CORPORATIONS OUTLINE

Professor Eric Talley, Fall 2015

TABLE OF CONTENTS
Background and Corporate Formation........................................................................................................2
Conceptual Accounts of Business Law...................................................................................................2
Agency Law (Common Law Business Association)...............................................................................3
Corporate Formation..............................................................................................................................14
Legal Identity of a Corporation.............................................................................................................21
Creditors’ Rights & Corporate Finance.....................................................................................................24
Piercing the Corporate Veil...................................................................................................................24
Capital Structure, Valuation, and Accounting.......................................................................................27
Corporate Debt and Bondholder Rights................................................................................................29
Shareholders’ Legal Rights and Derivative Action...................................................................................36
Derivative & Direct Action Procedure..................................................................................................36
Substantive Fiduciary Duties.................................................................................................................46
Waste (Ultra Vires & Corporate Purpose).........................................................................................47
Duty of Care......................................................................................................................................49
Duty of Loyalty..................................................................................................................................51
Duty of Good Faith............................................................................................................................58
Indemnification, Advancement, and Insurance.....................................................................................60
Insider Trading...........................................................................................................................................62
Corporate Governance...............................................................................................................................67
Structure, Voting, and the Proxy System...............................................................................................67
Proposals and Inspection Rights............................................................................................................71
M&A, Takeovers, and Changes of Control...............................................................................................75
Hostile Bids and Defensive Tactics.......................................................................................................76
M&A Attack Framework...................................................................................................................78
M&A Cases.......................................................................................................................................79

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BACKGROUND AND CORPORATE FORMATION
CONCEPTUAL ACCOUNTS OF BUSINESS LAW
 Major Themes of Course
 Objectives/Nature of what a business organization is and does
 Objectives – What should be maximized, and for whom?
 Corporate Constituencies
o Owners/Shareholders
o Directors (Board)
o Officers (CEO, COO, CFO, etc.)
o Creditors (Debtholders)
o Suppliers of land
o Community and Customers
o Employees and Agents
o Suppliers
 Means – What economic problems do we corps encounter in achieving?
 Conceptions of the Firm (Hart)
o Nexus of Contracts – Multiparty contract law
o Cosean View – Means of coordination across markets. This view focuses on the
corporation as a means to manage transaction costs.
o Principal/Agent View – Corporation as a way to address ownership/control problems.
Law should provide a way of keeping agents in check and principals accountable.
o Property Rights View
 Residual Claimant – The stakeholder who ultimately will be entitled to assets
once liabilities are paid, and the person whose stake is unsecured. The ordinary
shareholder, in many circumstances, is one of many owners/residual claimants.
 Fixed Claimant – One who gets a fixed payout from the corporate treasury (like a
bondholder).
 Hart’s property rights view asserts that because the residual claimant is bearing
the risk, they have more incentive to make good decisions, so should be the
governing people.
 Facilitating Nature of Corporate Law – DGCL and Corporate law provides a series of default and
immutable rules. The code and body of common law empowers individuals to create own forms.
 Default Rules – Can be modified with contracts, in the corporate charter, bylaws, or by
director/shareholder vote. Majority of corporate law is default rules.
 Immutable Rules – Parties to a corporation cannot modify.
 Policy Debates – Key tensions in how corporate law protects certain individuals and
incentivizes/deters behavior.
 Rationales for Business Association Law
 Encouraging appropriate amount of labor, capital, investment, etc. in markets.
 Incentivizing entrepreneurship and economic growth
 Protecting 3rd parties
 Encouraging efficient allocation of risk and uncertainty

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  Equitable distribution of wealth
 Democratic legitimacy within the corporate form

 Genetic Building Blocks of Modern Corporation – Key Attributes

 Independent Legal Entity (Corporate Personhood)
 Limited Liability
 Separation of Ownership and Control (Agency Costs)
 Legal Formalities to Establish and Maintain
 Infinite Life
 Centralized Management
 Internal Complexity

AGENCY LAW (COMMON LAW BUSINESS ASSOCIATION)

 Basics of Agency Law
 Basic Definition: Restatement (3rd) of Agency § 1.01: Agency is the relationship resulting from
 M – the manifestation of consent by one person (“principal”) to another (“agent”)
 B – that the agent shall act on the principal’s behalf
 C – subject to the principal’s control
 C – and consent by the agent to so act.
 Function: For our purposes, agency law governs who can be held accountable when an agent
commits a tort or breaches a contract with some 3rd party.

 Typology of Agency Relationships

 Spectrum of Agency (from most to least authoritative)
 Employee/Servant – Principal would be liable in tort and contract.
 Agent Independent Contractor – Principal would be liable in contract only.
 Non Agent Independent Contractor – Cannot bind principal.
 Significance – Tax, Employment, and IP rely on the distinction between independent contractors
and employees.
 Tax – does the employer do withholding, social security, or medicare.
 Employment – (Uber). Wage and hour requirements/regulations, healthcare, unemployment
compensation.
 IP – Independent contractors can produce work for themselves, while employees are
presumed to produce IP for their employer.

 Elements of Demonstrating Agency

 Actual Express Authority – Express legal authority, usually in the form of the contract, creates
an agency relationship. Principal and agent specifically agree to relationship.
 Gorton v. Doty – Court seems to ignore right of control. Conditioning loan of car on Coach
driving was enough to create a condition furthers the master’s interests. Weird case. Likely
an insurance issue to insure that the injured received compensation. Automobile is new, so it
was likely decided this way so that cheapest cost avoider (owner/policyholder would exercise
care in delegating).

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 Actual Implied Authority – Relationship, contract, manifestations permit a reasonable inference
that the agent is acting on behalf of the principal, subject to principal’s control, in an agency
relationship.
 Jenson Farms v. Cargill – AIA can be inferred from GA Relevant factors:
 Management
 Guaranteed product disbursements
 Audits
 “Parental Relationship”
 Mill Street Church v. Hogan – Reasonable belief of the agent may be relevant. Factors
relevant in this case:
 Clearly a 2 person job M
 Past performance
 Court paid Sam
 Sam’s beliefs may be relevant towards inferring Bill’s belief.
 Apparent Authority – Plaintiffs can demonstrate apparent authority if the principal manifests
authority of agent to the 3rd party.
 Elements – Restatement 3rd of Agency § 8.
 1. Manifestation from Principal to third person
 Old Rule – Manifestation must be express and specific
 New Rule (Ampex v. 370) – Manifestation can be indirect through other methods
including:
 Reliable Intermediary
 Official Job Title
 In Ampex, despite being unauthorized to enter into contracts, a reasonable
person would infer from the job title that he was able to enter into contracts
 (in some circumstances, other communication may be sufficient)
 Assertive Actions
 Failure to correct mistaken assumptions
 Policy Concerns: How do we allocate this risk? Cheapest cost avoider logic at play in
Ampex
 Ampex 2nd Holding: without manifestation to the contrary, an employee/agent has
apparent authority to do things that are usual/proper to conduct business employed to
conduct.
 2. Sufficient to create reasonable belief in third person that authority existed
 3. *In some jx* - on which 3rd party reasonably relies to his/her detriment
 CA and DE do require detrimental reliance
 NY is less clear
 Inherent Agency Power – Considered a safety net used to establish agency on the basis of
equity. 2 Versions:
 Version 1:
 Application: Undisclosed Principal (plaintiff does not know existence or identity of
principal).
 Elements:
 Agent was a “General Agent”, by AEA or AIA had authority in at least some types of
transactions

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  Transactions that give rise to the action were usual or necessary to the agent’s
business on behalf of the principal.
 Agent acted on Principal’s “account” – in the principal’s interests
 Policy – Gap filler
 Watteau v. Fenwick – Articulates policy rationale. Bad things would happen if we were to
not implement some catchall—incentivize clandestine ownership structures.
 3rd Restatement § 2.06 (not yet adopted by ant courts): (1) 3rd party is justifiably induced
to detrimental reliance by agent acting on principal’s behalf (without actual authority), IF
principal noticed agent’s conduct and concluded that it might induce 3rd parties did not
take reasonable step. (2) No excuse that instructions would reduce the agent’s authority to
less than a 3rd party would reasonably believe it to be.
 Version 2 – Disclosed Principal
 Elements
 Agent is acting as a “general agent”
 Actions accompany or are incidental to transactions general agent would typically
conduct
 3rd party has a reason to believe that the agent is authorized and has no notice to the
contrary
 Policy Note – possesses some similarity to Apparent Authority. This may be because at
common law, this catchall was necessary to ensure justice, because of the narrower
definition of “manifesting consent” in apparent authority.
 As a practical matter, plaintiffs tend to allege everything they can, so they will use
everything, even if there is some overlap.
 Ratification - Really only applies to contract. The agent does not have authority at the time of
the creation of a contract to enter into it on the principal’s behalf, but the principal later assumes
liability.
 4 Part Test
 Existence - Principal must exist at the time the agent entered into the contract
 Principal’s Benefit - Agent must enter the contract, purportedly, on the Principal’s
behalf/benefit
 Affirmance – Principal must manifest intention to treat act as authorized with full
knowledge of the circumstances.
 Botticello v. Stefanovicz – We apply the same canons of construction used in contract
for offer and acceptance that we use for authority grants in principal-agent
relationships.
 Restatement 2nd:
 Affirmance can be
 Manifestation or conduct that evidences intent to affirm (§ 83)
 Receipt or retention of benefits that would only be available if there was a
binding contract (§§ 98, 99).
 Silence, if reasonably manifesting assent (§94)
 Does NOT need to be communicated to purported agent or the 3rd party (§95)
 Principal must be knowledgeable of material facts of transaction at time of the
affirmance (§91).
 Persistence – 3rd party cannot withdraw claim prior to ratification

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 Application to Corporate Governance: Boards of directors/managers must be completely
knowledgeable about the circumstances of the contract in order for the ratification to valid.
 (Estoppel) – Only in some jurisdictions
 Elements:
 Principal negligently creates appearance of purported agent’s authority
 3rd party reasonably believes authority to exist
 3rd party changes position in reliance on that belief
 Compare with Apparent Authority
 “Negligently creates” can include silence. Whereas apparent authority requires a
manifestation
 Change in position requirement
 Hoddeson v. Koos Bros – Furniture sale by man masquerading as a salesman. Koos Bros.
failed to correct a misimpression even with the opportunity to do so, therefore they
committed “negligence” by omission.
 Cheapest cost avoider logic – the company had a much better ability to detect an imposter
salesman than the customer.

 Tort Liability of the Agent to the 3rd Party

 Agent remains liable for torts regardless of principal’s liability under respondeat superior.
 If the principal is liable under respondeat superior, then both the principal and the agent are
jointly and severally liable.

 Contract Liability of Agent to 3rd Parties

 If the principal is not liable for the acts of the agent, there are two bases for agent liability:
 Common Law Fraud/Deceit
 Willful/reckless misrepresentation of agency
 Existence of agency is material
 Induces 3rd party to enter the contract
 3rd party justifiably relies on the contract
 Warranty of Agency (2nd Restatement of Agency § 329) - Purported agent who executes
contract on behalf 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.
 If the principal is liable, the agent is a bit more protected, but not completely.
 With a disclosed principal, the agent is not liable
 With an undisclosed or partially disclosed principal, agent can be liable as a guarantor on the
contract.
 Undisclosed – 3rd Party doesn’t know existence or identity of the principal
 Partiall Disclosed – 3rd party knows about existence, but does not know the identity.
 Atlantic Salmon v. Curran – Notice of the identify of the principal cannot be constructive
(filing a D.B.A. with authorities). Agent has duty to expressly identify the principal for
whom he purports to contract. DBA notice in newspaper is not enough disclosure

 Employer-Employee Relationships (Typology of Agency Relationships)

 AEA, AIA, and AA are applicable for both Master-Servant and Employee-Employer
relationships

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 Distinction from Simple Principal/Agent
 2nd Restatement § 2 –
 Master (employer) is a principal who employs agent to perform a service AND has the
right to control the physical conduct of the other in performance of that service.
 ServAant (employee) is an agent who is performing a service subject to the control or
right of control by the master.
 3rd Restatement §7.07 – employee is an agent whose principal controls or has right to control
manner and mean of agent’s performance.
 Evidence of “Control”
 Direct
 Explicit allocation in a contract
 Course of performance – P practices control over A’s physical conduct
 Indirect Indicia that would show the principal has a residual claimant (“owner”) status. When
you identify the residual claimaint, or person bearing the risk, you can find the person with
the most incentive to exercise control.E
 Lease rather than title to any equipment or inventory
 Contingent rent
 Profit/loss sharing
 Other Factors from 2nd Restatement § 220)
 Term of the relationship
 Agent is paid by job or with unit wage
 Agent work a regular part of the principal’s business
 P&A beliefs
 Who provides the supplies
 Location of the work
 Whether the principal is in business
 Extent of P’s control over details of work
 Whether the agent has distinct businesses
 Trade practices
 Skills required of agent
 Humble Oil v. Martin – Direct and Indirect indicia of control established an empoyer-employee
relationship. Relevant factors included:
 Indirects
 Terminable at will relationship
 Set hours for operation of the gas station
 Selling mainly Humble products
 Financial terms of agreement including cost-sharing, 75% commission, sharing of
residual cash flow with the gas station owner.
 Direct – formal control rights contained in the contract. Must make reports to Humble
 Limit – Actions must be within scope of master-servant relationship. However, the master can be
liable for actions outside scope if:
 Consequence was intended
 the master was negligent/reckless
 Conduct violated a non-delegable duty of the master, OR

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  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.
 But see Hoover v. Sun Oil – opposite conclusion. Not enough control. Compare facts:
 Agent held title to products, non-exclusive arrangement
 30-day notice prior to termination
 No reporting requirement
 No hours requirement
 Signs/Uniforms mandated
 Risk/return primarily born by agent
 Regulatory Application – Alexander v. FedEx (2014) – balance of § 220 factors heavily favor
finding of employment.
 Contract provisions that disclaim employment can be superseded by the indicia of control
 Notable reversal of summary judgment, and then ruling of summary judgment the other way
as a matter of law.
 Burden on page 992 – cal places presumption of employment. Burden is on person
challenging employment status.
 Apparent Authority and Employee/Employer – Miller v. McDonalds
 2nd Restatement § 267:
 Principal represents to 3rd party that another is servant
 3rd person justifiably relies on care or skill of such apparent agent
 Harm caused by lack of care or skill of one appearing to be an agent
 Difference: Justified reliance required.

 Scope of Agency
 Master/Servant Relationships – Defining Liability for the Master - § 219 of 2nd Restatement
 (1) M is liable for torts committed by S while acting within the scope of their employment
 (2) Master not liable for torts committed beyond the scope of the relationship UNLESS
 (a) M intended the conduct or the consequences, or
 (b) M was negligent or reckless, or
 (c) conduct violated a non-delegable duty of M
 (d) 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.
 Scope – 2nd Restatement § 228.
 (1) [Conjunctive Test] Conduct of a servant is within the scope of employment if, but only if
 (a) it is of the kind he is employed to perform;n
 Multi-factor Test – Arguello v. Conoco
 Time, place and purpose of the act;
 Similarity to acts servant is authorized to perform;
 Whether act is commonly performed by employees;
 Extent of departure from normal methods; and
 Reasonable expectations of employer.
 + More in the 2nd Restatement § 229
 (b) it occurs substantially within the authorized time and space limits;
 Difference between “frolic” and “detour” (Arguello)
 (c) it is actuated, at least in part, by a purpose to serve the master, and

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  Tests: (all in action in some jurisdictions)
 Bushey v. United States - Act is within scope of M/S relationship if it:
 Harm arises characteristically out of and in course of employment
 Harm is within the unique nexus/proximity of employment
 Harm is foreseeable (notwithstanding reasonable efforts by employer to
forestall it).
 Bushey Trial Court – Cheapest cost avoider approach – assign responsibility to
entity with the ability to avoid most cheaply.
 Friendly thinks this would be too great an expansion of liability.
 Traditional Purpose Test - § 228 in its text refers to purpose, but court’s have
stressed this.
 (d) if force is intentionally used by the servant against another, the use of force is not
unexpectable by the master.
 (2) Conduct of a servant is not within the scope of employment if it is different in kind from
that authorized, far beyond the authorized time or space limits, or too little actuated by a
purpose to serve the master.
 Note: Forbidden acts (§230) and criminal or tortious acts (§ 231) may still be within the
scope of the agency relationship.
 Non-Agent and Non-Delegable Duties - P may be liable for actions of a non-agent independent
contractor if IC was carrying out duties that P was not allowed to delegate.
 Certain statutory / regulatory duties:
 Antidiscrimination laws; antitrust laws; occupational health & safety regulations
 But see: Seabright Insurance v. US Airways (Cal. 2011) (OSHA duties found to be
delegable to contractors).
 Common law: Inherently dangerous activities
 E.g., Majestic Realty v. Toti : Activities necessarily…involving a peculiar risk of harm to
others unless special precautions are taken, and contractor negligently fails to take those
precautions.
 § 213 Restatement 2nd of Agency (negligent entrustment)
 Person doing business through others can be liable if negligent or restless in:
 Giving improper/ambiguous orders or failing to make proper regulations
 Employment of instrumentalities involving risk to others
 Supervision
 In permitting or failing to permit persons upon his premises who may or may not be
agents

 Agents’ Fiduciary Duties Towards the Principal

 Duty of Care and Skill: (Restatement § 379) Duty to use reasonable care to in discharging
obligations.
 Restatement § 379:
 (1)   Unless otherwise agreed, a paid agent is subject to a duty to the principal to act with
standard care and with the skill which is standard in the locality for the kind of work
which he is employed to perform and, in addition, to exercise any special skill that he has
 (2)   Unless otherwise agreed, a gratuitous agent is under a duty to the principal to act
with the care and skill which is required of persons not agents performing similar
gratuitous undertakings for others.

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  Proving Breach: Based on fault. The plaintiff must show that the agent engaged in grossly
negligent behavior.
 Focus: Process. Did the agent become reasonably informed of all facts, alternative
choices, etc.
 Causation: A’s breach must have caused some harm to the principal
 Duty of Loyalty: (Restatement § 387) Duty not to take from the principal. Triggered when some
type of conflict of interest arises between P’s and A’s economic goals/incentives
 Restatement § 387: Unless otherwise agreed, an agent is subject to a duty to his principal to
act solely for the benefit of the principal in all matters connected with his agency.
 Sub-Species:
 Duty to Account for Profits Arising Out of Agency
 Reading v. Regem
 Rest. § 388: “Unless otherwise agreed, an agent who makes a profit in connection
with transactions conducted by him on behalf of the principal is under a duty to give
such profit to the principal.”
 Duty not to act as/for adverse party against Principal
 Rust v. J.V. Intermediate
 Rest. §§ 389–92
 389: Unless otherwise agreed, an agent is subject to a duty not to deal with his
principal as an adverse party in a transaction connected with his agency without
the principal's knowledge.
 390: An agent who, to the knowledge of the principal, acts on his own account in
a transaction in which he is employed has a duty to deal fairly with the principal
and to disclose to him all facts which the agent knows or should know would
reasonably affect the principal's judgment, unless the principal has manifested that
he knows such facts or that he does not care to know them.
 391: Unless otherwise agreed, an agent is subject to a duty to his principal not to
act on behalf of an adverse party in a transaction connected with his agency
without the principal's knowledge.
 392: An agent who, to the knowledge of two principals, acts for both of them in a
transaction between them, has a duty to act with fairness to each and to disclose to
each all facts which he knows or should know would reasonably affect the
judgment of each in permitting such dual agency, except as to a principal who has
manifested that he knows such facts or does not care to know them.
 Duty not to Compete with Principal in Subject Matter of Principal’s Business
 Rest. § 393: Unless otherwise agreed, an agent is subject to a duty not to compete
with the principal concerning the subject matter of his agency.
 Duty to refrain from appropriating new business opportunities in Principal’s Business
 Rest. § 393:
 Duty of Candor
 Rest. § 381: Unless otherwise agreed, an agent is subject to a duty to use reasonable
efforts to give his principal information which is relevant to affairs entrusted to him
and which, as the agent has notice, the principal would desire to have and which can
be communicated without violating a superior duty to a third person.
 Duty of Confidentiality

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  Town & Country v. Newbery
 Rest. § 395: Unless otherwise agreed, an agent is subject to a duty to the principal not
to use or to communicate information confidentially given him by the principal or
acquired by him during the course of or on account of his agency or in violation of his
duties as agent, in competition with or to the injury of the principal, on his own
account or on behalf of another, although such information does not relate to the
transaction in which he is then employed, unless the information is a matter of
general knowledge.
 Rest § 396(b): Duty “not to use or to disclose to third persons, on his own account or
on account of others, in competition with the principal or to his injury, trade secrets,
written lists of names, or other similar confidential matters given to him only for the
principal's use or acquired by the agent in violation of duty. The agent is entitled to
use general information concerning the method of business of the principal and the
names of the customers retained in his memory, if not acquired in violation of his
duty as agent;”
 Proving Breach
 Principal/Plaintiff must show some decision involving a conflict of interest by agent
 Burden shifts to Agent to show:
 Decision was fair to the principal, OR
 Principal authorized agent to act with the conflict
 Defenses:
 Direct – would attack the plaintiff’s burden of proving negligence or conflict of interest
 Affirmative:
 Ratification/Authorization by the Plaintiff/Principal
 Must be fully informed
 Transaction must still be fair to plaintiff/principal
 Illegality/Public policy limitations as to underlying behavior
 Remedy – the legal action is in equity, so there will be injunctive relief or equitable damages
 Judge has broad discretion, but often we have “disgorgement” – or awarding all profit from
breach to the principal
 Has been allowed when A’s profits exceed loss/P has no loss – Reading v. Regem
 Constructive Trust when A’s gains have come from prospective business revenues
 If A profits less than P loses, the court can award the loss
 Punitive Damages available.
 Termination
 General Rule: Fiduciary duties end with the termination of the agency relationship
 Exceptions:
 When the agent is making preparations to sever and compete, then this can be a breach
 Confidential information can transcend termination of agency (Town & Country)

Cases:

 Gorton v. Doty (Idaho, 1937) – Gorton is a minor who was injured in a car accident in a car driven
by Coach Russel Garst. The car belonged to Ms. Doty, who was a teacher at the high school Doty
conditioned the loan of the car on Garst’s agreement to drive the car himself. The court interprets

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 this stipulation as sufficient to show that by driving the car, Garst was agreeing expressly to further
the purpose of Doty.
 Holding: Agency relationship created through AEA. Express verbal agreement (accepted by
performance). Key issue is the “behalf” (manifestations/consent undisputed – Control ignored).
Behalf furthered by the Coach agreeing to drive himself.
 Note: Bad case law. This was probably an exceptional case. Probably motivated by insurance
concerns and wanting to ensure that policyholders are careful with who they loan cars to.
 Dissent: Should not change agency law to accommodate insurance concerns.

 Jenson Farms v. Cargill (TKTKT) – Cargill has provided financing to Warren, which manages
silos. Warren has many bad debts, and it has discharged many in bankruptcy. Jenson Farms sues
Cargill under a theory of agency, trying to establish AIA, because Warren is functionally judgment
proof. Cargill documents indicated that it provided “strong parental guidance,” and it sent babysitters
and created serious strings in its loan agreements with Warren.
 Holding: The court finds AIA, due to the level of control exercised in the course of conduct.
 Factors:
 Management stipulations
 Mandated periodic audits
 “Parental Relationships”
 Mandated share of product went to Carville.
 Limits: Many of the Amici were concerned that this decision would turn ordinary loan
agreements into agency relationships (many commercial loans have veto, requirements, etc.).
Court limits by saying that Cargill was more than a creditor – it was also a buyer, business
partner. Cargill was wearing too many hates.
 Problem of Too Many Hats – This may be a cost to being too involved with the company
 Potential Solutions:
 Limit number of restrictions
 Make constraints more rule-like
 Take a stake in Warren as a subsidiary
 Do nothing – perhaps exercising this level of control is worth the potential liability in
some cases when it fails.

 Mill St. Church v. Hogan – Bill Hogan is member of the church, and he has been hired to help
paint. The church has authorized him to hire a helper – but they don’t like Sam, who has left the
church. He hires Sam anyway, because the other option will not get back to him. Key issue is
whether Bill had the authority, as an agent, to hire sub-agents, because that would make them liable
for compensating Sam, who injured himself. Church argues no.
 Holding: The court focuses on the reasonable belief of the agent (Bill). Following factors:
 Past performance
 Church had paid Sam before this instance
 Clearly a 2-person job
 Sam’s beliefs may be relevant towards making an inference about Bill’s beliefs

 Ampex v. 370 Leasing (5th Cir. 1976) – 370 Leasing sues for damages from Ampex for breach of
contract to sell computers. Joyce (founder/employee of Ampex) is friends with salesman from
Ampex (Kay). 370 started discussions to lease those machines to another company. Kay did not have

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 authority to sell the computers, but his title and the document would demonstrate to a reasonable
person that he was an employee with authority to sign a binding contract.
 Rule/Takeaway: Apparent Authority exists when principal behaves in a way that would lead a
reasonably prudent person to suppose that the agent had authority.
 Additionally – without manifestation to the contrary, an employee/agent has apparent
authority to do things that are usual/proper to conduct business employed to conduct.

 Watteau v. Fenwick (1892) – Silent owners of Humble’s ale house are propping him up. Humble
decides to buy Bovril and cigars on credit from Fenwick, but never pays. Fenwick files breach
action, but Humble skips town. Court basically lays out the IAP version 1 structure.
 Takeaway: Court articulates policy rationale for the catchall—without IAP we would incentivize
clandestine ownership structures.
 IAP test here adopted by § 195 of the 2nd Restatement of agency

 Botticello v. Stefanovicz (Conn. 1979) – Issue is whether agreement for sale of land is enforceable
when only one owner has signed off. The Stefanovicz’s were TIC in a property. Husband agreed to
lease and ultimately sell property, but wife did not agree. The court quickly disposes of the AEA or
AIA question, looking instead at ratification.
 Holding: No ratification
 Wife never affirmed. Receiving benefits of the lease does not translate into agreeing to sale.
Plus, she did not receive directly, just husband providing for family
 Husband never purported to act on behalf of the wife

 Hoddeson v. Koos Bros. (N.J. 1957) – Koos operates a furniture store. Hoddeson goes in and
purchases furniture, but from a man who is not the actual salesman. She pays him cash, he runs, and
she never gets her furniture. Issue is whether estoppel makes this crook an agent of the store.
 Holding: Yes. “Tortious dereliction of duty owed to an invited customer.” No apparent authority,
but there is a duty of care and precaution to customers that extends to ensuring that people don’t
pretend to be agents.

 Atlantic Salmon v. Curran (Mass. 1992) – Curran is a shifty businessman, acting as an agent for
several corporations of which he is the sole shareholder. He purchased salmon as a rep of Boston
International Seafood Exchange. However, then he creates another corporation, Marketing Designs,
that he claims is doing business as BISE. When it comes time to collect debts, he will not pay. MD is
only a partially disclosed principal.
 Holding/Takeaway: With a partially-disclosed principal, agent has duty to fully disclose
otherwise he is the guarantor.
 Windfall for the plaintiff, who knew that BISE was a corporation with limited liability. In this
way, they may have been better positioned to protect against a limit to their compensation during
negotiations and through insurance.
 Could still have been a theory through piercing the corporate veil.

 Humble Oil & Refining v. Martin (Tex. 1949) -

 Hoover v. Sun Oil (Del. 1965)

Corporations 13
 Alexander v. FedEx (2014)

 Miller v McDonald’s Corp. (Ore. 1997) –

 Bushey v. United States (2d. Cir. 1968) – Seaman Lane was an employee of USA, and he was on
shore leave. He got drunk and messed with the dry dock, flooding it, damaging the Bushey’s dry
dock. Defendant argues that Seaman Lane acted beyond the scope of this relationship, because he
did not further the purpose of the master per § 228(c).
 Holding: Friendly adds a foreseeability component to the purpose component of the agency test.
 Harm arises characteristically out of and in course of employment
 Harm is within the unique nexus/proximity of employment
 Harm is foreseeable (notwithstanding reasonable efforts by employer to forestall it).
 Policy Note: Relies on policy of tort law. Foreseeability is a crucial addition, because some
things may be incident to effectuating the purpose.

 Manning v. Grimsley (1st Cir 1981) –

 Arguello v. Conoco (5th cir. 2000) –

 Majestic Reality v. Toti (N.J. 1951) –

 Reading v. Regem (UK 1948) –

 Rash v. J.V. Intermediate, Ltd. (10th Cir. 2007) –

 Town and Country House & Home Service, Inc. v. Newbery (N.Y. 1958) –

CORPORATE FORMATION
 Basic Features
 Statutory Creation – certain formalities are prerequisite for existence
 Limited Liability – facilitates existence of securities markets
 Indefinite Life
 Transferable Shared Ownership (shares/stocks) – Limited liability is key to ensuring this exists.
 Delegated Centralized Management
 Legal “Personhood”

 Uses and Abuses

 Risk allocation and liability shield
 Tax Avoidance ~ sometimes an issue
 Investment vehicle – allows for diversified investment strategies by retail investors (relates to 1).

 Sources of Law
 Incorporation Statute (DGCL) – Corps is a highly statute-dependent area of law. Corporations
are a statutory carve out from typical agency law, so this is unsurprising. Because of the statutes,
this is an area where formalities work well. Form can sometime trump substantce.

Corporations 14
  Policy thought: Like the contract law governing bonds, we may favor clear-cut rules to
ensure that actors can respond to the rules and structure their behavior accordingly.
 Common Law Duties – the regime is not fully articulated. We draw common law fiduciary duties
from agency law. Tension between statutes and common law.
 Work fiduciary duties do may be different in corporate setting than in partnership, because of
the availability of exit. In partnership, it is much harder. In corporate law, you tend to be able
to trade securities.
 Query whether this logic would change the way we view fiduciary duties in closely held
corporations.
 Note: Corporate law includes default/immutable rules. Most rules are default, so individual
corporations can contract out of them. The caveat is that this can be hard, based on the opt-outs
offered by the statutes. In order to change rules, corporations may need to re-write bylaws or
change charter.

 Steps to Creating a Corporation - See corp formation checklist.

 Tax Considerations
 Double Taxation – Corporate profits are taxed at marginal corporate tax rate, and then
individuals who hold stock in the corporation are taxed on any revenue disbursements or capital
gains from sale of the asset.
 Rate:
 Corporate Income: Taxed at increasing, and then decreasing marginal rate. This decrease at
the top is likely due to competition to attract and keep huge multinational corps that are
bringing in a lot of profit.
 Shareholders
 Income – taxed at increasing marginal rates.
 Capital gains – fixed rate, only once income is realized as cash.
 Implications for corporations:
 Entity Choice - Corporate v “Pass-Through” entity (LLC; S Corp; Pship)
 Locus of Incorporation - US versus Foreign incorporation (see HO). Even within U.S.
jurisdictions, some have higher tax rates than others.
 Capitalizing Costs - “Impairments” (Depreciation/Amortization); Close Corps: distributions
vs other (e.g., comp; rent)

Corporations 15
  Closely held corps may want to avoid showing any profit, and disbursing huge salaries,
etc. to avoid double tax liability.
 Even large corps may try to use depreciation, etc. to raise costs to avoid showing profit
for tax purposes.
 Capital Structure: Defining “Taxable Income” & debt vs equity. Payments that service debt,
from the corporations perspective, are costs that are tax-deductible. However, there are
obvious problems that come form having a capital structure that is too debt heavy. So some
corps offer convertible bonds, to enable conversion to equity.
 Profit / Base Shifting - Multistate operations: Where income gets recognized
 Helping shareholders manage individual taxation - E.g., founders and IRC § 83(b) elections
 Artifact of 1969 federal tax amendment that characterized the moment of “vesting” of
stock a taxable event (taxed at ordinary income rates).
 Aim: Curb abusive tax deferrals on stock income.
 § 83(b) Optional Election: allows founders to opt to be taxed in full on value of stock
when initially issued, even before it is vested and/or fully transferrable.
 Why would you do this? If stock issues at formation, founders can (plausibly) claim that
stock has $0 value at this time (no tax)
 If election not taken, and corporation starts selling stock to outside investors (e.g. VCs),
stock will have taxable value at vesting
 Nearly all well-advised startups make the §83(b) election for founding SHs, and this must
be done w/in 30 days of initial stock issuance.
 Worldwide
 Repatriation of Income Earned abroad: U.S. uses a worldwide system of revenue taxation,
which puts our companies at a disadvantage, because to bring money back to the U.S. they
need to pay tax on that already-taxed revenue. Foreign parents only need to pay taxes on
revenue in the territory in which it is earned.

Corporations 16
 Tax Inversions – U.S. multinational merges with a foreign company, enabling it to relocate abroad
for tax purposes, while still maintaining its securities listing on U.S. exchanges.
 Eric L. Talley, Corporate Inversions and the Unbundling of Regulatory Competition, 101
Va. L. Rev 1649 (2015) – Thesis is that tax inversions are problematic but do not merit
government intervention because they are risky.
 Limits Corporate Inversion
 Foreign regulators – antitrust, direct investment, takeover panels, tax
 Must be strategic in practice
 Mergers tend to dilute U.S. shareholders’ stake in the company, and they can have high
tax implications for these Shareholders, which can lead to litigation here.
 Danger of overpaying for the company – could be implicated in derivative SH suit.
 Problem – Unbundling thesis. Increased federal corporate governance regulation has
displaced state law. Because federal law implicates publicly traded securities, corps can get
the benefits of their mandates/procedures, even if located abroad, as they apply to listing.
 Solution: role back federal regulation, or tax companies for consumption of federal
corporate governance mechanisms, allowing exemptions for US income taxes paid.
 Rebundling will allow corps to choose whether they want good governance structures and
higher taxes or worse governance and lower taxes.
 Background on U.S. Tax Law
 Headline tax rate of ~40% is very high relative to other jurisdictions. There are many
accounting ways to reduce income to effectively lower the rate.
 Residency – Del. Corporations are U.S. residents for tax purposes.
 Worldwide income tax (versus territorial system) leads to costs to repatriation of
revenues earned in foreign jurisdictions.
 Problematic:
 Keeps funds from possible profitable investment opportunities in the U.S.
 Foreign funds can be subject to exchange rate volatility
 Aggregate amount of cash held abroad is close to 2 trillion
 Workarounds: Loopholes to allow intercompany loans from sub to parent. But these
loans must be short term and last no more than a quarter, and they cannot roll over
like commercial paper. Short term nature makes it difficult to hedge market risk.
 Double Irish Structure – 2 subs, both incorporated in Ireland, with Bermuda HQ
for one. Bermuda sub owns patents, etc., and Irish sub licenses them for high fee.
Royalty payments are tax deductible, so Irish sub shows no taxable income, and
Bermuda shows a ton, but gets taxed at 0.
 Inversions – Relocate tax residency to foreign jurisdiction
 50% equity dilution would allow transaction to escape tax liability
 BUT if some percentage of SH are located outside U.S., and will not face
technologies, they may decide that the cost to US shareholders is worth it for greater
savings. This could give rise to derivative suits.
 2004 American Jobs Creation Act – number of reforms to make inversions less
attractive.
 15% tax on stocks for officers, directors, and block shareholders when U.S.
shareholders retain 60% of the value.

Corporations 17
  Corps react by increasing compensation of directors to account for this excise so
after-tax compensation remains unchanged.
 3 Conditions allow IRS to ignore expatriation claim – acquisition of all/sub all assets
by foreign corp, 60-80% ownership of surviving entity by owners of original U.S.
organization, and no significant activities in foreign acquirer’s place of incorporation.
 Functionally – 2 is the most important, sets different thresholds.
 <60% ownership in new entity by old SH – full recognition of foreign status.
 60% – 80% ownership – foreign residency status established, but certain gains
are a lower bound on taxable income for 10 years.
 80% or more, seen as U.S. surrogate and subject to full tax liability.
 Sometimes, foreign corp is too small to allow it to meet the 40% control
threshold, so the US target will pay skinny-down dividends. Some rules have
made this more difficult.
 2014 Guidance – tried to work on the 2004 rules
 Tried to address skinny-down dividends by scrutinizing large payouts made in
previous 3 years
 More scrutiny towards intercompany loans to US subs for 10 years after transaction
 AbbVie/Shire - backout concern about this wouldn’t ultimately work
 May be too late, now that large companies have already gotten out, there is a concern
 Limits on Inversions
 Domestic earnings still taxed same
 Alternative ways to avoid tax liability
 SH opposition – dilution and tax concerns
 Scarcity of possible foreign partners who could satisfy thresholds – complicated by
floating exchange rate risk
 Legal challenges
 Imposition of tax liability on SH
 Self-dealing
 Blasius challenge to improper manipulation of SH governance
 Revlon – excessively generous terms to foreign acquirer to enable satisfaction of
diluton threshold.
 Pfizer and Allergan Merger – Oddly-structured acquisition – some payment in stock

Talley Article Text:

Shareholder Opposition: Some U.S. shareholders may find inversion transactions objectionable
for a variety of reasons. First, as noted above, the applicable tax rules require these transactions
to dilute U.S. shareholders, thereby giving them less influence over the surviving company.
Second, most such transactions—unless significantly dilutive—are taxable to U.S. stockholders,
regardless of the consideration paid. Should the U.S. target have significant numbers of taxable
U.S. shareholders with large capital gains, or significant holdings by founders or other holders
who want to maintain a modicum of influence, an inversion transaction might prove extremely
unpopular, making approval less certain.
…
Legal Challenges: Almost all acquisitions of public companies give rise to some sort of legal
challenge. Inversion transactions— notwithstanding their tax benefits—are no exception. The

Corporations 18
 terms of the acquisition may be subject to a host of potential challenges, ranging from complaints
about the imposition of tax liability, to self-dealing, to Blasius-based challenges of improper
manipulation of the share- holder governance franchise, to Revlon-based challenges asserting
that the foreign acquirer received excessively generous terms of trade (possibly to make the
transaction meet the relevant dilution thresh- old).

 Internal Affairs Doctrine – Vantage Point v. Examen (Del. 2005)

 Definition: Jurisdiction of incorporation determines legal framework when analyzing rights,
duties, obligation, with and between corporate constituencies (board, officers, shareholders).
 Exception – State Long Arm Statutes – Allows plaintiffs to bring governance-related cases
outside the jurisdiction of incorporation, depending on conditions specified in the statutes.
 California – CA Corp. Code § 2115 – most (in?)famous of these
 Scope:
 Privately held corporations
 Majority of voting shares held by CA residents
 Majority of economic activity done in CA- includes property, payroll, and sales as
factors defined by revenue code.
 Function – applies California law to many corporate decisions that implicate it.
Significant for VC firms and start ups.
 Election / removal of directors;
 the indemnification of directors;
 fiduciary duty of care;
 limitations on dividends;
 voting requirements as to asset sales mergers, conversions and reorganizations.
 Piercing/alter-ego cases
 Distinctions between Cal and De – where this is relevant:

Corporations 19
 Vantage Point v. Examen – VantagePoint, a VC firm has 83% of the preferred shares which
are convertible for 1.43 common shares. They sue in California under § 2115, because they
want to get more $ in the transaction. California law requires a separate vote of the preferred
shares, which would enable them to block the transaction. California stayed the action
pending Delaware decision on applicability of the IAD.
 Holding: IAD precludes application of the Cal § 2115 to issue of cumulative voting.
 Conflict of Law Restatement/Choice of Law Doctrine § 302 – Jurisdiction with the
“greatest relationship interest” should apply law. In this case, the state of
incorporation is deemed to be closest to the transaction.
 § 302
 (1) Issues involving the rights and liabilities of a corporation…are determined
by the local law of the state which, with respect to the particular issue, has the
most significant relationship to the occurrence and the parties under the
principles stated in § 6.
 (2) The local law of the state of incorporation will be applied to determine
such issues, except in the unusual case where, with respect to the particular
issue, some other state has a more significant relationship to the occurrence
and the parties, in which event the local law of the other state will be applied.
 § 6 – absent state directive on when to apply state law, factors can be used to
determine which law to apply including:
 (a) the needs of the interstate and international systems,
 (b) the relevant policies of the forum,
 (c) the relevant policies of other interested states and the relative interests of
those states in the determination of the particular issue,
 (d) the protection of justified expectations,
 (e) the basic policies underlying the particular field of law,
 (f) certainty, predictability and uniformity of result, and
 (g) ease in the determination and application of the law to be applied.
 Conlaw – court offers some Due Process/Commerce Clause analysis to further justify
its opinion. A little weird.
 Design Thoughts: Some corps attempt to head off issue of VC wanting to hold out for a
better deal in the initial contract with the VC firm.
 Drag Along Provision – Forces VC to vote shares in favor of the deal, if more than
50% of votable shares vote in favor of the transaction. These have been upheld in
court.
 Pay to Play Provisions – Forces early round VC to keep reinvesting in later rounds,
otherwise you forfeit some rights. This can eliminate holdup and prevents dilution
when new shares are issued.
 Good Law – mentioned as good law in dicta in Lidow v. Superior Court, but hasn’t yet
been fully approved by California courts.

Corporations 20
LEGAL IDENTITY OF A CORPORATION
 Corporate Residency
 3 Tests
 Where you incorporate – applies primarily for tax purposes
 Center of gravity – similar to CA § 2115, where the majority of assets, employees, revenue,
property, etc. is located
 Headquarters/Nerve center Test – Locus of operations
 Hertz Corp. v. Friend – Interpreting 28 U.S.C. § 1332(c)(1) – making a corporation a citizen of
any state by which it has been incorporated and in the state where it maintains its principal place
of business. Prior to Hertz several circuits maintained that a principal place of business could be
where a corporatio’ns activities are centralized.
 Facts: NJ headquarters, DE incorporation, plaintiff sued in CA state court and Hertz tries to
remove on diversity theory.
 Test: “in practice it should normally be the place where the corporation maintains its
headquarters—provided that the headquarters is the actual center of direction, control, and
coordination, i.e., the “nerve center,” and not simply an office where the corporation holds its
board meetings (for example, attended by directors and officers who have traveled there for
the occasion).”
 Policy Thoughts:
 Avoids absurd results
 Simpler than center of gravity test – also probably changes less frequently.
 Better adheres to purpose of providing neutral forum that undergirds diversity jurisdiction
 Issues?
 Decentralized corporations – addressed, because person seeking to estagblish
diversity jurisdiction bears burden. Corp cannot use its decentralization to escape to
federal court. BUT it could use its decentralization to get out of federal court.

 Corporate Rights as Persons

 Background – Corporations have always been thought to have essential rights like ownership,
contract formation, suit to enforce. Early statutes gave corporations this power.
 Personal Rights – like religion and speech are newer.
 Gradual extension
 Contracts Clause – A1S10 – Dartmouth v. Woodward – invalidated statutory attempt by
WJNH to convert private university public.
 Santa Clara v. So. Pacific: Headnote states that Waite said: "The Court does not wish to
hear argument on the question whether the provision in the Fourteenth Amendment to the
Constitution which forbids a state to deny to any person within its jurisdiction the equal
protection of the laws applies to these corporations. We are all of opinion that it does."
 Otherwise – case just about taxation.
 No 5th Amendment right against self incrimination. Does not apply to artificial entities
per U.S. v. Kordel (1970).
 First Amendment Framework

Corporations 21
 Threshold question – Does this apply to a “person”? Because the amendment makes no
mention of persons.
 Commercial Speech – restrictions get intermediate scrutiny (less protection).
 Applies to speech “whose dominant theme is to propose a commercial transaction”
 Substantial Gov’t Interest + Narrow Tailoring
 In order to even get intermediate scrutiny, speech must (1) pertain to lawful material
and (2) not be misleading – Central Hudson v. Pub Service Comm’n (1980).
 Political Speech
 Contribution Limitations (not at issue in Citizens United).
 Various state and federal laws limit contributions to candidates (or candidate-
coordinated expenditures); anti-corruption rationale
 Corp & union prohibitions upheld in Buckley v Valeo (1976)
 Non-Coordinated Expenditure Limitations:
 Unregulated until 1940s; more restrictions in 1970s.
 Back-and-forth process between Supreme Court and Fed/State legislatures.
Buckley; 1st Nat’l Bank v. Bellotti (1978); Austin v. Mich. CoC (1990);
McConnell v. FEC (2003)
 “Strict scrutiny” for corp. speech, yet recognition that b/c corporate franchise
is creature of the state, some regulation permissible. Austin
 2 USC 441b and BCRA § 203 (Prohibiting corp/union advocacy outside PAC,
or “electioneering” expenditures inside election 30/60 day window)
 Exceptions for media corporations (& certain nonprofits)
 Disclosure / Disclaimer Requirements:
 BCRA §§ 201; 311
 Requires electioneering entity to disclose name (though not necessarily funding
sources) on communication, disclaim connection to candidate, and (usually) file
paperwork with FEC
 Citizens United
 Majority – Corporate expenditures get strict scrutiny. Trust in the governance
mechanisms of shareholder to intercede when they disagree with what the
corporate aggregate is saying.
 Religious Beliefs – Burwell v. Hobby Lobby
 Religious Freedom Restoration Act (42 U.S.C. § 2000bb) – Government shall not
substantially burden a person’s exercise of religious, even if the burden results from a
rule of general applicability…unless that application is:
 In further of compelling governmental interest
 Is lease restrictive means of furthering interest
 ACA – conflicts by requiring for certain employers healthcare pans that provide
“minimum essential coverage” – HHS regs said contraception must be included
 Hobby Lobby et al are closely held corps whose sharholders have sincerely held
beliefs conflict with the compensation for contraception plans.
 What does a corporation believe? Does corp speak for its shareholders?
 Dissents
 Stevens – Hard to know what shareholders or corporations want (Citizens United)

Corporations 22
  Ginsburg – This is very malleable. Companies could be strategic about how to
avoid regulatory costs (Hobby)
 Majority
 Alito – Ignores profitability critique. Says state corporate law ensures that
corporations represent shareholders (Hobby Lobby)
 Kennedy – Shareholder governance will intercede in cases where corp does not
speak for its shareholders. Agency issue will be regulated by state common law
and the shareholders themselves. (Citizens United).
 Policy Question: Does state corporate law adequately perform these functions?
 Business Judgment Rule – query whether its rationale applies in the realm of
politics.
 § 141(a) leaves affairs of corporation to the board…and challenging is very hard.
 Maybe shareholder activism is an avenue for addressing some of these concerns.

Corporations 23
CREDITORS’ RIGHTS & CORPORATE FINANCE
PIERCING THE CORPORATE VEIL
 Veil Piercing Framework
 Vertical Piercing – allows access to the shareholders’ assets. Basic Test: Did shareholder
transgress the shareholder-corporation boundaries? Was it viewed as an independent entity?
 Horizontal Piercing – Can reach sister corporation assets. Basic Test: Did the sister corporation
transgress the corporation-corporation boundaries?
 Piercing Legal Test:
 Unity of Ownership/Interest (factors from Associated Vendors v. Oakland Meats)
 Commingling of funds and other assets,
 Failure to segregate funds of the separate entities,
 Unauthorized diversion of corporate funds or assets to other than corporate uses
 Treatment by an individual of the assets of the corporation as his own
 Failure to obtain authority to issue stock or to subscribe to or issue the same
 Holding out by an individual that he is personally liable for the debts of the corporation
 Failure to maintain minutes or adequate corporate records,
 Confusion of the records of the separate entities
 Identical equitable ownership in the two entities;
 Identification of the equitable owners thereof with the domination and control of the two entities;
 Identification of the directors and officers of the two entities in the responsible supervision and
management;
 Sole ownership of all of the stock in a corporation by one individual or the members of a family
 Use of the same office or business location;
 Employment of the same employees and/or attorney
 Failure to adequately capitalize a corporation;
 Total absence of corporate assets, and undercapitalization
 Use of corporation as mere shell, instrumentality conduit for single venture/business of an individual
or another corporation
 Concealment & misrepresentation of identity of responsible ownership, mgmt, financial interest, or
personal business activities
 Disregard of legal formalities and the failure to maintain arm's length relationships among related
entities
 Use of the corporate entity to procure labor, services or merchandise for another person or entity
 Diversion to stockholder to detriment of creditors, or manipulation of assets/liabilities between
entities so as to concentrate the assets in one and the liabilities in another
 Contracting with intent to avoid performance by corporate entity shield against liability, or as
subterfuge of illegal transactions
 Formation and use of a corporation to transfer to it the existing liability of another person or entity
 Failure to pierce will sanction fraud or promote injustice
 Mere inconvenience/inability in enforcing a judgment or asserting regulatory dominion is
never sufficient.
 Mere ownership of controlling interest and (consequently) control of corporation is also
usually insufficient.
 Involuntary creditors tend to be treated more generously than voluntary creditors (who
can “price out” the risk)

Corporations 24
  Horizontal Equity: Will piercing enhance or reduce from extent to which similarly
situated parties are treated similarly?
 Fidelity to Statutory Goals: Pierce to ensure fulfillment & harmony of statutory goals
(e.g., weighing goals of Cal. Coastal Act against goals of Cal. Corp. Code against goals
of Cal/US Takings Clause)
 Also demonstrated in Walkovszky – policy of insurance for taxi cab drivers.
 Judge fundamentally gets to chose because it is an equitable doctrine. Appellate courts
review de novo.
 Tests must be applied to establish each link in the chain—the U.S. has not embraced any
entity theory of liability.

 Reverse Piercing – Would enable one who has gotten to SH/owner to get into that owner’s other
assets, like another subsidiary.
 General Rule: Similar test – unitary interest + fraud/injustice + assessment of harm to
innocent 3rd party shareholders in the pierced entity.
 No 3rd prong in NY – State v. Easton
 Open question in CA
 Majority of states allow some sort of reverse piercing.
 Sea-Land v. Pepper Source – Reverse piercing not allowed here, because the plaintiff did
not adequately show fraud/injustice prong.
 Internal Affairs Doctrine:
 NY: Use law of state having greatest interest in the litigation. - Intercont'l Planning, Ltd. v.
Daystrom, Inc., 248 N.E.2d 576 (N.Y. 1969)
 DE: Historically has used Delaware piercing doctrine if either the corporation is a DE
corporation, or its SH/corporate parent is.
 CA: Long arm statute (§ 2115): California piercing law usually applies if foreign corporation
falls under long arm statutw
 Strategic Means to Avoid Piercing?
 Respect corporate formalities
 Governance structure/docs, meetings, minutes
 No “commingling” of assets
 If formalities respected, SHs / sister corporations very likely can’t be pierced
 Possible exposure to fraudulent conveyance law

Corporations 25
  If not respected, things get murky
 Torts: Inadequate Capitalization
 Contracts: Fraud/Misrepresentation
 Individual vs. Corporate SH (?)

 Background: State corporate codes are carve outs from common law agency and partnership rules,
that limit liability of the share-holder principals for acts of the agents.
 Problem – this limit can invite abuse, so courts have created the carve out to the carve out that
allows creditors—in either contract or tort—to access the shareholders through the “Alter Ego
Doctrine”
 Alter-Ego Doctrine – limited equitable discretion to withhold or disallow statutory benefits when
court finds that the incorporation statute is being abused. Motivated by policy considerations
aimed at what the corporate form is intended ot provide.
 POLICY: Is limited liability a valuable attribute of corporate law?
 Pros:
 Encouraging entrepreneurship and investment
 Facilitating market for ownership interests
 Loss risk-spreading devices are available to those who deal with corps (like insurance)
 Enables shareholders to diversify their investments
 Reduces need for shareholders to expend costs in monitoring others.
 Possible Cons:
 Does not protect third parties from cost/risk externalization
 Outsiders have no ability or incentive to monitor management decisions
 Query whether SH have incentive or ability to monitor management – and if they do, they
don’t have any obligation to be concerned about the legal risk to others?

 Walkovszky v. Carlton (NY 1966) – Seon Cab Corp. owns two cabs, one of which struck the
plaintiff. The Seon Cab Corp. is owned wholly by Carlton, who also owns 9 other 2-cab cab
companies. Because Seon cannot pay recover, W wants to pierce horizontally and horizontally the
get access to shareholder assets and other subsidiary assets. Seon had no insurance.
 Holding: Piercing is inappropriate.
 Dissent: Public interest dimension. Taxicabs are a public service, and because legislature has
made insurance requirements, an individual who organizes companies without ability to
recompense injured should be held liable

 Sea-Land v. Pepper Source (1991) – Sea-Land is trying to recover on a bad debt from pepper
source. They pierce to owner Marchese, who is a slippery character. He shows no assets, but has
ownership of another company, Tie-Net (which he owns with some goof G. Andre).
 Holding: Reverse piercing not allowed. Plaintiff did not adequately show fraud/injustice.
 Plaintiff is a corporation itself
 There is another shareholder—so reverse piercing would cause him a double loss. There is
unitary interest and commingling funds—Marchese has been raiding corporate treasury, so
this is not fair.
 But query – cheapest cost avoider logic.
 Voluntary risk—contract. Not an involuntary creditor like a tort victim.

Corporations 26
 In re Silicone Breast Implants – Nationwide class action for bad breast implants. Attempt to pierce
Medical Engineering Corp. veil to get access to Bristol-Myers Squibb Co., a holding company.
Motion for summary judgment to dismiss case fails.
 Unity of Interest?
 Offices overlap
 Formalities – members confused at depositions
 Financial structure – Bristol gave intercompany loans to MEC and Bristol used MEC’s assets
 Swap Account—tiny amount of interest from cash generated by organization
 Injustice
 Tort victims – not well positioned to protect from this harm
 Claims of fraud?
 Court concludes given how messy this is, it is worthy of jury consideration
 POLICY: should the test be easier when the shareholder is a corporation?
 May make perverse incentives if the test gets any easier. Subs have legit functions to allow
asset transfer?
 Takeaway – shows court more forgiving when owner is a corporation itself.

CAPITAL STRUCTURE, VALUATION, AND ACCOUNTING

 Basics: Corporate Finances versus accounting:
 Corp Fin is understanding how cash flows from a corporation are valued and affect behavior.
 Fair Market value is key – looks at true value to inform valuation of company.
 Cash flows
 Forward looking
 Accounting – Backward looking. Balance sheets and income statements crucial.

 Time Value of Money – We have a bias to value cash in hand today more highly than cash in the
future. This is partly because we can use the cash for things now – like alternative investments.
 Notation:
 t = time (today is frequently denoted as “t=0”)
 T = terminal or “end” period (sometime in future)
 Ct = cash flow at time t (Alternatively denoted as Ft or Pt)
 r = “rate of return” from two periods of time
 Most financial economists speak the language of returns. One Period Return (between
t=0 and t=1):
P1 - P 0 P
r = = 1 - 1
P0 P0
 Discounting and Compounding are Same Math – Looking at how the value of money
changes over time.
 Compounding – asks how much $X will be worth in T years.
 Discounting – asks how much a future payment of $F realized in T years is worth today.

Corporations 27
 Formulas:
 Discounting:
F
P =
(1 + r )
 Compounding:

F = P * (1 + r)

 Compounding over multiple periods (t) when return remains constant:

F t = P 0 ´ (1 + r )t
 Discounting to Net Present Value for Each Future Cash Payment

F
P0 =
(1 + r )t
 Discounting a stream of cash flows to Net Present Value:

F1 F2 FT
P0 = N P V = F 0 + + + ... +
(1 + r )1 (1 + r )2 (1 + r )T
 Implication for Corporate Decisions - When deciding whether to use $1,000,000 to make a
plant or invest in equipment, we must make sure that the money would not be put to better use in
the market.
 Internal Rate of Return – Break-even interest rate. Discounting rate at which the company
would be indifferent in investing or not investing in the plant.
 Rules of Thumb for Time Valuation: Net present value of a typical investment cash flow
pattern increases when:
 Up front costs decline – less $ spent that could be placed elsewhere
 Size of benefit increases – Obvious reasons, more money later is still more money in today’s
value.
 Period of benefits lengthens – See above
 Interest Rate decreases – the amount which the cash would earn if just invested in treasuries
decreases, so projects look more lucrative in comparison – this is why the fed has kept
interest rates so low.

Corporations 28
CORPORATE DEBT AND BONDHOLDER RIGHTS
 Legal Framework
 Enforcing in Court
 What are the express terms of the agreement?
 Boilerplate provisions are given consistent meaning and discussed as a matter of law –
Sharon Steel v. Chase Manhattan
 Interpreting Boiler Plate provisions
 Winter’s Balance of the Interests from Sharon Steel – Where designed to protect
interest of parties, and where conflicting interpretations urged, interpret to sacrifice
interests of each party as little as possible. Distinguish between major and minor
concerns.
 Textualist Approach – Metlife v. RJR Nabisco – Courts limit enforcement to express
terms of the indenture. Rather than have a court examine the language and assign
meaning, the courts allow the market to price risk.
 Sophistication of parties is irrelevant – Geren v. Quantum. Textualist approach
enforced against small-time investors.
 Implied duty of good faith and fair dealing
 “[Would] the parties who negotiated the express terms of the contract … have agreed to
proscribe the act … as a breach of the implied covenant of good faith—had they thought
to negotiate with respect to that matter?” – Katz v. Oak Industries
 Winters Balance of the interests test – Sharon Steel
 Governance
 Trust Indenture Act: § 316(b) effectively requires unanimity for a change in the
principal/coupon payments.
 Where an economically similar transaction would clearly be allowed, then the transaction in
question is more likely to be allowed – Realogy v. Bank of N.Y. Mellon.
 Specific Situations:
 Sale of “substantially all” assets – Sharon Steel
 Incurrence of Additional Debt – MetLife v. RJR Nabisco, Bank of New York Mellon v.
Realogy Corporation
 Exchange Offers – Katz v. Oak Industries,
 Redemption and Call Protection – Morgan Stanley v. Archer Daniels Midland
 Company is not a fiduciary to bondholders – Katz v. Oak Industries
 Unless it enters insolvency – Gheewalla
 Maybe even after for a little while – Quadrant v. Vertin

 Background
 2 Primary ways for corporations to raise capital:
 Equity – Issuing shares of stock gives holders ownership rights as shareholders.
 Debt – various types of loans. No real ownership rights to recipients, but things can get
murky when corporations are insolvent.
 Differences:
 Seniority of claim – Debt holders have fixed claims on corporate assets over
shareholders. Equity has a residual claim (residual claimant)
 Tax Treatment – interest payments made by corporation are deductible.

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  Shareholders have voting rights
 Forms of Debt
 Bank Loans
 Commercial Paper
 Secured Debt/Leases
 Bonds
 Structure of a Bond – 10 years until maturity (when payments are finished). Bond has a face
value and promises 10 coupon payments each year.
C 1 C 2 C 3 C 10 F
N P V = -P rice + + + + . . . + +
( 1 + r )1 ( 1 + r )2 ( 1 + r )3 ( 1 + r )10 ( 1 + r )10
When markets are efficient, price of the bond will adjust so that the price paid is equal to the
NPV, because arbitrageurs will correct any differences by buying low and selling high until
the price evens out.
 Pricing/Rates – As long as the cash flow payment schedule is known:
 If the discount/prevailing market rate is known, then we can always calculate what the
price should be.
 Inverse relationship between prices and yields. If rates go up, then the value of those
fixed coupon payments as a return on the investment go down.
 Alternatively, if we know the price the market is valuing the bond at we know the rate
investors are using. This is much more typical.
 Yield to Maturity – Interest rate that equalizes today’s price with the present value of future
cash flows. This is the bond equivalent of Internal Rate of Return.
 Coupon Yield is different. That’s the amount of coupon relative to face value.
 Trading at Par – when bond trades at its face value. YTM and Coupon Yield must be
equal.
 YTM > Coupon Yield – Bond trades at discount. The coupon payment is less than it
would be from a bond issued today at prevailing market rates, so investors would not
want to pay face value for smaller cash flows.
 YTM < Coupon Yield – Bond trades at premium. Interest rates are lower than they were
when bond was issued, so this cash flow is worth more than it was originally thought to
be.
 Legal Terminology
 Debenture – long term unsecured debt
 Bond – long term debt secured by the property of the debtor.
 Indenture Agreement – contract that governs the terms of the bond.
 Issuer – company that issues the bonds.
 Underwriter – investment bank that negotiates the indenture agreement and sells the bonds to
other buyers. They bear some risk, but not too much, because if buyers will not bite, then
they must purchase the stuff (typically).
 Corporate Trustee – Appointed to monitor and enforce the terms of the indenture agreement.

 Relative Seniority:
 Debt – guarantee on corporate assets in the event of bankruptcy. Descending order of claim on
assets.
 Secured Debt/Leases – first priority

Corporations 30
  Senior Debt – usually held by banks
 Debentures
 Subordinated Debentures
 High-Yield “Junk” Bonds
 Equity – no guarantee on the corporations Assets

Bo nd+Rating
Mo o dy's S &P/+Fitc h Grade + Ris k
Aaa AAA Investment Highest Quality
Aa AA Investment High Quality
A A Investment Strong
Baa BBB Investment Medium Grade
Ba, B BB, B Junk Speculative
Caa/Ca/C CCC/CC/C Junk Highly Speculative
C D Junk In Default

 Sources of Law for Creditor Rights Against Corporation – Contract is the primary body of law
that protects investor rights. DGCL does not really touch this, with the exception of § 221 – which
allows a corporate charter to give bondholders same enumerated rights as shareholders.
 No fiduciary duties to bondholders, typically
 2 Questions For Legal Analysis
 Interpretation of express terms in indenture agreement
 Implied duty of good faith and fair dealing
 Intent of the parties? In contract this is typically critical, but it is less prevalent in bond
indentures because often the original buyer is not the party attempting to assert rights.
 Intent is very hard to ascertain when the instrument has changed hands so many times.
 Predictability is key – boilerplate provisions are interpreted consistently as a matter of law
in a courtroom setting. Individuals can choose to say out of market or shop around, but the
cost to future investors from taking away predictability would be large.

 Debt Restructuring – In the event of financial distress, companies may want to restructure their
obligations so they can maintain financial solvency. Investors will go along, reluctantly, because the
alternative could be bankruptcy, where they have a smaller chance of recovering any of their
investment.
 Exchange Offer - Debt restructuring maneuver that ideally overcomes holdout problems among
bondholders, who individually will not want to forgive any claims on the company’s assets. The
exchange typically involves the debt-holder trading the security back to the firm in exchanged
for cash, equity, or a new form of debt. To do this, the issuer offers exchange contingent on
majority acceptance of the removal of certain bondholder protections.
 Exit Consent – Exchange offers are often linked with consent solicitations – by which
bondholders agree to weaken certain negative covenants in the indenture that may prevent
the issuer from doing certain things.
 Problem: Most debt has anti-subordination provisions, which prevent debtors from issuing
debt that has a more senior claim on the assets of the company. The exchange offer allows
for companies to get rid of these provisions, leveraging the bondholder collective action
problem – no one wants to be last one to lose place in line.
 Advantages to Bondholder?

Corporations 31
  Avoid pitfalls and procedures that come with bankruptcy
 Avoid agency costs, because when assets start to run out, managers may just decide to
gamble to see if they can hit it big, knowing they’re unlikely to be successful anyway.
 Collective action Dimension: Depending on the likelihood of company failure, there may be
a rush to secure your debt, even if it is less, if you anticipate that other bondholders will vote
in favor of the exit-exchange.
 Trust Indenture Act – Heavily regulates how you can negotiate and change the terms of the
indenture.
 § 316(b) – to renegotiate the coupon/principal (any monetary amount) in favor of a reduction,
you need to have the consent of each individual bondholder. This imposes a de facto
unanimity requirement.
 Caveat – TIA does not prevent modification of financial covenants, that operate to ensure the
company can meet its obligations. To strip covenants, the company only needs to secure
consent of a majority of the bondholders.
 Katz v. Oak Industries – Does not prohibit exit exchange offers categorically, but it does identify
relevant factors to determine the coerciveness of the deal:
 Value of the exchange relative to market value of the debt on the secondary market – not as
coercive if the exchange offer values the bonds more highly than the market.
 Debt is widely held rather than closely held – If there are fewer owners, then we worry less
about the collective action problem.
 Exchange grants debt holders greater priority claims versus less priority claims. Collective
action problem is less pronounced if the move is to the back of the line.
 Liking exchange offer to consent vote – this seems to be the sine qua non of the transaction,
but not dispositive given the other factors.
 Note – Recently invalidated for being coercive to minority bond holders in Assenagon Asset
Mgmt. v. Irish Bank Res. Corp. – created some questions when debtor is subject to UK
jurisdiction.

 Call and Redemption Provisions – Term in the indenture that allows issuer to prepay the principal
on the note before maturity. This typically is limited by the indenture and often involves a premium
in the principal, that goes down over time as the bond approaches maturity.
 Call Provision: Allows company to pay the premium to eliminate debt.
 Advantages:
 Reduces downward interest risk for issuer in the near term
 Reduces transaction costs involved in refi
 Facilitates financing of debt in changing economic environments – variable interest rates.
 Disadvantages
 Limits upside profit for bondholders, who would profit by increased bond value if interest
rates were to fall.
 Bondholders will want to negotiate in a higher interest rate or some sort of constraints on
exercise.
 Time limit on vesting – cannot exercise right away.
 Large premiums
 Non-refundability provisions – cannot just redeem to lock in a lower interest rate –
Archer Daniels Midland

Corporations 32
CASES

 Sharon Steel v. Chase Manhattan (2d Cir. 1982) – UV Industries is a failing business. It has
outstanding debentures that it issued at a time with low interest rates worth ~$411 million. However,
interest rates have spiked dramatically, lowering the market value to $123 milion. Sharon Steel is
acquiring UV and its debentures. The dispute is whether Sharon Steel must pay all of the
bondholders the face value of the bonds now, or whether they can transfer to the new entity, and it is
based on a successor clause in the agreement.
 Holding: Successor clauses are boilerplate. When a corporation sells substantially all of its
assets, the debts can be transferred, otherwise they need to be bought off.
 Reads substantially all in light of purpose to protect debt holders from company trying to
liquidate to avoid payment.
 Winters asserts this balancing of interests test for when language is unclear. Applied here:
 Lenders added the clauses to ensure that the debtor would not compromise security of the
loan by selling assets or substantially altering the business.
 Shareholders/Board want to ensure they can have flexibility in the future so that they can
replace management and put a failing company up for sale to realize a return.
 Significance: Balance of the interest test for determining boilerplate provisions is rare and very
lender friendly.

 MetLife v. RJR Nabisco (S.D.N.Y. 1989) – BARBARIANS AT THE GATE! KKR has completed
an LBO of RJR Nabisco, which has added a lot of debt to the balance sheet. Met Life is an original
creditor, who is very upset with this transaction, so they sue.
 Leveraged Buy Out – debt financed acquisition of a company. Typically a buyer will issue debt
to purchase shares/assets from the current shareholders. Once the transaction is complete, the
debt will be added to the entity that is being bought, which will increase leverage. This is great
for shareholders who get to sell their stock at a premium, but it may have negative consequences
for current holders of debt and employees, whose jobs may need to be cut so the company can
focus on servicing this immense debt burden.
 Pros?
 Decreases tax burden, because payments to creditors are tax-deductible.
 Allows a single shareholder to now capture all of the profit
 Cons
 May hurt existing creditors, who do not really have a say in the transaction
 May hurt employees
 Plaintiff Arguments
 Implied Covenant of Good Faith and Fair Dealing – Alleged there was a good-faith duty not
to dilute the debt
 Equitable claim of unjust enrichment, frustration of purpose, unconscionability, and breach
of fiduciary duties.
 Fraud – 10b-5 violation and common law fraud.
 Holding: Court finds for RJR at summary judgment. Textualist Approach
 There can be no frustration of purpose, because Metlife anticipated the risk as evidenced by
internal memoranda
 Players are sophisticated financial entities that price risk, but this is not really a factor.

Corporations 33
  Securities fraud claim fails because Metlife was not a shareholder induced to buy or sell on
this information.
 Fiduciary duty argument – basically asserted that equity is so small that they are the residual
claimants, but this argument really only works in the event of severe financial distress – see
below.

 Bank of New York Mellon v. Realogy Corporation (Del. Ch. 2008) – Context is a take private LBO
financed by 3 tiers of debt. Tier II and Tier III were offered a chance for a 2nd lien with a lower tier
of debt, which seemed kind of coercive, because there was no vote required. Trustee for Tier II & III
debenture holders (which included Carl Icahn) sued, claiming indentures required any new loans to
be funded with cash (rather than exchange of other debt securities)
 Holding: Four corners/common sense.
 Takeaway – Economically equivalent transaction would have been allowed easily,

 Katz v. Oak Industries (Del. Ch. 1986) – Exit-Exchange Offers. Oak Industries has fallen on some
hard times, and Allied Signal Co. comes in to purchase a unit + some stock. However, to execute the
deal, Allied-Signal wants a certain percentage of debt holders to accept exchange offers, because the
debt is creating a major cash drain on the company. The offer is to exchange current debt for cash
that – generally valuing the bonds at higher than prevailing market prices. In order to secure
approval, a certain number of bondholders in each class must agree, and they must agree to
amendments to the indenture as they cash out. Plaintiff argues that this is a breach of contract and
breach of the duty of good faith.
 Holding: Nothing in contract prevents this type of coercion, and the duty of good faith and fair
dealing does not prevent coercion. Is
 Other Pieces of Law
 Company is not a fiduciary to bondholders. It would not be a breach for management to
try to transfer as much wealth as possible, because this arrangement is negotiated at arms
length – bondholder can protect self.
 Example of four corners presumption in practice.
 Factors relevant for determination whether the exchange offer is wrongfully coercive – and
therefore in breach of the duty of good faith and fair dealing:
 Value of the exchange relative to market value of the debt on the secondary market – not
as coercive if the exchange offer values the bonds more highly than the market.
 Debt is widely held rather than closely held – If there are fewer owners, then we worry
less about the collective action problem.
 Exchange grants debt holders greater priority claims versus less priority claims.
Collective action problem is less pronounced if the move is to the back of the line.
 Liking exchange offer to consent vote – this seems to be the sine qua non of the
transaction, but not dispositive given the other factors.
 Illustrates problem – class action problem (prisoners dilemma of bondholders) versus the holdout
problem (bondholders refusing to tender their shares in favor of a better deal)

 Morgan Stanley v. Archer Daniels Midland (S.D.N.Y. 1983) – Archer Daniels Midland has some
debentures with redemption provisions. One of the limits on the exercise of these debentures is that
the redemption cannot be financed by new debt issued at a lower interest rate. The debt is very
valuable, because it is paying a nice interest rate, and rates have fallen dramatically. ADM has raised

Corporations 34
money in many ways—issuing debt and equity—and it exercised the call provisions. Morgan
Stanley claims violation because debt was comingled with money from shareholders.
 Holding: No violation of contract.
 Franklin Life Insurance v. Commonwealth Edison Co. – Early redemption lawful when
funded directly from common stock issuing.
 Construing language against drafter is not applicable because of sophistication of party
 Equities in equilibrium
 Because contract is post-Franklin, parties should have known.
 Tension: Economically equivalent transaction would have violated. Could have done a buyback
with the new debt. Tension with how corps raise revenue.
 Potential limiting factor is shareholder activism and exercise of fiduciary duties that could
keep company from using a workaround.

Corporations 35
SHAREHOLDERS’ LEGAL RIGHTS AND DERIVATIVE ACTION
 Generally – Shareholders are seen as the true owners of a corporation. Therefore they are entitled to
stronger rights associated with fiduciary relationships. This has its basis in property.
 3 Forms of Rights
 Voting – Default rule empowers each shareholder to vote on certain issues related to
corporate policy.
 Director elections
 Amendments to charter and bylaws
 Shareholder proposals
 Decisions regarding mergers, acquisitions, liquidation
 Selling
 Suing – 2 bases for suit.
 Fiduciary duties – shareholders are beneficiaries of these duties owed by managers and
directors to the corporation. When suing to enforce fiduciary duty, often done on behalf
of the corporation through the derivative action process.
 Contract – shareholders may, in their individual capacity, be counterparties to contracts
with the corporation.
 Fiduciary Duties – owed to the corporation (not directly to the shareholders, who are the
beneficiaries).
 Duty not to Waste – officers cannot squander assets
 Duty of Care – Required to engage in thorough, careful decision making
 Duty of Loyalty – Self-dealing transactions may be suspect
 Duty of Good Faith – Indifference towards corporate welfare. Contrast from Duty of Good
Faith and Fair Dealing in the contract context.

DERIVATIVE & DIRECT ACTION PROCEDURE

 Attack Framework

 Procedural Hurdles for Plaintiffs in Derivative Action

 Bond-Posting Requirements (to cover legal expenses of corporation).

 Expressly prohibited in Delaware – DGCL § 102(f).
 If plaintiff prevails or there is a settlement, corporation must pay both sides’ legal fees.
 Cohen v. Beneficial – Substantive law that would apply in federal or state court
 Eisenberg v. Flying Tiger – bond posting requirements only attach to a derivative action,
so it is crucial to ensure that it is not direct.

 Special Pleading/Standing - Del. Ch. Ct. Rule 23.1 – Must allege with particularity/in a non-
conclusory fashion:
 Shareholder at time of the wrong
 Efforts if any to obtain action from the board
 Explain why efforts failed or were not required
 Affidavit affirming not being compensated to bring suit

Corporations 36
  Demand
 1. Demand Required or Excused?
 Decision/Action – 2 part Aronson v. Lewis test – Demand is futile only if plaintiff can
allege particular facts
 that create a reasonable doubt that directors are disinterested and independent, OR
 that create reasonable doubt that the challenge transaction was otherwise the
product of a valid exercise of the business judgment rule.
 Inaction/previous board action/board delegee action – Rales v. Blasband – Demand is
deemed futile only if plaintiff can allege particularized facts creating a reasonable
doubt that as of the time the complaint is filed the board could have properly
exercised independent and disinterested business judgment in responding to the
demand.
 Grimes v. Donald – if demand is excused, but made anyway, it is waived.

 2. Demand made and ignored, is it a wrongful refusal under test from Grimes?
 Wrongful refusal: Allege facts with particularity creating a reasonable doubt that the
board is entitled to the benefit of the presumption. If there is reason to doubt that the
board acted independently or with due care in responding to the demand, the
stockholder may have the basis ex post to claim wrongful refusal.

 3. Demand excused, none made. Special Litigation Committee either accepts the claim,
or it movies to dismiss. Claim goes forward if:
 NY - Auerbach v. Bennett - If SLC is not independent, then its conclusions are
irrelevant and derivative action can proceed. Courts use the following factors to
determine independence:
 Committee members Non-defendants
 No domination by named defendants
 Granted full authority surrounding the case
 Reasonable budget
 Access to outside counsel
 [Plaintiff bears burden]
 DE Zappata, In re Oracle – SLC bears burden of satisfying 2-part test.
 Demonstrate independence.
 Court applies its own business judgment to determine whether actions are
consistent with the spirit of the committee or whether they usurp shareholder
authority to bring the suit forward.

 Claim can go forward derivatively if SLC recommends pursuing the claim or if the SLC fails
the two-parta Zappata test.

 Direct Action vs. Derivative Action

 Gordon Test: Question “whether the object of the lawsuit is to recover upon a chose in action
belonging directly to the stockholders, or whether it is to compel the performance of

Corporations 37
 corporate acts which good faith requires the directors to take in order to perform a duty
which they owe to the corporation and through it to its stockholders”
 Lazar Test: Direct action: “challenges the right of present management to exclude him and
other stockholders from proper participation in the affairs of the corporation….defendants are
interfering with the plaintiffs’ rights as stockholders.”
 Eisenberg v. FTL – says that Gordon is limited to its facts, and opts to follow Lazar
articulation. Talley slide indicates that both tests are valid.
 BLL: For direct action in Delaware, courts ask per Tooley v. Donaldson, Lufkin, &
Jenrette, Inc.:
 1) Who suffered the harm? Plaintiff individual or the corporation? Individual harm can
include interference with participation, voting, or governance rights.
 2) Who would receive the benefit? The corporation or the stockholders, individually?
 DE courts used to consider whether the harm is “special,” or individual to the
shareholder. Special harms are not shared pro rata with other shareholders. Del. Supreme
Court in Tooley rejected this notion.

 POLICY – Why the Derivative Action Process

 Rationale – Board of Directors are agents on behalf of the corporation, and it would be odd for
them to decide to sue themselves. The corporation is the only entity that would logically have
standing to sue for breach of duty, so he derivative action process allows shareholders to compel
the board to force the corporation to sue the board.
 General Structure – 2 lawsuits rolled into one.
 Equity injunction forcing corporation to sue its board of directors/officers – Always named
after this action (e.g. S.H. v. X Corp.).
 Equitable legal suit by corporation against the board/officers/individuals
 Problems? Shareholders themselves may not be the best agents for the corporation. They may
have private agendas or want to extract some sort of individual concession from the board.
Therefore, the law places key limits on the derivative action process, like bonding, pleading,
demand, and special lit. committees.

 Derivative Action Process vs. Direct Action Process

 Direction Action – shareholder sues claiming that there is either a breach of a contractual duty or
a fiduciary duty owed to the shareholder individually. – Eisenberg v. Flying Tiger
 Derivative Action – sues corporate officers/directors/other fiduciaries on behalf of the
corporation, alleging breach of duty owed to all shareholders – Cohen v. Beneficial

Procedural Hurdles for Plaintiffs in Derivative Action

 1. Bond Posting Requirement – Derivative claimant with insignificant stake in corporation must
post security for the corporation’s legal expense in case claim fails. If claim succeeds or parties
settle, then the corporation would be on the hook for both sides’ legal expenses.
 1/3 of states, but not Delaware – Including NY.
 § 102(f) expressly prohibits bond-posting requirement in charter
 Cohen v. Beneficial – requirements are substantive so the apply in federal court. Would probably
not apply if suit was filed in Delaware district court.
 Eisenberg – only applies to derivative actions.

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 2. Special Pleading – Per Del. Ch. Ct. Rule 23.1, complaints in derivative actions must have a
particularized complaint that conforms to substantive requirements including:
 Subsection (a)
 Must allege that the plaintiff was a shareholder when the alleged wrong occurred
 Allege efforts, if any, to obtain action from the board
 Must explain why demand failed or why it was excused
 Must submit affidavit that the person is a shareholder and is not receiving compensati
 Subsection (b)
 Must file affidavit stating that plaintiff has not received, been promised, nor will accept any
compensation other than attorneys’ fees and reimbursements in the event that they prevail.
 All of these allegations must be more than conclusory assertions – this itself is a significant
hurdle, because there should be some facts that are difficult to discover. Plaintiffs can use:
 Books/Record requests in accordance with DGCL § 120 – see infra Shareholder Governance
section.
 New s coverage for significant companies
 Subsection (c) mandates court approval of any settlement

 3. Demand – Most states, including Delaware and NY, require that shareholders first seek board
action prior to derivative litigation. Several exception – making demand tends to be bad for
plaintiffs, because it narrows the scope of the litigation.
 Excuse: Demand would be futile. Plaintiff can bring action without making demand.
 Board Decision or Action – Aronson v. Lewis
 Test: Demand is futile ONLY IF plaintiff can allege particularized facts creating a
reasonable doubt that either:
 As of time of complaint, directors are disinterested or independent, OR
 The challenged transaction was otherwise the product of a valid exercise of business
judgment.
 Easier for plaintiffs – can show doubt as to independence or ability to validly exercise
business judgment. Plaintiffs get to pick which would be easier.
 “Non-Board Decision” or Inaction – Rales v. Blasband (covers inaction, previous board
action, or action of board delegees).
 Test: Demand futile only if plaintiff can allege particularized facts creating reasonable
doubt that as of the time of the complaint, the board of directors could have properly
exercised its independent and disinterest business judgment in responding to demand.
 In application:
 Part I Aronson/Rales not satisfied by:
 Naming all or a majority of current board as defendants
 Claiming that structural bias typically causes board members to be defensive
 Part I Aronson/Rales can be satisfied by alleging with particularity that:
 Interested
 Substantive case against them is strong – slippage with part II
 They have a material financial interest in outcome – “interested”
 Non-Independent:
 Closely connect to interested parties

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  Dominated/controlled by other interested defendants – more frequent application.
If the CEO is an interested party, and they dominate the board, then this can be a
strong point for plaintiffs.
 Securities regulation guidance – NYSE/NASDAQ independence metrics
 In re Dow Chemical – decision based on the corporate merits of the subject before
the board rather than extraneous considerations or influences. Cannot be
dominated or controlled by interested party.
 “Allegations of mere personal friendship or a mere outside business relationship,
standing alone, are insufficient to raise a reasonable doubt about a director’s
independence.” – Beam ex rel. Martha Stewart (2004).
 Disinterested – Directors can neither “appear on both sides of a [decision] nor expect
to derive any personal financial benefit from it in the sense of self-dealing, as
opposed to a benefit which devolves upon the corporation or all stockholders
generally.” - In re Dow Chemical
 Personal financial benefit can (but may not necessarily) extend to family
members or close friends.
 Consultants - Grimes – using external compensation consultant to set the officer
compensation creates a presumption of independence. DGCL § 141(e) protects
board members from relying on persons “the member reasonably believes are
within such other person's professional or expert competence and who has been
selected with reasonable care by or on behalf of the corporation.”
 If demand is unexcused, SH must make demand in order for action to proceed. Board of
Directors or Special Litigation Committee usually disapproves of demand, which means that the
SH/plaintiff must show that the decision falls under the wrongful refusal doctrine
 Grimes – Wrongful Refusal Test – “If demand is made and rejected, the board…is entitled
to the presumption of the BJR unless the stockholder can allege facts with particularity
creating a reasonable doubt that the board is entitled to the benefit of the presumption. If
there is reason to doubt that the board acted independently or with due care in responding to
the demand, the stockholder may have the basis ex post to claim wrongful refusal. The
stockholder then has the right to bring the underlying action with the same standing which
the stockholder would have had, ex ante, if demand had been excused as futile.”
 In application – must be more than conclusory. Must explain why, in the process of
deciding whether or not to respond to the demand, the board does not deserve BJR
protection for its decisions. Could be the same things that satisfy Rales.
 If demand is excused, and plaintiff makes demand anyway, then he waives excusal, and must
show wrongful refusal per Grimes as described supra.

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  If demand is excused, and plaintiff does not make a demand, then the question falls to whether
the special litigation committee recommends pursuing the lawsuit.
 Demand Futility in NY - Marx v. Akers
 Demand requirement
 Particularity in pleading
 Pleading must support prima facie case of futility – No distinction between action/inaction
 Grounds for futility
 Action egregious on its face that it could not have been the product of sound business
judgment
 Majority of board is interested/dominated by those who are interested
 Board did not adequately inform selves

 4. Special Litigation Committees (fork in law between NY and DE) – Unbiased committee, but
common for the SLC to side with the board. Unbiased committee to assess validity of plaintiff’s
claim.
 NY – Auerbach v. Bennett
 If SLC is not independent, then its conclusions are irrelevant and derivative action can
proceed.
 Factors – Auerbach v. Bennett

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  Non-defendants
 No domination by named defendants
 Granted full authority surrounding the case
 Reasonable budget
 Access to outside counsel
 Auerbach suggests burden may be on derivative plaintiffs
 If independent  BJR deference
 Procedures judged as gross negligence, similar to duty of care
 Substantive decision gets protection of BJR
 DE – Zapata Corp v. Maldonado – 2 part Test
 First, corporation has burden of proving independence, good faith, and reasonable
investigation by SLC.
 In Re Oracle: “At bottom, the question of independence turns on whether a director is,
for any substantial reason, incapable of making a decision with only the best interests of
the corporation in mind. That is, the Supreme Court cases ultimately focus on impartiality
and objectivity”
 Second, Court applies its own independent business judgment whether actions satisfy spirit
or whether they prematurely terminate stockholder grievance. – A gamble in practice.
 SLC Checklist:
 Independent Composition (still evolving standard) - Not implicated; not dominated;
objective; impartial; experienced (retired judges?); useful to refer to SRO rules.
 Fully empowered in its charter to make decisions on board’s behalf and speak in its name
(DGCL § 141(c))
 SLC must be given full access to company’s records; employee base; confidential
documents.
 Defendants / Other Directors cannot interfere with / “snoop” on SLC’s deliberations
 SLC should have access to / be advised by separate outside counsel, and other experts as
needed
 SLC should have adequate budget to discharge duties
 Att’y/Client Privilege: Applies to SLCs investigation, but SLC’s written report may waive
some/all.

 NYSE Independence Requirements – Not Delaware law, but can be useful in applying the
independence portions of Aronson, Rales, and Zapata. Necessary conditions for independence:
 No “material relationship” (supplier, customer, partner);
 No employees or close family members of employees;
 Can’t receive more than $100K from company per year (excluding director fees or independent
deferred comp/pension benefits);
 Can’t be an affiliate, employee, or family member of affiliate/employee of company’s external
auditor;
 Can’t be employed (or have family employed) at another company where the listed company’s
CEO serves on compensation committee;
 Can’t be an officer / employee (or have family that are) of another company that does significant
business with listed company

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 Creditors’ Derivative Actions – Creditors may start getting fiduciary rights when the corporation
approaches the zone of insolvency.
 BLL: Creditor can claim fiduciary relationship and sue derivatively in insolvency and after a
period of insolvency, not in any zone pior– NACEPF v. Gheewalla, Quadrant v. Vertin
 Before Insolvency:
 Only contractual duties owed to creditors
 Fiduciary duties owed to company do not change when in zone of insolvency.
 After Insolvency –
 Standing to maintain derivative claims for the creditors
 Creditors may not bring direct claims for fiduciary duty breach, they may only do so
derivatively on behalf of the corporation itself.
 Can only apply to company decisions made after insolvency.
 Creditors suing derivatively must still meet the requirements for a derivative action.
 Quadrant v. Vertin – No “irretrievable insolvency” requirement to creditors’ rights to sue
derivatively.
 Shareholders do not lose derivative standing during insolvency.
 Insolvency Defined
 Balance Sheet – All liabilities are greater than assets, and there is no reasonable chance that
the business can continue in the face of this fact.
 Cash Flow – Inability to make payments owed with the current cash inflow in the ordinary
course of business.
 Credit Lyonnaise v. Pathe Comm. Dictum – when corp is in zone of insolvency, the directors
may start to owe duties to more than just the corporation – duty to the community of interest in
the corporation.
 Problems this idea is meant to address? Agency – bond holders worry about squandering the
assets that may secure their debts.

CASES

 Cohen v. Beneficial Industrial Loan Corp. (U.S. 1949) – Plaintiff Cohen alleges certain breach of
loyalty claims, but together with another co-plaintiff, owns less than .0125% of all outstanding
shares. Suit was filed in District Court of N.J., and N.J. law requires that Cohen post bond for legal
expenses of corporation.
 Holding: No constitutional violation to the bond-posting requirement. Law is substantive (not
procedural) so must be followed in federal court.

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  Rationale
 Constitution:
 Due Process – States have plenary power & limit to reasonable expenses
 EPC – Deferential scrutiny, preventing frivolous suits is a legitimate purpose. Means are
reasonably related.
 Erie – Bond-posting creates a new liability, so it is substantive and not just procedural.
 Distinct from IAD – regarding the substantive assessment of the duty of loyalty claims, court
would apply Del. Law. – Tension with arguing that the bond posting requirement is procedural.
 Alternatives? Sue in Delaware or file direct claim.

 Eisenberg v. Flying Tiger Line, Inc. (2d Cir. 1971) – FTL is engaging in an odd merger to insulate
itself from shareholders. It creates a subsidiary, which in turn creates another subsidiary. The grand
child subsidiary acquires FTL, which makes shareholders owners of the initial sub, so they are
removed from management decisions over the real meat of the company. Plaintiff files suit directly.
Corporation claims this is derivative and subject to the bond-posting requirement.
 Holding: Plaintiff filed in his individual capacity. Applied the Lazar Test, which asks whether
plaintiff was being harmed in his individual capacity.
 Gordon seems to focus on the goal of the suit – whether it is to benefit shareholder indivually
or change some corporate action.
 Court in Eisenberg claims Gordon is limited to its facts.
 Takeway: Expresses preference for Lazar-type test in New York. Query whether the same would
apply in Delaware, which uses the Tooley 2-part test.
 Consider IAD – suit brought in NY may have easier way to demonstrate direct action, but it
is less relevant, because there are no bonding requirements in Delaware anyway.

 Grimes v. Donald (Del. Sup. Ct. 1996) – Grimes is challenging the contract that the board has made
with the CEO, because of the ridiculous golden parachute and constructive discharge provisions.
Grimes calls the board, which functions as a demand – this is a huge mistake.
 Plaintiff Allegations:
 Abdication – side issue
 Duty of Care
 Duty of Loyalty
 Waste
 Holding: Making a demand functions as waiver to ability to claim that demand is futile and
excused by Aronson.
 Perverse incentive for plaintiffs—holding effectively encourages plaintiffs to never make
demand on their boards, which may contravene the purpose for the demand requirement in
the first place (i.e., encouraging dispute resolution outside of court).
 If demand is made even if excused, court must apply the wrongful refusal doctrine
 Functionally the same as Aronson I or Rales, but is applied ex post to the board’s decision
whether or not to respond to the demand.
 Abdication Claim – statutory claim of willful abandonment of managerial duties under DGCL §
141(a). Grimes argues that the constructive discharge provisions ceded board oversight
prerogative to the CEO which is an abandonment of managerial duties.
 Court: They maintain oversight rights, but exercising them is dramatically more expensive.
Oversight has not been made impossible.

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  Court says this is a direct claim – but could be seen as derivative, because this action should,
in theory, have consequences for all shareholders and not be limited to Grimes individually.

 Auerbach v. Bennett (N.Y. 1979) – The company is on trial for violating the foreign corrupt
practices act, and must therefore pay substantial fines. The plaintiff alleges breach of duty of care. In
response the board set up a special litigation committee, which decided not to pursue claim.
 Holding: SLC was properly independent and correctly did not pursue claim.
 BJR for conclusions – but will look at things like fraud, bad process, etc.
 Independence factors:
 Non-defendants
 No domination by named defendants
 Granted full authority surrounding the case
 Reasonable budget
 Access to outside counsel

 Zapata Corp v. Maldonado (Del. 1981) – Breach of fiduciary duty claims against members of the
board. Demand would have been excused, and plaintiff never made one and pled futility. The SLC
recommended against pursuing. Supreme Court announced a 2-part test for demand-excused cases
that go to an SLC which in turn recommends dismissal.
 Test:
 First, corporation has burden of proving independence, good faith, and reasonable
investigation by SLC.
 Second, Court applies its own independent business judgment whether actions satisfy spirit
or whether they prematurely terminate stockholder grievance. – A gamble in practice.
 Only relevant where demand is excused and

 Ryan v. Gursahaney et al (2015) – Aronson applied in modern context. ADT board is reacting to
pressure from activist investors, Corvex, and opts to buyback their shares at a premium. Ryan sues
derivatively, arguing a slate of fiduciary breaches.
 Aronson 1 – No actual threat of proxy challenge. Entrenchment motivation not enough.
 Aronson 2 – Repurchase of activist shares is acceptable in Delaware as a business judgment
under precedent of Grobow v. Perot. To fall under scrutiny, the board likely needs to be deriving
some high level of compensation from the transaction, not just entrenchment.
 Hush Mail aside:
 Buy shares è force governance / capital changes è induce price increase è sell back at inflated
price + standstill agreement è often an ensuing price fall
 Cf: “Green Mail” phenomenon from 1980s (similar dynamic but with background threat to
conduct a hostile takeover if not paid off).

 In re Oracle (Del. Ch. 2003) – Importance of burden shifting. SLC found not to be disinterested.
 Standard for determining independence - “At bottom, the question of independence turns on
whether a director is, for any substantial reason, incapable of making a decision with only the
best interests of the corporation in mind. That is, the Supreme Court cases ultimately focus on
impartiality and objectivity”

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 North Am. Catholic Ed. Programming Fdn. v. Gheewalla (2007) – NACEPF is selling licenses to
Clearwire. Clearwire is able to pay some and not all. NACEPF throws a fiduciary duty claim in,
arguing that they have standing to sue derivatively because they are in zone of insolvency.
 Holding/Rule: Zone of insolvency is not good enough. Derivative actions are only available to
creditors once the company is actually insolvent. The fiduciary benefit that vests to the creditor
then cannot apply to any actions the board makes before the vesting.

 Quadrant Structured Products Co. v. Vertin (2015) – Company is clearly heading towards
insolvency, so a creditor takes a stake and starts guaranteeing payments on the debt they held. The
court denies a motion to dismiss, arguing there is no irretrievable insolvency requirement.
 Court notes that shareholders do not lose right to sue derivatively during insolvency. They
note that this puts the board in tricky space – how do they balance loyalties?
 BJR protection – the board gets to decide what to do and how to do it.
 Functionally good for the board, because they get two outs – they have valid BJR deference
for an action that benefits either bondholders or shareholders.

 China AgriTech – New people on the board get treated under the Rales test. If a majority of the
board is an old board – then Aronson may apply.

SUBSTANTIVE FIDUCIARY DUTIES

 Business Judgment Rule – Acts as a strong defense for management when shareholders allege
violation of fiduciary duties. The BJR is a presumption that management has been following its
duties. Does not give anything to duty of loyalty violations.
 Applies equally to officers Gantler v Stephens
 In the absence of BJR, plaintiffs get the benefit of an “entire fairness” standard of review.
 Statutory Authorty? DGCL
 § 141(a) – empowers the board to manage the corporation
 § 141(c) – Powers of delegation to committees and experts
 § 141(e) – Fully protected in relying on opinions of experts or through information generated
reasonably by committees.
 Rationale
 Board sophistication – courts are poorly equipped to evaluate business decisions. Board
members ostensibly have their position due to special training and experience
 Incentivizes managers to take risks.
 Shareholders can manage these risks through diversification of their investments. If they
don’t like the management style, they have the option to sell.
 Other ways to enforce besides litigation including: direct governance, compensation of
directors/termination through charter mechanisms, and use of the public securities markets to
buy control of the company. Also – reputational levers.

 Entire Fairness Standard

 Procedural – was there fair dealing
 Timing of transaction;
 Structure of transaction;
 How it was initiated / negotiated (e.g., competitive bidding?)

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  How it was disclosed to directors / shareholders
 How approval of directors / shareholders (if any) were obtained
 Substantive – fair price as a matter of substance
 Value of consideration paid / received
 In re Pure Resources – fairness opinion valuation methodology and how communicated
to shareholders is relevant. Cannot be blind reliance.
 Utilization of some sort of “market test”
 Value of alternative transactions (including waiting; doing nothing)
 Other elements that reasonably affect the intrinsic or inherent value of the transaction

 Fairness Opinions by Banks – Can be used in the entire fairness analysis. Report authored by
investment bank / financial advisor, addressed a corp’s board of directors, opining whether price
terms of a proposed transaction (merger, assert purchase/sale, stock sale, etc.) are substantively fair
 Uses:
 De facto requirement in M&A context after Van Gorkom for entire fairness.
 Bargaining leverage against negotiating partner
 Required pursuant to debt covenants (“transactions with affiliates”)
 DE Courts
 Not required per se, but can be a factor in favor of defendant – Houseman v. Sagerman
 Blind reliance is not enough – In re Pure Resources

W AST E (U L T R A V I R E S & C O R PO R A T E P UR POSE )

 BLL – Not a valuable duty for plaintiffs today.

 Plaintiffs have not won a waste claim in Delaware.
 Only win is Dodge v. Ford – BJR deference will be granted to the means that a board opts to use
to maximize profit, but there will be no deference for the decision whether or not to make a
profit.
 Management must only be able to articulate a rational basis for the action. This is easy to do.

 Background/Origin – Modern decedent of ultra vires doctrine

 Ultra Vires – would invalidate actions of the board that contradict the purpose of the corporation
as stated in the charter. Practice of fully articulating things in the charter is largely defunct,
because corporations will list their purpose as “any legal purpose.”
 Application today: Boards are barred from knowingly participating in or allowing illegal acts or
wasting assets with actions for which there is no rational basis in light of the purpose of the corp.

 Constituency Statutes – Permit directors to consider interests of stakeholders other than the
shareholder. Half of the states (but not Delaware) have these provisions. Most significant state to
adopt this is Nevada, and it is immutable.
 NRS 78.138 allows consideration of the following, but they do not need to be dominant factors:
 (a) The interests of the corporation’s employees, suppliers, creditors and customers;
 (b) The economy of the State and Nation;
 (c) The interests of the community and of society; and

Corporations 47
 (d) The long-term as well as short-term interests of the corporation and its stockholders
including the possibility that these interests may be best served by the continued
independence of the corporation
 Problems? While they may empower managers to consider more than just value and be “holistic”
when managing, they may also give easy outs to managers. They allow for more defenses in the
event of a shareholder suit. “Oh yeah, I was just doing that to protect the employees…”

 Benefit “H” Corporation

 Statutes exist in ~30 states. These corporations must articulate some sort of non-profit purpose.
There are reporting requirements for shareholders, they have dual goals. Opt in allows corps to
get the benefit of most of corporate law.
 Benefits
 Attract shareholders with special conscience towards the issue in question
 Bind to a purchase prevents application of the waste issue in the M&A context, because the
board would be forced to bring offer to shareholders without the dual purpose structure.

CASES

 A.P. Smith Mfg. Co. v. Barlow (N.J. 1953) – Plaintiffs are challenging a donation from A.P. Smith
to Princeton University as ultra vires. In NJ, a statute allowed corporate donations, and plaintiffs
argue that it does not apply retroactively to protect the donation.
 Holding: When large public policy decisions are implicated, we do not need to follow Zabriski
(which held that statutes changed post charter adoption do not affect charter), so the statute
makes donation acceptable and intra vires.
 BJR gives presumption to board. Do not need to prove donation to Princeton benefits the
corporation conclusively. Ostensibly the donation gives company goodwill and helps attract
Princeton grads, and that is sufficient.
 Goodwill may be priced into stock to give future shareholders the benefit, which would
increase value today.
 Limits:
 Problematic if the board is giving to pet projects
 Limited in NJ as a matter of statute to 1% of net earnings without a shareholder vote.
 Board cannot represent that the donation is in their individual capacity.

 Dodge v. Ford Motor Co. (Mich. 1919) – Ford Motor Company (FMC) is 58% owned by Henry
Ford and 10% owned by the Dodge Brothers. Prior to the events giving rise to this action, FMC paid
annual dividends, because it was hugely profitable. They have also been known to give special
dividend payments of tons of money to shareholders. However, in this year, FMC announced its
decision to forgo granting special dividends in favor of building a large facility to build more cars.
Dodge sues for the special dividend and to enjoin construction of the new plant (they are also
making cars at this point in time, having broken away from FMC).
 Holdings:
 Refuses to enjoin the expansion – Implicitly relies on BJR deference. The court recognizes
they are not business experts so they will not step in.
 Dividend Payment – compels payment of dividend.

Corporations 48
 
Court argues that this violates the fundamental purpose of the corporation – to deliver
value to shareholders
 Antitrust in disguise – FMC is lowering prices, and by withholding dividends, starving
Dodge of capital needed to compete.
 Minority oppression – cannot exit by selling shares. Ford will not buy them back, and
other buyers know that Henry Ford owns 58% and can impose his will on minority.
 Perhaps there would have been a different outcome if the shares were publicly traded,
because Dodge would have had an easier time alienating.
 Ford straight up says that he does not want to maximize profit – he wants to make a
reasonable profit. Bad facts for defendant.
 Takeaway: BJR gives deference on how boards make a profit, but not whether boards opt to try
to maximize profits.

 Shlensky v. Wrigley (Ill. App. 1968) – Investor in the Chicago Cubs wants to compel Wrigley, the
majority owner, to install lights at Wrigley Field. The investor claims the lights are keeping the
organization from playing more lucrative nighttime games, which is depriving them of revenue and
condemning the poor cubbies to season after season of disappointing baseball. The plaintiff
compares the Cubs’ revenue with the White Sox, who play at night but are actually worse.
 Holding: Valid exercise of business judgment. Refusing to install lights generates goodwill in the
neighborhood and helps with the Cubs’ brand.

D UT Y OF C AR E

 BLL:
 Van Gorkom Test
 Whether, prior to making the decision, the board took reasonable steps to inform themselves
of the material information relevant to the decision
 Gross negligence standard
 Francis
 Negligence can include non-feasance - recently board inaction has been tackled by good
faith, but this is the law in Delaware.
 Less-exacting negligence standard when the defendant is a bank-like institution.
 Entire Fairness:
 Procedural fairness – fair dealing
 Substantive fairness – fair price

 Generally – Duty of care is the most procedural of the duties. While it does have BJR deference
attached, it is the lease protected.
 The inquiry focuses on how the board has collected information and made decisions.
 Plaintiffs can use this for decisions that appear foolish or are insufficiently researched.

 Kamin v. American Express Co. (N.Y. 1st Dept. 1976) – AmEx made a bad investment in
Donaldson, Lufkin, and Jenrette (DLJ) that has lost much of its value. The board opts to solve this
by creating an in-kind dividend to shareholders where each shareholder gets a pro rata number of
shares of DLJ stock. Kamin sues because the payment of this in-kind dividend prevents the company

Corporations 49
 from recognizing a loss on the investment for tax purposes. Board does not want to take the loss on
the balance sheet and hurt market value of AmEx shares.
 Holding: This may not have been optimal, but if the board deliberated and consider all of the
benefits and costs, then the BJR applies.
 Possible loyalty issue at play – Some board members are officers who stand to profit through
bonuses by showing company profitability. But not well briefed by plaintiffs.
 No argument that there was domination
 Officers are only make up 4 out of 20 board members.
 DGCL § 170 – Directors of corporation, subject to restrictions in charter, may declare dividends
out of capital surplus or out of profits. Cannot do so if insolvent or in breach of fiduciary duties.
 Accounting Note: AmEx was able to carry financial assets on books at historical cost value.
Market to Market Rule requires showing what the securities are valued at now, with exception
for debt to maturity. Argument that added fuel to fire in 2008, because could create a waterfall of
devaluation in books.

 Smith v. Van Gorkom (Del Sup. Ct. 1985) – CEO of TransUnion wants to execute a large sale to
Pritzger. Transunion is holding a ton of cash but is generating very little income, which is
problematic because it lessened the value of certain tax deductions they were entitled to. The
solution was to merge with an operating company that generated a lot of cash so the tax assets could
have some value. Board considers a management LBO, but Van Gorkom does not like this (close to
retirement, so no benefit for him). VG contacts Prtizger, who offered a nice premium. Pritzger was
concerned that he would do the diligence and make a bid, and others would outbid, so he negotiates
several lockups including a toehold stake, access to information not available to others, and a no-
shop provision. Board has some expertise, which was not an issue in this case, but could be. They
did not take much time to deliberate approves it, and shareholders file suit.
 Holding: Board did not take sufficient legal steps to discharge duty.
 Test:
 Whether, prior to making the decision, the board took reasonable steps to inform
themselves of the material information relevant to the decision
 Gross negligence standard
 Application: Board did not disclose duty of care. No one examined anything or deliberated
on the proposal. Poor documentation.
 Shareholder Actions cannot cleanse because the breach because of the lockups and the board
negligence.
 Significance: First time when courts started to do duty of care analysis separately. Underscores
the importance of good documentation.
 Individual parties liable – large disincentive to management/officers.
 Legacies –
 Passed § 102(b)(7) – option to immunize directors from personal liability to stockholders.
Cannot apply to duty of loyalty, and must be in the charter.
 Does not mention officers, but held to apply later
 Fairness Opinions by banks
 Remanded for Entire Fairness Test Cinerama v. Technicolor
 Procedural – was there fair dealing
 Timing of transaction;
 Structure of transaction;

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  How it was initiated / negotiated (e.g., competitive bidding?)
 How it was disclosed to directors / shareholders
 How approval of directors / shareholders (if any) were obtained
 Substantive – fair price as a matter of substance
 Value of consideration paid / received
 Utilization of some sort of “market test”
 Value of alternative transactions (including waiting; doing nothing)
 Other elements that reasonably affect the intrinsic or inherent value of the transaction

 Francis v. United N.J. Bank (N.J. 1981) – Old widow inherits ownership/board position at Pritchard
& Baird, a reinsurance company. She is distraught, so she basically looks away as her sons loot the
corporate treasury and skip town. Francis, the trustee in bankruptcy for the company, files suit
alleging breach of duty of care.
 Court: Duty of care can be breached by failure to supervise.
 Ordinary standard of negligence for bank-like institutions – special duty to public

 In re Cornerstone Therapeutics (2015) – Concerns interpretation of § 102(b)(7) with respect to

pleading requirements. Allegation is breach of duty of loyalty with multiple named defendants.
Some who are not involved with the self dealing seek dismissal of damages claims that are unrelated
to loyalty relying on their 102(b)(7) provision in the charter.
 Holdings:
 Individual Ds must be treated on individual basis
 To survive motion to dismiss, plaintiff seeking damages must plead satisfactorily that
individual defendants violated fiduciary duties as to a non-exculpated issue (i.e. something
like loyalty or good faith).
 Here: p’s claims against non-conflicted directors were (essentially) that they were negligent
in approving transaction, which is an exculpated Duty of Care claim.

D UT Y OF L OY A L T Y

 BLL Framework – No BJR Proection. Framework established by DGCL § 144.

 When director/officer is interested in the transaction, a board member may cleanse by:
 144(a)(1) – Informed board vote of majority of disinterested directors
 Benihana of Tokyo v. Benihana – When a board member negotiates on behalf of the
counterparty and it is well-known to the board as a matter of background that the director
has the conflict, then the board is considered well informed.
 144(a)(2) – informed shareholder vote of majority of disinterested shareholders
 Per Gantler v. Stephens, the shareholder vote will not function to cleanse if it is required
for the action anyway. The vote must pertain only to the director’s conduct.
 Functionally – 2 votes required, one to cleanse, one to authorize
 In the case of forebearance, only the cleansing vote is necessary.
 Using both disinterested board vote and shareholder vote as cleansing, then the board gets
BJR deference – MFW v. Kahn
 Corporate Opportunities Doctrine Broz v. CIS / Guth v. Loft
 Test for Violation

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  Corporation is financially able to take opportunity
 In the line of business – In re eBay Shareholder Litigation
 Practical advantage to it
 Interest or reasonable expectancy
 By embracing opportunity, director has put self-interest into conflict with the corp.
 Affirmative Defenses in some jurisdictions:
 Source – received in personal capacity
 Incapacity of Company due to antitrust, bankruptcy, financial inability, or preferences of
the counterparty.
 Applies to all company activities – including the development of IP – AngioScore v. TriReme

Relevant DGCL Provision

(a) No contract or transaction between a corporation and 1 or more of its directors or officers, or
§ 144 between a corporation and any other corporation, partnership, association, or other organization in
which 1 or more of its directors or officers, are directors or officers, or have a financial interest,
shall be void or voidable solely for this reason, or solely because the director or officer is present
at or participates in the meeting of the board or committee which authorizes the contract or
transaction, or solely because any such director's or officer's votes are counted for such purpose,
if:
(1) The material facts as to the director's or officer's relationship or interest and as to the
contract or transaction are disclosed or are known to the board of directors or the
committee, and the board or committee 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
(2) The material facts as to the director's or officer's relationship or interest and as to the
contract or transaction are disclosed or are known to the stockholders entitled to vote
thereon, and the contract or transaction is specifically approved in good faith by vote of
the stockholders; or
(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 stockholders.
(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.

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Flowchart (after Kahn v. MFW)

 Historical Duty of Loyalty Doctrine – Bayer v. Beran (N.Y. 1944) – Advertising campaign for the
company uses the wife of the president as a spokeswoman.
 If plaintiff pled (with sufficient particularity) the existence of a conflict of interest that was…
 Financial in Nature
 Either Direct or Indirect
 Was “Material” / not de minimus;
 Then no BJR; transaction/decision was prima facie voidable. D must prove “fairness” to escape
liability

 DGCL § 144 (1967) – provided other ways to avoid voiding and liability for conflicted transactions
– 3 cleansing mechanisms.
 Disclosure to board & authorization
 No quorum requirement for authorizing directors

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  “Majority of disinterested” directors’ votes needed
 Disclosure to SH & approval
 No apparent Quorum requirement;
 No explicit “majority of disinterested” SHs requirement, but one was subsequently read into
statute (Fleigler v. Lawrence (1976))
 Transaction entirely fair at time of auth./appr./ratif.
 Burden of Proof?
 Substantially similar in NY and CA, with NY only concerned with “substantial” conflicts of
interest, instead of material.
 Applicationt o Duty of Care? Court in Van Gorkom seems to hint that a cleansing vote would
have discharged his duty.

 Corporate Opportunities Doctrine – Limits fiduciaries (board member and majority shareholders)
from taking advantage of opportunities without first offering them to the corporation.
 Applications:
 Significance Intangible assets – human capital
 Overlapping directors
 Parent – Subsidiary relations
 Test: Is the new business opportunity a corporate opportunity
 Classic Test – Fairly static – asks whether corporation has ability + interest/expectancy.
 Fairly static test that does not necessarily account for corporation’s desire to
grow/change.
 Broz v. CIS / Guth v. Loft
 Factors?
 Corporation is financially able to take opportunity
 In the line of business
 Practical advantage to it
 Interest or reasonable expectancy
 By embracing opportunity, director has put self-interest into conflict with the corp.
 Advantages
 Allows for consideration of future direction of corporation
 Permits analysis of passive investing activities – In re eBay.
 Consequences for Fiduciaries
 Fiduciary must attempt to cleanse under § 144 prior to taking the opportunity.
 Full disclosure is necessary—existence, material details, and the conflict of interest.
 Should probably be formal – Broz
 Seek approval/rejection of opportunity by the company
 Some states, excluding DE allow for implied rejection through inaction
 Voting members must be disinterested in the transaction
 Demonstrating entire fairness is very hard
 Potential Damages
 Equitable injunction barring the transaction
 Equitable damages
 Punitive damages
 Affirmative Defenses: Allowed in some jurisdictions

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  Company’s incapacity
 Legal prohibitions like antitrust and bankruptcy
 Financial distress that makes taking advantage of the opportunity impossible – Broz
 Refusal to deal by the counterparty
 Problems? Speculative
 Source of the opportunity – If the fiduciary was approached/learned of the opportunity in
his/her personal capacity.
 Advance Waiver – DGCL § 122(17) – Action of board members or charter provision may
renounce any interest/expectancy in a category of opportunities presented to board by the
shareholders/board members.
 Often done by board resolution

 Benihana of Tokyo v. Benihana (Del. 2006) – Benihana founder Aoki does some insider trading, so
he his barred from holding a controlling amount of stock in his U.S.-listed company. Creates a trust
where his kids are the trustees and he is the beneficial owner. Trust controls BOT, which has a
50.9% controlling stake of common stock in Benihana, Inc. (its American subsidiary). The kids want
to raise more money, so they agree to issue more preferred stock to Abdo, a board member in his
own right, who is also a fiduciary to another company. These preferred shares are convertible and
would ultimately eliminate the controlling stake of BOT. Aoki files suit alleging breach of duty of
loyalty. Benihana claims that § 144(a)(1) applies.
 Holding: (a)(1) board cleansing vote was sufficient to remove loyalty-breach liability.
Constructive knowledge that Abdo was director at BFD is okay – he gave the presentation,
negotiated on behalf of BFD, etc.
 Confidentiality claim fails (Abdo allegedly used confidential information to help him
negotiate on behalf of BFD)
 No entrenchment (Blasius) fiduciary duty violation here, because there is ample evidence to
support finding that board intended to use the equity offering to raise operating capital.
 Choice of equity vs. debt given BJR deference

 Broz v. Cellular Info. Systems (Del. 1996) – Broz is a fiduciary to Cellular Info Systems but he is
also the president and sole stockholder of another telecomm company. He bid on a telecomm license
through his other company. He did not formally disclose to the board, but he probably did enough
that the conflict was known by speaking with the directors, CEO. There was no formal rejection of
the opportunity.
 Holding: No violation. Fails because it is not an opportunity that the corporation could have
taken advantage of.
 Possibility of company being acquired and wanting the opportunity was too speculative for the
court.

 In re eBay Shareholder Litigation (Del Ch. Mem. Opinion 2004) – Plaintiff challenge eBay
founders’ taking advantage of IPO spinning, a practice by which banks like Goldman in this case
lure clients for IPOs by offering them the chance to buy at the offer price for future IPOs (which
enables them to make a ton of money really quickly). The problem is that this opportunity is offered
to the decision-makers, not the company, and the shareholders bring suit.
 Holding: Corporate opportunities doctrine applies – applies the test
 Investing cash in marketable securities was clearly a part of the business.

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 Within expectancy – not like a broker offering a stock tip, this is a transaction involving the
company.
 Aside – Aidng and Abetting Breach of Fiduciary Duty
 Elements
 Existence of fiduciary relationship
 Breach of fiduciary duty by the fiduciary
 Resulting damage
 Knowledge of breach by party alleged to have aided/abetted the breach
 Substantial assistance or encouragement by party alleged to have aided/abetted the breach
 Plays a role in suits against financial directors – In Re Rural Metro (2014).

 Angioscore v. TriReme (2015) – IP complaint against a former director by a medical device

company for breach of duty of loyalty. Director has fiduciary duties to the company even while
inventing his own things. Company makes angio stints. However, previously disclaimed some
interest in other types of IP under § 122(17). The director does not disclose R&D activities (could
have even taken steps to conceal it – back dated provisional patent).
 Defenses? Patentable inventions are not a corporate opportunity. Inability to take advantage
because his counterparty did not want to deal with Angioscore.
 Holding: Corporate opportunities doctrine extends to all company activities, including
development of IP.

 Dominant Shareholder – Dominant shareholders can owe a fiduciary duty to other shareholders in
the corporation. However, this is largely limited to duty of loyalty issues.
 Definitions
 Controlling Shareholder – Owns more than 50% of the votable equity in the company. De
facto dominant shareholder.
 Dominant Shareholders can have <50% stake in the corporation. 25% is where a party likely
has dominant shareholder status.
 17.5% shareholder found dominant in In re Zhongpin.
 Duty of Loyalty Issues that Arise
 What constitutes a conflict of interest?
 Direct: Decision/transaction resulting in a material, non-pro-rata distribution of corporate
property (e.g., cash; assets; corp. opportunities; information)
 Indirect: Decision/transaction that, while it did not distribute assets, advanced the DSH’s
financial interests in a material, non-pro-rata manner.
 Sinclaire v. Levien
 Zahn v. Transamerica - If you are a dominant shareholder, you may also be acting as
a director. The usual rule is that when you are acting as a director, you must do so in a
way that looks after the shareholders. When you cast votes as a shareholder, you no
longer have to look out for welfare of entire corporation.
 In zero-sum game, where it is your duty as a director to ask what is in the best
interest of the company, Del. Courts have been skeptical about saying what is, so
you likely get deference (problem of benefiting many consitutencies). – C.f.
Quadrant v. Vertin.
 Zahn – disclosure is key. The only offense you can point to is candor in this case,
because sh had right to know that they were getting bullied so they could protect.

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  Cleansing defense from § 144
 Entire Fairness – always available from common law
 Procedural Cleansing, while available, looks a little different.
 Courts have extended § 144’s procedural elements broadly, including in the dominant
shareholder context – Wheelabrator
 Problems?
 May be hard to find disinterested directors
 DSH may try to use own shares to cleanse
 Solution: Fliegler v. Lawrence: SH approval cannot cleanse unless the vote
constitutes majority of disinterested shareholders...
 Therefore: Even if disinterested parties vote to approve, courts have maintained
additional skepticism in the DSH context
 BLL: When a dominant shareholder wants to take an action that may breach duty of
loyalty, it may cleanse using a vote of the disinterested shareholders (imported from §
144(a)(2)). If this vote is successful, and the plaintiff still wants to challenge the action,
the burden shifts to the plaintiff to prove entire unfairness.

 Sinclair Oil Corp. v. Levien (Del. 1971) – Sinclair is the dominant shareholder in Sinvien, a
Venezuelan subsidiary in which it shares control with Levien. Levien alleges (1) diversion of
opportunities to other subsidiaries, (2) allowing other subs to breach of contracts with Sinven
without prosecuting, and (3) excess dividend payments. Court only allows the breach claim.
 Holding: Excess dividend payments and diversion of opportunities do not breach a DSH
fiduciary duty.
 Excess Dividends – Minority shareholder is getting a pro-rata share of the dividend being
paid out. Motives do not matter (BJ)
 Opportunities – No self-dealing. There are subsidiaries all over the place. Voting is okay.
 Breach goes through, because it is non-pro-rata transaction that generally gets scrutiny under
intrinsic fairness (which is no different from EF in Delaware)
 Takeaways:
 In M&A context, a subsidiary that is publicly held will need to go through a cleansing vote
 In the opportunity context, in deciding whether to take business, the parent can opt to vote its
shares in any way that it wants.

 Zahn v. Transamerica Corporation (3d Cir. 1947) – Zahn and Transamerica hold different classes
of shares in Axton-Fisher. Transamerica is a Class B shareholder, and can issue a call on Class A
shareholders with 60-day notice. Transamerica learns some private information about A-F’s
inventory, so issues a call, and Zahn takes the conversion, but later finds out that Transamerica had
this information. Alleges breach of duty of loyalty by dominant shareholder.
 Holding: Reverses grant of motion to dismiss. If Zahn can prove allegations in complaint, then
there can be rescission.
 Common Law Principles
 No full disclosure
 No cleansing
 POLICY – PROBLEM OF MULTIPLE CONSTITUENCIES : How should a dominant
shareholder in one class weigh responsibilities to different classes? Transamerica may have been
liable to other Class-B shareholders if it had disclosed that information

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  Gilbert v. El Paso – directors may need to make decisions that benefit the corp at the expense
of a certain group of shareholders. This is unavoidable and should not give rise to liability as
long as the director can justify the decision.
 In re Trados – Possible for director to breach duty to one set of stockholders through action
facing others.
 Quadrant v. Vertin (supra) – BJR protection for decision to privilege interests of bondholders
over interests of shareholders or vice versa.

 In re Wheelabrator – Waste Management owns 22% of Wheelabrator. WM wants to acquire most

of the company from other shareholders. Plaintiff fails to allege facts that there was inadequate
disclosure.
 Holdings:
 Duty of Care
 3-hour meeting was not on its face grossly negligent.
 Disclosed process followed by a shareholder vote
 Query whether this is acceptable after Gantler (requires separate votes for actions that
already require shareholder approval).
 Duty of Loyalty - Cleansing vote of disinterested shareholders shifts burden onto plaintiffs to
show entire unfairness of the transaction.
 Takeaway Framework:
 1. If there is a conflict of interest (potential duty of loyalty issue) with a dominant
shareholder, then the dominant shareholder has the initial burden to demonstrate entire
fairness of the transaction (substantive and procedural).
 2. DSH can get a cleansing vote:
 Of disinterested directors – DSH must show it did not dictate the terms of the transaction
to the board members and that the committee had real bargaining power. (Kahn v.
Lynch). Cleansing vote shifts burden to plaintiff to show entire unfairness.
 Of disinterested shareholders – Shifts burden to plaintiff to show entire unfairness.

 Kahn v. M&F Worldwide (Del. Sup. Ct. 2014) - infra – Grants BJR deference when examining
mergers between dominant shareholder and subsidiary when there is a double cleansing procedure in
place ex ante.
 Rule: Where we cleanse with both special committee approval AND disinterested shareholder
vote, the transaction gets BJR deference.

D UT Y OF G OO D F A I T H

 Summary
 Definitions/Tests
 In re Disney - Breach of Duty of GF occurs when
 “Intentional dereliction of duty,
 a conscious disregard for responsibility…
 Deliberate indifference and inaction in the face of a duty to act”
 In re Caremark/Stone v. Ritter – Breach of duty of good faith occurs by omission when:

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  (a) the directors utterly failed to implement any reporting or information system or
controls; or
 (b) having implemented such a system or controls, consciously failed to monitor or
oversee its operations thus disabling themselves from being informed of risks or
problems requiring their attention.”
 Typology of Duties
 Waste – Hard/Impossible for plaintiffs in most modern circumstances
 Good Faith – hard, but not impossible.
 Duty of Care – Gross negligence showing is probably the easiest
 Subset of Duty of Loyalty – The main reason is that breaches of the duty of good faith do not
merit § 102(b)(7) protection in indemnification for individual directors, even though these look a
bit like duty of care cases. Therefore this is dangerous for individual defendants.

 DGCL Statutory Sources for Finding of Duty of Good Faith

 § 102(b)(7) (Disallowing charter provisions exculpating directors for acts/omissions not done in
good faith)
 § 141(e) (Directors “fully protected” if they rely on reports/records of committees / experts, if
reliance is in good faith)
 § 144(a) (Allows cleansing of conflict of interest by disinterested board and/or shareholder vote
if in good faith)
 § 145 (Allowing indemnification of directors / officers, but not for actions not taken in GF)

 In re Disney Shareholder Litigation (Del. 2006) – Disney Board compensation committee offered a
job to Ovitz, a big time Hollywood agent. They determined his compensation. For tax purposes, it is
rare to give a salary of more than $1 mil, but they gave him many options and a golden parachute.
They also gave him a not for cause termination provision that granted him tons of money. When he
started, it was clear he did not mesh with the culture, and they decided to do a not for cause
termination. Plaintiffs have three issues: (1) the board breached fiduciary duties by hiring Ovitz, (2)
Ovitz breached his dutes, and (3) the NFT violated fiduciary duties.
 Initial Pleading: Provided recipe for pleading allegations of oversight failure as breach of
fiduciary duties, when board argues it relied under § 141(e) on advice of delegee (e.g., Comp.
Committee, Graef Crystal). How
 Directors didn’t actually rely on expert advice;
 Directors relied, but not in good faith;
 Directors did not believe expert’s advice was within expert’s professional competence
 The process in selecting expert was grossly negligent;
 Patent deficiency in expert’s advice;
 Board’s decision unconscionably wasteful
 Secondary Pleading: Focus on Good Faith elements of the claim
 Duty of Care – quickly dismissed. Compensation committee relied and while not perfect, was
good enough.
 Duty of Good faith
 Holding: Ultimately no finding of liability for the board or for Disney. But this case announces
the GF duty as a new FD Doctrine.
 Good Faith Definition: Breach of Duty of GF occurs with:
 “Intentional dereliction of duty,

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  a conscious disregard for responsibility…
 Deliberate indifference and inaction in the face of a duty to act”
 In terms of categorization – it’s likely an extreme version of the duty of care. Without any
duty of care breach, there’s not really a Duty of Good Faith breach,
 This matters because it gets around § 102(b)(7) protection

 Stone v. Ritter (Del. 2006) – Failure of oversight. Clients were able to launder money through
AmSouth, and the directors allowed it to happen in spite of the suspicions of employees. This left the
company vulnerable to $50 million in penalties/settlement. Trial court found facts confirming
inadequate oversight and compliance.
 Holding: Complaint dismissed – no good faith liability, but set the standard for breach of the
duty of good faith/nonfeasance – reaffirmed Caremark.
 In re Caremark – Physician Medicare schemes:
 Directors incur liability for failure to engage in oversight with:
 (a) the directors utterly failed to implement any reporting or information system or
controls; or
 (b) having implemented such a system or controls, consciously failed to monitor or
oversee its operations thus disabling themselves from being informed of risks or
problems requiring their attention.”
 Framework/Test: For duty of good Faith
 Test

 Subset of Duty of Loyalty
 Does not make a ton of sense from a substantive standpoint, because this is not self-
dealing. But the holding ensures that § 102(b)(7) is not available and indemnification is
more difficult.
 Differences from typical duty of loyalty issues?
 This version of DoL exists outside traditional context where a material financial
conflict of interest exists
 Unlike other DoL cases, the BJR is still in play

INDEMNIFICATION, ADVANCEMENT, AND INSURANCE

 Statutory Basis: DGCL § 145 – sets conditions under which corporations can and must indemnify
directors for fiduciary duty claims.
 (a) Power to indemnify all outlays in 3rd party actions if D/O acted in good faith and in
reasonable belief of corp’s best interests; can be no reasonable belief of illegality.
 (b) Similar for derivative actions, but only for expenses; and if person has been “adjudged to be
liable,” trial court judge must approve indemnification
 (c) Mandates indemnification for direct or derivative claims if D/O has been “successful on the
merits or otherwise”
 Cases dispute: What qualifies as success on the merits? Settlement or victor?
 Waltuch v. Conticommodity – Not paying or admitting wrongdoing seems to be sufficient to
be successful otherwise.
 Left Open: What if money is committed to a settlement? Up in the air still.

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  (d) Procedure for A and B
 (e) Advancement of fees allowed as corp. deems appropriate if D/O undertakes to repay should
amounts not be allowed in indemnification
 Citadel v. Rowan – Broader right to advancement of fees held up.
 Blankenship v. Alpha Appalachia (DE 2015) Explicit advancement / indemnification
provision in charter cannot weaken provision later, upon commencement of civil or criminal
action.
 In Re Genelux (2015) Fee advancement allowed for director-intervenor
 (f) Indem./Advancement rules not exclusive of other rights in bylaw, agreement, SH / director
vote or otherwise; limits after-the-fact rescission of rights (in charter/bylaw)
 (g) Broad authorization to purchase D/O insurance, whether or not the corporation would have
the power to indemnify.
 Note: Less restrictive than the indemnification conditions – this is possibly attributable to the
fact that insurance companies can price this into their contracts, and they can set terms that
the board must adhere to in order to buy insurance. Better at pricing risk.

 Waltuch v. Conticommodity (1996) – Context – server market manipulation. Spends $2 million

defending claims and CFTC claims. Private claim leads to settlement (Conti pays). CFTC claim ends
with admission of wrongdoing, and they pay $100k in addition to accepting other sancitons. Waltuch
wants to sue to recover indemnification money spent.
 Issues:
 CFTC Action – directors concede acting in bad faith. So § 145(a) should not apply. BUT §
145(f) allows changes in charter, and the charter does not mention good faith but indemnifies
all expenses.
 HOLDING: (f) is confined by (a) and (b) – only actions taken in good faith can receive
indemnification from the company
 Private Action - § 145(c) requires mandatory indemnification for all successful actions.
What is superior to (a)/(b)? No admission of wrongdoing in this action, but there’s the CFTC
good faith thing out there.
 HOLDING: Mandatory provisions of the code trump everything, including A/B’s
limitation.
 Takeaway: (a) and (b) are immutable. (c) is immutable and is the trump card.

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INSIDER TRADING
 BLL Attack Framework
 Common Law – Goodwin v. Agassiz – Not much in common law allows shareholders to sue,
because fiduciary duties are owed to to corporation.
 Statute/Regulation – Rule 10b-5
 Materiality
 Non-Public Information
 Buy/Sell on the basis of that MNPI
 Violates a duty of confidentiality (disclose or abstain)
 Traditional Theory – SEC v. Texas Gulf Sulphur
 Statutory Insiders – Directors, officers, block shareholders with 10% stake
 Constructive Insiders – fn 14 Dirks – those entrusted with confidentiality.
 Misappropriation Theory – U.S. v. O’Hagan
 Those who owe a duty of confidentiality to the source of the information
 Tipper/Tippee Liability
 Dirks v. SEC – Personal benefit described liberally – superseded by:
 U.S. v. Newman – Personal benefit must be objective, consequential, and possess the
potential to be pecuniary.

 POLICY: Why ban insider trading?

 Arguments in Favor –
 Fairness – Doesn’t seem right. Not fair. Courts have pushed away from this intuition.
 Ensuring equal information in the marketplace. – Also pushed away from by courts
 Insiders will over-invest and outsiders will under-invest, because they are concerned about
not being able to run with the big guys.
 Arguments against enforcement/downsides
 Legal tests are unintuitive – hard to tell what qualifies
 Trading on insider information may lead to faster/more efficient markets
 Compensation for employees – incentives
 Unfairness due to hazy definitions – personal benefits test
 Prohibition can defeat itself because the less insider trading that goes on, the more lucrative it
is to engage in it.

 Goodwin v. Agassiz (Mass. 1933) – Common Law – Senior executives at mining firm purchase
more of the company’s stock in the market because they heard a geologist opine on lucrative mineral
deposits in company-owned land. Plaintiff was a stockholder who had sold his shares to the
executives, and he sues alleging breach of fiduciary duty.
 Holding: Because there is no duty owed to shareholders directly but instead to the corporation
writ large, there is no breach. Fiduciary duties do not capture this behavior.
 Information was still speculative – did not know for sure about minerals. This concern
evolved into the materiality requirement with rule 10b-5.
 Takeaway: Common law did not offer a remedy for this behavior. But certain intuitions become
incorporated into the regulatory framework.

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 Statutory/Regulatory Framework for Insider Trading Ban
 1934 Exchange Act – Enacted to improve securities markets. The statute does not elucidate a
ban on insider trading directly. The SEC, however, made the rule from a number of provisions:
 § 10(b) – Bans fraud in connection to purchase/sale of security
 More provisions focus on tender offers, shareholder proxies, and mandatory disclosures
 1933 Securities Act - § 17(a) addresses securities and securities-based swaps.
 Blue Sky Laws
 Mail/Wire Fraud statutes
 **Laws enforced primarily with respect to

Statute/Regulation Text

Exchange Act It shall be unlawful for any person, directly or indirectly, by the use of any means or
§ 10(b) instrumentality of interstate commerce or of the mails, or of any facility of any national
securities exchange—
…
(b) To use or employ, in connection with the purchase or sale of any security registered on
a national securities exchange or any security not so registered…any manipulative or
deceptive device or contrivance in contravention of such rules and regulations as the
Commission may prescribe...

SEC It shall be unlawful for any person, directly or indirectly, by the use of any means or
Rule 10b-5 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.

 Elements of Insider Trading

 Material – Defendant must be in possession of information that has material value
 Information that a reasonable investor would find important to decision-making counts as
material – TSC v. Northway
 Significance of the event can be based on expected consequences. A low-probability
event with huge consequences would be material, and a high probability event with
limited consequences would be as well.
 Accounting Standard – Material is 5%
 Not much of a safe harbor for investors. This is up to the discretion of the factfinder.
 Non-Public Information – Information cannot be available to the general public.
 Not reasonably available to the general public.
 Texas Gulf Sulphur – to avoid liability, one must waituntil the market absorbs the
information.

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  This is easier now – information gets absorbed within minutes
 Selective disclosures fail this test.
 Buy/Sell on the basis of that MNPI
 Rule 10b5-1 – Presumption that a possessor of MNPI is always trading on the basis of that
information.
 Affirmative Defenses:
 Pre-existing share-buy plan. These typically rely on some algorithm that enables directors
and officers to purchase stock. Otherwise, they may always be guilty of purchasing in
violation of IT laws because of their status.
 Organizational Defendants are immune provided that the person executing the trade has
been shielded from MNPI.
 Violates a Duty of Confidentiality – “Disclose of Abstain”
 Traditional Theory – People with a duty to the corporation, including officers, directors,
dominant shareholders, and constructive insiders (like lawyers and accountants).
 Statutory Insiders 34 Act § 16(a) – Officers, directors, and block shareholders with more
than 10% of outstanding shares.
 Constructive Insiders – Dirk fn. 14 – Due to position of trust/confidence they are given
access to inside information. Incorporated in 10b-5(2)
 Explicitly agreeing to maintain MNPI in confidence;
 Implicit agreement, established through a history, pattern, or practice of sharing
confidences;
 Implicit agreement presumed if MNPI received by close family member (rebuttable
presumption)
 Misappropriation Theory – Duty can be owed to any producer of MNPI – from people who
write articles in the WSJ, to ratings agencies, to board members. Nothing is necessarily owed
to the corporation itself.
 Agency-Based duty – recall the agency tests from above. Would need to establish that the
duty arises from some sort of agency relationship – recall Confidentiality does not
necessarily terminate at the end of agency.

 Dirks v. SEC (1983) – Secrist is a whistle-bower at a corporation. He calls his friend Dirks, who is a
financial advisor, and shares his story with him. Dirks himself does not trade on the MNPI, but he
passes it on to his clients, who do. Secrist is a former officer, so he owes a duty to the company, but
Dirks is not.
 Traditional Case of Tippe/Tipper Liability: Dirks is not liable because he is not trading himself
and he did not owe a duty of confidentiality to the company.

 Tipper/Tippee Liability
 Original Tipper is liable if he/she
 Had a fiduciary duty of confidentiality to the corporation
 Breached the duty of confidentiality by
 Disclosing MNPI to the Tippee
 For a “personal benefit”
 Dirks – Broad View – personal favors
 BLL – Newman - “objective, consequential, and represents at least a potential gain of
a pecuniary or similarly valuable nature…” Simple friendship is not enough.

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  Except “meaningfully close personal relationship” – Maybe husband and wife
would qualify.
 Tippee must actually trade on this information
 Tippee incurs liability if all of the above factors are true of the tipper, and
 Tippee knew or should have known that:
 Tipped info was confidential MNPI
 Tip was for a personal benefit
 Used that info to trade, OR tipped someone else for personal benefit (same benefit
analysis as described above from Newman).
 ABC Hypo: Annette is the senior Vice-President to Zephyr Inc., a publicly traded company. She
learns information that Zephyr is about to be awarded a big government contract, to be
announced in 48 hours Annette tells Bob, a business school classmate of hers, who she knows
has been struggling financially. (Bob, meanwhile, thinks Annette tipped him because she wants a
job with his firm.) Bob calls Clarissa, his investment adviser / broker, and makes a large
purchase order for Zephyr stock. To justify his trade, Bob tells Clarissa about Annette’s tip,
adding “please don’t tell anyone else about this – it’s highly sensitive.” Clarissa executes Bob’s
order; in addition, she purchases significant shares on her personal account
 Only Clarissa is likely to be liable, because Annette did not do this for personal benefit, so
she cuts off liability for Bob. BUT under a misappropriation theory of the duty of
confidentiality, Clarissa has likely breached a duy of confidentiality to Bob. This depends on
the establishment of Clarissa’s agency relationship with Bob.

 United States v. O’Hagan (1997) – The SEC found James O'Hagan, a partner at a law firm guilty of
57 counts of fraud for profiting from stock options in Pillsbury Company based on nonpublic
information he misappropriated for his personal benefit. O'Hagan knew that Dorsey's client, Grand
Metropolitan PLC, was considering placing a tender offer to acquire a majority share in Pillsbury
Company. O'Hagan bought a large number of stock options without telling his firm and later sold his
options for a $4.3 million profit.
 Holding: A security-trader who fails to disclose personal profits gained from reliance on
exclusive information is guilty of employing "a deceptive device...in connection with the
purchase of a security." The security-trader knowingly abuses the duty owed toward the source
of information, whether the source is the company he works for or not.
 Significance: SCOTUS endorsement of the misappropriation theory of the duty of
confidentiality.

 United States v. Newman (2d Cir. 2014) – Two hedge Fund traders were charged with insider
trading. See write up from Quinn Emmanuel on the outcome of the case:

The Second Circuit largely accepted defendants’ arguments, holding that “a tippee’s knowledge of the
insider’s breach necessarily requires knowledge that the insider disclosed confidential information in exchange
for personal benefit.” The Court also rejected the Government’s theory that the information defendants
obtained was sufficiently suspicious to support constructive knowledge of the insiders’ disclosures and
benefits. Although the Court acknowledged that “information about a firm’s finances could certainly be
sufficiently detailed and proprietary” to support an inference of knowledge, it found no such evidence existed
in Newman.

In addition, the Court concluded that the insider-tippers did not actually receive any personal benefit in

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 exchange for their tips. Rejecting the Government’s showing as to personal benefits received by the insiders,
the Second Circuit concluded that if generalized career advice and friendship were sufficient personal benefits,
“practically anything would qualify.” The Court instead held that the law requires “an exchange that is
objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable
nature.” Put more directly, the Government must establish a relationship between the tipper and tippee that
“suggests a quid pro quofrom the latter.”

 Takeaway/Rule: To incur liability, tipper/tippee must have transacted for personal benefit.
Newman limits what counts is an objective, consequential, and pecuniary exchange. In Newman,
the career advice and friendship was not sufficient.

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CORPORATE GOVERNANCE
 Generally
 Corporate Governance definitions
 Functional – How do we divide decision-making authority and veto power among the
corporation. This is possibly shaped by legal and regulatory constraints.
 Balance needs to coordinate and delegate
 Respond to information shocks
 Address agency costs within the corporation
 Descriptive – Method by which control of company is divided, considering
 Overall goals of the corporation
 Laws / customs affecting corp.
 Interests of key corporate “Constituencies”: Shareholders, board of directors,
management
 (excludes: disclosure, non-SH constituencies, exec compensation)
 Background: Because shareholders are the true owners of the company (they are the residual
claimants of all of the profit the company is capable of generating), they have rights bondholders
do not have:
 Vote – key issues involving corporate policy, including election, amendments to charter,
bylaws, proposals, merger/acquisition, sale of assets. Default of pro-rata control (can be
adjusted with classes of stock).
 Sell – Exit the company by selling to other individuals if dissatisfied with governance
 Sue – Derivative action process. Beneficiaries of fiduciary duties owed to the corporation.
May also sue as counterparties vis a vis the corporation.

STRUCTURE, VOTING, AND THE PROXY SYSTEM

 4 Key Questions
 Who gets to vote, and how is voting power distributed?
 Default Rule: Pro-rata voting of shareholders.
 Contracting out of Default Rule:
 Corporate charter can create multiple classes of stock, each with different voting power
(DGCL § 212(a))
 Companies can also have “voteless” stock, or even “vote only” stock
 Stroh v. Blackhawk (p. 558)
 DE courts have even allowed corporations to distribute power unequally within a class of
stock, if provided for in the charter
 Volume Dilution (Providence & Worcester v. Baker (De. Ch. 1977))
 “Tenured” Voting / Loyalty Shares (Williams v. Geier (De. Ch. 1987))
 What about non-stockholders?
 DGCL § 221 allows charter to give voting rights to “the holders of any bonds,
debentures or other obligations” (Rare in practice)
 Also, SHs can designate a proxy to vote their shares. § 212

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  When do votes take place, and what do SHs vote on? What issues are they precluded from
voting on?
 Shareholder meetings:
 Regular Meetings § 211(b) (must be held at least annually)
 Special Meetings § 211(d)
 Del: Only board can call one, unless bylaws/charter provides otherwise
 Other states give minimal block of SHs right to call meeting (e.g. Cal: 10%)
 Decisions where a SH Vote is required under statute or regulation:
 Election of board members (§ 211(b))
 Removal of board members (§141(k))
 Authorizing Amendments to Charter / Bylaws (§§109; 216; 242)
 Repealing Majority-Vote bylaws previously adopted by SHs (§216)
 Authorizing Mergers / acquisitions (§ 251)
 Authorizing Sale of all / substantially all assets (§ 271)
 Authorizing Dissolution of corporation (§ 275)
 Precatory Votes & SH Proposals (SEC Rules 14a-8(i); 14a-11)
 NYSE/Nasdaq: Share dilutions exceeding 20% (Nasdaq Rule 5635(d); NYSE Rule
713(a))
 Things shareholders are generally not allowed to decide (§141(a)):
 Ordinary business decisions
 Proposing charter amendments, mergers, or dissolutions (though SHs must ultimately
authorize such changes – see above)
 Nominating board candidates (absent hostile challenge or proxy access bylaw)
 How are SH votes actually tabulated / counted?
 Usual Rule (As Noted Above) = Ordinary Voting: for each issue / board seat, SH gets votes
= (total # shares) x (votes per share)
 Alternative: Cumulative Voting: Form of voting procedure that tends to give a greater chance
of representation among SHs with a minority stake in the company. SH gets a “bank
account” of votes = (total # shares) x (votes per share) x (number candidates), and can spend
them as she sees fit
 Statutory Authorization: DGCL § 214: Cumulative voting is not the default rule, but can
be included in the corporate charter (same rule in NY: § 618)
 Note: Cal. Corp. Code § 301.5 : mandatory cumulative voting; but publicly traded
companies may opt out
 How does the voting “proxy system” work, and how is it regulated?
 Although shareholder meetings are sometimes interesting / exciting, the practice of voting by
proxy often means that the real action occurs before the meeting
 This is the period during which the current board / officers attempt to solicit proxies from
shareholders

 Cumulative Voting
 Suppose client wants to win seats on a firm that uses cumulative voting, and wants to know how
many shares she needs to own in order to place some target number of members on the board
 N = Total number of voting shares outstanding
 D = Total number of director seats up for election;

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  S = Total number of voting shares your client owns/controls (S≤N)
 T = Number of open seats client wishes to “target” (T≤D)
 Total number of shares that your client must either own or control to be assured of her desired
result:
 S > (N•T) / (D+1)
 Application: Hedge Fund activist wants to get 7 out of 12 open board seats. 130,000 shares
outstanding.
 S = (130000 x 7) / 12 + 1
 = 910,000 / 13
 = 70,000

 Proxy System – For items that must/can be approved by a vote of the shareholders, most of the
action occurs prior to an actual shareholder meeting. Management and challenges will solicit proxies
from shareholders, which are essentially grants of consent to the management/challenger plan.
Heavily regulated by § 14 of the exchange act.
 Process:
 1 – Record date. Usually associated with the annual meeting of shareholders, which is
required by DGCL. This is the date that serves as the cutoff for being an owner of record at
the meeting.
 Problem? What if you sell after record date and show at the meeting and vote?
 Solution – sometimes there are two record dates which can solve the problem
 Broker-held stock? Broker sends you the proxy card and you instruct them on how to
vote
 Uninstructed shares – can only vote in routine manners
 Explicit Prohibitions on uninstructed shares
 Issues with contested / competing proposals
 Merger / Acquisition proposal
 Matters involving SH appraisal

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  Matters altering terms of stock / debt
 A variety of voting / quorum rules
 A variety of executive compensation issues
 Matters that would give rise to ≥ 20% dilution
 Election of directors (even uncontested)
 2 – Proxy Solicitation – Packets get sent out to the shareholder by the corporation. Proxy
challenger may also try to persuade the board to get access to the shareholder lists to send out
the materials, or the board can include them.
 3 – Shareholders Return Proxies (or don’t) – Some may not return cards and just show up at
the meeting instead.
 4 – Meeting
 Payment – Corp. must sometimes fund the board or the challenge if successful. See flowchart:

 Statutory Authority - § 112 – Allows corporation to agree to compensate all proxy fights in its
bylaws.

 Blasius – Special Duties in Proxy Contests - Provides a special intermediate duty between business
judgment and entire fairness.
 Case Facts: Atlas corpo board attempts to pack the board with its own nominees. Weaver (CEO)
wants to restructure some businesses. Some shareholders are passive and do not care, but Blasius
is an activist investor with a 9.1% stake. They intended to restructure the corporation, but the
board is not happy. Blasius files a proxy proposal to amend the bylaws to expand the board to 15
members. In response, the Board amends the bylaws preemptively, to add two members, to
ensure that they maintained their control.
 Holding: This violated a duty owed with respect to shareholder voting powers.
 Test: (2 part – burden shifting test)

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  If the plaintiff can show that the board has acted for the primary purpose of impeding the
effectiveness of shareholder voting power
 Then the defendant board must bear the heavy burden of demonstrating a compelling
justification for the board’s actions.
 Note on application: This test is very hard for defendants to overcome.
 Classification?
 Duty of loyalty by Chancellor Allen
 Open Question – could lend itself to cleansing votes, particularly given the Court’s
willingness to consider broadening the scope of § 144 in Van Gorkem.
 But very much its own thing. It falls somewhere between BJR and EF
 Limits
 Approved by DSC – MM v. Liquid Audio
 Mercier v. Inter-Tel – Board can demonstrate a compelling justification under Blasius if
their action:
 Serves, and is motivated by a legitimate corporate objective, and
 Is reasonable in relation to this legitimate objective and not preclusive/coercive with
respect to shareholder voting.
 Strine – Corporate Law Stories – “Blasius did not convert the corporation into an ongoing
New England town meeting.” 

PROPOSALS AND INSPECTION RIGHTS

 Rule 14a-8 Framework – Provides mean by which a shareholder or group of shareholders can
submit at the corporation’s expense their own proposal for consideration at the shareholder meeting.
 Eligibility – (b-f)
 Stake/Holding – 1% or $2000 in market value for at least one year.
 Must prove ownership of 1% or $2000 in market value for at least one year prior to
submitting the proposal.
 Formalities
 Timeliness
 Possible Bases for Board Exclusion – Subsection (i)
 1. Improper subject for shareholder action – state law is very important in determing what is
permissible and what is not
 2. Would require violation of law if implemented or commit self to course of conduct that
would violate fiduciary duties
 CA Case
 3. Misleading of Fraudulent
 4. Relates to personal greivances
 5. Concerns a small-stakes matter and is “not otherwise significantly related to the
company’s business”
 Lovenheim v. Iroquois Brands – Significant relation expands to more than simple
economic interests. It can include issues of public policy significance. Must be some
nexus between the issue and the company’s business however.
 6. Matter beyond power to effectuate

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  7. Relates to ordinary business operations and is not proper action for shareholders. – Closely
tied to 1, also relates to shareholder prerogatives under § 109 and management prerogatives
under § 141(a).
 Bulletin – any matters of grave concern. Agrees and widens Trinity v. Wal-Mart.
 8. Relates to director elections/candidates
 AFSCME v. AIG – Proposals relating to the process of elections are okay. Proposals
relating to specific elections or candidates are not.
 9. Conflicting Management Proposal
 SEC Bulletin 10/15 – Only if the shareholders could not logically vote in favor of both
proposals.
 Note: Could invite abuse.
 10. Proposal Already Substantially Implemented
 11. Duplicative of another SH proposal
 12 Submitted in past and lost
 13. Relates to specific amounts of cash or stock dividends.

 Lovenheim v. Iroquois Brands – Shareholder Lovenheim wanted to implement a proposal to form

committee to study imports of inhumane foie gras. Board does not include under 14a-8(i)(6), arguing
that it does not affect enough business (<5% of asets or gross sales), and is not significantly related
to the company’s business. Could have also challenged under (7) – ordinary busines ops or (1) not
proper shareholder action. Issue is what constitutes “significance relation” to the business.
Complicated by the SEC’s reversal of opinion on this issue.
 Holding: The limitation is not limited to economic significance. It can also consider public
policy significance provided that there is some nexus
 Significance: Provides some color to (5). Also shows limitations of precedential value of NAL’s,
particularly when the SEC has been inconsistent in the past.

 AFSCME v. AIG (2006) – AIG wants to require bylaw that provides certain conditions under which
the board must accept candidates into its proxy materials. This “proxy access provision” would help
shareholders compete in elections with board-favored candidates. AIG gets a NAL from the SEC
under (i)(8), under the theory that the proposal “relates to an election,” even though the proposal
does not relate to a specific election. AFSCME challenges.
 Holding: (i)(8) does not foreclose proposals that deal with election procedure.
 The SEC’s statement in the 1976 guidance was important – they see some capriciousness
being exercised by the SEC
 NAL letter is less authoritative because it only applies to those facts, and does not set down a
general rue, which is what the court is trying to do.
 Takeaways:
 (i)(8) only applies to specific elections
 DGCL § 112 enacted in response to this decision.

 CA, Inc. v. AFSCME (2008) – Certified question from SEC. Shareholders offer a bylaw proposal to
create a compensation mechanism for shareholders who offer a short slate of proxy challengers.
Would instruct the corporation to compensate successful challengers. This would turn off if the corp.
adopted cumulative voting. The company excluded, and sought a NAL from the SEC under (i)(1)

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 and (2), thinking it would intrude on directors’ § 141(a) duties and would impair ability directors’
ability to adhere to common law duties.
 Holding:
 1) Shareholders get many rights that can relate to the process, but are not substantive. §
141(a) is not violated with process rights. All process requires some expenditure of funds.
 2) However, (i)(2) is valid here, because the proposal could require violation of fiduciary
duties. The language “shall cause” neglects situations in which board owes duties to
shareholders and not to compensate the board.
 Takeaways:
 Fiduciary Outs – allow board to not include proposals that would force a violation of
fiduciary duties.
 For proxy expense compensation, board gets to make this determination, in good faith, if it
would be consistent with their fiduciary obligations.

 Shareholder Inspection Rights

 Legal Source – state-based right of action
 DGCL § 220
 Long Arm Statutes/Common Law Right – N.Y. B.C.L. § 1315, Cal. § 2115.
 All states’ common law inspection rights are relevant then.
 This probably doesn’t come under the purview of the internal affairs doctrine.
 Big opportunity for activists.
 Right is contingent on shareholder’s ability to articulate a “proper purpose” for requesting the
inspection.
 “reasonably related to interests as a shareholder”
 Shareholder may sue to compel access, but when this happens, the burden of proof is weird.

Key Differences in Inspection Statutes:

Note the burdens in Delaware: Shareholder benefits from presumption when looking for copies of
shareholder lists. Corporation.

 King v. VeriFone Holdings, Inc. (2015) - § 220 records requests can be used to beef up a
derivative shareholder suit. Would be best to make this request prior to filing a lawsuit.

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  For the corporation’s standpoint, if you think you have a good chance at prevailing in § 220-
based litigation, then you would obstruct the records request access.

 Crane v. Anaconda (1976) – Issue is whether the corporation must produce both the CEDE and
NOBO shareholder lists. CEDE is more readily available, but it contains less information. The
NOBO list actually has names.
 Takeaway: The NOBO list only needs to be given if it is in the possession of the board.
 In CA, court can compel the company to produce the list.

 State ex rel. Pillsbury v. Honeywell, Inc. (Minn. 1971) – Petitioner was a member of an anti-war
group opposed to production of anti-personnel frag bombs. Purchased 100 shares of Honeywell
Stock, and he wanted original shareholder ledger, current ledger, and munitions records. Honeywell
refused the request as improper. Affirms trial court dismissal of plaintiff’s case. No purpose
reasonably related to interest as a shareholder.
 No interest in company before he learned of munitions

 Sadler v. NCR (2d Cir. 1991) – Commerce clause assessment of CA long arm statute. Indirect
inconsistency if internal affairs doctrine is not honored—failed commerce clause argument. Raises
the question of plaintiff’s ability to forum shop.
 Court: Yes, if you are a resident of a state with a generous long arm statute, you may forum shop.
Shot down NCR’s argument that this upsets Delaware legislature’s decision.

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M&A, TAKEOVERS, AND CHANGES OF CONTROL
 Background on M&A
 Motivations:
 Strategic – 2 companies that do similar things would like to consider merging so that they
can try to access new markets. Value to combine operations and capture synergies.
 Financial – Ways to reorganize what the company or companies do to save money or make
money. Tax inversions, the merger at issue in Van Gorkem. Sell off assets. Things that don’t
invoke operations, but ways to create value by restructuring.
 Conglomerate – trying to monopolize or diversify their own companies. An umbrella
corporation could merge with a sunscreen company to ensure that they are always able to
move product.
 This can raise problems – lack of competency, shareholders can accomplish this
diversification themselves, etc.
 Not popular moves among investors.
 Mutuality
 Friendly – merger executed with permission of the board
 Hostile – takes the form of a tender-offer to stockholders. Often done behind board’s back.
 Mechanics (Proxy contests may permeate each of these mechanisms).
 Statutory Merger - §§ 251, 253 – Often used to acquire the whole of a subsidiary.
 Must be some negotiation
 Shareholder approval required
 Triangular Merger – acquirer drops a subsidiary (“catalyst”) who takes over the other
company. At the acquirer level, it removes the shareholder consent mechanism.
 Hybrid - 2-step. Takes advantage of statutory process. Short form merger with fewer
voting and approval right when you are a 90% owner.
 MFW – belt and suspenders could cleanse
 Wheelabrator may put you in entire un-fairness land.
 Asset Sales – DGCL § 271
 Deal would allow all or substantially all of assets to be transferred
 Must be submitted to shareholder vote
 Target company would have no assets but cash that would be distributed to shareholders
 Tender Offers – Direct offer to shareholders. Only one that is capable of being hostile.
 Buyer offers a price at which he will purchase shares if he gets a certain percentage of
shares (usually 51%). If 51% do not tender, no deal. If more than 51% tender, pro-rata
allocation of the premium.
 Heavily regulated by federal law
 Can also take the form of an exchange offer.
 Stock Sales – DGCL §§ 151, 161. Stock comes from corporation’s treasury of stock.
 Stock comes fro the company’s treasury of unissued or self-owned shares. If it exceeds
number of shares outstanding, then control will pass to the acquirer.

 Weinberger v. UOP (1983) – Interested transaction involving a controlling shareholder. Provides

some more color on what constitutes an unfair transaction in M&A context. Two board members

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 who sit concurrently on the acquirer’s use internal report to get upper hand and help signal make a
bid and negotiate the deal.
 Holding: Posturing in this deal by those board members was a clear breach of candor,
confidentiality, that were never dealt with. Deal must be done with entire fairness.
 Entire Fairness Remedies
 Fair Price?
 Proper compensation for what it would have been absent fraud, self-dealing, etc.
 Proper remedy = fair price – price actually paid in merger.
 See appraisal proceedings – § 262 DGCL
 Instead of voting for a proposal, you can initiate an appraisal proceeding which
would force a judge to comment on the price.
 Sometimes, judge will say measure of fairness is the merger price.
 Must give written notice that you plan to exercise Appraisal
 After meeting you don’t need to vote, but if you vote, you better vote against.
You cannot exercise for shares that have been voted in favor of the
transaction.
 Note – 5% interest on the price. Good return on pre-judgment interest rate. Good
investment option. – appraisal arbitrage. As long as you owned one share on day
of the merger, you can buy more.
 Bottom line – know that right exists, know when it exists, and what it does.
 Even if not an appraisal rights suit, we will mimic what we would do in an appraisal
suit.
 Weinberger Court says way that they’ve been doing appraisal proceedings is not
great.
 Block method does not work well.
 Post-Weinberger – We can still use block method, but a discounted cash flow
method/risk analysis is predominant.
 Fair Dealing – court can fashion equitable remedies including:
 Enjoining merger
 Voiding a completed merger (which is rare, because it is often unfeasible)
 Recissory damages – unfeasible
 Fair price – price paid
 Significance:
 Block valuation for appraisal no longer the only method
 Overrules proper purpose for merger requirement
 Good analysis of entire fairness and the remedies available

HOSTILE BIDS AND DEFENSIVE TACTICS

 Hostile Acquisitions – only the tender offer can operate without the cooperation of the target
company’s board. You can still work through the board, but this is the only way to bypass.
 Pros and Cons? Can or should the board erect barriers?
 Pros – allows the board to fight off short-term-ism and focus on developing the core
competencies of the company.

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  Cons – activism/hostile offers may benefit the shareholder by keeping the board on edge or
guaranteeing them a nice-size payout in the event of an acquisition.
 Defensive Mechanisms
 Bid Deterring Strategies – Many companies like these more because they can avoid takeover
 Poison Pill – Revlon/Unocal – makes company blow up in the event of acquisition.
 Staggered Boards – Would function to keep you from fully taking control until the 2nd round
of elections. May put a damper on an activist/raider.
 Change of Control Triggered Contracts - Executive golden parachutes, IP license
transfers, leases, bond put options.
 IP Licenses that transfer back to licensor in the event of a change in control
 All bonds become due and payable immediately – would be an “asset,” or at least nice
liability, that will implode right away.
 Post-Bid Strategies – Problem is that all of these fundamentally alter the company and are very
costly.
 Paying Greenmail to Hostile Acquirer – Repurchase of shares from potential acquirer at a
premium. Cheff v. Mathes
 Discriminatory Self-Tenders – Buy up shares of the company to make acquisition difficult,
or in Unocal, buying the remaining and saddling target with debt. Make additional purchases
more expensive
 Pac Man Defense – revert to try to take over the acquirers – Martin Marietta
 White Knights – Mgmt/Board-Favored Bidder – Revlon
 Lockups with a Friendly Bidder – Revlon, Van Gorkom – Asset/stock sales. 2-step
mergers, termination fees, no-shops, confidentiality, topping fees.
 Enforceability – Courts have come out on different sides of these defenses.
 Reasons to defer to board – business judgment, allow them to focus on long-term value.
Boards should be entrusted to decide when whether and how much. May want to be able to
hold out for a higher price on behalf of their shareholders.
 Reasons to worry about deference – shareholders want to be able to pressure boards to
behave, be on their best behavior. Boards could get lazy.

 Poison Pill/Shareholder Rights Plan – Scorched earth defense of the company.

 Takes advantage of board rights
 Right to buy own stock
 Right to opt to pay dividends
 Right to amend bylaws
 How it Works
 In Kind dividend – Rights that grant contingent option to buy/sell/exchange in another
security with the company. A classic example would allow you to take your single share and
split into single shares. Will give you the right to buy another share at ½ of the market price.
 Triggering Event – when some party without permission of board crosses a specified
ownership threshold (traditionally 20%, but has been walked down to as low as 5%).
 Triggered in a non-pro rata way. Everyone gets this right except the shareholder who has just
crossed this threshold. Functions as a sever dilution of the acquirers stock
 Flip In vs. Flip Over –
 Flip Over - you to buy the stock of the acquiring company at a discount – functions
because obligations merge with the companies.

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  Flip In – You get to buy two shares of target stock at discount (half price)
 Cracker Barrel just had SH approval on a poison pill.
M&A A TT AC K F R A M E W O R K

When the company is taking defensive action, we assess their actions under Unocal

Basic Unocal Analysis: Applies when the shareholders will not inevitably lose their future ability to sell
their shares for a “control premium.” The company is still functionally “alive.” Burden is on directors to
show both threat and that their actions were proportional.

(1) Threat Prong – Is the board acting independently, in good faith, with due care and does it have
reasonable grounds to conclude that a danger exists to corporate policy and effectiveness?
 When the corporation is not going to dissolve, D/O’s functionally get BJR deference in deciding
what can constitute a threat. Can consider all constituencies (couched with idea that this will
redound to a payoff to shareholders in the future)
o Shareholders
o Employees
o Customers
o Surrounding Community
o Trade Creditors
o Capital Creditors
 Board essentially gets BJR deference in selecting constituencies that it wants its actions to
benefit, as long as company is solvent.
 Valid Threats from case law?
o Unocal – two-tiered, front-loaded tender offer thought to be coercive to shareholders;
threat to R&D commitment.
o Cheff – If we extrapolate and try to place in this framework, the threat to a change in the
sales framework, layoffs, etc.
o Talley mentioned undercutting creditors, layoffs, community harm

(2) Proportionality Prong – The board action must be reasonable in relation to the threat posed.
 Measures cannot be “draconian” or “coercive and preclusive.” Unocal is not carte blanche to just
say no – Unitrin v. American General (1995)
o Dead Hand Poison Pills are preclusive/coercive, fail Unocal II – Carmody v. Toll Bros.
o No Hand Poison pills fail – Mentor Graphics v. Quickturn
 Versata v. Selectica – measures that are preclusive/coercive are those that are “insurmountable”
or “impossible to outflank”
o Poison pill that triggered at 4.99% was okay
o To find something preclusive/coercive, it must render a proxy contest nearly impossible
or utterly moot
 Board has substantial leeway in structuring its measures to respond to a legitimate threat.

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Revlon/Unocal Analysis – Applies when the board’s action will inevitably remove the shareholders’
future ability to extract a control premium. The company is functionally transferring ownership or
dissolving. D/Os must show that they acted against a threat to shareholder value in a
proportional/reasonable way.

(1) Threat Prong – Because the time-horizon for the shareholders to receive value is condensed to the
immediate present, the only relevant constituency that can be considered is the shareholder.

(2) Proportionality? Not much color to this, but the board is not always obligated to take the best deal in
terms of dollar value. The board can opt for a deal that will way the shareholders sooner or deal with
someone who has better credit.

Distinguishing Between Revlon and Unocal

 Talley’s Rule of Thumb – Ask whether the shareholder will retain the possibility of selling his
shares for a control premium
o Yes  Unocal analysis. Consider all corporate constituencies.
o No  Revlon analysis. Maximize shareholder value today.
 Paramount v. Time – Fluid aggregation of shareholders merges with another fluid aggregation of
shareholders. Even though Time is being acquired, its shareholders retain the ability to sell
shares in the new aggregation at a control premium in the future. (Unocal applies).
 QVC v. Paramount – Even though all shareholders would hold shares, they would be minority
shareholders subject to a dominant shareholder. Lose control premium. (Revlon applies).
 Selling most profitable division – close but could be Revlon.
 Selling 43% of the company. Yesterday this could have been Unocal, but today it is much closer.

M&A C ASE S

 Cheff v. Mathes (1964) – Historical precursor to board duties in M&A context. Ultimately paid
greenmail to a hostile acquirer. Hostile acquirer took a stake in the company and wanted to change
the way its salesmen did business. He was ultimately paid a substantial premium on his shares, and
other shareholders challenge this action.
 Holding: For inside directors – they have a material conflict of interest – so we put entire fairness
burden on them to justify their actions on the basis of fair price and fair dealing. For outside
directors, we place the burden on them as it was a defensive action, but it’s not as rigorous as
entire fairness. They must show.
 Disinterested board acted in good faith for interests of corporation
 After reasonable investigation, board had reasonable grounds to perceive danger to corporate
policy and effectiveness
 Significance: Grows into the Unocal doctrine.

 Unocal v. Mesa (1985) – Company was spending a lot of money in R&D, and investors were upset,
thinking that it was insulating the directors from having to give earnings back to shareholders. Mesa

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 (T. Boone Pickens) did not believe in the amount of R&D. Therefore, they came up with a two-tier,
front-loaded, tender offer to essentially coerce people to tender early. Unocal responds by making a
selective exchange offer to give debt worth $72 in the event that Mesa petroleum succeeds in their
tender. This means that shareholders will hold out for the $72 and avoid the first wave. No one will
actually have to be bought out by them, because everyone will wait.
 Holding: Board action is justified.
 2-Prong Test (Board has burden)
 Threat Prong – (Revlon dials back what can count as a threat).
 Proportionality Prong

 Big question: When does Unocal standard transition into Revlon standard.
 Paramount v. Time gives some clarity on where the switchover point.
 Courts consider this over and over – this is where arguments are made on both sides.
 Unocal v. Mesa
 Anytime the board decides to adopt a defensive measure that is meant to deter an outsider form
launching a hostile acquisition, we apply the Unocal analysis.
 Test: 2-prongs. Burden is on the board.
 Threat Prong – Board must demonstrate that it views a threat, acting in a:
 Independent
 Usually this is taken when there is no duty of loyalty issue anyway.
 Good faith
 Due Care
 Reasonable grounds to conclude danger exists to corporate policy and effectiveness.
 Proportionality Prong – Action must be reasonable in relation to the threat posed
 Examples of Application
 Applied Here
 Threat Prong
 2 tiered offer, may have had the effect of being coercive. Causing shareholders to
suffer collective action problem
 Commitment to long-term investment in R&D and developing oil fields. Mesa
wants to alter the long term strategy. We want to retain staff and dividends.
 Proportionality
 Cursory in the opinion – relatively sparse here
 We’ve already signed off on greenmail, so discriminatory exchange offers are not
an issue.
 Left impression that the big question is threat – changes in later cases.
 Paramount v. Time
 Only applied when there is no serious
 Relevant Constituencies. In threat prong, Unocal seems to want to maintain status quo, keep
long-term plans in place, and implement what you have in mind for shareholders.
 Ultimate goal does need to be sh value
 BUT in identifying a threat, since all you want to do is maintain status quo, you can point to
threats to relevant corporate constituencies – corporate constituencies, creditors,
 We can think about constituencies yielding value in the long term for shareholders.
 As a practical matter, we could almost always find constituencies

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  BJR very similar. Directors must make these arguments.
 Development since Unocal
 Unitirin v. American General – Upholds defensive share repurchase. But focuses on the
threat prong.
 In dicta, court says do not read unocal as entitling you to always say no. There could be a
scenario where the threat is not so great to do away with the merger.
 Cannot be “draconian” – Coercive or preclusive
 Is the defense so strong that it makes it virtually or mathematically impossible for this
person to ever succeed in the future, or does it still allow the possibility of a sale?
 Left wondering – what is preclusive/coercive
 Carmody v. Toll Bros – Poison pills should have a board ability to vote to cancel the poison
pill. This would function to channel action through board. But acquirers could try to get
people on the board through proxy context
 Dead Hand poison pill – would allow directors who voted for the pill to cancel, but only
them.
 DSC said that these provisions became to coercive/preclusive relative to the takeover
threat.
 Versata v. Selectica (2010) – Up until this point, almost all pills had a trigger at 15-20%.
Selectica decides it wants a 4.99% trigger. They tried to justify this on a tax basis. Makes it
much harder to win a proxy context. Challenged as not proportional.
 5% is okay – still not preclusive/coercive.
 Tax rationale part of it
 Preclusive Measures are those that are insurmountable or impossible to outflank
 Proxy context would be near impossibility/utterly moot
 Takeaway – Preclusive/Coercive standard gives a long leash to board in responding to a
threat. Not preclusive enough.

 Revlon v. MacAndrews and Forbes – Hostile bidder, Ronald Perelman, seeks to take over the
Revlon corporation through Pantry Pride. Board decides to take some defensive measures (advised
by Marty).
 Board Defensive Mechanisms
 Defensive share repurchase in exchange for debt that is worth way more than the shares. IOU
limited to 33%, but many people were interested, so they got a pro-rata allocation of notes.
 Provisions in the notes – covenants not to engage in restructuring without your
permission.
 UNLESS independent board members vote to switch this off.
 Poison Pill
 Involved debt interests
 20% trigger
 Revlon shareholders would have right to exchange shares for these notes that they would
want. Pantry Pride could take over the entire company, but they would get something
with a lot of debt.
 These do not deter Perelman, who keeps coming.

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  White knight – Subsequent deal with Forstmann Little, protected by contractual lockups.
Forstmann Little agreed to maintain the structure of the company as is. Also had some
confidential information.
 No-Shop
 25 Million Cancellation Fee (~ 1.5% purchase price)
 Option on Revlon’s most profitable divisions.
 Pantry Pride Challenges everything
 Holding/Revlon Test:
 Substantially similar to Unocal – board has burden of proving threat and proportionality.
 Thinking of this in relation to the threat analysis under Unocal.
 Threat changes when the company has decided to liquidate – long term interest of
shareholders is out the window once it becomes clear that the company is going to be
broken up
 Can’t argue that Perelman would screw over bondholders – would have made sense
under a Unocal analysis, but does not work because all that matters here is immediate
shareholder value.
 We move out of Unocal, because
 If this were a stock deal/not a cash deal then stock liabilities will apply – almost automatically in
Unocal. A little messy. With cash liquidation, we are almost certainly in Revlon.
 Key Note on Agency – The contract with Forstman Little is unenforceable against the company
because the board breached their fiduciary duty, so there is no actual/apparent authority to make
the contract.
 You can pass Revlon analysis, but you need to be reasonably related to maximizing shareholder
value.

 How to Decide whether to apply Revlon or Unocal

 Revlon: When breakup becomes inevitable.
 Later cases expand:
 Breakup means that shareholders are just getting cash and walking away
 Trigger for when Revlon applies is to ask whether there will be any change in control
 COC – Control of firm will shift form a “fluid aggregation of unaffiliated shareholders”
to “a single entity or unified group”
 50% threshold is a good rule of thumb for a change in control
 Time warner – even though 40%, they are merging with another fluid aggregation,
but they are making a huge company, which is an important note.
 QVC – everyone would still be around, but they would be minority shareholders
subject to a dominant shareholder.
 Liondel v. Ryan – Only triggered once board has negotiated and agreed to all of these
things happening.
 Talley’s Rule of Thumb
 Rationale: Why is it better to be a shareholder of widely held company?
 *Target shareholders do very well when there is an acquisition – one reason
 Less subject to domination
 Therefore, does strategy cause shareholders to lose ability to extract control premium?
 Yes – Revlon
 No – Not Revlon

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  Hypos
 Corporation A
 43% - could have been Unocal 15 years ago. Today its very close.
 TAX INVERSION ALERT.
nd
 2 – profitable divison – spinoff of most profitable division
 Consider threat prong like a BJR in Unocal
 When cases go bad for the board under Unocal, they go down on proportionality. The BJR
functionally applies
 Under Revlon – there is no real deference on the threat prong. It must be a threat to
shareholder welfare, today. Shareholders today don’t care, so we better ensure that
reasonable steps to maximize

 Loose aggregation merging with loose aggregation -> unocal applies because the shareholdes are
still going to have value going forward.

 Hostile Tender Offer is very-much gone. Now what you do is shareholder governance to challenge
the election of the board.

 Soetheby’s – Good meshing of Blasius and Unocal. Sort of the future of Revlon-Unocal doctrine.
Because, we no longer live in the world where hostile tender offers have any value. Third Point and
Ethan Loeb has decided that Soetheby’s was ripe for a governance challenge. Soetheby’s is a very
traditional business. Nature of auction market has changed – they are getting record revenues, but
Loeb wants them to scale. It’s clear that they’re going to challenge.
 Shareholder Governance Poison Pill Device
 Change the threshold – passive investor like an index fund could purchase 20% without
triggering the pill – Non-13D investors
 10% threshold for 13D investors, activists.
 Also applied to groups – Wolf Packs. A whole bunch of hedge funds that buy 4.9%. Once
one of these wolf packs forms.
 Did have a turn-off valve. Was not triggerd if someone made a play for 100% of the
company.
 Suit – Plaintiffs claim violation of both Unocal and Blasius.
 Holding: No preliminary injunction. But Parsons says this is a close call.
 Blasius Analysis – No way of showing that primary purpose was entrenchment. Minute show
primary purpose was to impair wolfpacks from skirting law.
 Few signs of entrenchment
 Not a staggered board – entrenchment not likely
 Some members agreed to work with Loeb
 Not preclusive/coercive effect
 But – Footnote 39 – shows a ton of ambivalent. Case was mooted, but this will be an
issue going forward. How do Blasius and Unocal fit into defense against governance
manipulations.
 Unocal Analysis – two things. Does the pill fail unocal? Does the discrimination against
activists have more bite on proportionality prong?
 Poison Pill
 Threat Prong

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  D
 D
 Proportionality Prong
 Discriminating against activists does seem to be tailored to the threat
 Waiver to Third Point – closer.
 At 10% chance of winning is far reduced to 20%
 Could still be a threat even if he does not take control
 Even threats short of gaining control can be a worrysome under unocal
 Aftermath – Third Point continues to fight in Proxy context, but Soetheby’s ended settling.
Southeby’s agreed to expand the size of the board and name all of the new members as third
point nominees. Got around 30% of the board.
 Ended up ridding the board of the CEO
 Successfully agitated to change business model
 BUT even though revenues are high, the stock price has plummeted.

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