coverage of the vehicle which
struck the plaintiff, are insufficient to assure him the recovery
sought.

d. Final Thoughts
a. Small Firms
i. Single owner (& small) firms are significantly more likely to lose veil piercing
motions
ii. Better predictor of outcomes than legal factors: undercapitalization, lack of
formalities, commingling assets, domination / control, etc.
b. Large Firms
i. No publicly traded firm has EVER lost a veil piercing claim.

  21
 The Role of Purpose of Corporations

Think about: what ought the corporation be doing? What goal should it be pursuing?

Two Dimensions of Fiduciary Law

The Goal Level of Judicial Scrutiny
Towards what end should the corporation i.e. how much discretion do managers/directors
operate? have? When do courts second guess managerial
decisions?
- Shareholders, creditors, employees

No BJR protection à

I. Business Judgment Rule

a. What Is It?
i. A legal presumption that a corporate officer / director has exercised care and
good faith in carrying out her duties on behalf of the corporation
ii. Places burden on party complaining of breached fiduciary duty to overcome it
b. Who gets the benefit of the BJR?
i. Generally, all corporate fiduciaries (board members, executives, dominant
shareholders)
c. When does it apply?
i. 1) There is no self dealing, no fraud, no illegality AND 2) board exercises judgment
d. Statutory sources for the BJR
i. Never actually articulated in the DGCL.
ii. But BJR is often inferred from § 141:
1. DGCL § 141(a)
a. Board’s power to manage corporation’s affairs
2. DGCL § 141(c)
a. Power of delegation to committees / experts
3. DGCL § 141(e)
a. Board members are “fully protected” in relying on opinions &
information generated by committees or others competent to render
such opinions/info

  22
 e. BJR does not apply to loyalty! The presumption of BJR is rebutted when the
plaintiff shareholder pleads a violation of that duty

i. Why does this matter? Different standards of review

Entire  Fairness  is:  

DE  is  very  vauge  on  this.  
Weinberger  –  fair  process  and  a  
fair  price.    Fair  price  means  
“modern  financial  evaluation  
techniqies”.  Have  an  outside  
expert  come  in  and  attest  to  the  
evaluation  of  this.  The  transaction  
didn’t  harm  the  shareholders  
financially.  These  things  are  hard  
to  prove.  
 
Think  of  it  as  there  was  no  harm  
at  all,  looking  at  it  through  the  
shareholders  eyes.  
 

  23
 AGENCY CONFLICT

I. Enforcement of Contract: You can’t provide for every exigency in a contract.

1. Ideal Solution: Full Contract
Super specific contract that says exactly what the manager does in every potential
scenario. What’s the problem? You can’t foresee every possible situation. You can’t
contract away every problem
2. Alternative Solution: Allocate Control to Investor
In principle, one could imagine a contract in which the financiers give funds to the
manager on the condition that they retain all the residual control rights. Any time
something unexpected happens, the investors decide what to do
II. Thus: Separation of Ownership and Control. This can cause problems.
a. Outright theft by management
b. Self-dealing by management
c. Managerial entrenchment
d. Bribes by management
III. Three Solutions to the Problems caused by separation of Ownership/Control
a. Solution 1: Fiduciary Litigation
• Managers and directors owe a fiduciary obligation to the shareholders. If managers fail to serve the
best interest of the corporation, they may be personally liable for breaching their fiduciary obligation
o This right can only be enforced by shareholders
o Why do S&V think that shareholders are more vulnerable than other corporate constitutents
(employees, creditors, etc.)
§ Employees have the power, they can strike. This power is better than the
shareholder’s power. After investing shareholders are no longer providing value and
can be taken advantage of
§ It’s not perfect, but it can fix some stuff
§ Hard cause you’re asking a judge to second guess what management is doing
b. Solution 2: Shareholder Voting
• Shareholders can also protect their interest by voting their shares or otherwise participating in the
firm’s governance. Shareholders could elect new directors
o Few problems:
§ Rational apathy
• Would shareholder voting be more/less effective with concentrated
ownership? Depends. The group of people who hold a decent sized block
would be nice. But if someone holds 51%, that would be problematic cause
that person could control the company and push the risk to others and they
don’t have a say. It creates potential conflicts with minority shareholders
§ The issues that you get to vote are largely structured by the management team
• “It is not how people vote, but who counts the vote” – Stalin
c. Solution 3: Hostile Takeovers
• If a firm is poorly managed, a hostile takeover can be used to improve governance. A hostile takeover
occurs when an acquirer buys all (or most) of a firm’s stock. The acquirer can then replace the board
of directors and fire the firm’s management team.
o How could an acquirer make money off this strategy?
Buy low and then fix it up à sell it a lot.

  24
 FIDICUIARY SUITS

I. General Overview
a. The Goal = Shareholder primacy. The corporation should try to maximize shareholder returns
(Dodge v. Ford)
b. The Means = How to pursue shareholder primacy? BJR gives directors and officers broad
discretion about the means (Shlensky v. Wrigley), but not about the goal
II. Flowchart
a. Step 1: Direct or Derivative
i. If direct à skip to step 2
ii. If derivative: (i) did plaintiff clear procedural hurdles (bond posting, special
pleading), and (ii) demand requirements.
b. Step 2: type of fiduciary suit
i. DoC & Waste (i.e. no conflict of interest [& no fraud or illegality])
1. BJR applies
a. Can be overcome by showing either (i) no rational basis (Waste), or
(ii) defective/uninformed process (Duty of Care)
2. Watch out for 102(b)(7) protection (for directors only)
ii. DoL (P must show conflict of interest [or Bad Faith??])
1. 102(b)7 does not apply
2. No BJR presumption, unless
a. Defendant has cleansed under 144 (or analogous law)
b. Defendant can still win by showing entire fairness
III. Fiduciary Law as a Social Reminder
a. Defendant directors/officers rarely lose
i. Risk of liability very low (particularly when we consider insurance /
indemnification)
b. Yet fiduciary law may still serve a purpose
i. Not effective at compensating injured shareholders
ii. But may improve corporate governance practices
iii. Sermon on ‘good’ corporate conduct à shapes business norms
iv. Santa Claus: threat of coal in the stocking
v. Increases formalities
vi. Cleansing conflicts of interest
c. Lingering Question: does any of this improve actual decision-making, or is it just a costly
process to get to the same result?

  25
 FIDUCIARY LITIGATION

I. Direct or Derivative Lawsuit

Direct Derivative
Brought by the shareholder in his or her own Brought by a shareholder on corporation’s
name behalf

Cause of action belonging to the shareholder Cause of action belongs to the corporation as
in his or her individual capacity an entity

Arises from an injury directly to the Arises out of an injury done to the corporation
shareholder as an entity

a. If the corporation suffered more à derivative Ex: steal money? Corporation harmed.
b. If the shareholders suffered more à direct. Take away the right to vote? Shareholders
II. Direct Lawsuit
a. Director/Officer misconduct rearranged the relative slices of the pie (e.g. removing dividend
rights held by particular class of stock). Often brought as a class action. Direct injury to SHs.
III. Derivative Lawsuit
a. Here Director/Officer misconduct decreased the size of the pie (e.g. selling away corporate
assets to the CEO’s sister at a low price). NOT a class action
b. Complaining shareholders actual role is running the litigation on behalf of the company.
Shareholder can’t opt out because it’s not a class.
c. The suit is res judicata, even for shareholders who are
d. Plaintiff incentives
i. Corporation must pay a successful plaintiff’s litigation costs (typically a percent of
damages recovered).
ii. Success includes both settlement and judgment
iii. Why are they doing this? They’re solving a free rider problem. If the suit is good,
we want to bless you by paying everything. If it’s a bad suit, we’re not going to
pay for wasting everyone's time
e. Defendant incentives
i. Law permits indemnification of individual defendants’ litigation costs after a
settlement, but not if there is an adverse verdict.
f. Risk of Type 1 and 2 errors
Strike suits
- Plaintiff counsel has incentive to bring
- Management has incentive to pay
Meritorious suits
- Management has incentive to settle in ways that ensure
indemnification
- Plaintiff lawyer has incentive to settle so as to get on to next
case
Hence, settled too lightly

  26
 IV. Judicial approval of settlements
a. To be approved, the settlement is supposed to be fair, reasonable and adequate.
b. The settlement must not be collusive, but rather the product of arm’s length negotiations
following adequate discovery.
V.     Procedural Steps of a Derivative Suit
    a. Bond Posting Requirements
  i. Plaintiff must post a bond to guarantee that if the corporation incurs expenses in
connection with the derivative suit, the court can order those expenses reimbursed
by means of the bond.
1. Eisenberg v. Flying Tiger – just wants them to pay $
   
    b. Special Pleading Requirements
  i. Eligibility Requirements
1. FRCP 23.1
a. (1) that the plaintiff was a shareholder or member at the time of the
transaction of which the plaintiff complains or that the plaintiff's share
or membership thereafter devolved on the plaintiff by operation of law
2. Shareholder must have owned shares at time the misconduct occurred
3. Many states also require that shareholder continue to own throughout trial
4. What happens to SHs who fall into two groups?
a. 1) Owned at time of misconduct but not at trial
i. They get nothing
b. 2) Bought shares after misconduct
i. They get a windfall
ii. Fair and Adequate Representation
1. MBCA § 7.41(2): Named plaintiff must be a fair and adequate representative
of the corporation’s interests (i.e. you might challenge a plaintiff’s fairness or
adequacy if you think they are bringing suit for an unrelated strategic purpose,
and/or they have unclean hands)
2. On what grounds can fairness and adequacy be challenged?
a. Conflicted interests (such as bringing suit for unrelated strategic
purposes); Unclean hands
iii. Particularity
1. The complaint shall also allege with particularity the efforts made by the
plaintiff to obtain the action the plaintiff desires from the directors or
comparable authority
    c. Demand Requirements
   
i. Most states (including DE) require SHs in derivative suits first to approach Board of
 
Directors and demand that the board pursue legal action.… unless the SH can claim
a valid excuse why demand on the board would be pointless (“futile”)
ii. In shareholder derivative litigation, the shareholder plaintiff makes the threshold
directional decision whether to (i) make a demand on the board of directors asking it
to pursue the alleged claim, or (ii) purport to initiate litigation on behalf of the
corporation and allege that pre-suit demand is excused as futile.
iii. Purpose
iv. (1) Gives board a chance to take over lit. / oppose lit.
v. (2) filter out strike suits or other non-meritorious litigation

  27
 vi. What is Demand?
1. Demand must identify alleged wrongdoers, describe the factual basis of the
wrongful acts, the harm caused to the corporation, and request remedial
relief.
vii. Why does a SH not want demand?

If the shareholder makes a demand on the board (rather than alleges that demand is excused), in litigation
challenging a subsequent demand refusal, the law deems the shareholder to have conceded that a
majority of the board is disinterested and independent as to the underlying claims. Thus, once a
shareholder makes a demand on the board, the implicit concession that a majority of the board is
independent narrows the court’s inquiry to the board’s good faith and the reasonableness of the
investigation, i.e., business judgment rule review.

viii. Excusing Demand:

1. Demand requirement will be waived if making demand would be futile.
2. If demand not excused, Board has discretion to dismiss lawsuit
a. Bus. Judgment Rule = “Presumption” of due care
3. If demand is excused, Board cannot cause dismissal
a. Can still move for dismissal, on advice of Special Litigation Committee
ix. When is Demand “Futile”
Works                                Doesn’t  

  28
 x. Grimes v. Donald – should not have tried to make demand
1. Abdication claim – renounce privileges. More likely to qualify as direct claim
2. Consequences of Futility Determination
Demand Made Demand Not Made
Demand Required SH waives futility claim; BoD Court will grant motion to
Refusal to pursue s.t. BJR dismiss by corporation
Plaintiff Loses Plaintiff Loses
Demand Excused SH waives futility claim; may SH can proceed, unless SLC
claim “Wrongful Refusal” dismissal passes Zapata test
Plaintiff Loses Plaintiff has a chance

d. You bring suit. Pre-discovery, D’s will likely say that nothing in the pleading suggests
demand is futile. D pleads facts to cast reasonable doubt (Aronson).
e. Demand Required / Excused (DE, NY, & several other states)
i. You always have to make demand if you’re a P. Demand is filling 2 kind of weird
roles.
1. Gives board a chance to take over lit. / oppose lit.
2. filter out strike suits or other non-meritorious litigation
f. Universal Demand (followed by ALI, 12 states)
i. Primarily fulfilling purpose of giving the board a change to take over lit
ii. Require a written demand unless the plaintiff makes a specific showing that the
irreparable injury to the corporation would otherwise result. Plaintiff always required
to make demand on the board in derivative action
1. Burden is on plaintiff if majority of board is independent
2. Burden is on defendant if board is not majority independent
g. Sample Problems (KRB 224-25)
h. Agricorp Corp. is an agribusiness: it owns and operates many large farms. It has five
directors, including Alice Adams, who is the Chairman of the Board and Chief Executive
Officer. Adams learns of an opportunity to purchase a large farm in Indiana.
i. Adams and two of the other directors decide to buy the Indiana farm for themselves.
Assume that this constitutes self-dealing in violation of the duty of loyalty. A
shareholder wants to sue. Is this a direct or derivative lawsuit?
1. Answer: This suit is derivative. The injury is to the corporation, which lost an
opportunity; the defendants’ duty also runs to the corporation.
ii. Assuming the lawsuit is derivative in nature, is demand required or excused under
DE law?
1. Answer: Under Delaware law, demand is excused. A majority of the board is
directly self-interested in the challenged transaction. Under both the Rales
test & the Aronson test (prong 1), this conflict makes demand futile. The
same would be true if they otherwise received a direct personal benefit from
the transaction.
iii. Assume the board knew this lawsuit was about to be filed. What could the board do
(prior to litigation) to make demand required?
1. Make it a board with 7 people so that no majority. Yeah might sound wrong
but it works. You could do this after the 3 execs already bought the farm.
iv. Suppose only Adams is going to buy the land. She discloses the opportunity to the
other directors. The other directors vote to have the corporation reject the
opportunity and to approve Adams’s personal purchase of the land. A derivative suit
is to be brought. Is demand required or excused under DE law?

  29
 1. Answer: Under Delaware law (Aronson test), the answer depends on
whether plaintiff can create a reasonable doubt as to whether the directors
who approved the transaction were controlled by Adams or that the decision
to approve was not a product of valid business judgment. As to the first
prong, plaintiff must allege that through personal or other relationships the
directors were beholden to the controlling shareholder and direct the
corporation in such a way as to comport with the wishes or interests of the
controlling person.
v. Suppose that the other directors had not voted on Adams’s purchase, but had
merely acquiesced in it. Is demand required or excused under DE law?
1. Answer: This problem raises an interesting question. Under Delaware law,
the Aronson standard does not apply to cases in which the board is alleged to
have failed to exercise effective oversight. Instead, the Rales test governs
such cases. “A court must determine whether or not the particularized factual
allegations … create a reasonable doubt that, as of the time the complaint is
filed, the board of directors 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.” Rales v.
Blasband.
2. Under NY law (similar facts) a court found that where a majority of the board
knowingly acquiesced in the challenged transaction demand would be
    excused (Barr).
    i. Special Litigation Committees
  i. They are a truly amazing creation. Only instance in American jurisprudence where a
defendant can free itself form suit by merely appointing a committee to review the
suit. Composed of disinterested and independent directors.
ii. The authority of a corporation’s board of directors to appoint an SLC to investigate
derivative claims arises from the principle of corporate law that directors, rather than
shareholders, manage the business and affairs of the corporation
iii. How do you select a SLC? Non-defendants; not dominated by interested parties;
given full power & access to counsel; have no direct financial interest in the outcome
of the litigation. They could be members of the board, but that’s unlikely. You’d have
to prove that they were truly independent. DE will look at this closely (See Oracle).
j. Zapata Test for SLC’s (Delaware approach)
i. SLC recommendation (dismissal) will only be followed if both are satisfied:
1. Procedural inquiry: Did SLC act independently, in good faith, and with a
reasonable investigation (burden of proof on defendant)? and
2. Substantive inquiry: Does dismissal pass independent judicial inquiry into
business judgment?
k. Auerbach v. Bennett – (GTE is bribing people, Auerbach, a SH, is mad) NY case.
i. If SLC IS NOT “independent,” its recommendations are meaningless:
1. Independence Factors: Non-defendants; no domination by named directors;
full delegation of board’s authority to SLC; access to reasonable budget;
access to counsel
2. Note: Decision not clear about who bears burden here
3. But…suggests indirectly that burden on derivative plaintiff
ii. If SLC IS independent:
1. Procedures used by SLC scrutinized under (something like) gross negligence
standard
2. Substantive Decision of SLC gets protection of the Business Judgment Rule
  30
 iii. Tootsie Pop Defense
1. What did court mean by describing GTE’s actions as “two-tiered”? What are
the two tiers?
a. First tier: Illegal payments (No BJR protection)
b. Second tier: Committee recommendation (gets BJR protection) even if
the actual conduct would never be
c. In reality, the thought is that pursing litigation for this probably isn’t in
the companies best interest.
d. DE – this shit would never pass.
l. In Re Oracle Derivative Litigation
i. Zapata is still law. What this case changes is the 1st part of the Zapata test
(procedural inquiry) is more involved than we thought – especially the
independence aspect of it. You can have structural bias that influences
independence. It’s an intellectually honest case.
m. Thus the chart is a lot simpler

  31
 DUTY NOT TO WASTE

I. Duty Not to Waste

a. Modern descendant of Ultra Vires Doctrine:
i. Actions undertaken by officers or board that are contrary to purpose of the
corporation (usually as stated in charter) are invalid
ii. When the business-purpose terms of charters were more specific, such claims
were common
b. Ultra vires claims less important today than they were historically:
i. Most corporations have broad charter provisions
ii. DGCL §§ 101(b); 121(a); 124
c. Even “waste” claims are extremely rare
d. Bottom Line on Waste
i. While BJR gives discretion to managers in deciding how to maximize SH
profits…
ii. …the “waste” limitation withholds such discretion for decisions about whether to
pursue that objective.
iii. Thus, in spite of BJR’s protection, management must be able to articulate a
rational basis for decision.
iv. In practice, this if often relatively easy to do
II. Cases
a. Charitable contribution AP Smith Co v. Barlow (give money to Princeton) Since control
of economic wealth of corporations, the common law has begun to recognize the
doctrine that such donations tend reasonably to promote corporate objectives. It is thus
within the implied corporate power. You can give money to charity but it cannot be a pet
charity.
b. Accumulation of surplus Dodge v. Ford Motor Co. (Ford won’t pay dividends) The new
plant can be constructed cause Ford and his team are in a better place to make the call
than we are. But, Corporations are organized primarily for the profit of the shareholders.
The directors are to use their powers primarily for that end. Gotta pay dividends.
i. Refusal to pay dividends is a breach of fiduciary duty. You have a lot of discretion
how to pursue SH best interests and maximize profits (under BJR), but it
doesn’t give you discretion about whether you should maximize profits.
ii. Under BJR, courts won’t scrutinize decisions about how to maximize profits; but
they will scrutinize decisions about whether to do so.
c. Absence of misconduct Shlensky v. Wrigley (lights at Wrigley) The court will not disturb
the “business judgment” of a majority of the directors, absent fraud, illegality, or a
conflict of interest. Corporations are not obliged to follow the director taken by other,
similar corporations.

  32
 DUTY OF CARE
I. A director owes a corporation the duty of care. She must do what a prudent person would do
with regard to her own business. Regulates thoroughness and diligence in deliberations
i. Nonfeasance - Director is liable only if the breach caused a loss to the corporation
ii. Misfeasance – D’s liable if grossly negligent or irrational
b. Director is not liable if they meet the BJR. Don’t have to be right, just prudent.
c. SH ratification of a duty of care problem kills the claim
d. BJR gives presumptive protection; P must show gross negligence (perhaps ordinary neg. in
some special cases
II. Two Conceptions of BJR
Doctrine of Judicial Abstention Alternative Liability Standard
Doctrine prohibiting judicial review, absent Assuming no conflicts of interest, court will
conflicts of interest (or certain other still review board actions, but will apply
problems). Process based look BJR-level review (i.e. rational basis
¡ Court will not review BoD decision review).
¡ Preconditions: ¡ No liability for negligence
§ No fraud, ¡ Instead liability based on:
§ No illegality, § Fraud,
§ No self-dealing, § Illegal conduct,
§ [must be informed § Self-dealing,
decision]? § Or lack of any rational basis
(i.e. criteria similar to gross
negligence)
a. The BJR is sometimes seen as a tradeoff between authority and accountability.
III. Kamin v. American Express
a. Strong Abstention version – “The directors’ room rather than the courtroom is the
appropriate forum for thrashing out purely business questions which will have an impact on
profits, market prices, competitive situations, or tax advantages”
b. The question of whether a dividend should be declared or a distribution of some kind should
be made is exclusively a matter of business judgment for the board of directors. More than
mistaken judgment must be shown. No reason for superimposing judicial judgment as long
as it appears that the directors have been acting in good faith.
c. The deference accorded Amex’s board was (and in many respects is) very typical.
IV. Until the mid 1980s, it was thought that the duty of care was very similar to the waste
doctrine (recognized in judicial rhetoric, but easily sidestepped in practice.) That system
remained in place until…
V. Smith v. Van Gorkom – Oct 14 and 15
a. Facts
i. Aug –Sept 1980: To take advantage of unused tax credits senior management discusses
two possible solutions:
1. Leveraged Buyout (LBO) - another company that is providing its own cash to buy
a. Better option for Trans. You need the acquirer to be bringing in something
to the table.
b. Leverage really concentrates risk on the equity holder
2. Management Buyout (MBO) - the management is the purchaser of the firm.
Current mgmt. is trying to buy the company from the shareholders – lots of
conflict of interest.
ii. CFO Romans does a feasibility study. Easy at $50, hard $60. VG takes $55.
iii. Peterson (Trans-Union controller) runs the numbers and says that at a purchase price of
$55, 50-80 million would remain outstanding after 5 years.
  33
 iv. VG meets with Pritzker and agree deal would be $55 cash out merger proposal. VG says
that TransUnion would be free to accept any price higher. Pritzker says he’ll serve as a
stalking horse only if Trans would let him buy 1.75 million shares at market price ($38)
which he could then sell to highest bidder. He’s doing this (buying NEW shares in Trans Union)
before he does the deal because it protects him from being a stocking horse—he’s making a first bid,
and someone else might come in and buy the company for 60 dollars per share, so that if someone
else buys it, he still has a way to make a lot of money in Transunion. He’s basically guaranteeing
himself of a 20M profit. Either he gets that profit, or he gets the whole company.
1. What does it do for a competing bidder who sees that Pritzker just did this?
a. He can overbid and mathematically pay less
b. Anyone who beats him in this game is paying a tax to Pritzker
c. A device to make it hard for Trans Union to shop itself
v. 7 days later, senior mgmt. meeting called and they all hate the proposal (save 2 ppl).
Has special board meeting and based on info provided by inside ppl (VG, Romans, legal
advice, knoeledge of market history) they approve 2 hours later. 1 condition: Trans
reserved right to accept better offer made during the market test period.
vi. Senior mgmt. is all mad after word of this gets out. They redo the deal. Solomon Bros is
hired to solicit other offers and only 1 company emerges then withdraws. Merger is
approved by 70%.
b. The legal test for procedural challenges to business judgment rule
i. “The determination of whether a BJ is an informed one turns on whether the
directors have informed themselves ‘prior to making a business decision, of all
material information reasonably available to them.”
1. Did board discharge its Duty of Care in Sept. 20 meeting?
a. Del. C. 141(e): Delaware corporations law allows directors to rely on
professional or expert competence. This is a standard defense used in
fiduciary suits
b. Does not apply in this case because: VG is not expert - is CEO - and
completely made up $55. Roman's feasibility analysis - perhaps useful for
range, but not a valuation. Lawyer's advice: bad advice
2. If not, did board’s subsequent actions cure?
a. Board wants to rely on the market test to justify the $55 price.
b. What is the “market test”? Idea that if an investment bank can get more
bidders, then the price was low. If no other acquirer was going to pay
more, then Pritzker was paying the market price. In general, that’s a good
defense but in this case it was weird.
c. Why doesn’t this protect board? Market test was not determinative of
one thing or another
3. If not, did SH approval of deal “cleanse” breach?
a. No. Insufficient disclosure.
ii. P won against the BJR so what happens now?
1. It changes the standard of review from deferential scrutiny à strict
scrutiny
a. Plaintiff doesn’t win (at least not yet): Cause remanded for
determination of whether the transaction was “entirely fair”
b. Burden here is now on the defendant (with some caveats). If
defendant’ can’t carry the burden, the court will determine fair price
that should have been paid.
iii. What's the effect of finding that transaction was entirely fair?
1. Effect of judicial finding that the transaction was entirely fair: monetary
remedies.
2. Cinerama v. Technicolor: "Entire Fairness is an affirmative defense”
  34
 a. Meaning that plaintiff’s attorney is not going to get reimbursed and it
would block injunctions and other non-
iv. What is the test for determining entire fairness? (not a real science)
1. Procedure:
a. Aggressive bargaining by fiduciary
b. Fiduciary’s knowledge of business
c. Whether outside valuation advice sought from an expert investment bank
2. Substantive
a. Magnitude of premium over market price
b. Whether lock ups are so large as to preclude 3rd parties from making
competing bids.
c. Van Gorkam legacies
i. 1) Caused widespread panic within defense bar
1. Liability insurance rates increased
2. Directors threaten to quit/decline appointment.
3. These forces (or at least perception of them) catalyzed passage of § 102(b)(7)
of the DGCL (does not let directors contractually get out of liability for
breach of DoL and/or actions in bad faith)
a. (7) A provision eliminating or limiting the personal liability of a director to
the corporation or its stockholders for monetary damages for breach of
fiduciary duty as a director, provided that such provision shall not
eliminate or limit the liability of a director:
4. Does not apply to duty of loyalty, acts done in bad faith, intentional misconduct or
knowing violation of law
5. Caveats: Text does not say officers as well as directors. It really protects outside
directors from duty of care claims. It would not have protected Van G but the
outside members
ii. 2) Began an era of greater focus on “fairness opinions” all companies in the
M&A context
1. Fairness Opinions: A report authored by an investment bank and addressed to
a company’s board of directors opining about the “fair” price for something).
a. Bargaining leverage against negotiating partner
b. Required pursuant to debt covenants
c. De facto requirement in M&A after Van Gorkom
2. What does it consist of?
a. Opinion letter from IB (short), valuation analysis w/conclusion (long)
3. How does the investment bank do the valuation?
a. Usually opines about range of fair valuation (instead of a single price.)
b. But some i-banks don’t even give a range; instead provide only an
assessment of whether proposed terms are fair.
4. Multiple valuation approaches can be/are used (beyond our scope)
a. Comparable companies
b. Comparable transactions
c. Discounted Cash Flow
d. Option Pricing

BJR only applies if

d. There is no self-dealing; no fraud; and no illegality AND
e. Board exercises “judgment”
1. Was board sufficiently informed prior to making decision?
2. Did board deliberate?
3. Did outside experts present a “fairness opinion” or other report that the board could rely on?

  35
 DUTY OF CARE: Duty to Monitor    

I. Board of Directors has a duty to actively monitor management

II. Francis v. United Jersey Bank
a. (Mom lets sons run biz crazy) : A director should acquire at least a
rudimentary understanding of the business of the corporation such as being
familiar with the fundamentals of the business in which the corporation is engaged
b. Important things about directors the Ct notes
i. If you don’t think you have enough business knowledge to be one, don’t
ii. D’s are under a continuing obligation to keep informed of Corps activities
iii. May not shut their eyes to corporate misconduct
iv. Do not have to inspect day to day, but need general monitor
v. Maintain familiarity with the financial status
c. BJR protects (i) considered actions and (ii) considered inactions, but does not protect
unconsidered inactions.
III. In Re Caremark Litigation
i. Caremark is a healthcare provider. Middle management use company funds to bribe
doctors (i.e. consulting contracts, research grants, etc.) for referral business. SHs
then bring a derivative suit against directors to recover the fine that Caremark paid to
the Feds and for an injunction to implement better monitoring system.
ii. Caremark suggests largely in dicta that you must have some sort of corporate
monitoring system.
iii. This opinion will come to be cited as a core opinion for the fiduciary duty to act in
Good Faith. (You want to have bad faith cause then you can get into 102(b)(7))
IV. Duty to Monitor Legacies
a. Directors/Officers will have personal liability for poor oversight only if:
i. There is no reporting system or control, or
ii. They ‘consciously failed’ to monitor or oversee operations
1. Director/Officer knew or should have known violations were occurring
2. D/O took no steps in good faith effort to remedy situation
3. Nonfeasance was proximate cause of losses.

  36
 DUTY OF LOYALTY  

I. Regulates self-dealing transactions by management. Historically,

any shareholder could void a conflict of interest transaction for
any reason (regardless of the fairness of the transaction)
II. BJR does NOT apply to DoL cases
III. DGCL 144
a. (a) No [self-dealing] transaction … shall be void or voidable solely for this reason … if:
i. (1) The material facts [relating to the conflict of interest] are disclosed or are known to the
board of directors, and the board in good faith authorizes the contract or transaction by the
affirmative votes of a majority of the disinterested directors, even though the
disinterested directors be less than a quorum; or
ii. (2) The material facts [relating to the conflict of interest] are disclosed or are known to the
shareholders entitled to vote thereon, and the contract or transaction is specifically approved
in good faith by vote of the shareholders; or
iii. (3) The contract or transaction is fair as to the corporation as of the time it is authorized,
approved or ratified, by the board of directors, a committee or the shareholders.
b. (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.
IV. DGCL in English
a. Self-dealing transaction is okay if any one of the following occurs:
i. 1) Material facts disclosed + majority of the disinterested directors say it’s cool
[cleansed]
ii. 2) Material facts disclosed + Shareholders say it’s cool [cleansed]
iii. 3) Self-dealing is fair as to the corporation at the time it was authorized [entire
fairness] (burden on defendant to show fairness)
V. Core Duty of Loyalty Analysis
a. If π shows conflict à entire fairness
b. If Δ shows cleansing under 144 à BJR
VI. Modern Duty of Loyalty

  37
 VII. What constitutes disclosure under DGCL 144? Material facts are disclosed
VIII. What makes a director disinterested?
a. Status-based: By a 2003 NYSE rule change (and a similar one at NASD), the majority of
directors on each publicly held firm must be “independent”: no “material relationship”
(supplier, customer, partner), no employees or close family members of employees, $100K
profit max, from company per year (excluding director fees or independent deferred
comp/pension benefits), etc.
b. Transaction-based (DE) vs. status-based (NYSE)
i. Delaware a transaction based. We’ll do a separate analysis for the transaction in
question. We’ll look at every deal individually
c. Lack of direct financial interest in transaction (Aronson)
d. Structural bias (recall Oracle case)
IX. Which shareholder votes count for 144(a)(2)?
a. Quorum
i. # of directors who must be present at a board meeting for it to be valid
[§141(b) & 144(b)]
ii. § 144(b): “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.”
iii. § 141(b): “A majority of the total number of directors shall constitute a quorum
for the transaction of business unless the certificate of incorporation or the bylaws
require a greater number. . . .”
b. Authorizing/Approving
i. # of directors who must vote for an item for it to count as a valid action of the
board [§141(b)]
1. Majority of directors present at meeting with quorum (default)
2. “The vote of the majority of the directors present at a meeting at which a
quorum is present shall be the act of the board of directors unless the
certificate [or bylaws] shall require a vote of a greater number.”
3. You can modify this
X. Cleansing
# of disinterested directors (or
SHs) who must vote for action
to remove conflict of interest
[§144(a)(1) & (2)]

b. Majority of all disinterested

directors (regardless if they
attend meeting)

c. à you CAN have authorized

action that is not cleansed
 

  38
 XI. Example
a. 5 directors: Dr. Dreyfus [interested director]; plus four disinterested directors: Alice
Adams, Bob Brown, Charlie Conners, and Ed Edmond. Assume, however, that only
three directors show up at the board meeting to approve the musician contracts.
i. Do they have a quorum? Yes [See § 141(b)] they have 3 out of 5 directors.
ii. Does the fact that Dreyfus is one of the three directors present matter for quorum
purposes? Not a problem. See § 144(b) “Interested directors may be counted in
determining the presence of a quorum”
iii. Alice and Ed vote for transaction. Dr. Dreyfus abstains. Has it been approved?
Why? [look at both 141(b) and 144]. Approved for § 141 purposes but not “cleansed”
for § 144(a)(1). A majority of the directors present vote for the transaction [satisfying
141(b)], but we only have 2 out of 4 independent directors. Need to get one more
independent director to satisfy 144(a)(1).
XII. KRB Questions Pg. 346
a. Susan Alexander is a ‘‘singer’’ who is trying to break into the bigtime opera circuit. A
few years ago, she took up with wealthy Charlie Kane, and has now married him. He
would like to promote her career. Kane is CEO and majority shareholder in the
Chicago Inquirer. The shares of the Inquirer are worth a total of $100 million.
i. Suppose that the Inquirer’s board of directors votes to make a $20 million donation
to start a Chicago City Opera Co. (CCO). The Chicago community is eager to have
this opera company, and the company thus stands to receive much goodwill in the
area. If Alexander does not sing with the company, is there a problem?
1. Answer: Yes, there may be a problem. The amount is probably too large.
And, the CCO seems like a pet charity of Kane’s (recall A.P. Smith).
a. Note: this type of transaction would generally be entitled to BJR
protection. The problem is whether the donation is so large that it
would constitute “waste”. Hard to say how a court would rule, but
potentially a problem.
ii. Suppose that, out of appreciation for Kane, the music director of the CCO offers to
star Alexander as the lead soprano in a new production of the opera ‘‘Rosebud.’’ Is
there a problem? Suppose that, when offered the lead, Alexander responds:
‘‘Thanks, you’re so sweet. But Charlie is so rich, you know, and we really don’t need
more money. I’d love to sing the lead, but how would it be if I did it for free?’’
1. Answer: This may be viewed as a conflict, even if Alexander does not take
any money since the performance itself may benefit her career.
iii. Suppose that Kane owns 100% of the stock of the Inquirer. Do your answers to the
questions above change?
1. Answer: It is his money. No other shareholder can complain.
iv. Suppose that Alexander is a genuine star, and the CCO offers her the ‘‘Rosebud’’
lead after holding an audition at which the judges unanimously voted her the best
lyric soprano.
1. Answer: the audition process appears to sanitize the conflict, by suggesting
“entire fairness” [see DGCL 144(a)(3)]

  39
 DUTY OF LOYALTY: Corporate Opportunities Doctrine

I. Introduction
a. Part of Fid. Duty of Loyalty
b. Limits corp. fiduciary’s ability to pursue new business prospects individually without
first offering them to corp.
c. Can be seen as a special type of self-dealing because you’re stealing an opportunity
d. Applications of particular interest/salience:
i. Firms with significant human capital components
ii. Corporations with overlapping directors
iii. Parent / subsidiary
II. DGCL 122
a. You can renounce in your certificate of incorporation for certain classes of investment
opportunities
b. “Every Corporation created under this chapter shall have power to….(17) Renounce, in its certificate of
incorporation or by action of its board of directors, any interest or expectancy of the corporation in, or in
being offered an opportunity to participate in, specified business opportunities or specified classes or
categories of business opportunities that are presented to the corporation or one or more of its officers,
directors or stockholders.”
III. Roadmap of the Corporate Opportunity

- Interest/Expectancy
- Line of Business (eBay)
- “Fairness” & Hybrid Tests

- “Incapacity” based
Defenses (Broz)
- “Source” based defenses

a.
b. Broz v. CIS
i. Broz serves in a capacity for 2 companies. Opportunity to get Michigan-2 arises and
he informally clears opportunity with CIS’s CEO (in addition to several other board
members at CIS). Broz should have approached the board as a whole and asked
about the opportunity. He’s trying to do the right thing but he’s being sloppy. This
fails at (1) a  nd (3) below.
ii. Court identifies 4 considerations that support a corporate opportunity:
1. Corporation is financially able to take the opportunity
2. Opportunity is in the corporation's line of business
3. Corporation has an interest or expectancy in the opportunity
4. Embracing the opportunity would create a conflict between director’s self-
interest and that of the corporation
  40
 c. In Re eBay SH Litigation
i. (Spinning offers to insiders) When a unique offer is given to select insider
directors and officers, it is a corporate opportunity that should not be taken
advantage of
ii. How does the court analyze whether the IPO allegations should be treated as a
corporate opportunity?
1. The opportunity here is for eBay to be an initial purchaser and get it at a
low price with a huge first day bump
iii. Line of business. Is eBay a mutual fund?
1. eBay’s 1999 10K shows that it had $949M in total assets, of which $550M
(58%) were equity investments
IV. Definition 1 of Corp. Opport.: Alternative Test (plaintiff bears burden of proof)
a. Interest or Expectancy (narrow test)
i. Interest = the firm already had a pre-existing contractual right to the opportunity
ii. Expectancy = though not a contractual entitlement, reasonable for the firm to expect
to receive the opportunity
b. Line of Business (broader test)
i. More dynamic test. Meant to capture the corporation’s expansion potential. Not
limited to the firm’s current interests or expectancies.
c. Hybrid Tests
i. ALI holds corporate executives to a higher standard than outside directors
d. Fairness
i. Focuses on the fairness of holding the director/officer accountable for his outside
activities. Very subjective
V. Definition 2 of Corp. Opport.: Defenses (defendant typically bears burden of proof)
a. Corporate Incapacity
i. Corporation could not pursue the opportunity because of financial limitations, legal
constraints, or other considerations. Most effective when alleged incapacity is
observable to third parties
b. Source
i. Defendant became aware of opportunity through his personal capacity, unrelated to
his service to the firm. Hard to prove
1. Look at question 3 KRB page 351. How would this complicate the source
defense?
c. Corporation Renounces Opportunity
i. See DGCL § 122 (17) (next slide)
ii. Does this limit damages or merely affect the scope of corporate opportunities.
VI. Consequences of Corporate Opportunity Status
a. The fiduciary must generally disclose the existence of the C.O. (and her conflict of
interest) to the board/SHs.
b. Corp. has right of first refusal on project
i. But can choose to give it to fiduciary…
ii. Must disclosure/rejection be “formal”? No, but that’s more helpful (see Broz)
iii. Is it subject to same three “cleansing” criteria as for D.O.L. under DE 144?
Yes. It’s a little different. It’s a parallel form of cleansing. Under 144 we cleanse by
having the indy. directors say it’s fine or shareholders say it’s fine. SEE CHART.
c. Remedy: Gains-based (constructive trust)
i. Injunctive relief & punitive damages also.

  41
 VII. Example Problem (KRB 356-7)
a. George is Vice–President for Marketing of Zapco Enterprises, Inc., a manufacturer of
video game software used in arcades and home systems. One of George’s duties is
to test competitor models. One day George leaves work and travels to a near-by
video arcade to test a new game. While visiting the arcade, George meets two young
computer software engi  neers who have developed a new voice recognition program
for personal computers. After further meetings with the engineers, George decides
the program has promise and offers to help market it. The two engineers set up a
new corporation called ‘‘Wordco, Inc.,’’ and hire George as a marketing consultant.
George receives 10 percent of Wordco’s common stock and also becomes entitled
to a commission of $10 for every copy of the program sold by Wordco. Zapco sues
George for violating the corporate opportunity doctrine.
b. Assuming Zapco is incorporated in Delaware, has George violated the corporate
opportunity doctrine?
i. Answer: Probably not a corporate opportunity: (i) no interest or expectancy; and (ii)
probably outside Zapco’s line of business (? Depends how broadly we define
Zapco’s line of business). Also, the source defense likely protects George.
c. What if the engineers had approached George at Zapco’s booth at a computer trade fair?
i. Answer: It appears the engineers intended to offer the product to the company, not
to George in his individual capacity. (source defense unavailable)
d. Would it be relevant to the outcome that the two engineers refused to work with Zapco,
because they refused to work with a mere game company?
i. Answer: The refusal to deal defense is analogous to the capacity and financial
incapacity defenses.
e. Assume that after meeting with the engineers, but before signing the contract with Wordco,
George approached Zapco’s Chief Executive Officer and told him about this project. The
CEO said Zapco had no interest in the project and no objection to George working for
Wordco as long as it did not interfere with his Zapco duties. Result?
i. Answer: OK. Under Delaware law, formal consideration by the board is not required
(Broz v. CIS).
f. Suppose the transaction was a corporate opportunity. In perfect good faith, George takes it
for himself. He then mentions to the firm’s lawyer that he (George) is working on this word-
processing project on the side. The lawyer sees that this is a corporate opportunity, which
should have been offered to the company. Based on the lawyer’s advice, George tells the
board of directors about the opportunity, offers it to the corporation, and asks the board to
ratify his taking the opportunity. The board does so. Is George insulated from liability?
i. Answer: As long as the opportunity still exists and could be pursued by the Zapco, a
vote of the board will formally cleanse George’s actions, providing a “safe harbor.”
Presumably, however, plaintiff still could prevail by showing that the board made an
uninformed decision or lacked independence.

  42
 DUTY OF LOYALTY: Dominant Shareholders

I. Vertical vs. Horizontal Conflicts

a.
b. Class 23: Why are we particularly worried about horizontal conflicts?
i. There has to be some harm to party. You can cause the firm to be running in certain
directions that only benefit the dominant, not the minority shareholder
c. Shareholder-to-shareholder fiduciary duty (analogy to fiduciary duties in partnership).
i. Right runs directly to SH
1. What effect does this have on litigation procedure? Sidesteps need for a
derivative lawsuit
2. Can defendant prevail by showing “fairness” to corporation? No. Duty not
owed to the Corp.
II. Cross Voting: One SH of A that has a lot of Stock in Company B, and votes in favor of his
Company B interests on votes made for the benefit of Company A.
III. A dominant/controlling shareholder owes a fiduciary duty (duty of loyalty) to the rest of
the corporation
a. Delaware says if you are a controlling shareholder, you owe fiduciary duties. What’s diff
is what is the content of the duties.
i. Mass: In small closely held firms, you owe (see Donahue) AND you also have to
give equal opportunity
ii. They’re really worried about closely held firms
b. The conflict here is really a conflict amongst different shareholder groups
IV. What does it mean to be dominant?
a. You can be dominant with less than 50%.
i. Courts usually presume dominance at 25%
ii. The real legal question is can you effect the outcome
V. When minority SH complains, focus predominately on DoL
a. Other claims aren’t as strong because you aren’t a manager, so you don’t have duties of
waste, care, GF.
VI. MINORITY SHAREHOLDERS/PARENT-SUBSIDIARY
VII. Sinclair v. Levien
1.  The directors of Sinven took a number of actions that were not in the best
interest of Sinven, but were in the best interest of Sinclair (like paying out
extra-large dividends instead of investing in business infrastructure). Levien,
one of the minority shareholders of Sinven, sued Sinclair for breach of
fiduciary duty.
b. It was not self dealing because the dividends were paid out in proportion to stockholdings.
Basically, this case said that if there is a parent corporation dominating a subsidiary, they
can't take actions that would help the parent but hurt the subsidiary's minority shareholders.
But, if the parent and the minority shareholders get the same benefit from a transaction,
then the business judgment rule applies.
i. Since Levien cannot show that the dividends results from “improper motives and
amounted to waste,” BJR is satisfied and the dividend policy must be upheld.
c. When does a conflict exist?
  43
 i. Direct: Dominant SH forced decision resulting in a non-pro-rata distribution of
corporate “property” (e.g., cash; assets; info.; corp. opportunities)
ii. What is a non-pro-rata distribution? What if there are multiple classes of stock?
iii. Indirect: Dominant SH forced a decision that didn’t result in a non-pro-rata
distribution, but still favored the DSH’s outside business interests and not the
minority SH’s
VIII. EXAMPLE
a. Change the facts of the case: Suppose that a third party oil company was interested in oil
exploration in international waters off the coast of Venezuela. Sends letter to Sinclair board
proposing a joint venture with either Sinclair itself or Sinven.
i. Can the CEO: Accept the opportunity on behalf of Sinclair without disclosing the offer
to the Sinven board/SHs?
1. Apparently no: See Zahn v. Transamerica [next case]
ii. Can the CEO: Disclose opportunity to Sinven board/SHs, but announce that Sinclair
will use all its power (even its majority stake in Sinven) to ensure that the joint
venture goes to Sinclair & not Sinven?
1. Apparently yes: Thorpe v. CERBCO 676 A.Zd 436 (Del. 1996), but controlling
SH may be liable for damages incidental to their breach of duty.
IX. MULTIPLE CLASSES OF STOCK
a. In firms with multiple classes of stock (i.e. common + preferred), plaintiffs often litigate
based on dominant SH fiduciary duties.
b. Easier to classify the case as “direct” as opposed to “derivative”
c. Easier to show a conflict of interest (i.e. preferred stock has different financial rights than
common) and thereby avoid BJR.
X. Zahn v. Transamerica Corp
a. Trans controlled Axton-Fisher. Trans allegedly “conceived a plan to
appropriate the value of the tobacco to itself by redeeming the Class A stock
at the price of $60 a share plus accrued dividends...and thereafter, the
redemption of the Class A stock being completed, to liquidate Axton-Fisher.”
This resulted in Transamerica gaining most of the value of the tobacco for
itself and precluded Class A stockholders from participating in the liquidation.
Zahn says Class A stockholders did not know.
b. (1) One of the situations where dominant shareholders show up is
when you have multiple classes of stock.
i. Also seeing how much flexibility firms have with their classes of stock. We have to
have some way to make sure that we are not favoring one class over another
c. (2) They failed to disclose their motivations
XI. CLEANSING AND DOMINANT SHAREHOLDERS
a. DGCL § 144 does not apply; only gives only the requisite procedures for cleansing DoL
transactions by directors/officers.
b. But it has become so routine that courts have begun to analogize to it in other contexts:
i. DoC (informed SH vote)
ii. Interested transactions effected by dominant shareholders
c. What problems would you expect in analogizing § 144 to the dominant SH?
i. See Fliegler v. Lawrence … [Must have a majority-vote of the non-dominant
shareholders (e.g. a majority-of-the-minority or MOM clause) to cleanse].
XII. Shareholder Ratification
a. Ratification = like cleansing. After the fact it’s like the shareholders saying that we bless
this.
b. In each case, all material facts must be disclosed to shareholders

  44
 c. As you can see, it gets weaker and weaker as you go down. Delaware and other states are
very worried about dominant shareholders.
d. SH ratification of a DoC problem kills the claim
e. SH ratification of a director conflict shifts the burden of proof to the plaintiff and the plaintiff
must show waste (i.e. no rational basis for the action);
i. DGCL 144 only applies to this scenario
f. SH of a dominating shareholder conflict shifts the burden of proof to the plaintiff, but the
plaintiff only needs to show that the transaction was unfair (no BJR).
XIII. PROBLEM p372/374
XIV. DreamTeam, Inc. (DTI), which is incorporated in Delaware, is a Hollywood studio owned
in equal parts by Mouse, Duck, and Flintstone. The three also constitute the board. DTI
has recently signed a contract with director Olivia Stone for a new movie, Fillmore.
Stone has based the film on (what she considers) the scandalous presidency of Millard
Fillmore. In the movie, Stone will star Flintstone as the diabolical mastermind behind
(what Stone claims is) the newly discovered CIA plot to assassinate Fillmore. For
directing this movie, Stone will receive $25 million; for playing the villain, Flintstone will
receive $5 million.
a. The Stone contract was approved by a 2–1 vote among the board of directors, with Mouse
objecting. Mouse now brings a derivative suit to enjoin the contract. What result?
i. Answer: Business judgment rule. Mouse will lose unless he can show waste, which
seems unlikely. Neither Flintstone nor Duck had a conflict with respect to the Stone
contract
b. The Flintstone contract was approved by a 2–1 vote among the board of directors, with
Mouse objecting. Mouse similarly sues to enjoin the contract. What result?
i. First, consider this a contract between a corporation and one of its directors. What
result?? Cleansed under DGCL 144??
1. Answer: No. Ratification requires a majority vote of the disinterested
directors. As there is a 1-1 vote among the disinterested directors, there is no
ratification. Hence, Flintstone would bear the burden of proving that the
contract is fair.
ii. Second, consider this a contract between a corporation and a controlling
shareholder. What result now??
1. Answer: Successful ratification would shift the burden of proof to plaintiff
Mouse, but Mouse would need show only that the contract is unfair. But
again, the test is whether a majority of the disinterested shareholders have
ratified the contract, and here the vote is 1-1.
c. Stone will use the movie to push her distinctive fringe-left political philosophy. Mouse shares
this philosophy; Duck does not share it, but does not care as long as the movie makes
money; Flintstone objects to the philosophy. Can Flintstone block the use of a DTI movie for
political ends?
i. Answer: Probably not. To be sure, an officer, director, or controlling shareholder who
used the corporation for political ends at the expense of the corporation’s financial
returns would be violating a fiduciary duty. Yet such a fiduciary would not violate that
duty in including a controversial political philosophy in a DTI film, if the fiduciary
thought that doing so maximized the returns to the firm.
d. Suppose Mouse had been absent when the Flintstone contract was considered by the
board. The contract was approved by a vote of 2–0, both Duck and Flintstone voting in the
affirmative. Mouse objects (a) that the action was invalid for lack of a quorum and (b) that
the contract should be enjoined as unfair and unauthorized. What result?
i. Hint look at both 144 and 141.
  45
 ii. Answer: Mouse loses on (a) and (b).
1. As to (a), under Del. Gen. Corp. L. § 144(b),Flintstone can be counted
towards a quorum even though he is interested in the transaction. Duck and
Flintstone constitute a majority of the board and a quorum.
2. Mouse’s claim under (b) points up the distinction between the vote needed to
create authority to take action and the vote needed to provide the protection
offered by § 144. Section 141(b) provides that a majority of those present and
voting suffices to authorize the corporation to take action. By contrast, under
§ 144(a)(1), only the votes of disinterested directors count for purposes of
ratification.
XV. Protection of Minority’s in CLOSELY HELD FIRMS
a. Minority shareholders are more vulnerable in closely held firms. There is no market
for the shares—thus, if the management stops paying dividends and you can’t sell your
shares, you’re screwed.
b. Why are minority shareholders particularly vulnerable to “freeze out”?
i. It is difficult to prevent this under traditional principles of corporate law because it is
not seen as a conflict of interest, and is thus given BJR protection.
c. Donahue v. Rodd Electrotype Co.
i. Sons buy out the shares of father who just dies and dad’s wife is way mad. Is all,
“You should have given me the same opportunity!”
ii. Court imposed a fiduciary duty of “utmost good faith and loyalty” between
shareholders in closely held firms. Moreover, minority SHs must have equal
opportunity to sell shares to corporation on same terms as controlling SH.
1. But note, subsequent courts have reduced the scope of the Equal Opportunity
rule (Wilkes v. Springside).

  46
 DUTY OF LOYALTY: Obligation of Good Faith

I. Introduction
a. Core of DoL analysis = DGCL 144  
i. If π shows conflict à entire fairness
ii. If Δ shows cleansing under 144 à BJR
b. Good faith was traditionally ‘‘subsumed in a court’s inquiry into the director’s satisfaction of
her duties of care and loyalty.’’ (Cede v. Technicolor (1993) = first DE case to suggest that
GF was a separate duty apart from care and loyalty)
c. Directors have a duty to act in good faith. To violate the duty of good faith, a director’s
conduct must rise to the level of an “intentional dereliction of duty, a conscious disregard for
one’s responsibility”. - Disney
d. If you prove someone acts in bad faith, you can get out of BJR without having to
show a conflict of interest.
e. Duty to Act in Good Faith not an independent FD. Subsidiary of the fiduciary duty of loyalty
II. Why argue bad faith?
a. May sidestep BJR & 102(b)(7) without showing conflict of interest
i. 102(b)(7)(ii)
1. Expressly denies money damage exculpation for ‘‘acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of law”
ii. BJR
1. Our law presumes that “in making a business decision the directors of a
corporation acted on an informed basis, in good faith, and in the honest belief
that the action taken was in the best interests of the company.” Those
presumptions can be rebutted if the plaintiff shows that the directors breached
their fiduciary duty of care or of loyalty or acted in bad faith.
III. In Re Disney Co. Derivative Litigation
a. Ovitz was president of Disney and they don’t want him there anymore. They terminate him without cause
and pay him $130 million. Shareholders, led by Brehm, filed a derivative lawsuit against Disney
executives, represented by Eisner (the CEO) saying that paying him was a waste of assets
b. Waste argument especially fails because to prove corporate waste, a P must prove that the
exchange was so one-sided that no biz person of ordinary, sound judgment would conclude
that the corporation received adequate consideration.
c. Makes GF sound like separate COA
d. Bad faith ≠ gross negligence (not same as DoC)
e. Bad faith ≠ conflict of interest (not same as DoL)
f. Judge suggests 3 categories of bad faith:
i. 1) Intentional act against corporation  
ii. 2) Intentionally causes corp. to violate law
iii. 3) Intentionally fails to act in face of known duty to act
IV. Stone v. Ritter
a. AmSouth, which is accused of money laundering, is being sued by a shareholder who is
mad that they could have saved all this $ had they just monitored everything better. P brings
derivative lawsuit.
b. Plaintiff’s claim dismissed by Chancery court. Why?
i. Plaintiff argued that demand was excused as futile. Must allege facts creating a
reasonable doubt that:
1. “the board of directors could have properly exercised its independent and  
disinterested business judgment in responding to demand”
  47
 2. Key factors: (i) majority of board has (financial or family) interest in the
outcome of the lawsuit, or (ii) underlying transaction is not the product of valid
business judgment.
ii. What are the problems here?
1. No financial conflict if 102(b)(7) applies. Does it?
a. Does not protect “acts or omissions not in good faith”.
b. Does this mean π must bring suit under fid DoGF, or merely show lack
of good faith in a suit brought under DoC or DoL?
2. Failure to act may be a ‘valid business judgment’.
c. Chancery Ct. analyzed Stone v. Ritter under legal doctrine of good-faith
i. Court invokes the Caremark decision (discussed under DoC) as a test for failure to
act in good faith
ii. Court found that no such breach occurred here
1. Lack of proof regarding awareness of “red flags”
2. Remains unclear whether Caremark requires deliberate failure to act (as
opposed to a pattern of failing to act constituting gross negligence)
d. Court then seeks to “Clarify” a doctrinal issue
i. Duty to Act in Good Faith not an independent FD
ii. Rather, it is a subsidiary of the fiduciary duty of loyalty.
V. Practical Consequences of Ritter
a. To what extent is a plaintiff entitled to discovery in Caremark claims, as compared to
standard duty of care claims??
i. Answer: Generally speaking duty of care claims covered by the BJR should be
resolved at the motion to dismiss stage. Plaintiff generally is not entitled to discovery
in such cases, but rather must use the “tools at hand” (such as § 220 inspections) to
craft a complaint offering particularized allegations. Stone contains no such
admonition. Unclear whether plaintiffs bringing a Caremark claim under DoL are
entitled to discovery on issues, such as what the directors knew and when they knew
b. What remedy is available to a plaintiff who successfully brings a Caremark claim?
i. Answer: The duty of loyalty traditionally focused on cases in which the defendant
fiduciary received an improper financial benefit. Accordingly, the traditional remedy
was to strip that benefit away from the defendant. In related party transactions
whose terms are unfair to the corporation, for example, the transaction may be
voided. Where a defendant usurps a corporate opportunity, the corporation gets a
constructive trust on the opportunity.
ii. By subsuming good faith into the duty of loyalty, however, Stone presents the
prospect of loyalty cases arising in which the defendant received no financial benefit.
In such cases, the traditional remedy is inapt. There is no transaction to be voided or
a res to be seized. This remedial consequence illustrates the basic problem in Stone.
The doctrinal and remedial aspects of the duty of loyalty have little relevance to
Caremark claims.
c. Can you cleanse bad faith?
i. No, that would require saying to the shareholder “Hey, I’m going to launder money.”
You can’t vote on illegal activity. You cant vote on "bad" behavior and cleanse it just
because you informed them before the vote

  48
 VI. Status of “Good Faith” Now
a. Ritter + Disney = Directors will only be liable if they acted in “bad faith” AND only a
“conscious disregard” of duty (not mere gross negligence) can establish bad faith.
b. Probably has to have some sort of intentionality/deliberateness. It has to be some
sort of purpose
c. (1) After Stone, the signal is that Good Faith is not a simple “end run” around § 102(b)(7)
protections
i. Labeling GF as subsidiary to DoL appears to raise the bar of proof in cases above
gross negligence (i.e. π needs to show intent)
d. (2) Appears to expand DoL to cover bad faith cases where there is no conflict of interest
(GF type DoL cases)
e. (3) Creates greater ambiguity in boundaries between fiduciary duties, and creates
particular confusion in understanding of duty of loyalty.
f. Does an exculpation provision adopted pursuant to DGCL § 102(b)(7) preclude monetary
liability in Caremark claims?
i. Answer: Because 102(b)(7) provisions may not exculpate directors from liability for
breaches of the duty of loyalty, the recharacterization of Caremark as a loyalty-based
claim removes such claims from the ambit of the exculpatory provisions.

  49
 OVERVIEW OF SHAREHOLDER VOTING/GOVERNANCE

• Contractual Foundation of Shareholder Voting

o Basic existence of SH voting is mandatory, but
o Flexible in #votes/share, thresholds, issues SHs get to vote on, etc.
• Proxy Voting and Proxy Fights
o Proxy voting helps insure valid quorum, but
o Asymmetric cost to insurgents vs. incumbents
à Few actual Proxy fights à voting is largely a rubber stamp of current board
• Shareholder Proposals (publicly traded firms)
o Easy (& low cost) to get on ballet, but generally precatory
o Exception = Bylaw amendments [can indirectly be used to give SHs right to nominate
directors - Rule 14a-8(i)8]
• Shareholder Inspection Rights
o Access to SH list (valuable in tender offer or proxy contest).
o Must have some corporate purpose for info request
• Control in Closely-Held Firms
o Shareholders can contract over how they will vote their shares
§ Election of directors (voting trust / vote pooling agreement), and
§ Certain other matters (drag along rights)

But

Directors cannot contract away their vote/discretion.

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 SHAREHOLDER VOTING – GENERAL

I. Shareholder voting is both default and mandatory

a. Default. (parties can easily modify contractually). You can give some classes more rights than
others, limit what can be done, etc.
i. DGCL 212: “Unless otherwise provided in the certificate of incorporation and subject to §
213 of this title, each stockholder shall be entitled to 1 vote for each share of capital
stock held by such stockholder.”
1. It’s possible to have a stock with 10 votes for each share or a non-voting stock
ii. Flexibility: You can modify vote thresholds, cumulative voting, quorum requirements, use
of consents, create classified board, etc.
1. Private firms take more advantage of this cause investors value familiarity
(standard practice) and proxy rules only apply to publicly held firms
b. Mandatory (parties can’t modify, or can only do so at significant cost).
i. There must be at least one class of shares that can vote on required matters
II. Direct v. Indirect vs. Advisory
a. Keep in mind that the board controls majority of corporate decision-making (representational
democracy). SHs get to vote on 3 types of matters:
i. Indirect matters (electing the directors)
1. Annual SH meeting which is required once a year
ii. Direct matters
1. Some require a direct vote (mergers, major asset sales, reorganization, charter
amendments)
2. Meaningful but only applies when mgmt. puts the matter to them. More of a
blocking right than a voting right
iii. Advisory matters (these are non-binding votes)
1. Shareholder proposals are examples of this
2. Ex: executive compensation
III. Voting at annual or special meetings
a. Nominating committee of the incumbent board of directors nominates a slate of directors to be
elected at next annual meeting. Incumbent board also identifies other issues to be put to vote.
b. These things are done at the company expense
i. Management prepares proxy statement and card
ii. Management solicits shareholder votes (typically with aid of proxy solicitor)
c. In order for shareholders to take action, there must be a quorum at the meeting (default: a
majority of the shares entitled to vote)
d. Most matters require a majority of shares present at a meeting at which there is a quorum
i. DGCL § 216 and MBCA § 7.25(c)
e. Some things require approval by a majority of all outstanding shares
i. Mergers, amendments to the charter
f. Election of directors requires a plurality of votes cast

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 PROXY VOTING

I. Close vs. Public Corporation Shareholders

II. History of Proxy Voting and Rules

a. Two layers of regulation
i. State (DGCL § 212)
1. All corporations are required to have an annual SH meeting
2. You need a quorum but if you don’t have a lot of shares, you won’t go. Without
proxy voting we would not have quorum
3. Proxy voting was initially a state law response (vote by mail!)
ii. Federal (Securities Exchange Act 34 Act and SEC Rules 14a-1 to 14a-9)
1. Securities laws (33 and 34 Acts) increase disclosure and insure SH have
accurate info about what’s going on
2. Section 14(a) of the 34 act regulates anyone who solicits a SH proxy vote
3. If you solicit proxies, must give each SH a “proxy statement” (14a-3 to 14a-5)
a. More disclosure required for contested meetings
b. Must file material with SEC (14a-6)
4. Feds also regulate “fraudulent” proxy statements (14a-9) & SH proposals
(14a-8)
5. Proxy Fight
a. Mgmt can either (i) mail insurgent group’s proxy to SHs or (ii) give list of
all SHs so insurgent can mail directly (14a-7).
i. In either case insurgent bears cost
b. Mgmt will chose to mail it directly because they don’t want you know. In
either case, the insurgent bears the cost.
c. Mgmt proxy is paid for by the corporation. You want them to focus on
doing their jobs.

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 III. How Proxy Voting Actually Works

a. Shareholder appoints a proxy agent to vote their shares at the meeting. The appointment is
effected by means of a proxy card. The card can specify how shares are to be voted or give
agent discretion. These can be revocable. Normally proxy is unopposed.
b. What’s on a proxy?
i. Must identify each matter to be voted upon
ii. May give discretionary authority to vote on other matters that may come before the
meeting, but not elections to office for which a bona fide nominee is not named
iii. For, Against, and Abstain boxes required for each matter other than election of directors
iv. For and Withhold Authority boxes for election of directors so that a shareholder may
withhold authority to vote for individual directors
v. Proxies may be revoked and if more than one proxy is given, the latest proxy governs
c. What happens if SH does not return the Proxy card??
i. Answer: Shares not counted towards the quorum, and no vote cast.
ii. Under the proxy voting system finding a quorum is typically not a big problem because
many shares held by institutional investors who vote the shares.
d. What happens if SH returns the Proxy card, but does not specify how she will
vote on one of the items?
i. Answer: Shares count toward meeting the quorum, and the proxy agent will vote the
shares as specified in the DEF14A filing.

  53
 PROXY CONTESTS

I. Types of proxy contests

a. A shareholder (a.k.a. the insurgent) solicits votes in opposition to the incumbent board of
directors
i. Electoral contests: Insurgent runs a slate of directors in opposition to slate
nominated by incumbent board
ii. Issue contests: Shareholder solicits votes against some proposal
1. E.g., Shareholder urges fellow stockholders to vote no on a merger
II. How to analyze proxy fights
i. The corporation may not reimburse either party unless the dispute concerns
Rules  from   questions of policy.
Levin  and   ii. The firm may reimburse only reasonable and proper expenses.
Rosenfeld  à  
iii. The firm may reimburse incumbents whether they win or lose.
iv. The firm may reimburse insurgents only if they win, and only if shareholders ratify the
payment.
b. Since most proxy fights can be classified as questions over ‘policy’ (& expenses are
generally treated as reasonable & proper), we can simplify:
c. Reimbursement depends on two factors:
i. Who won the proxy contest
ii. The identity of the party (Insurgent or Incumbent)

d.
III. Levin v. MGM – solicitation methods employed during proxy fight
a. MGM was experiencing a conflict for control of the company. MGM did not employ an illegal
or unfair means in their proxy solicitation campaign. The expenses are not expensive and
mgmt. did not violate a federal statute or SEC rule or regulation.
b. If corp. pays incumbent’s costs, what incentives does this create? They can hire all the
top firms and conflict them out. Nah nah, you can’t hire
Skadden cause they are ours!
c. Is the fact they’ll lose their job a conflict of interest?
Not the way the law is treating it. If anything it’s protecting them
d. Why not reimburse Levin’s efforts? Creates the incentive to
challenge
e. Who pays Levin’s costs? Levin does. This may create a problem
cause it’s a lot of money he has to pay.
f. The Court points out that the disagreement is over policy. Why does this matter? It’s
substantive to the business. To get reimbursed, you need to classify this as policy dispute.
IV. Rosenfeld v. Fairchild – reimbursement approved
a. (shareholder doesn’t like that $ is being used in proxy battle) When the directors act in good
faith in a contest over policy, they have the right to incur reasonable and proper expenses
for solicitation of proxies and in defense of their corporate policies.
b. All costs (both sides) reimbursed by corporation
i. Incumbent costs primarily reimbursed while in office
ii. Insurgent costs ratified by shareholders after the fight

  54
 c. Defendant wins (all costs reimbursed). Why?
i. Defendant wins because the dispute involved questions of corporate policy and the
expenses were reasonable.
V. Proxy Fight vs. Tender Offer
a. Proxy fights and tender offers suffer a common problem: they are expensive
(especially tender offers (i.e. takeovers))
b. Proxy Fight
i. Proxy fight à replace board
ii. The problem with the proxy contests is that unless you already own a huge chunk of
the costs, it’s just not worth it to you
iii. Who benefits? Everyone else
c. Tender offer (takeover)
i. Tender offer à buy up stock à replace board
ii. You could buy the entire stock (get all the benefit) or just buy enough to get control
iii. Who benefits? You
d. If tender offers require big premiums and proxy fights rarely happen, what does this imply
about management?
i. (1) Implies that they are pretty entrenched such that a proxy fight would be hard to do
ii. (2) there is so much value that you can pay a big premium and still be fine

  55
 SHAREHOLDER PROPOSAL  

I. Proxy fights and tender offers suffer a common problem: they are expensive (especially tender
offers (i.e. takeovers)). By contrast a SH proposal can be fairly inexpensive.
a. Qualifying SHs can add a proposal to the company’s proxy statement
b. Expenses thus borne by the company
II. What are shareholder proposals?
a. Add a proposal to the company’s proxy statement; expenses borne by the company
b. “A shareholder proposal is your recommendation or requirement that the company and/or its
board of directors take action, which you intend to present at a meeting of the company's
shareholders.”
c. The proposal asks the board to do something and it’s all done as an advisory matter
i. Even if proposal passes it does not require board to actually implement any new
safety precautions (merely precatory). Board can reject the proposal.
ii. Rule 14a-8(i)(1): If I have complied with the procedural requirements, on what other
bases may a company rely to exclude my proposal?
(1) Improper under state law: If the proposal is not a proper subject for action
by shareholders under the laws of the jurisdiction of the company's
organization;
(2) Violation of law;
(3)Violation of proxy rules;
(4) Personal grievance; special interest;
(5) Relevance: If the proposal relates to operations which account for less
than 5 percent of the company's total assets at the end of its most
recent fiscal year, and for less than 5 percent of its net earnings and gross
sales for its most recent fiscal year, and is not otherwise significantly related
to the company's business;
(6) Absence of power/authority;
(7) Management functions: If the proposal deals with a matter relating to the
company's ordinary business operations;
(8) Director elections: If the proposal;
(9) Conflicts with company's proposal: If the proposal directly conflicts with
one of the company's own proposals to be submitted to shareholders at the
same meeting;
(10) Substantially implemented: If the company has already substantially
implemented the proposal;
iii. DGCL Sec 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
d. So why bother with it?
i. Draws attention to the issue! It’s public and requires a response
III. Who are the proponents of shareholder proposals?
a. Hedge and private equity funds; pension funds; individual activists; charities
IV. What types of issues are in proposals?
a. Corporate Social Responsibility (CSR): global human rights policies, contract supplier
standards, sexual orientation, recycling, pesticides
b. Corporate Governance: takeover defenses, CEO compensation, say on pay
i. Governance – tend to get more votes
V. How can companies respond?
a. Attempt to exclude on procedural or substantive grounds
i. Must have specific reason to exclude that is valid under Rule 14a-8
  56
 ii. Co. must file reasons for exclusion with SEC staff (seeking no-action letter) Rule 14a-8(j)
b. Include with opposing statement
c. Negotiate with proponent
i. Wide range of possible compromises
d. Simply adopt proposal as submitted
VI. Lovenheim v. Iroquois Brands
a. Says they should look into their practices to see if it uses an inhumane method of feeding for
foie gras.
b. Iroquis relies on Rule 14-a(8)(i)(5) to exclude:  
i. Corp can exclude if proposal relates to operations which account for,
1. < 5% of total assets,
2. < 5% of net earnings or gross sales, and
3. Is not otherwise significantly related to Corp’s business.
VII. AFSCME v. AIG
a. Labor union AFSCME owned large block of AIG stock.
b. They are trying to advance a shareholder proposal that would require (mandatory, not
precatory) the company to include SH nominated directors
c. Why doesn’t 14a-8(i)(1) kill this proposal?
i. SHs have the power to initiate bylaw amendment. Bylaws are rules of
governance, not specific action. It’s a rules of the game amendment. They are
saying they have control over the rules by which directors are elected.
d. After this decision, the SEC changed the rule to say that you can change the rules of the game
about how directors are nominated, but you can’t block specific candidates by saying specifically
in the bylaws “Susan can’t be a director.”

  57
 SHAREHOLDER INSPECTION RIGHTS

I. Inspection rights are not a topic that SHs get to vote on, more like FOIA request
1. Shareholder list; books & records; minutes from board meetings
b. How might this information be valuable for SH voting contests?
i. Pre-discovery info; proxy contests
c. Does federal law provide inspection rights?
i. Rule 14a-7(a): Nope. Nothing in federal proxy rules require boards to turnover
shareholder lists.
d. Does state law provide inspection right?
i. DGCL 220(a)(4)(b): Under DGCL § 220, shareholders can inspect the stockholder
ledger (list) and other books and records for a proper purpose, which is a purpose
that is reasonably related to the shareholder’s economic interest as a shareholder.
(PRIMARY purpose has to be proper)
II. Say on Pay
a. Since 2011 (implementation of Dodd-Frank), publicly traded firms have to give shareholders
an advisory opinion on executive compensation (say on pay) and golden parachutes
III. Tender Offers
a. The basics. Acquirer announces that it is willing to buy up to X shares at price of $Y/share.
i. X is often a high % of outstanding SHs, and
ii. Y is normally well above (e.g. 30% premium) current trading price
b. Tender offer is open from date A to date B (e.g. Nov. 12th to Dec. 28th) [sometimes period is
extended]
c. SHs can choose to ‘tender’ (i.e. sell) their shares at price Y during the offer period.
d. Tender offer is often contingent on some minimum number of shares being tendered (i.e.
Acquirer only wants to go through with the deal if at least 80% tender their shares)
i. If offer is oversubscribed (more shares tendered than will be purchased),
shareholders are paid out on a pro-rata basis.
e. Subject to federal regulation (Williams Act)
IV. Crane v. Anaconda
a. Crane wants to acquire Anaconda. Crane wanted shareholder list to make tender offer.
Court held that this was a business-related purpose and ruled for plaintiff.
b. Legal standard to get this info in NY (Anaconda is a Montana Corp. But, right to inspect
corporate records is an exception to the internal affairs doctrine. For shareholder
inspection we use the place where the business is, not incorporated)
i. Must be SH
ii. Must own over 5% of stock (or hold shares for more than 6 months)
iii. Must have proper purpose.
V. Pillsbury v. Honeywell, Inc.
a. Plaintiff wanted to stop bombs being manufactured during war by making shareholder
proposal. This was not seen as a proper purpose under DE law.
b. Legal standard in DE
i. Must be shareholder
ii. Must have a proper purpose related to his economic interests
1. (Can have multiple purposes, but primary purpose
has to be proper)

  58
 CONTROL IN CLOSELY HELD CORPORATIONS

I. Problems of Small corporations

a. Locked In
i. You’re vulnerable because you’re locked in. Also, they may put in additional
restrictions about who you can sell the shares to
ii. If you are trying to sell your shares, you first have to write an offer to the other people
and if no one else wants them, then you can get permission from the outside
b. Frozen Out
i. They risk being frozen out of decision-making and compensation. Minority
shareholders may have no control over companies activities. They may be denied
compensation if denied employment
II. How you can solve this problem
a. Voting Trust
i. Transfer shares to trustee. Trustee becomes the nominal, record owner of the
shares. The trustee votes the shares in accordance with the provisions of the trust
agreement, if any, and is responsible for distributing any dividends to the beneficial
owners of the shares
ii. Historically, courts are suspicious. Advantage of having no possibility of shareholder
deadlock. Disad? Complete loss of control’ limited (most states limit to 10 years); still
possible for board to oppress
iii. Requirements
1. Under DGCK 218, a copy of the trust document must be filed with
corporations registered Delaware office
2. Courts today are reluctant to re-characterize an agreement as a trust
b. Vote Pooling Agreement
i. They contract to coordinate voting. Shareholder remains the holder of the stock but a
group of shareholders have decided that they will vote their shares in some specified
way.
ii. Straight Voting
1. The number of votes you have is equal to the number of shares you have and
you vote on each director’s seat separately. Directors are elected by a
plurality of the votes cast at the meeting on a one share-one vote basis.
Some complain that this allows 51% holder to elect 100% of seats, and gives
no representation to minority.
iii. Cumulative Voting
1. Each shareholder gets a number of votes = # of shares owned times # of
vacancies
2. Number of shares necessary = #directors desired X #shares outstanding +1
to elect desired number of #directors being elected +1
directors
iv. Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling (vote pooling)
1. Shareholders of a corporation may agree to jointly exercise their voting rights.
They can also agree to have an arbitrator decide how they will vote.
Contracting as shareholders is cool.
III. Shareholder Agreements Constraining Director Power
a. Very common. Specify compensation and/or dividend policy. Require SH approval of board
actions
b. Shareholders can contract over how they will vote their shares, but Directors cannot
contract away their vote.
  59
 c. McQuade v. Stoneham
i. (1) Stockholders may combine to elect directors.
ii. (2) Stockholders may not “control the directors in the exercise of the
judgment vested in them by virtue of their office.”
iii. How could this holding haven evaded and McQuade could have won?
1. Get agreement that he will be elected a director. Have by-laws state that
officers may be removed only for cause or by the unanimous vote of the
directors.
a. Need to make sure that amending the by-laws requires unanimous
director and/or shareholder action.
2. Alternatively, employment contract coupled with stock buy-out provision.
a. If they fire him, he can get damages and require them to buy back his
stock (so he’s not stuck with his investment).
iv. McQuade, McGraw, and Stoneham to be elected directors – only valid one
v. McQuade, McGraw, and Stoneham to be appointed to specified officer positions
vi. McQuade, McGraw, and Stoneham to be paid specified salaries
vii. No fundamental changes in corporate governance structure unless parties all agree

IV. General Rule from Ringling and McQuade

a. In closely-held firms:
i. Shareholders can contract over how they will vote their shares, BUT
ii. Directors cannot contract away their discretion.

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   61
 MERGERS AND ACQUISITIONS

I. Not all acquisitions are hostile

a. Before we can address takeovers we need some background on the basic structure of mergers
and acquisitions
b. Also want to address the appraisal remedy for minority shareholders (an important protection
that arises in mergers and acquisitions).
c. Finally, fiduciary duties will re-emerge in the M&A context (slightly different standards, but
similar theme)
Motivation Means

Mutuality Method
You can pay in cash or stock

II. Are M&A deals in SH’s interests?

a. Target
i. Nearly all empirical studies of “abnormal returns” on announcement show target SHs do
well
1. Estimated Range: 15% - 50% announcement date rise in share prices.
2. Premia tend to be the highest with hostile acquisitions
b. Acquirer
i. Statistical studies show that it has no real effect, mixed record. Range between +/- 5%
ii. Cash acquisitions seem more likely to produce positive announcement returns (any idea
why?)
III. Statutory Merger (type A)
a. Statutory Merger (traditional) (DGCL 251)
i. Like fusion two firms are merged into one
ii. Target: Bd & SHs (majority of all outstanding)
iii. Acquirer: Bd & SHs (generally)
b. Statutory Merger (triangular) (DGCL 251)
i. Acquirer creates subsidiary corporation [Merger Co.]
ii. Target then statutorily merged into subsidiary
iii. Target: Bd & SHs (same as above)
iv. Acquirer: No SH vote (& no appraisal rights)
1. Technically the parent corp. gets to vote the subsidiary’s shares.
IV. Asset Acquisition (type C)
a. Acquirer buys target’s assets directly (? liabilities ?)
b. Appraisal remedy may not be triggered by asset sale. Varies state to state. See DGCL 262(c)
c. Target: Bd & SHs (if deemed sale of “substantially all” assets)
d. Acquirer: May need Bd if large deal (don’t need SHs
V. Stock Acquisition (Type B)
a. Acquirer buys stock directly from target SHs
b. Typically through a tender offer (subject to Fed. Disclosure requirements)
c. Target: No Bd or SH vote needed (just need SHs to sell)
d. Acquirer: Bd. + needs to comply with tender offer rules (Williams Act)

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 FREEZE-OUT MERGERS

VI. Remedies for Dissenting Shareholders

a. Appraisal: normally appraisal is the exclusive remedy for a dissenting
shareholder (provided SH could not show unfair decision-making process). Some have
compared appraisal to a private form of eminent domain (i.e. takings).
b. What is the purpose of appraisal under 262(h)? How do you think valuation analysis will
play out under the new rule set forth in this case?
i. The goal is to determine fair value taking “into account all relevant factors.” Finance
experts will be brought in to testify regarding the firm’s valuation. Once we get here, it’s a
battle of the experts
c. What does it mean to say appraisal is an exclusive remedy?
i. A: Plaintiff is forced to give up her stock and cannot ask for an injunction, or seek to
block the merger in any other way. DE takes a middle of the road position on
exclusivity (i.e. appraisal is exclusive unless plaintiff can show procedural defects /
fraud).
d. What does SH have to do to exercise his appraisal rights? (see DGCL 262)
i. A. (i) Hold onto shares through effective date of merger, (ii) perfect his right by
sending written notice to the corporation prior to the vote, and (iii) can’t vote in favor
of merger
e. What happens if merger price is unfair but there are no procedural defects and SH
fails to perfect appraisal rights?
1. A: Plaintiff is out of luck
f. Weinberger v. UOP
i. Involves fiduciary duties of a controlling SH. Merger process here is pretty complicated
ii. Weinberger, brought this action to challenge the shareholder vote for a cash-out merger
between D, UOP, Inc., and D’s majority shareholder, Signal. P asserted that Signal
breached their fiduciary duty to the minority shareholders by withholding relevant
information and not disclosing conflicts of interest.
iii. Who is the primary defendant here?
Signal (the SH).
iv. Is Signal a dominant SH? Do they owe a duty?
Yes. Original SHs
v. What type of fiduciary duty is at issue here?
Duty of loyalty (self-dealing)
vi. Lets recast case in terms of DGCL 144 (more modern analysis). What do you need
under 144(a)(1) or (2)? What about under (a)(3)?
144(a)(1) & (a)(2) = disclosure + approval. What is missing here?
Here there was no disclosure of a key fact (the study by A&C).
A144(a)(3) = fairness.
vii. What is the traditional metric for determining this under DE law?
Delaware Block. What is that? Why is it a problem?
Under this approach, three elements of value were examined, which were
market value, asset value, and earnings value. These values are then
averaged in order to determine the fair value of the equity of the company.
However, the problem with this approach is that each element is weighted, and
this weight is arbitrarily determined.
viii. Is appraisal the plaintiff’s exclusive remedy in cases like this? When is appraisal
inadequate?

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 Yes, normally appraisal is the exclusive remedy for a dissenting shareholder
(provided SH could not show unfair decision-making process). Some have
compared appraisal to a private form of eminent domain (i.e. takings).
ix. Did plaintiff in Weinberger perfect his appraisal right?
No. But court suggests an equitable solution.
Why? In part because Weinberger makes it harder for plaintiff to get an
injunction than the previous DE law (Singer)
x. What happens if merger price is unfair but there are no procedure defects and SH fails
to perfect appraisal rights?
Plaintiff is out of luck
g. Appraisal Remedy Considerations
i. The effectiveness of appraisal is limited by practical considerations:
1. No payment till litigation resolved
a. no/low interest payment on appraised value. [DE 262(h)]
2. Low court valuations
a. DE block method (DE abandoned this in Weinberger but other states still
follow the old rule)
3. Cost of legal representation
a. Appraisal is sought by individual SHs (not a class action). Unless SH
holds very large number of shares the recovery is unlikely to justify the
cost.
h. More Appraisal Questions
i. Is appraisal a more important right in publicly-held firms or privately-held firms?
Why?
1. Appraisal is more important in privately held firm. Judge cannot come up with a
better value than the NYSE
ii. For publicly held firms, when (if ever) should a court use an appraisal valuation
different than the current price on NYSE?
1. Never? In publicly held firms, there is a standard floor price, which is the market
price. The existing market price of a publicly held firm means that an acquirer at
least has to pay more than market price.
iii. Many states do not provide an appraisal right for publicly held SHs. Is the market
protection adequate??
1. Maybe.
iv. Technically, in a merger appraisal rights apply to both target and acquirer SHs.
Yet, in practice it is almost never used by acquirer SHs. Why not?
1. Benefit of triangular merger is that the only SH that could complain is acquirer
itself. Typically doesn’t have much of an evaluation effect.

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   65
 HOSTILE TAKEOVERS
I. The label of the type of takeover is from the BoD/mgmt. perspective. Not all acquisitions
are hostile
a. Friendly = with board management blessing. Typically structured as either a merger
(triangular or normal), or an asset sale
b. Hostile = without board management blessing. Typically a tender offer to SHs directly
II. Judicial Ambivalence toward defensive tactics of hostile takeovers
Reasons for Deference Reasons for Scrutiny
• Boards are supposed to make • Managers may have strong self-
decisions and plan long-term strategy. preservation incentives (private benefits
• Implicit decision: Not to sell/bust up of control)
firm. • If a takeover attempt is “worth it”, it may
• Or if sell, obtain best price possible for be because board/mgmt is doing a poor
SHs job

Deferential Scrutiny Strict Scrutiny

BJR Entire Fairness

Takeover 1.0 Takeover 2.0 Takeover 2.1

Cheff Unocal Revlon
BJR w/ bop Defensive Measures Inevitability
on directors Threat + Prop. Duty to Maximize

III. Cheff v. Mathes

a. Creeping tender offer – What Maremont is doing as he tries to get the company. You don’t
have to disclose your identity, you just keep buying shares in the open market.
b. Takeover Law 1.0
i. BJR with burden of proof on directors
1. NO presumption that board acted in SHs interest
2. Instead, directors must affirmatively demonstrate:
a. Reasonable investigation gave Bd. grounds to perceive danger to
corporate policy and effectiveness; and
b. Good faith actions.
3. Opinion suggests that inside directors will be held to a higher standard.
c. What counts as a threat to corporate policy? Ct doesn’t specify
IV. Greenmail
a. When a targets board purchases a potential bidder’s stock for an above-market price
b. Still legal but tax penalty = IRC § 5881: 50% tax on income related to greenmail. Disincentive
c. Defined as any consideration paid by corp to purchase stock that has been held for less
than 2 years, if that selling SH(s) had threatened a tender offer / takeover, and the
corporation did not offer the same terms to other SHs
V. Tender Offer Rules (Williams Act)
a. Regulates tender offer. Once you purchase 5% of the company, you have to identify
yourself pretty quickly thereafter.
b. Also, regulates the timing of tender offers (slows down the process so that company has a
chance to seek other offers or defend against the tender offer).

  66
 c. Rules outlined in Sections 13 and 14 of the Exchange Act of 1934. See pages 290-295 and
340-348 in SS.
d. Problems
i. Suppose you represent a horror movie fan named Jason. He plans a series of
movies that will outdo Planet of the Apes in the number of sequels. To do so,
however, he needs a large inventory of chain saws. Jason calculates that the
cheapest way to acquire the machines is to take over Texas Chain Saw, Inc.
He asks for advice about how to do so.
1. Suppose he wants to acquire a foothold at market prices. Can he secretly buy
20 percent?
a. Yes, but within 10 days of acquiring 5 percent, he must disclose his
purchases. Thus, if the 10 days after acquisition of 5 percent pass
before reaching the 20 percent level, the acquisition can no longer be
kept secret. (§ 13(d)(1)).
2. Jason worries that when he announces his tender offer Steven Spielberg will
recognize the genius of his plan and counter with a rival offer. Can Jason pull
a Saturday Night Special: announce the tender offer on Friday afternoon, and
hold it open only through the next Monday?
a. No—the law mandates a 20-day minimum. Rule14e-1(a) (SS pg. 348)
3. Jason only wants 51 percent of the company. To encourage people to tender
early, may he accept the stock on a first-come-first-served basis?
a. No. He must accept stock on a pro rata basis from all shareholders
who tender during the 20-day period. Section 14(d)(6) [pg 292-94 in
SS]
4. Jason wants to start with a low price, and raise it only if insufficient people
tender. May he do so?
a. Sure, but if he does raise the price, he must pay the higher amount to
the people who tendered early. Sometimes referred to as “cookies for
everyone.” 14(d)(7) [pp. 292-94 in stat supp].
5. Jason believes the existing CEO of Texas Chain Saw, Inc. could help
accomplish his plans. Jason would like to offer the CEO a one year transition
employment contract that includes a lucrative bonus agreement. Assume the
CEO is a shareholder of Texas Chain Saw, Inc. Does this contract create
any problems for Jason?
a. Possibly. Extra compensation paid to one SH (the CEO). Rule 14d-
10(a)(2) [pg. 346 in SS].
b. Does 14d-10(d)(1) qualify this in any way?
i. Probably OK. Note, subsection (d)(1) is a 2006 SEC
amendment to encourage friendly tender offers.

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 VI. Junk Bonds and an Open Society
a. Wasn’t a lot of takeover action in 1960s and 1970s
i. Managerial Society: close network of elite business leaders (hostile takeover = social
taboo)
1. More importantly = only big companies had the resources to pull off a large
acquisition (& their managers were already part of the club).
2. Outsiders couldn’t finance large deal
b. Changed in 1980s with takeover frenzy. Increased use of high yield corporate bond
(junk bonds)
i. Investment grade = AAA, AA, A, BBB
ii. Junk bond = worse than BBB (higher likelihood of default)
iii. Hard to sell Junk Bonds prior to 1980.
1. Milken noticed that the yield on junk bonds was extremely high given their risk
profile. In plain English = Milken created a market for corporate junk bonds
2. Helped corporate raiders raise huge amounts of cash without having to come
crawling to the manager’s club.
3. Bonds often paid off by target firm’s revenues post acquisition
c. Targets don’t sit idly by while acquirer makes hostile offer
i. Bribe them to stay away (i.e., greenmail)
ii. Play hard to get (delay, drain the pocket book ((force assets of the firm to leave
before the acquirer get there))
iii. Find someone else (alternative acquirer; allocate rights to 1st/preferred bidder)
iv. Fight fire with fire (Pac-Man defense)
d. Defensive Tactics
i. Most anti-takeover tactics either: é cost of acquirer;é time necessary to gain control
ii. Imagine a world with no takeover defenses = BoD of target won’t be able to
defend, try to get a higher deal, ability to negotiate is off the table.
iii. Imagine a world where all takeover defenses are permitted at the discretion of
mgmt. = target firm mgmt. can’t hinder an offer. Does it matter if the board is
independent of mgmt.? yes. Then we worry that they’re using it to entrench the
current mgmt. team.
VII. Unocal v. Mesa
a. The oil rights that Unocal owned was worth more than Unocal. T Boone (of Mesa) wants to
purchase and liquidate. He tried to acquire the company by buying 37% upfront (to get over
51% ownership threshold). Brings a suit that prevents Mesa from
participating in the self tender
b. Two-Tiered Tender Offer
i. Stage 1 – tender offer for at least __%;
ii. Stage 2 – merger to squeeze out everyone else
1. More common way to do this is to say that the offer will
iii. Typically SHs receive same thing regardless which stage they’re in
1. Ex: firm trading at $50/S.
a. Ex 1: Acquirer offers $60/S for up to 100%. Target doesn’t tender
cause of a hold out problem – they think they can get more $.
b. Ex 2: Acquirer offers Stage 1 = $65/S; Stage 2 = $55/S. You are
scared that you won’t get what you want so you may want to tender
here.
i. First best world – everything is defeated
ii. What you really want is to communicate with the shareholders
to hold out so that you’ll get 70.
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 c. Comment: the Unocal “Junk” Bonds
i. High Yield Corporate Bonds
1. Corporation is obligated to repay principal ($54) plus interest (r%) on a
defined date (typically ten years after issuance). Value depends on interest
rate relative to the likelihood of default (i.e. Bankruptcy)
2. Intermediate Priority in Bankruptcy
a. Senior Debt (paid first in bankruptcy)
b. Junk Bonds & other junior debt (paid next)
c. Equity (paid last = the residual)
ii. T.Boone just gives SHs junk bonds of Unocal and says that they say are $54.
Pickens could have found buyers for the junk bonds, have them priced, and
then give everyone cash.
iii. Two conditions to the Self Tender (as originally proposed)
1. Mesa Exclusion: Mesa could not participate
2. Mesa Purchase Condition: Tender only kicked in if Mesa acquired a
controlling interest (>50%)
iv. SHs (not just Mesa) are furious about the Mesa Purchase Condition à No shares
will tender cause people would rather have $74, but because of that the Mesa
purchase condition won’t be triggered.
1. In response to SH complaints Unocal agrees to waive the Mesa Purchase
Condition. Unocal will buy up to 50 million shares at $72/share. Forces firm to
“reduce exploratory drilling” (a good thing, as this is why firm was underpriced
to begin with)
v. Final holding of DE Supreme Court = “[T]he device Unocal adopted is reasonable in
relation to the threat posed”
d. Takeover Law 2.0 – Board bears burden of proving both prongs
i. Before you take the action….
ii. Cheff states: (1) You have to show that there was a Threat. Board acting
Independently, in Good Faith, & with Due Care, has reasonable grounds to conclude
that a danger exists to corp. policy & effectiveness. BJR with burden on board. Easy
to satisfy.
1. What constitutes a threat to corporate policy and effectiveness?
a. Must be a policy conflict (not just personal). “Board’s power to act
derives fro its fundamental duty and obligation to protect the corporate
enterprise, which includes stockholders, from harm reasonably
perceived, irrespective of its source” [Cites to DE § 141(a) & §
160(a)]” (harm to other constituencies can be added)
iii. Unocal adds: (2) Proportionality Prong. The action must be reasonable in relation
to threat posed. This gives the court power to review substance of board’s action
(significant distinction from BJR).
1. A few cases since have added texture: Unitrin v American Gen. (1995):
a. Protective measure cannot be “draconian”: “preclusive” or “coercive”
(not clearly defined). If not “draconian,” then inquiry surrounds whether
response is in “range of reasonableness”
e. After this case, the SEC outlawed exclusive self tender

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 VIII. Revlon Inc. v. MacAndrews & Forbes Holdings, Inc.
a. What is the signal for $3 difference in friendly/hostile? Worth more without you
b. Poison pill – once an acquirer passes a threshold, it triggers all these rights.
c. Good if you think the acquirer is undervaluing your company (they have to say this to satisfy
the threat prong).
d. Effective defense
i. If Perlman gets 20%, $65 notes will leave the company. It’s supposed to force
Perlman to negotiate and not make this hostile poison pill.
ii. Perlman comes back with a TO of 47.50. Rev retaliates and brings Frostmann in.
Frostmann will quickly sell off some big assets of the business so the noteholders
can be repaid in full. They approach Frostmann for a mgmt. buyout. In response,
Perlman makes a bid that’s a quarter higher.
e. Pre Forstmann measures
i. Poison Pill
ii. Self Tender/Share Repurchases
f. Post Frostmann measures (courting the knight)  
i. No-shop provision
ii. Cancelation fee
iii. Option on crown jewels
g. Revlon Analysis
i. They say the basic test is no different than Unocal.
1. “[Directors must bear] the burden of proving that they had reasonable
grounds for believing there was a danger to corporate policy and
effectiveness, a burden satisfied by a showing of good faith and reasonable
investigation”
2. “In addition, the directors must analyze the nature of the takeover and its
effect on the corporation in order to ensure balance - that the responsive
action taken is reasonable in relation to the threat posed”
ii. Once a sale becomes inevitable, you have to become an auctioneer and try to get a
price for the shareholders.
iii. Contraction
1.

h. Takeover Law 2.1

i. If sale/break-up is not inevitable à apply the standard Unocal test (threat +
proportionality)
ii. If sale/break-up is inevitable à duty is to get highest price for SHs (Board
becomes auctioneer)
1. Referred to as “Revlon Duties”
iii. Key issue is determining when “Revlon Duties” are triggered
iv. When are Revlon duties triggered?
1. Decision made by the court. Bidding war. If a company starts soliciting bids
from others, then it looks like they are for sale.
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 2. When it becomes inevitable that the firm will either be broken up or
experience a change of control
v. Are second bidder lockups necessarily bad for SHs of target firms?
1. In this case it looks bad. But the rationale is that if you don’t offer these
things, Forstmann may not even bid at all. It sounds weird but sometimes it’s
helpful to do.
vi. If Revlon duties are triggered, how active does target mgmt. need to be in
soliciting bids?
1. If you get competing bids and get a lower bid, that’s a violation of Revlon.
IX. Impact of Revlon on Friendly Deals
a. 1st) Here they are trying to sell. This is not the normal corporate law analysis, not the normal
BJR rule. You are violating Revlon if you give one offer
b. 2nd) You have to act like an auctioneer. Revlon applies to every single merger once it’s
actually happening. It’s an omnipresent kind of thing.
c. One thing that Revlon doesn’t do is if you can say that the sale is not inevitable, mgmt.
remains fairly protect from hostile deals. To do a truly hostile deal is hard in this
environment cause they can just say no.
X. Summary of Modern T-O Cases
a. Intermediate Scrutiny in T-O defense context.
i. One of two levels
b. “Mere” resistance of a takeover
i. Unocal duty (threat/proportionality prongs)
ii. Num. constituencies and time horizons OK.
iii. But lockups can’t be too preclusive/coercive
c. Board actions suggest that Sale, Change of Control, or Break-up is inevitable:
i. Revlon duty (maximize short term SH welfare).
d. Consequences of flunking applicable test
i. Unenforceability of defensive measures
ii. No liability for directors (absent more)

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 SIDE PAYMENTS

I. Side Payments
a. Golden parachute – Substantial benefits given to a top executive (or top executives) in the
event that the company is taken over by another firm and the executive is terminated as a
result of the merger or takeover.
b. Side payments
i. Where does the CEO’s power to block a sale come from? They’re in the negotiating
role and can influence. They can become uncooperative and hurt matters
c. Why do these even happen?
i. Incentive alignment – the side payment increases the CEO’s chance of helping the
shareholders. They may lose their job and related perks. It’s difficult to acquire a firm
over CEO objections
ii. Rent extraction –
d. What do CEO’s get when their company is sold?
i. Benefits negotiated prior to the merger - $6.5 million bump
ii. Benefits negotiated in connection with the merger
e. Why do SHs go along with this?
i. Analogous to riders
f. Has this been cleansed? Once they do this they’ve cleansed it.
i. What are they actually cleansing? The full package. You can’t really separate the
two.
g. Existing Legal Protections
i. Auction Constraint: Second Bidder
1. Revlon requires board to get best price for shareholders. This limits side-
payments by the first bidder because you can offer a high payout and nothing
to the CEO. Caveats? You may have one or two possible acquirers
ii. Tax Penalty
1. Hit with big penalty if payment are 3X annual compensation
2. This is an imperfect protection because the acquirer may pay the tax of the
CEO
iii. SEC requires disclosure of side-payments, but…
iv. Advisory SH vote on side payments (Dodd Frank)
h. Aren’t takeovers supposed to discipline (punish) poorly performing managers?
i. Sure you’re getting punished, but on the way out the door you’re getting money

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   73
 SECURITIES REGULATION
I. History and Fundamentals
a. Depression was blamed at least in part on deceptive fraudulent trading
b. Securities Act of 1933
i. Regulates the offering and sale of new securities (IPO)
ii. Registration statement filed with SEC
c. Securities Exchange Act of 1934
i. Regulates secondary market activity of registered companies
ii. Periodic Reporting
1. Form 10-K (annual)
2. Form 10-Q (quarterly)
3. Form 8-K (episodic)
iii. Anti-Fraud Provision § 10(b)
1. à SEC Rule 10b-5
d. The Securities and Exchange Commission
i. Created by 1934 Act. It’s an independent agency that enforces the securities laws.
e. What is a security?
i. Securities Act § 2(a)(1): “…any note, stock, bond, debenture, investment contract or,
in general, any interest or instrument commonly known as a ‘security”
1. Listed financial instruments: note, stock, bond, debenture
2. Generic catch all terms: “investment contract”
ii. Single most common source of legal malpractice claims against business lawyers
iii. Some instruments are per se securities
1. Stock (Landreth Timber Co. v. Landreth (US 1985))
iv. While others are rarely treated as securities
1. General Partnership Interest [Goodwin v. Elkins (3d Cir.) (because partners
have a legal right to control the firm a general partnership interest is not a
security)]
v. Other instruments depend on circumstances
1. Unclear what counts as an “Investment Contract”
2. See four-factor Howey Test (KRB pg. 408): “[1] a contract, transaction or scheme
whereby a person invests money, [2] in a common enterprise, [3] and is led to expect
profits [4] solely from the efforts of the promoter or a third party”
f. What is the purpose of securities laws?
i. Full disclosure - Make sure that investors have all the information they need to
make informed decisions
ii. Prevention of fraud - Insures accuracy of disclosed information.
g. What is the consequence of being a security?
i. There are min threshold requirements/exemptions for filing. For really small
businesses it’s not that hard to find an exemption
ii. If an instrument is deemed a security, this has two very important consequences:
iii. Triggers SEC registration (33 Act) & periodic reporting (34 Act)
1. Wouldn’t this imply that every private corp. which sells stock to an investor
would need to be registered with SEC and file periodic reports? Not quite.
Numerous exemptions from SEC registration are available.
iv. Triggers Securities Antifraud Rule (Rule 10b-5)
1. Can you use a similar exemption to evade Rule 10b-5? NO. No exemption
from fraud. 10b-5 applies to the purchase/sale of ANY security.

  74
 II. Rule 10b-5: Public or Private Firm
a. It shall be unlawful for any person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce, or of the mails or of any facility of any national
securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in the light of the circumstances
under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security
b. Various Markets
1. Primary market: corporation is direct party to the transaction: selling (or
buying) its shares to an investor.
a. Example: IPO, self tender
2. Secondary market: corporation is not a party to the transaction. Shares
bought and sold by two investors.
a. Example: most transactions over NYSE, NASDAQ.

1. No. Only when

company is
buying/selling stock.

2. Yes. Always gotta

disclose

c. Application to Public and Privately held firms

i. Privately Held: Only need to worry about Rule 10b-5 when buying / selling own
stock in the primary market
1. Important. But limited risk of liability
ii. Publicly Held: Need to constantly comply with Rule 10b-5. Secondary market
activity is a daily occurrence.
1. Need to closely monitor ALL corporate disclosures. Executives need to be
informed of risks before making any public statements. Big risk of liability.
d. Rough Roadmap
i. Is investment a “security”??
1. If yes à triggers rule 10b-5 obligations
2. Unlawful for any person to make false/misleading statements or omissions “in
connection with the purchase or sale of any security”
ii. Rule 10b-5: two applications
1. Corporate liability for false/misleading statements or omissions (disclosure
obligations)
2. Insider trading liability

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 e. Robinson v. Glynn
1. 10(b)(5) is a much broader protection than state level fraud claims
2. Howey Test: “[1] a contract, transaction or scheme whereby a person invests
money, [2] in a common enterprise, [3] and is led to expect profits [4] solely
from the efforts of the promoter or a third party”
3. His profits were not expected solely from the efforts of the promoter. Court
says Robinson was not a passive investor, he was involved in mgmt. so
doesn’t fit Howie 4 factor test. Not a security in this case. This was an
ordinary commercial venture
4. Would the case have come out different if GeoPhone were a Corp rather than
an LLC? If it were a corporation we wouldn’t even investigate this, we
wouldn’t go through the Howey 4 factor test. This leads to the weird result that
something that doesn’t pass the Howey test is per se a security.
III. Rule 10b-5: False or Misleading Statements
a. 10b-5 has two applications today: disclosure liability and insider trading liability
b. The SEC created rule 10b-5 after a company president who contacted his SHs and offered
to repurchase their stock, without disclosing that his company had just landed a valuable
government contract. While this looks shady, was actually ok back then so then the SEC
passed the rule
c. In re Cady Roberts & Co. – you have to abstain from trading or disclose if you are aware of
material non-pubic information
d. SEC v. Texas Gulf – corp was liable for a misleading press release
e. Elements of a 10b-5 lawsuit - the traditional elements of fraud
i. Scienter – D acted with an intent to deceive, manipulate, or defraud. Negligence is
not enough but recklessness generally is
ii. Causation – The mistreatment caused the damage. Sometimes split between loss
causation and transaction causation
iii. Materiality – reasonable investment would consider the misstatement important.
Often plead with same factors as causation
iv. Reliance – pre-Basic plaintiff must show she relied on affirmative
misrepresentations. Hard to show you relied on an omission. Even before Basic,
courts have adopted a rebuttable presumption of reliance in omission cases.
f. Basic v. Levinson
i. On again off again romance. Deny merger 3 times, then merge. There is a legit
secrecy interest here cause you don’t want this everywhere.
ii. Damages could be huge here – it’s over a 2 year period of time!
iii. Identifying a Class
1. Plaintiffs class is a group of investors who either sold (or bought) stock
subject to false/misleading information. Plaintiffs are sellers when
company hid good news & buyers when company hid bad news.
2. Class is defined by 1st date – when the false/misleading info first
appears and 2nd date – when the info is corrected. The correction can
come from anywhere, it does not have to come from the corporation
3. How does the class definition affect total damages? Well P’s want a larger
class. But the concern for other elements of your case is that you have to
prove reliance for all the members of your class.
4. The fraud-on-the-market theory creates a rebuttable presumption of
reliance. Court notes “that without the presumption it would be impractical to
certify a class.” Without this, you’d have to prove that each of them relied
individually (they read the paper and relied on that statement you made)
  76
 iv. Materiality Analysis
1. Basic adopts reasonable investor approach, and suggests that materiality
depends on the probability that uncertain event will occur and magnitude if it
does. Essentially this is cost benefit analysis.
a. p * m > threshold
b. Since magnitude is gonna be really high, there is always a
presumption that merger negotiations are material, even if
probability is rather low
2. Anything the company can do to keep the negotiations private? They can say
no comment. But if that’s their policy they have to say it all the time. The
policy has to be in place before discussions arise
v. Reliance Analysis (fraud on the market)
1. Fraud on the market changes reliance requirement by shifting it. Plaintiff’s rely
on the “integrity of the market price” so there is a rebuttable presumption
of reliance. Burden on D to show that P didn’t actually rely.
2. It doesn’t matter if investors ignore corporate disclosures. You sold at
the same price and harmed by the same amount. It’s not a matter of what you
knew. Whatever harm you suffer is just measured in dollars.
vi. Event Studies
1. Statistical method to assess impact of an event on the value of a firm
2. Material = statistically significant abnormal return and causation (at least for
loss causation)
3. Also helpful in estimating damages
vii. Basic’s Legacy
1. Basic made it easier for plaintiff’s to show MATERIALITY, RELIANCE,
AND CERTIFY A LARGE CLASS OF PLAINTIFFS
2. Coupled with fact that 10b-5 applies to any purchase or sale of Co. stock,
even if Co. is not buying/selling:
a. Very large damages (often > $100M) [see White’s dissent]
b. Created the modern securities class action lawsuit
c. Made many plaintiffs lawyers very rich
viii. Reaction to Basic
1. Private Securities Litigation Reform Act (PSLRA) passed by US congress
in 1995.
a. Designed to limit frivolous securities lawsuits. Prior to the PSLRA,
plaintiffs could proceed with minimal evidence of fraud and then use
pretrial discovery to seek further proof. PSLRA created heightened
pleading requirements
2. Halliburton Co. v. Erica P. John Fund, Inc.
a. 9 to 0 Court upholds Basic v. Levinson
b. Presumption of reliance still valid, but
c. Defendant can try to rebut the presumption at the class certification
stage by introducing evidence that there was no price movement.
3. Basic v. Levinson created an explosion of securities fraud lawsuits
under Rule 10b-5.
a. Typical fact pattern: company makes an error (often an accounting
misstatement) in a periodic SEC filing.

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 IV. Insider Trading
a. Standard fact pattern: defendant failed to disclose material nonpublic information, and then
traded on the basis of this information
b. Legisative authority for insider trading comes from 10(b) and 10b-5
c. Abstain or Disclose/Equal Access Test: IT Law 1.0
i. When [anyone] posses material nonpublic information, must ABSTAIN or
DISCLOSE
ii. SEC v. Texas Gulf Sulfur: Dicta: rule applies to anyone in possession of material
inside information. Equal Access Test (i.e. create a level playing field)
1. Equal Access test is criticized as too broad
d. Classical Theory
i. Permanent Insiders IT Law 2.0
1. When insiders posses material nonpublic information, must ABSTAIN
or DISCLOSE
2. Chiarella v. US: Chiarella did not owe a duty since he was not a fiduciary of
target co. Court rejects the Equal Access Test from Texas Gulf Sulphur. But
Texas Gulf Sulphur not overturned since it involved insiders.
ii. Temporary Insiders and Tippees: IT Law 2.1
1. When [______] posses material nonpublic information, must ABSTAIN
or DISCLOSE
a. Permanent Insiders,
b. Temporary Insiders, and
c. Tippees, if 1. insider breached fid duty by tipping &
2. tippee knows of breach
2. Dirks v. SEC: extends IT liability to two groups
e. Misappropriation Theory
i. Outsider Liability: IT Law 3.0
1. When [______] posses material nonpublic information, must ABSTAIN
or DISCLOSE
Permanent Insiders,
Temporary Insiders, and
Tippees, if 1. insider breached fid duty by tipping &
2. tippee knows of breach
Outsiders, if breach fid duty owed to source of the information
2. O’Hagan v. United States
a. They say he had a fiduciary duty to his law firm and his clients (to not
steal information). He’s bidding up the price of his own firm’s client that
is trying to acquire Pillsbury. He’s breaching a duty to the source of the
information, not the stock that he’s buying. He’s engaging in self
dealing.
b. Lets say he wanted to disclose, who would he disclose to? His firm,
the source of the information. If he tells his law firm, that gets him off
the hook for insider trading law but is on the hook for duty of loyalty.
They don’t have to approve the trading.
V. Example Problem p. 496
a. WSJ had a column that would talk about a certain stock, and that would cause the
price to go up or down depending on the talk. Before publication, he discloses the
info to some of his friends.
i. O’Hagan is consistent with finding that Winans violated § 10(b) and Rule 10b-5 by
misappropriating information belonging to the Wall Street Journal. But if WSJ
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 permitted employees to trade on this basis, then no liability under 10b-5. No
deception and no misappropriation of info belonging to WSJ.

VI. Putting together Classical vs. Misappropriation Theory

a. Rule of thumb: silence is OK absent a duty to disclose.
b. Recurring themes of IT Law:
i. What duty triggers Abstain or Disclose obligations, and
ii. Who is subject to this duty?
c. Classical Theory (IT Law 2.0 & 2.1):
i. Duty to Abstain or Disclose arises from fiduciary obligations owed to a corporation &
its shareholders
ii. Duty applies primarily to insiders.
d. Misappropriation Theory (IT Law 3.0):
i. Separate duty owed to the “source” of information
ii. Potentially extends liability to outsiders.

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