Santa Clara Law



Sole ProprietorshipGPLLPLPLLLPLLC (hybrid of P and Corp.)CorporationClose Corp.PC (like LLP)FormationOwner and entity are identicalExpress agreement or as a matter of lawFiling per RUPA; limited to licensed professionalsFiling per RULPAFiling; can’t be used by licensed professionals(operating agreement recommended)Incorporate per state statuteIncorporate per state statute; elect this in charterFinancingContributions from owner; loansEvery partner must contribute capital (loosely defined) and profit; can also borrowEquity and debt, subject to formalities and possibility of thin incorporationTransfersN/ACan freely assign financial interest (but limited market),but need unanimous vote to assign managementEasy to sell shares on open marketLike a corporation except share transfer restrictions are commonTax1 level1 level (taxed in each state partnership does business)1 level(can elect 2)2 levels (unless elect S-Corp, which places restrictions on owners)ManagementOwner has sole authority1 vote per capita; majority wins, except unanimity required for extraordinary mattersGeneral partners have management rights, but limited partners are passive investorsCan choose member or manager managed; voting per interestShareholders elect board as brain with plurality, and they hire officers as brawnCan run via shareholder’s agreement instead of a boardProfits and AssetsOwner has exclusive claimEqual sharing in profits; partnership owns the assetsDividendsLiabilityUnlimitedLimited, except for individual malpracticeLimited, except for GP (status-based under RULPA)LimitedLimited to investment, but subject to veil piercing if formalities aren’t metLimited, except for individual malpracticeDutiesAgency duties if employeesMeinhard “utmost good faith and loyalty” to partners and partnership (duty of care is limited)Good faith, care and loyalty to LLC (not members); modifiableDirectors have duties to corporation and shareholdersOfficers to corporationAnd majority to minority shareholdersFormalitiesNoNoYes (needed to continue limited liability)Minimal / thin statutes (all about freedom to K)YesYes, but can opt-outDissociationN/ARight to be bought out at dissociation (b/c absence of market to sell)DE = payout if rightfulCA = no payoutCan sell shares for FMV on free marketLike a corporation except less of a marketLife SpanAt willUnder RUPA, can choose to continue after a dissociation; dissolution caused by express will of any partnerDissociation ≠ dissolutionPerpetual lifeMay dissolve at willPros/ConsNo formalitiesMax flexibility1 level taxOnly for small businessesNo default rule∞ liability1 level taxDefault rulesMandatory payout (b/c no market to sell)Fragile (because of mandatory payout)Hard to add partners/raise capitalTaxed in many statesUnrestricted limited liabilityCan pick taxes Flexible management Can modify dutiesStableNo mandatory payoutLegal uncertainty (b/c statute is thin, so analogize to P or Corp)Centralized mgmt.Flexible capital structurePerpetual life (not affected by dissociations)Expense/formalitiesAgency costsTaxed twice (or S-Corp)No formalitiesUnlimited liabilityLimited liability (restricted for some)FormalitiesLimited liabilityCommonReady market (easy to come and go)Limited liability (with some restrictions)Flexible mgmt.Fewer formalitiesLess of a marketDE 102(b)(7) charter provision = defenseunless bad faith / duty of loyalty implicatedFormationIncorporationPromoters’ contractsDefective incorporationAfter incorporationMeeting, bylaws, board…CapitalizationEquity and debt (risk of thin incorporation and subordination)Distributing ControlVoting mechanisms Shareholder contracts (trusts, proxies, agreements, pooling)Failures = deadlock, oppression (b/c majority minority duties)Remedies = buyout, dissolutionBankruptcy ProblemsPiercing the corporate veil (if didn’t follow formalities and fraud)Dividends and accounts payableMergers/AcquisitionsThrough board (asset purchase or merger)Tender offerPowers and OrganizationHierarchy: securities law > corporate statute > charter > bylaws > board Shareholders (exercised at meetings with quorum [proxies] or written consent)Elect/remove directors with pluralityApprove fundamental corporate changes by majority voteInspection rightsDirectors = brain (collective powers exercised at meeting with quorum or unanimous written consent)Appoint/remove officersPropose policiesOfficers = brawnPower via actual/express authority, agency (implied, incidental, apparent), or ratificationPresident, Chair, VP, Secretary, TreasurerSecurities Regulation (fed = disclosure, state = merit)Shareholder Litigation (direct/derivative & indemnity)------------------------------------------------------INTRODUCTION------------------------------------------------------Business organizations (as opposed to non-profits) are:= a set of contracts among a group of constituents (owners, creditors [including tort victims], officers and employees), aka “the firm”Formed for a business purposeIntended to be profitableFinanced by investors who expect to make money by sharing in the company’s profitsTheories Role of governmentEntity theory = state created the corporation, so ok to regulate itContractual theory = corporation is founded in private contract, so state should merely enforce contractsWhose interests corporations should serveFinance model = the interests of the shareholders b/c they own itLong term model = shareholders don’t know what is in their long term interest, so mangers need to be insulated from them or their interests realigned Society model = about what’s best for societyProblems the law should fix besides agency costsBehavioralist school = how to control for the fact personal behavior is different from organizational behaviorInformation school = control how information is shared and valued in organizationsPower school = control how power affect behaviorRole of a business lawyerPlanner/risk-avoider/conservativeDrafter (collegial, not adversarial)Counselor/main client contactSpecial ethical problems when interests of agents conflict with those of the entityMake it clear who you are representing via engagement letter (the entity? the individuals?)Legal frameworkMany different legal structures with different default rulesAll about efficiency and promoting commerce by reducing transaction costsAuthorityState = formation and organizationFederal = securitiesCA vs. DE in generalDE favors certainty, the board, and process over substance, plus:Nice tax structure, competent judiciary, fast Sec. of State, and electronic meetings okDoctrine of independent significance = if two ways to do it in statute, then pick eitherCA favors minorities and shareholders 21st Century EntitiesDigital Organizations / Virtual Corporations = relax in-person meeting/signing requirementsSocial Enterprises/Low-Profit LLC = relax fiduciary duties directors have to owners ------------------------------------------------SOLE PROPRIETORSHIP------------------------------------------------= business owned directly by one person who has sole decision-making authority, exclusive claim to business profits, and direct ownership of all business assets (most popular in US b/c it’s so easy)AboutLegally, the owner and company are identical (not really a separate business entity)No statutes (CL), so no default rulesJust start doing business under a new nameMay need a fictitious business name statement (county-level) so people know who to hold accountable for your business’ dealingsPros/ConsNo formalities to form or operateMaximum flexibility in structuring and operating the businessThe state doesn’t give you any power, so they can’t revoke your right to do businessTaxed onceSuitable only for small biz w/ few employeesOwner has to devise structure, making it hard to admit new investors successivelyUnlimited liability through vicarious liabilityCan limit through insurance (often inadequate) and contracts (awkward)------------------------------------------------------------AGENCY------------------------------------------------------------= when one person acts on another’s (or company’s) behalf—the foundation to partnershipsPros/ConsPro: enables principal to accomplish more than could acting aloneCon: have to supervise agent b/c may not always act in principal’s best interest (= agency costs)E.g. compensation, procrastination, monitoring, losing opportunities, etc.FormationElements (employees, but not true ICs):Manifestation by principal that agent will act on his behalfAgent is subject to principal’s control Agent manifests consent to act for the principal (by agreement or conduct)Expressly (oral or written agreement)As a matter of law (when parties enter into an association that has the legal attributes of an agency relationship, even if they aren’t aware of this relationship) (Cargill = D controlled the grain elevator and became his principal by interfering with his internal affairs since that was easier than starting a new company, so liable for his contracts. Not the traditional lender/borrower relationship b/c too much control)Doesn’t include: supplier/reseller, franchisor/franchisee (if doesn’t go beyond setting standards or says each is independent), lender/borrower, or parent corporation/subsidiaryExamples:Principal-agentClient-lawyerPatient-doctorLayperson-clergypersonHeirs-executorWard-guardianStudent-teacherAgent’s Fiduciary Duties (policy = reduce agency costs)Duty of loyalty (higher than in contracts where it’s a duty of “fair dealing”)= must act loyally for the principal’s benefit in all matters connected to their relationshipImplied (Huong Que = employee automatically has duty of loyalty absent a contract to the contrary)Principal’s interests > agent’sBut no breach if principal consents to the act with full knowledge of material factsAgent cannot:Acquire an improper personal material benefitAct on behalf of an adverse partyCompete with the principalImproperly use the principal’s propertyDisclose principal’s confidential informationDamagesPrincipal gets expectancy + punitive damages and attorney’s fees, regardless of recovery against third parties (Tarnowski = principal gets benefits received by agent as a result of violating duty of loyalty by simply adopting representations of juke box sellers in exchange for payment instead of looking for best deals, thereby conveying false info to principal)Unlike in contracts, there are no efficient breaches Duty of care, competence and diligenceDuty of reasonable candorDuty to keep account of money (don’t commingle)Principal’s Fiduciary DutiesLimited in US, but must:Follow express and implied contractual terms with agentDeal fairly with agentFurnish info to agentRefrain from harming agent’s business reputationIndemnify agencyPrincipal’s Liability Authorized acts: principal is liable if agent had the following to engage in the conduct:Actual authority= created by principal’s manifestation to the agent such that he reasonably believes the principal wishes him so to actAgents liable only if principal is unidentifiedScope:Express authority = oral or written communicationsImplied authority = conduct/acquiescence (so be clear if you mean “no”)Incidental authority = agent has authority to do whatever is required/appropriate in the usual course to accomplish his responsibilities (ex. can buy paint and use ladders if you’re hired to “paint a house”) Note: lawyers do not have authority to settle without client’s approval, but can act on behalf of client with power of attorney (Koval)Apparent authority (largest umbrella)= created by the principal’s manifestations to a third party (Fennell = no apparent authority when “agent” makes manifestations to a third party, so even though attorney said he could settle that’s not binding since client made no such manifestations that he was his agent)Unauthorized acts of the agent (a scoundrel’s last refuge)Ratification = affirmation of agent’s prior act so it is as if it was done with actual authority (Daynard = law firm knowingly accepting the benefits of P’s work means P is its agent and P’s contacts that were ratified are sufficient to give the court PJx over the firm)Shown by assent/conduct that justifies a reasonable assumption principal consentsMust:Be timely and Principal must have all material facts (Papa Johns = no b/c employer did not have knowledge employee’s statement was false and other employees encouraged him to file a report, not the employer)Estoppel (equitable doctrine)= principal induced 3rd party’s detrimental reliance (or knew of reliance and did not stop it) based on the 3rd party’s incorrect understanding that the act was done on behalf of the principal, so he is estopped from denying an agency relationshipTortious acts of the agentPrincipal is liable if:Actual/apparent authority or ratificationNegligent in choosing or supervising the agentAgent fails to perform duty to act carefully delegated by principalEmployee acting “within the scope of employment” = MAIN (Papa Johns = not responsible for deliveryman who filed a false police report against a customer to justify being late b/c does not server employer to be late)All negligent actsIntentional acts if they are:Foreseeable (e.g. bouncer at a bar) and Intended to serve employer (so not the drunk Navy guy opening valves and hurting the dock)Agents are also personally liable for their own tortious acts-------------------------------------------------------PARTNERSHIPS------------------------------------------------------= two or more co-owners (people or other bus orgs) carrying on a business together (both made capital contributions of some sort) for profit (not a separate entity from owners)IntroductionAuthority: Uniform Partnership Act in all states but LA, RUPA/UPA 1997 in mostBased on agency theoryTheory: Assumes close personal relationships between few partners, since each is an agent of the partnership and can create personal liabilities for the othersPros/ConsEasy to organize an inexpensive to operate (no formalities; can default into it)Taxed once (“pass through” partners)Fragile (minorities have a lot of power b/c mandatory buyout)Personal liability if not LLP, LLLP, or limited partner in LPPartners are taxpayers in each state partnership does business (paperwork)Hard to add new partnersFormation General PartnershipsExpress agreement orAs a matter of law when relationship has certain attributes (e.g. contributions and share $)Don’t need intent (Holmes = express agreement to divide profits is prima facie evidence, but what matters is intent of parties to carry on a business together, not to “form a partnership.” Here intent was present b/c talked about doing everything together to make the makeup company and P worked for a year w/out expectation of pay, so it’s a partnership and default rule says split profits)No formalities required (except possibly a trade name registration)BUT SHOULD ALWAYS MAKE A PARTNERSHIP AGREEMENT (i.e. a contract)!Limited Liability Partnerships (created by RUPA in 1997; in most states including CA)Must strictly follow procedures in RUPA (cannot arise as a matter of law!):Partners must approve the decision to organize as an LLP by the same vote required to amend the partnership agreement (if silent, then default = unanimous)File an LLP partnership statement with the Secretary of State Then file annual report and pay a franchise feeCompany name must indicate it’s an LLPPurpose: no personal liability for partnership debts (see below)Grant of LLP status continues so long as it’s in good standing (Apcar = only get protection if you renew it since we want incentive to file so state gets its fees, so no shield for lease obligation entered into after LLP status had lapsed)Notes:Usually limited to licensed professionals (everyone else can be an LLC)Insurance for tort victims often requiredLLP is a citizen of every state in which each of its partners is for diversity Duties and LiabilitiesFiduciary obligation = must act in the best interest of their common venture, aka duty of “utmost good faith and loyalty” to partnership AND partners b/c liable to each other (Meinhard = partners owe each other duty of finest loyalty so must tell partner about opportunity to extend lease b/c “partnership opportunity,” so by not telling P, D appropriated it and violated the duty even though didn’t intend to defraud) Higher duty than if merely contracting together, and not waived by acquiescence (Enea = don’t need a partnership agreement to require a partner rent a shared property at FMV)RUPA = duties are “limited to” loyalty (narrowly defined in §404) and careCA = duties “include” loyalty and careGeneral PartnershipsSee LPs and LLLPs below Jointly and severally liable for partnership obligations, but creditors must exhaust partnership assets firstPartner who created the liability must have been carrying on in the usual way of the business of the partnership (like “course of employment” test)The act of every partner in usual course of business can bind (aka create liabilities for) the partnership unless you file a statement of authority to limit one’s authorityPartners have duties to indemnify each other (so pick rich partners)Limited Liability PartnershipsPartners who had paid full amount of capital contributions will not be liable (RUPA 306)Although still liable for own malpractice/negligence (just not partners’)But may be personally liable for claims by former partners (Ederer = in NY personally liable when former partner seeks an accounting on dissociation, but most states call former partners creditors, so put this in the agreement)Creditors are sophisticated and usually look for collateral like personal guaranteesFinancingRaise capital through:Capital contribution of owners and/orEvery partner MUST contribute somethingDefault = money or property, but can be services per agreementBorrowing money from (increases liabilities):3rd party lendersPartners (can contribute AND lend)Problem of additional capital contributionsSmall businesses have a hard time attracting capital b/c information costs are higherSo new partners may insist on disproportionate share of profits or control Default = need unanimity to admit new general partner (usually ok by majority of capital accounts)Can’t force current owners to contribute more without an agreement…Ownership InterestsManagement Interests andEvery general partner has one vote (i.e. per capita)So equal say in management decisions even if capital contributions aren’t equalMakes sense if few close, engaged owners, not passive investorsBut partnership agreement can create classes of partners w/ different voting rightsUsed for tax planning so parent has all management rights but kids still get capital accountsUsually need majority vote, but unanimity required for “extraordinary matters” (including transferring management rights, adding new partners, and becoming an LLC)So important to have provisions for breaking deadlocks in the agreementFinancial InterestsAccountsBalance sheet equity capital account = total value of partners’ equitySeparate accounts for individual partners reflecting capital contributions and share of profits/losses No right to receive current distribution of profits without majority vote RUPA 401(b)But still taxed (so force tax distributions in partnership agreement)Losses can be used to offset other business incomePartners have a right to:Share in the profits and lossesDefault = equal sharing RUPA 401(a) But in CA if partner contributes only services then not subject to recovery by cash partner b/c services = cash absent K (Kovacik) Good to link profit share to share of contribution to avoid windfallsBe paid at dissolution the value of their equity (aka residual interest in enterprise)Transfer their shares to third parties (since it’s personal property)Default = can freely assign financial but not management interest (need unanimous vote for that b/c law assumes close working relationship) (Casey = can only put right to receive profits, not voting or management rights absent evidence of unanimous agreement, up for sale at foreclosure auction)Can assign financial and keep management, but still liable for partnership debts as a manager (have to withdraw to escape!)Be bought out upon dissociation (b/c absence of market for shares makes it hard to leave)Default = at will partnership, so no penalty for dissociating at any timeBut if you breached the partnership agreement, then damagesThis makes partnerships very unstable, and valuation may be difficult or partnership may not have enough cash on hand to payValuation problems…Partnership owns the partnership property, not the individual partnersEnding a PartnershipDissociation= withdrawal or death of a partner, two types:Rightful, if:No partnership agreement or“At will” per the agreement or dissociated per the terms in the agreementWrongful, if:“For a term” per the agreement and dissociated before that term in breach of contract (then liable for damages, but still get value of partnership interest)That partner is still liable for partnership obligations incurred when he was a partnerShould file a statement to put 3rd parties on notice you are not liable for further obligations (RUPA 704)Under RUPA Art. 7 remaining partners have the option of continuing the business if they can buy him out (but under UPA had to make a new partnership)Dissolution= when partner(s) decide to close down the business entirelyCaused by express will of any partner that need not be supported by justification (Girard Bank = wrote to partners telling them she was dissolving the partnership before she died, so it was dissolved during her life)Often triggered by:DissociationEvent specified in partnership agreementCircumstances making it illegal to continue the businessCourt order (when “no longer reasonably practicable to carry on the business”)Example = deadlockBut if expelling a member for wrongful conduct fixes them, then no need to automatically force a dissolution (about finding least disruptive way to solve the problem) (Dunbar = two member LLC deadlocked, where one is expelled as an active manager, so can now continue with business)Partnership then only continues to conclude the businessWinding up= process of closing down the business by selling the company or liquidating its assets (McCormick = RUPA says must liquidate land via forced sale after court ordered dissolution absent agreement) BUT (Horne = RUPA requires partners get cash after dissolution, but doesn’t have to be a forced public sale if partners can stipulate to asset value)Then pay creditors and distribute any net balance to partners according to their interests Termination = when winding up is complete Limited Partnerships (created by ULPA, now covered by RULPA in 2001)Formation = must file a certificate with the statePurpose: general partnerships often recast themselves as limited partnerships to raise capital from passive investors Not that common (LLC, created recently, is now preferred), but still used by VCs and for family estate planning b/c LLC has a fee not imposed on LPsExceptions to rules above:Profits/losses not shared equally (instead split per capital contribution)LiabilityGeneral partners = management and financial rights, so unlimited liability UNLESS organized as a limited liability limited partnership under RULPA, where limited liability for all! Limited partners = passive investors (no management rights), so liability limited to amount of capital contributionUnder ULPA, limited partners were liable to relying third parties if they participated in “control of the business” (limited safe harbors)But now under RULPA liability is status-based, not fact-based, so limited partners are always shielded Exceptions to general rules for partners above:Can only transfer interest to third parties if partners agreeCan withdraw without interrupting the partnership-----------------------------------------LIMITED LIABILITY COMPANIES----------------------------------------= hybrid/incorporated partnership (newest entity)IntroductionAuthority = LLC enabling acts (very thin with a lot of “may” provisions)Different in every state, unlike for partnerships where states adopted a uniform actAlthough ULLC does exist, just made after states already had their acts so ignoredTheory = maximizing freedom of contract (taken pretty far…); ability to buy limited liabilityLegal treatment = Since LLC statutes are thin often need to analogize elements to partnerships or corporations to see which laws should applyPros/ConsUnrestricted limited liability for all partners Can elect partnership or corporate tax treatmentFlexible management rights (choose corporate or partnership structure)Can modify dutiesNo mandatory payout on dissociation (except in DE, where it’s fragile)Thin statute, so legal uncertainty if treated like a partnership or corporationFormation Required: file articles of organization with Secretary of State and pay a fee Optional: operating agreement (i.e. a contract)Helpful, but not required for formation (Moon) and signing is not dispositive of membershipInterpret reasonably! (VGS = agreement is silent on % of board vote required, but if unanimity were required then no reason to expressly state 1 manger’s approval is needed for mergers)Only invalidated if inconsistent with mandatory statutory provisions (Elf = don’t need to follow formalities b/c LLC statute is about freedom of contract so substance over form. So long as there is intent, an LLC can be formed and the agreement can do whatever, including have an arbitration clause)Can convert from corporation or partnership to LLCStill personally liable to creditors from a general partnership prior to conversionFinancing and Ownership InterestsSame as partnerships except: default = voting per profits interest, not per capitaManagement, can elect:Participatory structure (like a partnership) orSince member-managed, any member is an agent of and can bind the LLC/has dutiesCentralized structure (like a corporation) Since manager-managed, only managers are agents of and can bind the LLC/have dutiesManger removal: default = majority member vote (Broyhill = operating agreement that says manager must be appointed by unanimous vote but is silent on removal does not require unanimity for removal, so ok to remove with 55% interests when member with remainder was terminated by bankruptcy) Duties and LiabilitiesUnrestricted limited liability, not even liable for own negligence (better than LLPs) so long as:Properly formedMembers have paid their promised capital contributions in full andLLC is not a fraudCorporate veil piercing standards (see below, but easier to satisfy b/c fewer formalities)Fiduciary dutiesDuties of:Care (gross negligence standard)Good faith/fair dealing inherent in every contractLoyalty (VGS = breached when two directors don’t give notice to a third of acting by written consent b/c purpose of written consent statute is to enable quick action when minorities can’t object but here could have, so no BJR)Largely modifiable, but can’t be eliminated or unreasonably restricted or reduced (Hunt Sports = “members may compete” clause in operating agreement can limit the duty of loyalty so long as it’s not eliminated, which this doesn’t [only eliminates one aspect—competition], and is not unreasonable, which this isn’t [b/c freedom of contract for LLCs and on notice]. So ok for member of LLC competing for NHL stadium to make his own deal for it)DE:Narrow (“limited to” duties of care and loyalty)Duties to the LLC (not to the other members) May be imputed to a separate entity formed and controlled by fiduciaries of another for the purpose of engaging in transactions with that other (Barbieri = LLC made up entirely of D Corp.’s officers owes a duty to D Corp., but the Partnership made up of LLC and someone else does not b/c no showing the other partner knew or/benefited from his partner’s relationship with D Corp.)And majority owners can owe fiduciary duties to minority owners (Anderson = in Tennessee they do b/c like a partnership, so can’t kick member out and pay him under the agreement, then sell his shares to someone else for more money b/c co-opting his value)Can be expanded, restricted, or eliminated by contract EXCEPT must keep duties of good faith/fair dealing and can’t limit liability for bad faith violationsCA: Broad (“include” duties of care and loyalty)Only managers owe duties to LLC/members (same as a partner does to partnership/partners)Can limit these, but can’t eliminate themEnding an LLCDissociationULLC: can freely dissociate (wrongful or rightful) and get a payoutDE: only allows for rightful dissociation, but then you get a payout (so more fragile)CA: can freely dissociate, but no payout right So you still have an economic interest, but no longer management rightsSilent statute and operating agreement? Then can choose (Lieberman = P retains equity but not management interest on dissociation b/c that’s what he indicated he wanted. Don’t need to mandate withdrawal of both, thus triggering liquidation of his equity interest)Dissolution Same as partnership except dissociation never automatically leads to dissociation---------------------------------------------INTRO TO CORPORATIONS----------------------------------------------= entity that consists of an intangible structure for the conduct of its affairs/operations, the essence of which is created by the state, and that possesses the rights/obligations given or allowed it by the state (more or less parallel those of natural persons)HistoryDevelopments:Special state acts for each charter broad federal (for securities) and state statutes Model Code (in 25 states), DE and CA show major variationsRestrictive (b/c fear of organizations) enabling statues permitting any lawful businessUnlimited limited liability (aka <porous> corporate shield) (BEST INVENTION!)Pro = more capital invested, increased tolerance for risk takingCon = creditors (including involuntary, i.e. tort victims) may go unpaidTrend toward state congruence (result of competition)Corporations = people in federal law b/c separate legal entity, so they have the following :1st Am. free speech rightsDPC and EPC rights4th Am. lesser right against unreasonable searchesBut NO 5th. Am. right against self-incriminationTypesPublic = functions as governments (ex. cities, airport authorities)Government = wholly/partly owned by a gov to perform a special purpose (ex. Amtrak, USPS)Nonprofit = no shareholders b/c profits are not paid in dividends (ex. hospitals)Charitable/eleemosynary = purpose to benefit other groups, so no taxes on profits and contributions are deductible (ex. private universities)Mutual-benefit = purpose is to benefit its members, so no taxes on profits but contributions are not deductible (ex. social clubs)BusinessPublicly held/reporting = presence of a ready market for corporate stock so required to follow SEC Acts Shareholder sees himself as owner of shares, not the company Professional management (by officers) and monitoring (by board) Closely held/private= stock cannot easily be traded Shareholder sees himself as owner of the companyConsequences:Greater latitude in internal management (usually shareholder managed and monitored)Shareholders stand in fiduciary relationship to each otherCan escape some formalities, BUT if too lax then courts disregard corporate form and allow personal liability (see piercing below)Statutory close(d) corporations= a special kind of closely-held corporation created by statuteDark corner of corporate lawFormation:Elect this in your charter (since board is required otherwise)< 35 shareholders in CAOrganized like an LLP and run via a shareholders’ agreement instead of a board:Management structure is informal May dissolve at willShare transfer restrictions are commonBut you get corporate tax treatmentProfessional corporation = must be a licensed professional to be a shareholder, and personally liable for malpracticeFormation = elect this in your charterOrganized like a closed corporation (aka like an LLP)But you still get corporate tax treatmentCorporate Pros/ConsProsFlexible capital structure (many “off the shelf” variations, so don’t need to get creative)Easy to enter and leave b/c:Liquid market for shares and Management rights not tied to sharesCentralized management structure (can manage capital raised by large number of ppl)Shareholders = passive investors who vote for extraordinary corp. acts per share (often via proxies, but ok b/c institutional shareholders are informed)Can only initiate dissolution or a lawsuit to oust directorsDirectors = elected by shareholders to form board and set policy (BRAIN)Officers = elected by directors to manage day-to-day operations (BRAWN)Perpetual life (b/c separate and distinct legal entity, so death/exit of owner has no effect)Scope of limited liability for shareholders = corp. is solely responsible except:Lending institutions may require guaranteesShareholders must satisfy unpaid amounts of capital contributionsIf corporation is a shamWell-established form for all types of business (so standard forms & easy to do things)ConsExpense and trouble of formation and maintenance Formation = charter, bylaws, minutes, qualify in states you do business inContinuing costs = annual reports and fees, minutesRequired initial and continuing formalities (meetings, minutes, separate funds)Agency costs related to separation of ownership and controlTaxed twice (corporation taxed on earnings, and shareholders taxed on dividends)Can avoid this by:Being a Type S Corporation (elect this within 90 days of formation) and treated like a partnership for taxes if:< 75? shareholdersComes from tax law, not corporation statutesIncorporated in US with no nonresident alien shareholders1 class of stock, and all shareholders agree to elect Type SShareholders are individuals, estates, or trusts (not companies)Not a life insurance company or certain other typesNot paying dividends (reinvest that money and pay as salary, which is a deductible expense)Not making any money -----------------------------CORPORATE FORMATION & CAPITALIZATION------------------------------IncorporationPromoters’ Contracts = contracts by person organizing the business before it exists Since corporation doesn’t exist yet there is no limited liability, but parties do not expect promoter to be held personally liable since acting on behalf of the nonexistent principalLiabilities of corporations Once formed, corporation is only bound if:Ratification = board adopts a resolution ratifying the acts and relating back to when they occurred (logical impossibility)Adoption = ratification without a retroactive effectFormally by the board orInformally through performance + knowledge of K terms (Mac Arthur = SOF then starts on date of adoption… can’t relate it back via ratification b/c that’s a legal fiction) Liabilities of promoters = joint and severalLiability before adoption depends on:Intent of parties andHow K is drafted Be careful to avoid lack of consideration (courts consider equities)Good to include a written option granted to promoter for benefit of to-be-formed corporation to enter into this KLiability after adoption continues (corp. is just secondarily liable) absent a novation (= release) by other contracting parties. Can be:Automatic (if language was in K)FormalInferredWhere to incorporate, consider:Substantive provisions of state corporate law because of Internal Affairs Doctrine:= state of incorporation generally governs your internal affairsBUT in CA, §2115 says if you have > 50% of shareholders here then we’re imposing some sections of our corporate law on you DE says this is unconstitutional under CC, but CA hasn’t (Vantagepoint)Cost of incorporating in a state other than the one where you do business Must pay annually to qualify wherever you do business (or can’t enforce Ks)Tax savings for big public companies, but not worth it if smallerPick DE if going to operate in multiple states (but CA is good for IP issues…)Can always re-incorporate How to incorporate (automatically perpetual duration after doing the following):Prepare articles of incorporation/charter/certificate which includes:Name of corporation (must contain designation as corporation) (TM issues)File trade name registration and feesNumber and types of shares authorized to issue (per state and federal law)Name and address of company’s registered office and agent for service of processName and address of incorporators Responsibilities = signing this and holding organization meetingCorporate purpose (now “any lawful purpose,” but used to be ultra vires problem)Number and names of initial board of directorsNeed not be shareholders; can have as few as 1 (lonely board meeting)Optional provisions concerning managementFile articles with Secretary of State and pay required feesThen state issues you a charter and you’re incorporated!Defective incorporation (different from promoters’ contracts)= where corporate power is used in good faith, but incorporation was faulty/not complete Curative doctrines rejected by Model Act (Robertson = since these don’t exist, doesn’t matter if P believed he was dealing with a person or a corporation. Before the certificate is issued the individuals are liable for any acts taken, period):CA and DE retain these, but won’t as soon as there’s a caseDe facto corporationLaw allowing for incorporationGood faith attempt to incorporate under the lawCorporate power used in honest belief corporation existedCorporation by estoppel= persons who treat entity as a corporation will be estopped from later claiming it was notProcedures After IncorporationHold organizational meeting= incorporator must hold a meeting under the statute Or can have written consent in lieu of meeting if unanimous agreementMust take minutes of the formal proceedingsShareholders have inspection rightsSubject to discovery and generally admissible as evidence Adopt bylaws = contain provisions relating to the business and affairs of the corporation Usually focus on shareholders and officersElect board of directorsRMBCA and DE = ≥ 1CA = 1 if 1 shareholder, 2 if 2, and ≥ 3 if ≥ 3Have board (through meeting or unanimous written consent):Appoint officers (1 person can be everything but secretary [to prevent fraud])CA requires:CEO/President/Chairman to be the general manager CFO/TreasurerSecretary to be the custodian of corporate recordsDE and RMBCA have no requirementsCan make up as many titles as you want (VPs, Brewmaster…)Just describe responsibilities in bylaws or board resolutionsAuthorize initial share issuance Adopt & novate promoters’ KsPass a resolution approving compensation of CEOAdopt a corporate seal (for old time’s sake)List officers on banking resolutions, etc.Capitalization = cash or other assets put into the corporation on a long-term basis (WANT A MIX)Equity = cash or other assets contributed in exchange for stock (results in shareholder status)Types:Common stock (required by corporate statute)Right to vote on certain matters, profits (via dividend), assets if liquidatedPreferred stock (optional; what VCs want)Pro: right to receive dividends and assets before common stockholders, but limited amountsCon: voting rights subordinating to common stockholders and redeemable at the option of the corporation (so closer to debt than common stock)Can be converted to common stockDifferent classes/series Can distribute rights infinitely between classes/series (if in charter)CA = each class has veto rights for big transaction votesDE = only need majority of sharesOptions to purchase shares at a fixed price during a period of time Rights = short term, Warrants = > 1 year termTransferable with no voting or dividend rightsTo get limited liability must be (Hanewald):Duly authorized (can’t give out more shares than in charter, but can amend)Validly issued in accordance with corporate law and charter (need minutes!)Fully paid, so nonassessable (corporation can’t demand future payments)Consideration can consist of:Model Code and DE = any tangible or intangible property/benefitCA = not future services, and promissory notes must be securedIf issued for less (sometimes hard to value…), then watered stock Certificated or notPar Value (not recognized in most states, but just put this in charter as $.01 to be safe)= dollar figure specified in the charter that means:Stock can’t be issued for lessMoney from sale of par value stock goes into special account that can’t be reduced below aggregate par value of outstanding shares (way to protect creditors)Fees and taxes are based on thisIf you don’t pay par value for your shares, then no limited liability (Hanewald = shares not nonassessable since par wasn’t paid, so personally liable for corporation’s debt to P)Pros/Cons:Pro = ownership rights, possibility of big payout, information rightsCon = subordinated to debt if corp. goes bankrupt (see below)Preemptive rights RMBCA, CA and DE = opt-in statutes, so must be in charter= give shareholders opportunity to buy a proportionate share of new issues so their ownership interests won’t be diluted (Katzowitz = must be offered at book value unless valid business reason not to b/c protects those who don’t buy from unfair dilution)Important for closely held corporations, but problem for public b/c causes delayShare transfer restrictions (so not freely transferable)Used to maintain status as S, close or professional corporationExamples: Vesting of shares (retaining tool since appreciate over time until vested)1st refusalFirst option rightConsent restraintsMandatory redemption rightsBuyout agreements = require corporation to purchase departing shareholder’s interest Valuation problems, so put formula in charter (book or liquidation value, $ flow) (Denkins = mid-year balance sheets aren’t good evidence of book value, need year-end)Debt= loans of cash or other assets represented by notes (results in creditor status…can be this and shareholder)Types:Bond = secured long-term debt instrument (usually by mortgage or deed on corp. property)Junk bond = high-yield, but subordinated to other debtInvestment grade bond = low credit riskBowie bond = secured by future IP royaltiesDebenture = unsecured long-term debt instrumentConvertible to stockPros/ConsPros:Interest payments are tax deductible to corp. (unlike stock dividends) Preference over all stockholders if corporation goes bankruptIf not repaid then qualify for tax deductionCons:No ownership rightsPossibility of thin incorporation at formation of corporation (Obre = not if equity is 50%, which is reasonable for tractor biz, and no one was duped b/c disclosed)= nominal stock investment and obviously excessive debt structureSo have a low ratio (between 1:1 and 2:1) with enough equity to cover core assetsResults in subordination (equitable doctrine)= court subordinates shareholder debt to other creditors in the event of bankruptcyLeverage= possibility of making a return on borrowed money greater than the cost of borrowing itIncreases risk, but also benefits shareholders by increasing their returnsMaximize this by having ~55% debt (ala public utilities)------------------------------------CORPORATE POWERS/ORGANIZATION-----------------------------------Hierarchy of Authority(Roach = bylaws are void if in conflict with statute, so having 70% quorum requirement in bylaws is invalid b/c statute says must be in charter, so default to majority and no need for dissolution)Federal securities lawState corporate statuteCharter (aka articles/certificate of incorporation) Can only be amended by shareholdersBylaws (Datapoint = can’t take away [actually or effectively] right of shareholders to act via written consent b/c intent of statute is to have this make things faster, not prevent takeovers) (Paulek = provision in bylaws attempting to give power to maintain bylaws to the shareholders violates the charter which says only the Board can maintain bylaws, so void)Can change these sorts of provisions in charterCan be amended by shareholders AND the board (flexible)Board of directorsShareholdersPowers:Elect and remove directors (with or without cause + notice) with a pluralityIf uncontested, can use bylaws to allow votes against a director (then holdover rule may apply where old director continues to serve until a new one is elected)Nominated by the board and presented to shareholders via a proxy statement But now those who qualify can require corporation to reimburse them for soliciting a competing proxyProtection in closely-held corporations = make supermajority required to remove director-shareholders without cause (but can remove outside directors easily)Amend bylawsApprove fundamental corporate changes proposed by board w/ majority vote, like:MergersAmendments to the charterInspection rights (since board owes duty of candor must make these “available”):Shareholder listCan be used to send competing proxy, make tender offer, solicit votes, etc. RMBCA: all shareholders have accessDE: need a “proper purpose” to access (DeRosa = ok to enable union to communicate) (Mite Corp = ok to purchase stock)CA: ≥ 5% shares or purpose “reasonably related” to shareholder interestsBooks and records RMBCA: good faith and proper purposeDE: proper purpose (Seinfeld = need to present evidence that establishes a credible basis so court can infer legitimate issues of possible waste/mismanagement…disagreement with business judgment is not enough)CA: purpose reasonably related to shareholder interests NOT to propose action or restrict the board (Gashwiler = shareholders can’t vote to let 3 directors sign conveyance of corporate property b/c that’s a corporate power which must be exercised by “the board”) (Manson = board powers come from the state. Shareholders can’t act in relation to the ordinary business of the corporation. If you want to act, then have a close corporation and get rid of the board altogether)And can be a bitch! (Hall = only obligation = pay in full for shares, don’t need to participate even if deadlock)Exercised:At meetings or Need a quorum (or more if in charter)Easier than for board meetings b/c can use proxies= generally solicited by corporation and with your approval they have power of attorney to vote for limited timeCan be called by the board or in CA ≥ 10% of shares entitled to voteMust have annual meetingsIf majority is required, then majority of quorum will doAttendance isn’t required (and neither is rationality…) (Hall = can prevent a quorum on purpose by refusing to attend)Via written consentRMBCA = unanimousDE = true majorityCA = true majority except unanimity for director electionsDirectors = brainDirectors can’t act in individual capacity unless board delegated power to themCollective powers (can only limit these in the charter):Appoint/remove/oversee officersMake important policy decisionsSend out proxiesExercised:At meetings (after notice [or waiver] and with minutes by majority?) orNeed a quorum (can’t use proxies)If vacancies, quorum still based on number of authorized (not actual) positionsCan ratify past actions if there wasn’t a quorumEXCEPTION = committees of ≥ 2 board members w/ delegated powers (& mins)Via unanimous written consentTypes of directorsInside/active = substantial shareholders, so active role in decision-making Outside/passive = informal advisors who offer discipline and act in crisis situationsOfficers = brawnPowers via:Actual/express authorityStatutes (general requirements like “President is CEO”)Charter or bylawsBoard resolutionAgencyImplied/inherent authority = generally recognized duties that come with officeIncidental authority = acts incidental to actually/impliedly authorized dutiesApparent authority = based on principal communicating with third party directly; only defeated if person dealing with officer knew he lacked actual authority (Hilton = parent company told community to go to local hotels, so liable)Board acquiescence Ratification (last refuge of a scoundrel; need disclosure & can’t ratify illegality or waste)Specific Powers (where officer can bind the corporation):PresidentInherent power to bind the corporation in the “usual course of business” (Molasky = can’t bind the corporation to guarantee a personal obligation b/c not in the usual course of business so need authority or board ratification)Broad, so how can you be sure when you’re dealing with a corporation?Ask for evidence of board approval (like minutes or secretary’s certificate)Get a corporate authority opinionAsk to see the bylawsChair of the BoardSometimes the CEO, other times largely ceremonialNo implied powers b/c ambiguousVice PresidentInherent power to serve in the place of the president (if incapacitated or absent) (Anderson = VP can bind the company by signing something as the president when president is absent even if contract erroneously describes his signatures as that of the president) (Hufstedler = if VP signs something and secretary attests to it, can assume contingency arose which authorized him to act for president)“Absence” should be defined in bylawsIf multiple departmental VPs, then implied powers based on titleSecretaryCustodian of internal affairs and non-financial records, and certifies records (In Re Drive In Dev. Corp. = can enforce a guarantee under estoppel when secretary certifies that the board authorized something even if it didn’t)No business powers (Dahl = can’t sign an affidavit b/c too far from certification duties)TreasurerInternal powers and custodian over corporate funds (Overseas Films = no authority to make the company guarantee the repayment of another company’s loans b/c extraordinary [should have alerted P to inquire])Can have a treasurer who reports to a CFO (treated like a VP)------------------------------------DISTRIBUTING CORPORATE CONTROL-----------------------------------Voting MechanismsMandatory: Straight voting (x shares = x votes per each director seat) Effect = majority shareholders can elect all directors CA = mandatory that cumulative voting can be invoked by ANY shareholder (Campbell = can still remove directors for cause this way, but must give them notice so they can defend)# of open seats × # of your shares = # of votes (cast all for 1 or spread out)Effect = increases chance minorities can elect directors (= factious board?)But influence ≠ controlIf elected cumulatively, must be removed cumulativelyDE and RMBCA = opt-in to cumulative votingOptional (put in charter):Staggering = different seats up each year (provides continuity; undermines cum. voting)Class voting (if in charter) = different classes of stock can vote for different seats (can help minorities)Weighted voting where one class/series shares are worth more votes (Providence = but can’t have variations w/in each class)Shareholder Contracts (to control shares held by others)Voting trusts= formed in the ordinary way under trust law with voting stock as its corpus where trustee votes shares according to terms of the trustNot popular b/c drastic measure to relinquish all control, expensive, and complicatedBut used in family businesses to give younger generation an interest Specifically enforceable (usually last 10 years)ProxiesIrrevocable: agencies for a particular purpose Revocable: agencies for specific meetings (< 1 year)Shareholder voting/pooling agreements (POPULAR)= two or more shareholders providing for the manner in which they will vote their shares via contract (so no statutory duration) Often just for closed corporations, but no longer in CA (Galler = but if closely-held and no public injury since only the parties are shareholders, then ok to uphold it)Remedy is usually damages, but sometimes specific enforcement (Ramos = specific enforcement for closed and closely-held corporations)Can cover anything they want (since shareholders have no fiduciary duties) so long as:Not an illegally formed voting trust or In violation of public policyCourts traditionally don’t favor agreements limiting discretion/authority of directors (since they have a duty to all shareholders and limiting their discretion impairs that ability)BUT trend is to allow encroachments in closely held corporations if everyone knowsFailuresDeadlock= unable to actIf board is deadlocked but president can still act, then okBut if shareholders are deadlocked and can’t replace a board, then screwedPrevent it by:Having an odd number of directors (but one can abstain…)Coin flip mechanisms Oppression = when minority’s reasonable expectations are frustrated by a majority w/ so much power they treat the minority unequally by (Beatley = reasonable to assume employees thought they’d get dividends when employment ends b/c long-standing policy…about what majority should have known minority thought):Serving themselves to corporation’s assets (selective liquidity) (Rodd Electric = no right to get money back, but equality of opportunity for stock repurchases for closely-held corporations. Note: here group as majority shareholder) Refusing to share information (freeze out) (Brodie = remedy is what the minority reasonably expected when they bought shares, which usually will not include liquidity) NOT when a majority simply votes their shares to elect directors who run the company in a way the minority doesn’t likeEspecially affects:Closely-held corporations (lack of market for stock means minority can’t escape) Former employees who cashed in options and are now minority stockholdersBecause majority owes Meinhard fiduciary duty of utmost good faith/loyalty to minority (in contrast with duties owed by directors) when dealing with corporate operations and assets Unless:Waived as to specific events in charterValid business purpose (Blackwell = “fair” doesn’t mean “equal,” and here there was a good business reason to restrict buyback of shares so ok)Minority also has limited duty to majority (ex. preserve “S” status when transferring shares)Slightly different per stateDE = equality opportunity in liquidity with business reason defenseCA = reasonable expectations RemediesPrevention via voting mechanisms and shareholder contractsBuyout= corp. can elect to purchase shares owned by shareholder petitioning for dissolution Introduces instability…Dissolution if:Recommended by board and approved by shareholders, then filed with Secretary of State and liquidated (aka voluntary) Initiated by shareholders with sufficient number of shares if:Deadlock or Directors acted illegally/oppressively/fraudulentlyBy agreement under request or a certain eventSecretary of State initiates b/c delinquent in formalities (taxes, reports, agents)AG initiates b/c fraudCreditors initiate b/c insolvent and want recoveryAppointment of a custodian/provisional director (but who wants to?)Contractual provisions (e.g. arbitration)Pro: cheaper and fasterCon: narrow grounds for appeal and limited discovery-----------------------------------CORPORATE BANKRUPTCY PROBLEMS-----------------------------------Piercing the Corporate Veil= When the shield of limited liability is judicially pierced and shareholders are personally liableApplies to horizontal/reverse piercing if entities somehow connected as 1 enterprise (Sea-Land = unity of interest by showing corporations are D’s playthings with no formalities and money was personally borrowed and moved between them)But ok to have riskier parts of biz as subsidiaries to protect parent if formalities metAfter P has proved the corporation is liable and its assets don’t cover judgment, consider:Undercapitalization at time of formationCreates an inference of inequitable conductBut no one knows how much is enough (although liability insurance counts and some states have a statutory minimum which is enough) (Walkovszky = can’t pierce to own D, who owns main corporation and all subsidiaries of taxis, b/c even if all taxis owned by one company they weren’t undercapitalized)Corporate formalities (follow to demonstrate separateness and strengthen shield):Issue shares Hold shareholders’ and directors’ meeting with minutes (even if “lonely”)Sign written consentsDon’t let shareholders make decisions as if they were partnersSharply distinguish between corporate and personal propertyDon’t use corporate funds to pay personal expensesDon’t use personal funds for corporate expenses without proper accountingKeep complete corporate and financial recordsIssue stock certificatesEquitySome courts requires fraud (Fusion Capital = need to show such unity of interest that they are inseparable, that the corporation was influence and governed by D, AND that adherence to corporate fiction would sanction fraud, which here it wouldn’t since P knew the corporation had no money)Actual = purpose to deceive (DE)Constructive = breach of a legal or equitable duty irrespective of moral guilt that is fraudulent b/c of tendency to deceive others or injure public interestType of claimant:Contract claimants Assumption of the risk is often a defense (should price services accordingly) But smaller contractors may not have leverage to raise pricesAnd risks aren’t rationally evaluated when there is fraudTort claimantsWe feel bad, but limited liability is worth it overall Inadequate recovery for P is NOT relevant (Arrow Bar = can’t pierce veil of bar who served drunk driver with insufficient assets and no insurance b/c followed most formalities)Choice of LawInternal affairs? Unclear since 3rd parties are involvedMatters b/c P wins the most in CAOverall, veil is pierced about 40% of the time (more so in small companies) But large public companies always win (if they’re even sued)Dividends = return to equity holdersTypes:Distributions = giving out profits per shareRedemptions = paying equity holders for their stock (that stock can then be reissued)Can only do this out of “surplus” b/c don’t want board to drain assets (Klang = balance sheet is not conclusive indicator of surplus since doesn’t take appreciation into account, so board was ok to rely on investment firm)Subordinated to debt in the event of insolvencyCA = corporation must meet two tests in order to pay a dividend (otherwise directors are personally liable):Balance sheet test = after its made the assets are 1.25x the liabilities (about solvency) andIncome test = need to have positive retained earnings DE = loose solvency test (easier to make dividends)Accounts payableVendors are often stiffed when corporation goes under, but can control for this through contracts restricting distributions-----------------------------------------CORPORATE FIDUCIARY DUTIES----------------------------------------Derived from (BUT NOT) agency law, because shareholders (in position of vulnerability) entrusted management of their property to D/O and justifiably relies upon their good faith, confidence, and trust.IntroductionWhoDirectors (collectively) are agents/fiduciaries of the corporation and shareholders Officers are agents/fiduciaries of the corporationShareholders have no fiduciary duties toward each other or the corporationExcept regarding oppression (see above)Pros/ConsDefault rules are efficient b/c minimize agency costs Can’t contract for everythingEncourages voluntary transactions (wealth enhancing)Encourage managerial risk aversionInefficient to litigate these after the factMay interfere with contracts/private ordering (and marketplace controls for a lot…)Duty of Care= directors must act in good faith as reasonably prudent directors would, including duties to:MonitorMust put reasonable reporting systems in place (Caremark = absent some reason to suspect wrongdoing, no need to inquire beyond these. Ok to assume honesty in reporting. Need systemic failure of the board to establish breach of duty)InquireWhen circumstances would alert a reasonable director in “like position”Covers both malfeasance and nonfeasance (no dummy directors)May reasonably rely on others’ reports to meet thisStandard = gross negligence (objective)= must act in good faith as a reasonably prudent director wouldSo more than in contracts where standard is merely “fair dealing” Exception: greater care in trust-like business (like insurance) (Francis = widow breached duty by having no idea what is going on and letting sons steal from business. She could have threatened them with a suit to deter them, so “spawned in the backwater of her neglect”)Should only be about process (WLR Foods = rationality of defensive measures shouldn’t matter, so can only get discovery about the process the board took)Business Judgment Rule= presumption that board is not liable for poor business decisions (doesn’t apply to inattention) Policy = shouldn’t impose liability for bad business judgment b/c:Shareholders voluntarily undertook that riskAfter-the-fact litigation is a bad way to evaluate these decisionsPotential profits often corresponds to potential riskRebuttable (burden on P, then shifts to duty of care analysis) if:No rational business purpose (i.e. no-win decision/waste)Interested transaction (i.e. conflict of interest) so duty of loyalty is implicatedInterested board member should disclose and abstainBad faith (as defined in Disney below)Illegal transactionGrossly uninformed (Van Gorkom = board didn’t know about Van Gorkom’s role in forcing the sale of the company and establishing the purchase price, which was essentially a guess. They should have informed themselves of the intrinsic value of the company and given it more than 2 hours consideration. Their reliance on others was unfounded!)Exculpation Statute DE 102(b)(7) as Affirmative Defense to Breach of Duty of CareEnacted in response to Van Gorkom (other effect = big emphasis on records of process taken)= allows shareholders to eliminate personal financial liability of directors in charter unless (Bancorp = partial disclosures in merger proxy statement that were materially misleading are immunized under 102(b)(7) because inadvertent breach of duty of care):Breach of duty of loyalty / improper personal benefit orAct or omission in bad faith (subjective test as defined in Disney) (= directors get BJR b/c compensation committee was adequately informed, so no bad faith)So Ps try to frame everything as “bad faith”= intentional/conscious disregard of responsibilities (Tyson Foods = spring-loading, aka a compensation of stock right before good news, is bad faith b/c board had material, non-public info and intended to circumvent a valid shareholder-approved restrictions plan, so implicates duty of loyalty) (Gifford = intentional violation of shareholder approved stock option by back-dating [issuing stock and changing date to get benefit of gain] + fraudulent disclosures about compliance is disloyal, so bad faith)= acting with a purpose other than that of advancing best interests of the corporation (aka being DISLOYAL) (Malpiede = no bad faith where rejected $9 bid for initial $7.75 merger b/c need to look at the whole deal, not just the price) (Stone = no bad faith where bank employees fail to file money laundering reports and have to pay a fine b/c can’t prove officers failed to supervise in bad faith)= acting with intent to violate the lawDuty of Loyalty (easier for P to prove and get insurance settlement)= implicated when there is a conflict of interest between director and corporation, where must exercise powers in the interest of the corporation Not interested if merely stands to benefit by virtue of stockholdingsEx. “washout” financing where VC owner contributes more, but significantly dilutes other shareholders - duty of loyalty implicated, but ok b/c would have gone bankruptOverlaps with bad faith, discussed above (Tyson Foods) (Gifford)Standard = directors must prove entire fairness to the corporation given the business context at time of the transaction (objective) (Lewis = directors of two corporations use one to lease space for cheap from another at the expense of its shareholders, so no BJR b/c D could not disprove breach of duty of loyalty)Consider: Process (undue pressure, arms length)Whether it was affirmatively in the corporation’s best interestIf initiated on behalf of the corporation by disinterested personsSafe harbor statutes (= satisfy procedural rules and you can shift the burden)If directors can show they used any of the following to approve the interested transaction:Disinterested & fully informed director vote (often independent committee)Directors must prove they were truly independent, fully informed, and had freedom to negotiate at arm’s lengthDE = can have committee of 1, so only need 1 disinterested directorCA = need 2 or more on a committee and need a quorum for a voteDisinterested shareholder vote (take out interested shares) orHarder b/c need disclosures, a meeting or written consentCL intrinsic fairness test (Marciana = don’t have to use statutes, and here ok b/c personal loans without board approval [since deadlocked] ok b/c bona fide attempt to help save the company and statutes were realistically unavailable)Then they get the following:DE = shift the burden of proof to shareholders and give directors BJR protection (Benihana = when board knew about D’s dual role as negotiator and director they knew enough to be adequately disinterested and get BJR protection)CA = Shift the burden of proof to shareholders orMinority = transaction isn’t automatically void, but no other effect (still argue)Specific CasesCorporate opportunity doctrine (most common at small, closely held corporations)= where D/O pursue economic opportunities on their own behalf the corporation also wants to pursueAbout fairness (burden on director who took the opportunity)Guth line of business test (Broz = not obligated to refrain from competition with his company’s acquiror since it was contingent/uncertain):Can the corporation take the opportunity (financially)? Is the opportunity in the corporation’s line of business?Does the corporation have an interest or expectancy in the opportunity? About tie between property and nature of corporation’s businessDoes the fiduciary have an interest against the corporation?ALI safe harbor (but not required per Broz) = bring the decision to the board and have them reject it formally to defeat expectancy interest (NE Harbor Golf Club)Good to have a bright line, but disincentive for directorsDE 122(17) = can have charter or resolution renouncing corporation’s interest in specified business opportunities (everyone wants it now)BJR applies to this decisionCompensation agreementsDistinguished from other self-interested transactions b/c necessary and sufficiently recurring/publicized for comparisonsSo usually a duty of care rule with BJR (P has heavy burden of demonstrating no reasonable business person could consider it adequate) But when personal interest in the transaction (i.e. own compensation), duty of loyalty is implicated and burden is on DCorporate Social ResponsibilityObjective is mainly enhancing shareholder profit (Dodge), but what about stakeholders?Examples:EmployeesSuppliersCustomersCreditorsDuty of care issue b/c can implicate bad faith since not directly advancing interest of shareholders (i.e. increasing profits)Charity generally gets BJR protection b/c considered marketing/building goodwill so arguable indirect benefit to shareholders (Wrigley = ok for directors not to allow night games b/c considering effect on the neighborhood is in long term interest of the corporation. Since no fraud or conflict of interest, it gets BJR)Other Constituencies Statutes= allow D/O to consider stakeholders and short/long term interests (but no bright line)Effect: diminishes duty of care to shareholdersNote: corporations are inherently good b/c advance prosperity and maintain political pluralism----------------------------------------------MERGERS/ACQUISITIONS-----------------------------------------------TypesAcquiring corporation negotiates directly with targetTypes (some transactions may have elements of all 3):Asset purchase (cash/stock for assets)= buy selected assets from target companyLiabilities only assumed if explicit OR equity demands it (e.g. defective product injury and no one else left to sue)Usually acquired by subsidiary to reduce liability to parentRights: shareholders get voting but dissenters do NOT get appraisal rightsPurchase of stock (cash/stock for stock)Often a hostile tender offerAfter acquisition, target is a subsidiary of the acquiring companyStatutory merger (cash/stock for stock)= mush two companies together under state corporate lawRights: shareholders get voting and dissenters usually get appraisalWays to avoid dissenters’ cash-out rights:Do an asset or stock purchase! Market out exception = when public companies receive cash/shares b/c valued in the marketTriangular merger = use a subsidiary to enter into the mergerDe facto merger doctrine and successor liability= if substance is the same as a merger, then effects should be same (Glen Alden = bought target as subsidiary, then it bought all of the acquiror’s assets and liabilities for shares, then acquiror dissolved)Abandoned except to protect creditors (Hariton = since there are two ways of achieving the same result there are two effects, so if you pick to not do a statutory merger then no dissenters’ rights) (Knapp = can’t allow a formality to defeat recovery of tort victim, and since D is better able to spread the loss and could have gotten its targets insurance, it pays)Tender offer (other way to overcome a hostile board = proxy fight to through them out)= acquiring corporation purchases directly from shareholders of target corporation a controlling interest in company’s stock (non-statutory)Can be with or without board approval, but if without then “hostile”How? Bidder buys a “tow hold interest” to become a shareholder with inspection rights, then solicit via the shareholder listPlace newspaper ad to buy more shares at a “premium” contingent on having enough shares tendered to give bidder controlMust be open to all security holders in same class under 14d-10So no discriminatory self-tender offers like Unocal under Securities Exchange ActShareholders either do nothing, sell in the open market, or tender to the bidder (can take back and get benefit of better deals until bidder has control 14d-10)Once he has control, bidder uses it to merge companies and squeeze out the boardShareholders are forced to exchange their shares for tender offer amountFederally mandated disclosurePurpose: to protect shareholders from having to respond without adequate infoPrivate sellers less likely to be pressured, but if public with time limit…So ID a tender offer by statutory purpose (Hanson = not a tender offer where D terminated tender offer and then made private purchases of stock from a few sophisticated individuals b/c not publicized and they don’t need help)Do the selling shareholders need protection or are they sophisticated?Is there a substantial risk they lack info needed to evaluate the proposal?Is it publicized?Defensive measures= director primacy, so can put defensive measures in place w/out shareholdersPoison pills= shareholder rights plan that gives all shareholders other than unwelcome acquiror the right to buy additional stock at a discountTriggered when someone announces purchase of x% of stock Formation: can be adopted without shareholder vote b/c right to declare dividend unilaterallyBut shareholders don’t want the pill to block a good deal for them just b/c the board wants to keep its job… (tension)Purpose: to dilute ownership interest and increase acquisition costProtects against unfair takeover by encouraging acquiror to negotiate with the board Only triggered 3 times ever, so usually works!Board dutiesDE = Unocal (see below) NY and Penn = BJRDeal protection measuresOnly ok if untainted by director interestBidder doesn’t want to be stalking horse (= where his action starts a bidding war), so target can get extra payment in exchange for certainty via these:No shop = board won’t actively solicit biddersNo talk = board won’t talk with potential suitors who come knockingLock-up = bidder can buy selected shares/assets at a discount Stockholder voting agreements = major stockholders agree to vote for the transaction to assure sufficient shareholder approval in advanceTermination/break-up feesForce-the-vote provisions (Omnicare)= where board agrees to submit merger to shareholder vote even if it withdraws its own support for a superior proposal CA = doesn’t allow it?DE and Model Act = ok with fiduciary out?DE doesn’t approve locked deals without shareholder approvalEnhanced Board Duties in Takeovers (b/c risk of entrenchment)For unilateral defensive measures:Threshold = Unocal proportionality test before BJR protection where must (= met here b/c reasonable grounds to believe danger to corporate policy b/c of P’s stock ownership since approved by independent board, and defensive measure of self-tender offer was reasonable to this threat):Reasonably perceive a threat to current corporate strategy as shown by:Acting in good faithInformed through reasonable investigation (helps to have independent committee)Have defensive measures that are balanced/proportional to the threat, not draconianMust be reasonable chance you can get a better value for the shareholdersSome states just call it a duty of loyalty issue b/c self-dealing (b/c want to stay in power)For deal protective devicesCan’t be preclusive or draconian (Omnicare = when it’s mathematically impossible under a contractual lock-up measure for other proposals to succeed and the vote is forced, these contractual expectations must yield to supervening director fiduciary duties)When break-up/sale is inevitable (no longer defending it):= duty shifts from preservation of the corporate entity to maximizing value for shareholders (Revlon = no BJR b/c focused on shoring up sagging market for note-holders [contract creditors, not shareholders] instead of getting best price for shareholders)So when bidding is in progress can’t have concern for anyone/thing unless it is rationally related to benefiting shareholdersThis duty only comes up once the decision to sell has been made (Lyondell = ok for board to “wait and see” while in play since this is exercise of business judgment, not conscious disregard of duties) --------------------------------------FEDERAL SECURITIES REGULATION-------------------------------------State Securities Laws (based on merit review)Mostly preemptedSubstantive review of whether securities are suitable for citizens (paternalistic) Federal Securities Laws (based on full disclosure)Securities Act of 1933Regulation of offersMust register a statement with the SEC unless:There’s a federal and state exemption (e.g. 4(2) = transactions by an issuer not involving any public offering)Must be made by a prospectusRegulation of salesRegistration statement must be declared effective by the SEC unless exemptionSecurities Exchange Act of 1934Formed SECImplemented quarterly and annual reporting for companies that have issued securitiesRegulates:Insider trading Purpose: efficiency, fairness, administrability 10(b) = Board anti-fraud mandate, where can’t dupe shareholders into selling shares cheaply to you based on insider info Theories:Classical = insiders shouldn’t deal with their shareholders from a position of superior info (duty of candor) (Chiarella = when D learned info from working at printing press and then traded on it his silence is ok b/c no affirmative duty to disclose so no fraud)Misappropriation = insider trading if some duty to another party was breached in connection with the trade (O’Hagan = lawyer who gets info from around the firm and trades on it violates 10(b) b/c owed duty to his firm)“Duty” can arise even if just history of sharing confidencesCommunications (e.g. proxy solicitation) Acquisitions and tender offersRequires ownership disclosure (so you can’t become a majority owner by secret)Sarbanes-Oxley= imposes uniform requirements on all public companies, many not disclosure-basedDuty of care encroachment on state corporate lawCFOs and CEOS must certify to accuracy of financial statements and that they designed internal controls to promote reliable reportingIndependent audit committee requirementsWhistle-blower protectionsPre-crime reporting proceduresLawyer reportingCode of ethics requirement------------------------------------------SHAREHOLDER LITIGATION----------------------------------------------How to Alter D/O Personal Liability:Exculpation statutes (above)Indemnification statutes (although not permitted for intentional acts)Goal = want to broaden universe of capable ppl who will serve and deter meritless claimsOfficers are employees, so have right to indemnification for expenses/losses in carrying out their employment, but directors aren’tMandatory DE 145(c) = entitled to be indemnified for expenses if they are “successful on the merits” “wholly or otherwise” (Waltuch = success when suit is settled and dismissed with prejudiced where corporation pays but individual doesn’t)Settlement with prejudice and dismissal without any assumption of liability = success in DE (needn’t demonstrate freedom from wrongdoing or go through with a whole trial)CA 317(d) = not “or otherwise” Permissive= empowers but does not require corporations to indemnify anyone who is a part of a suit “by reason of” fact he is D/O (Heffernan = if you make this mandatory and a complaint accuses former director of knowing liabilities because of his position as a director, then nexus is made even though he’s no longer working for you)Purchase insurance Can fill the gap, but limits for intentional acts (so P tries not to sue for fraud b/c wants insurance money)Personal/direct suits (what Ps want)= shareholder sues to enforce his own rightsAllowed in close corporations even if in a public one it would be derivative Examples:DividendsInspection rightsVoting rightsEntrenchmentFraudOppression and dilutionDerivative suits (what Ds want)= shareholder sues on behalf of the corporation for alleged breach of fiduciary dutyLine can be blurry between direct and derivative action…Demand requirement: must ask directors to pursue lawsuit on corporation’s behalf unless they can show demand futility b/c of collusion Most states makes this a matter of BJR, but DE makes a judge apply its own business judgment to see if board can get it (Zapata = court must determine itself whether the motion to terminate the action by the independent committee should be granted given public policy and the corporation’s best interests)If board gets it, can seek dismissal Subject to many procedural rules like FRCP 23.1Effects: P gets attorney’s feesMore complexDistributes recovery to the corporationHas a preclusive effect so others can’t sue ................
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