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STOPPED AT SEPT 24Bean’s RulesLeave a paper trail. If it isn’t written down, it didn’t happen.Things are always more complicated than they seem. Keep peeling the onion even when you know you have finished.There are no legal problems; just people problems.There are no secrets.You will never have all the information you would like to make a decision.No one likes surprises or the person responsible therefor.Just because you don’t hear the footsteps behind you does not mean they’re not following you.When an acquirer comes to you with an offer, the target’s fiduciary duty is to deny and get a higher price“come back with a better price so I can show the court I got the best price”When merger talks start, the price of the target goes upShort term money market investors buy the sharesTarget puts in the poison pill so the acquirer won’t make a tender offer to shareholdersShort term holders want the deal to go through and make a quick profit Acquirer withdraws the offerWas the defense mechanism for the purpose of maximizing shareholder wealth and getting a better price or the purpose of entrenching the egomaniac directors?Wilkes – freeze out of a minority shareholder Massachusetts – three part freeze out test Delaware – freezeouts of minority are allowed, should have bargained for protection Terms to KnowFor profit corporation Non-profit corporation (NPOs) Benefit corporation (hybrid between for profit and non-profit corporations) Board of Directors (BOD) – people who run and make decisions for the company Elected by the shareholders, shareholders do not make decisions for the company – normally CEO is on the BOD, not always though Shareholder: people owning shares of apportion of the company Stakeholder: anyone who can be affected by the action of the business Franchising: system for selective distribution of goods/services under a brand name through outlets owned by independent businessmen Bad faith Boys club Social nature of human beingsOversight Independent directors: member of the company’s BOD who was brought in from outside the company – has not worked with the company for a period of time, not tied to the company’s existing way of doing business – in Mi, have to be less than 5y of being paid by the company to qualify. Executive committee: group of directors appointed on behalf of, and within the powers granted to them by the BOD – operate with the authority of the board between board meetings Fiduciary duty Duty of care Duty of loyalty Business Judgment Rule (DBR): DE 141 Mi 501 Waste P’s burden of proof What must a board do to preclude application of the BJR? BJR and officers Procedural due care Substantive due care Public Benefit Corporation (PBC) – 36 states have PBC laws IntroductionDelaware: Extensive corporate case law and has complete and continually updates corporate law – legislature creates and amends the law frequently to deal with new issues Corporate law is primarily based on state law Other states look to De Legal Entities: Sole proprietorship: Formation: no formalities in formation, individual just forms without action/filing Profit/Loss Sharing: sole proprietor keeps all profits/bears all losses Sole proprietor’s assets belong to the business Pass through taxation – all income from business is the income of the sole proprietor Liability: sole proprietor is personally liable for all the debts of the business General partnership: Formation: consent to form partnership – agreement by partners to participate in a common enterprise for profit – NO public filing necessary One partner/one vote (per capita voting) for ordinary business decisions Unanimous vote for “extraordinary decisions” such as adding a new partner or selling major asset – may be varied by partnership agreement Profit/loss sharing: equal sharing of profits, pro rata sharing of losses (may be varied based on K) Pass through taxation Liability: partners personally liable for all debts of the partnership Limited Liability Partnerships: Formation: filing of certificate, limited partnership agreement required Profit/loss sharing: determined by agreement Pass-through taxation Liability: general partners personally liable for the debts of the partnership, third parties may compel limited partners to satisfy their contribution Have to comply with the states LLP law Corporations: C Corp, B Corp (Non-profit), S Corp, LLC Formation: filing of a certificate of incorporation + registration is required Separation of management and ownership: management by BOD and officers – significant requirements for annual meetings/special meetings Shareholders vote on: Election of directors Extraordinary transactions (mergers, acquisitions, sale of all assets, etc.) Amendments to articles and (in some states) bylaws Non-binding resolutions and requests for studies by shareholder proposal For LLC: members and interest holders (not stock/shareholders) Taxation: C Corp: double taxation B Corp: tax exempt S Corp/LLC/LLP: pass through taxation Liability: generally noneThe Role and Purpose of CorporationsPurpose: to increase/maximize the wealth of the shareholders Shareholders can only lose what they invest in the corporation—individual shareholders are protected from any loss beyond their investment Citizens United v. Federal Election Commission, 558 U.S. 310 (2010) Facts: non-profit company using budget for political speech film (Hillary). CU sought an injunction against the FEC for violating 1A rights. Court never explicitly said corporations are “human beings” RULE: corporations are legal persons A.P. Smith Mfg. Co. v. Barlow, 98 A.2d 581 (1953) Facts: BOD made 1.5k donation to Princeton. Minority shareholder filed suit claiming donation was a violation of maximizing the wealth of shareholders as it might possibly decrease the dividend and profit of the company. Held: charitable contribution is a lawful exercise of the corporation’s powers – Court held that the spending came expressly within the authority of the board permitted by the state – state created enabling laws to allow corp’s to donate and reserved the power to change the laws so by incorporating in that state you are agreeing to present and future lawsA corporation needs board authority for corporation to do anything – powers come from bylaws Ultra vires (outside board’s powers –decision was beyond the power of the corporation) Intra vires (within powers of board of directors—decision was within the power of the corporation)Corporations are there to make profit, but it is ok to do things in public interest Donation here was a valid use of authority, as it created good will in community, created a favorable business environment, and promoted liberal education Benefit corporations are explicitly created to do things other than make profit Business Judgment Rule from AP Smith BOD makes decisions and its presumed that it is done in the best interest of the shareholders – BOD immune from liability if they can show the decision was made within their authority and in good faith Presumption that the board acted: on an informed basis, in good faith, in the honest belief that their action was in the best interest of the corporation Elephant bumping: person trying to get money from another corporation, so they bring another big show with them who supports their pitch so the CEO thinks what they are asking for is right – CEO spends shareholder money, not their ownHow to overcome the BJR:Show duty of care was breached by gross negligence (there is no established criteria for GN) Breached care Breached loyalty Acting in bad faith Dodge v Ford Motor Co., 170 N.W. 668 (1919) Facts: Henry Ford was majority shareholder and the company grew rapidly from 1911 -1916 with regularly yearly dividends at $1.2 million and special dividends as high as $10 million. Ford dropped the car price from $900 to $360 during the boom and said that it would no longer pay special dividends because it wanted to build a new plant. Dodge brought suit to get dividends.Implicit purpose of for-profit corporations is to make profit, not incidental Courts aren’t supposed to declare dividends, but they did hereUsually board decides whether to declare dividendsCorporation cannot make its company less profitable RULE: it is within (intra vires) the BOD power to make a business decision, but it must be in the best interest of the corporation and its shareholders – the court cannot/will not decide when/how much a company pays in dividends Expansion of BJR: more power to courts and less deference because court reaches the substance of Ford’s decision to not make dividends Narrow exception to the presumption of integrity in director decision-making for cases in which decision makes refuse to evaluate the range of options and take an irrational decision with no business purpose Dominant Shareholder (Ds): person who owns a controlling number of shares in a company – shareholders elect who is BOD, Ds has huge influence based on one share/one vote Dodge v. Ford today: Trend is that corporations’ decisions are not based solely off maximizing the wealth of shareholders – can consider humanitarian concerns, common goods, etc. – Ford would claim that not paying dividends and reinvesting money into the company and cutting the price of cars would be profitable long term just need to related the business decision to business purpose that will benefit the company Shlensky v. Wrigley, 237 N.E.2d 776 (1968) Lights at Wrigley – a corporation’s president and board have authority to determine what course of action is best for the business – as long as they can show a valid business purpose for their decision, that decision will be given great deference by the courts – court will not disturb BRJ absent a showing of fraud, illegality, conflict of interest. BJR: presumption that board formed judgment in good faith to promote corporation’s best interest BJR is rebutted where the decision:Lacks a business purpose (care/loyalty)Is tainted by conflict of interest or is otherwise self-interested (loyalty)Is so egregiously bad that it amounted to a no-win decision (very rare-care or loyalty) Corporate opportunity (loyalty) Results from a conscious failure to exercise oversight and supervision (care or loyalty)Uninformed decision-making (care)Law-breaking – when a director makes a decision that breaks the law (loyalty)BJR is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the cation taken was in the best interest of the companyPublic Benefit CorporationLyondell Exam Question Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (2009)A court will find that a director acted in bad faith if the director intentionally failed to act in the face of a known duty to act, demonstrating a conscious disregard for the duty.Held: A fiduciary satisfies its good-faith requirement if it cannot be demonstrated that the fiduciary intentionally failed to act in the face of a known duty to act.????????Disney: bad faith fiduciary behavior varying standardsSubjective bad faith: motived by actual intent to do harmLack of due care: fiduciary action taken only by reason of gross negligence and without any malevolent intent; failure to inform self of available material facts, without more, cannot constitute bad faith Intentional dereliction of duty: conscious disregard for one’s responsibilities; intentionally fails to act in face of known duty to act Revlon duties don’t arise because in play; only have duty to seek best available price when board embarks on a transaction its own or in response to an offer that will result in change of control – no court can tell how get best price Shares: must be authorized by the articles of incorporation Common shares: give holder the right to any profits generated by the company, if the BOD ultimately approves the distribution Corporate Shares: common shares with equal voting rights and with equal rights to residual claims of the corporation Options: similar to shares, investor only as a residual claim, can tie to an employee’s performance Call options: give the holder of the option a right to buy Out of the money: stock doesn’t reach the option price In the money: stock is higher than the option price Put option: gives the holder of the option the right to sell Debt: corporation may borrow from smaller investors by issuing bonds or debentures Holders of debt have little say in operation, but get paid out first The BOD of a PBC has to consider the public benefit, in addition to shareholder return on investment, in their decision-making. Although state corporate law statutes and the tax code treat PBCs as for-profit enterprises, the legal focus is not solely maximizing shareholder wealth. The PBC laws empower the BOD to consider additional stakeholders alongside?shareholders and leave it to the board to determine the relative weight to place on shareholders’ and other stakeholders’ interests.What Are the Legal Requirements for a PBC?In general, much of the traditional corporate law and structure apply equally to PBCs.? The most significant legal requirement of PBC laws is that a PBC’s directors must consider constituencies in addition to the company’s shareholders.?Under the Delaware statute, once a corporation has become a PBC, its board must:“Balance” the interests of the shareholders, other constituencies affected by the company’s conduct, and the specific public benefits identified in the corporation’s certificate of incorporationProvide to shareholders biennial reports regarding the PBC’s promotion of the public benefit; andBefore issuing or selling shares, notify any person acquiring the shares that the corporation is a PBCOther states have stricter requirements.?Model Public Benefit Corporation Law -- §201. Corporate Purpose General public benefit purpose. - A benefit corporation shall have a purpose of creating general public benefit. This purpose is in addition to its purpose under [cite section of the business corporation law on the purpose of business corporations].Optional specific public benefit purpose. - The articles of incorporation of a benefit corporation may identify one or more specific public benefits that it is the purpose of the benefit corporation to create in addition to its purposes under [cite section of the business corporation law on the purpose of business corporations] and subsection (a). The identification of a specific public benefit under this subsection does not limit the purpose of a benefit corporation to create general public benefit under subsection (a).Effect of purposes. - The creation of general public benefit and specific public benefit under subsections (a) and (b) is in the best interests of the benefit ment: Every benefit corporation has the corporate purpose of creating general public benefit. A benefit corporation may also elect to pursue specific public benefits under subsection (b).Subsection (c) confirms that pursuing general and specific public benefit is in the best interests of the benefit corporation. Because the basic duty of a director is to act in a manner that the director reasonably believes to be in the best interests of the corporation, decisions by the board of directors that promote the creation of general or specific public benefit will satisfy the requirement to act in the best interests of the corporation. If an ordinary business corporation includes in its articles of incorporation a statement of a specific purpose, it is by definition in the best interests of the corporation for the directors to pursue that purpose. Thus the rule in subsection (c) would be the case in any event with respect to specific public benefit purposes, but specific public benefits have been referred to expressly in subsection (c) to avoid the confusion that might result if subsection (c) only applied to the creation of general public benefit.AGENCYFiduciary Obligation of AgentsBasic issue in corporate law is tension between giving directors freedom to act in their judgement, decision making autonomy and punishing them for “misdeeds” Why incorporate? – limits liability, most you can lose is your investment, difficult to pierce the corporate veil Agency: Formation: Need consent of the partiesPrincipal consent to the agent acting on their behalf Agent consents to do as directed Principal has control over agents – broad control Liability of principal to third parties Tort: principal may be liable if agent was acting on behalfContract liability: principal bound to K formed by agentFacts of agency: Principal, agent, third party Apparent authority: agent has authority to act on behalf of the principal, based on conduct or “holding out” by the principal suggesting that the agent has the authority to act on her behalf and the third party’s reasonable belief that the agent has the power to act on the principal’s behalf. Duties of Agent to principal: duty to be loyal in all matters connected with the agency relationship/candor/diligence/obedience Loyalty: a duty to avoid self-dealing or taking of opportunities of the principal The agent is liable to disgorge any/all secret profits obtained from a transaction that breaches the duty of loyaltyDuty of candor – duty to provide information to the beneficiary; this is often not clearly expressed as a subset of the duty of loyalty but can be best understood in this wayDuty of good faith and fair dealing – agent has a duty to her principal to act with due care and diligence in executing tasks (tort/contract principals) Reading v. Regem, 2 KB 268 (1948) – solider using position to get things around CairoWhen a servant uses their position for personal profit without the consent of the master, the master is entitled to the proceeds of the unauthorized undertaking Agent is disloyal if take advantage of the position he was in and could not have gained personally otherwise – result: disgorgement of profits to the principle Agents have fiduciary duties to the principal General Automotive Manu Co. v. Singer, 120 N.W.2d 659 (1963)Agent has a duty to act in good faith and to further the interests of the principal – can’t compete in the same business Employee violates his fiduciary duty when he is engaged in competitive activities Obligation to pursue utmost good faith and loyalty and not act adversely to principal – disgorgement is the remedy because he did not disclose Rash v. J.V. Intermediate, 498 F3d 1201` (10th Cir. 2007)Agents basic fiduciary duties include: duty to account for profits; duty not the compete with the principal; duty of full disclosure on matter pertinent to the principal’s business; deal opening with employer and to fully disclose to the employer matters affecting company business Game plan day 2: FINAL EXAM question: “Similar issue” but different facts, did Salmon or GA eliminate further litigation in this area? Business law deals in equity and the results are always “fact specific.”PartnershipsCharacteristics of a partnershipPersonal liability of partnersLimited durationDissolution on exit of one partner No independent existence apart from other membersLimited transferability of ownership interestsPass through taxation (no double taxation)Income is actually income of the individual partners Types of PartnershipsGeneral PartnershipRelatively simpleInformalNo limitation of liabilityPass-through taxationLimited PartnershipFiling of certificate and agreement (with the state)General partners are personally liable; limited partners are notMUST have someone with unlimited liabilityCorporations can also be partnersGeneral partners run company, limited partners have limited abilities Pass-through taxationPartnership Laws Uniform Partnership Act 1917Partnership is an aggregate of its partnersIf a partner dies or leaves the partnership is terminated Each partner individually owns portion of all the assets Revised Uniform Partnership Act In general, a partnership is an entity In the partnership agreement the partnership can state that a partner can leave or die and the partnership will survive as an entity A majority of U.S. jurisdictions have adopted some form of either the UPA or the RUPA.Michigan Uniform Partnership Act at M.C.L. §§ 449.1 – 449.48 / Delaware Revised Uniform Partnership Act at Del. Title 6, §§ 15-101 – 15-1210.Only unsophisticated people with no access to legal advice (or those who believe know better than their lawyers) consciously form general partnerships now.The partnership form is fraught with the danger of liability for one’s partners’ actsThe availability of LLC, LLP, LLLP, PC, and other limited liability entities means that it is easy and cheap to avoid the dangers of partnership liability.Fiduciary Obligations of PartnersDuty of Care: directors have a fiduciary relationship to the corporation and must exercise the care of ordinary prudent and diligent persons in the like position under similar circumstances Duty of Loyalty: directors have a fiduciary to act on behalf of the beneficiary and to place the beneficiary’s interest ahead of the interest of the fiduciary Ways to violate duty of loyalty: Agent receives a payment from a third party in connection with a transaction actually between the principal and the third party. (Kickback (easy) versus tip or gratuity (harder?))Agent makes a secret profit by doing a transacting with the principal. (e.g., real estate agent secretly sending potential buyers away and purchasing the client’s house on the cheap); or selling a property s/he owns while the principal believes the agent is acting merely as agent.Agent uses their position to make a personal profit from someone who has no relationship whatsoever to the principal. (General Automotive)Meinhard v Salmon, 164 N.E. 545 (1928) Facts: Gerry leased property to Salmon to convert a hotel into office and retail space – Salmon (real estate developer) did not have the money to alter the building, so he got money from Meinhard (wool merchant)—Salmon invested half in alteration and Meinhard invested half in alteration During the first 5 years Salmon would split the profits 60/40 and the remaining 15 years they would split the profits 50/50. End of the original lease: Gerry offered Salmon more property right next to the original building for development Second lease began January 1922 and first lease ended April 1922. Salmon accepted the new development during his original lease term with MeinhardSalmon did not disclose the second lease to Meinhard and took it on to himself He could have limited the partnership to the first lease if he would have written it down in an agreement According to Cardozo, Salmon should have:Disclosed the new lease to MeinhardShared new profits with MeinhardGiven Meinhard the opportunity to contribute to second lease Held: Salmon and Meinhard were partners (co-adventurers) based on their business relationship therefore Salmon owned a fiduciary duty to Meinhard. Salmon’s opportunity arose as a result of his status as the managing co-adventurer, therefore he had a duty to tell Meinhard about it. (duty of loyalty)Cardozo extends Salmon and Meinhard’s original business venture to the second lease to mirror their obligations under the original leaseS awarded 51% of the shares of the partnership because he was allowed to control the company under the original leaseM awarded 49% of the shares because he was solely an investor under the original lease Rule: You can enter into a partnership without even knowing it or without having a formal agreement based on the parties’ relationship. Co-adventurers, like partners, have a fiduciary duty to each other, including sharing in any benefits that result from the parties’ joint venture. Joint ventures, like partners, owe each other the duty of highest loyalty while their venture continues Bean’s Rule – if it isn’t written down, it didn’t happenCorporate opportunities cannot be stolen by board or shareholders Raising Additional Capital: Each shareholder invests money and that goes into the corporate treasury Capital is used for operations Can’t issue bonds or sell stock to gain more capital for the corporation Buyout Agreement: a form of disassociation which occurs when a partner is no longer to be associated with the partnership, though the partnership may continue without that partnerVoluntary or involuntaryCalled a buy-out/buy-sell agreement Allows a partner to end their relationship with the other partners and receive a cash payment, series of payments, or some assets of the firm in return for her interest Good agreement must be tailored to the needs and circumstances Price is to be paid to the dissociated partner to equal the partner’s pro rata share of the partnership as if it were sold as the date of the dissociation Must occur soon after receiving the demand from the dissociated partner RUPA says 4m Wrongful dissociation can create liability for the dissociating partner Such as if the agreement is for a specific term or undertaking The buyout will be deferred until the end of the term/undertaking This applies to LLC arrangements also called an “exit strategy” In all buyout agreements, price and valuation are critical and never simple how do you value a business interest in a “going concern”? Valuation problems: no market/minority interest/control premium Solutions to valuation problems: Hire an appraiser Use book value-stale, mechanical, seldom, if ever, the same as “market” Original “going-in” agreement should provide some mutually acceptable method because it certainty will not be mutually acceptable when there is a dispute Outline of a buyout Trigger events: death, disability, will of any partner Obligation to buy v. option Firm Other investors Consequences of refusal to buy If there is an obligation If there is no obligation Price: Book value Appraisal Formula (e.g. 5x earnings) Set price each year Relation to duration (e.g. lower price in first 5 years) Method of payment: cash v. installments (with interest?) Protection against debts of partnership Procedure for offering either to buy or sell First mover forces others to set price G&A Investments v. Belman, 1984The mere filing of a complaint seeking remedies including the judicial dissolution of a partnership does not as a dissolution of the partnership A partner’s capital account is calculated by adding up the cost basis of all contributions the partner has made to the partnership, then subtracting all distributions the partner has received. Buy out formula: the amount shall be calculated as follows: by the addition of the sums of the amount of the resigning or retiring general partners capital account plus an amount equal to the average of the prior 3y profits and gains actually paid to the general partner, or as agreed upon by the general partners, provided said agreed sum does not exceed the calculated sum in dollars. CorporationsNature of the CorporationWhy Delaware: predictability – there is a huge case law body on what De statutes mean flexibility – substantial management flexibility judicial expertise – corporate law litigation in De is quick and judges are skilled legislative reform—De legislatures work closely with De bar to constantly reform their corporate and other laws to remove ambiguities, enhance predictability, and thus maintain their competitive edge specialized courts – DE chancery court for corporate matters Internal affairs doctrine: MBCA 15.05nationally, the law of the state of incorporation governs the relationship among the parties within the corporation doctrine does not apply to corporate relations with third parties state and federal courts outside De must follow corporate law rules of incorporating state, even if inconsistent with forum state law De does NOT follow the MBCA –De law is important regardless of where you actually practice Characteristics of a corporation: 6 things (1) Perpetual existence: unless otherwise designated in charter/articles/certificate(2) Separate existence: a corporation is a legal person; a single entity capable of owning property, contracting, committing crimes (In the US at least) and torts, suing and being sued Have some constitutional rights of natural persons YES: due process for property interest, equal protection, and commercial speech NO: privilege against self-incrimination, limited 4A rights against search and seizure, limited 1A RIGHRS Taxation: double taxation of corporate dividends and other distributions. Corporations (with the exception of S-corps, LLC, Sole Proprietorships) are taxed as individuals. Any distributions to shareholders are also income to those shareholders. This is seen as a major flaw and the most common reason other forms of business enterprises are utilized. E.g. Corporation makes $100. The corporation is taxed on the income at the corporate tax rate (35%). Corporation distributed the remainder of the $65 to shareholder who is then taxed 25% on the $65. (3) Limited Liability: in general, shareholders, officers, and directors are not liable to third parties for the debts of the corporation. Third parties’ contract with the corporation, not with an aggregate of partners or with a limited partnership and general partners. Likewise, with torts and tort liability. the veil of limited liability and separate exitance may be “pierced” in special circumstances thereby subjecting shareholders, generally those who are also directors who have behaved badly, to unlimited personal liability for the debts of the corporation. (4) Centralized Management by a board of directors (BOD)Separation of ownership and control. Every corporation must have a board of directors that manages the corporation.Only the board of directors, acting as a unit, can speak on behalf of the corporation or establish policy for the corporation. This permits shareholders to add their capital contribution to an entity managed by experts, get the advantage of their expertise in terms of returns on their investment, and yet avoid liability if things go bad.Officers of the corporation (e.g., CEO, CFO, vice-presidents, treasurer, secretary, etc.) manage the day-to-day affairs of the corporation in accordance with policies of the Board.Directors and officers are agents of the corporation but owe fiduciary duties to both the corporation and to the shareholders.(5) Passive Ownership by stockholdersStockholders have an extremely limited voice in corporate affairs of “public” corporations with many stockholders. Retail Shareholders effectively have no voice because of the transaction costs of coming together and acting as a group. (“hot issue” at the SEC and under attack)Shareholders vote on (1) election of directors, (2) extraordinary transactions (mergers, acquisitions, sale of all assets), (3) amendments to articles and bylaws, (4) non-binding resolutions Institutional participants in the stock market have an inordinate amount of influence. EX. “flash trading,” buy and sell millions of shares in several nanoseconds, taking advantage of nominal price differentials and other market anomalies. Are they shareholders? Purpose is to get in and out in less than a second. Minority shareholders generally express disapproval of corporate actions in a widely held, “public” company by “voting with their feet” (selling). They do not badger Management/Board, they simply sell. This is generally deemed to be what any “rational stockholder” would do. The point is to make money not change the company (6) Freely Transferable ownership interestsIn large corporations traded on major exchanges no one cares who the owners of the stock are. When one purchases shares on an exchange in a normal trade, the issuing company whose name is on the security traded has nothing to do with the trade and does not receive those funds. The seller gets the purchase price, the shareholder voting with his feet. The corporation receives proceeds on an exchange only when an initial public offering (“IPO”) is arranged or a subsequent offer is made by the anizing a Corporation:Articles of incorporation Also referred to as a “certificate” of incorporation (which is the document actually filed with the state of organization to create the corporation as a legal person) or the “corporate charter.” This document prescribes statutorily-required items [See DGCL § 102] such as:NameRegistered Office and Agent [WHAT IS THIS FOR?]Capital Structure (specify securities the corporation can issue)Purpose and Powers Most states now permit incorporators to state the corporation’s purpose as “to conduct any legal activities.” Initial CapitalizationSize and composition of board of directorsBy-laws provide details on internal operations Constituents and Terms Corporate actorsShareholders – own corporation, elect board of directors.Board of directors – manage affairs, including hiring top corporate officers (CEO, CFO, etc.)“Inside” directors - those who have full-time jobs within the corporation.“Outside,” or independent directors – high credential members (CFO, CEO) of other companies who are on the BOD Management / officers – a president and secretary are required by most corporate law statutes. There may also be numerous others, e.g. Vice Presidents, Chief Information Officer, Treasurer, and any other label the Board of Directors authorizes within the company.Corporate securitiesEquity securitiescommon stockpreferred stockDebt securitiesCorporate bonds - (generally these are “secured,” or backed by specific assets pledged to enhance the ability of bond holders to collect their investment if things turn sour). One means for legal entities to borrow money, pledging assets they own as security (think home mortgage or security interest on an auto loan).DeBENtures - These debt instruments (also referred to as securities) representing amounts borrowed by an entity that are not secured by specific assets and depend upon the overall credit of the entity for repayment.various levels Senior debtJunior debt (repaid in liquidation only after “senior” debt has been satisfied)SubordinatedConvertibleSources of corporate lawHistoryState corporation lawsDelawareModel Business Corporation ActJudge-made lawCorporation statutes are just general frameworks that specify the structure of the corporate form.Courts have been forced to create something like a common-law of corporations to fill in the gaps (which corporate lawyers are inevitably going to attempt to create to serve their clients’ interests).Judge-made law is easily apparent in the “fiduciary duties” for directors, officers, and controlling shareholders. Recall SalmonFederal lawThere is no specific federal statutory scheme for corporations, although there are a few federal corporations. The federal government exercises nearly exclusive control over the trading of securities by public.Securities Act of 1933 – registration of securities and disclosure requirements for offerings of securities.Securities Exchange Act of 1934 – periodic reporting requirements for securities of corporations subject to the ‘34 Act anti-fraud provisions for corporations subject to that law.Private Securities Litigation Reform Act of 1995 – procedural and substantive requirements for maintenance of securities fraud class actions against issuers by private litigants. Sarbanes-Oxley Act of 2002 – controls on financial reporting by publicly traded companies, prohibitions on personal loans to corporate officers and directors, disclosure of internal controls, and professional conduct regulations for corporate lawyers and accountants. The Dodd-Frank bill (special interest legislation).Corporate Social Responsibility: At least 2 important competing theories of how a corporation should be viewed: Private property of its stockholders (traditional American view, but definitely under attack in recent decades) although with responsibilities in fact to other constituencies or “stakeholders” such as employees, customers, local communities, the environment, etc. Social institution with public duties and responsibilities Promoters and the Corporate EntityA promoter is one who has an original idea and forms a corporation after he has entered into a contract on behalf of the corporationPre-incorporation promoter contracts – commitments on behalf of the legal entity that will operate the business prior to the formation of that entity Even if the corporation adopts a contract, the promoter is still individually liable unless the third party releases the promoter The promoter is personally liable until the new entity is formed -- then the promoter wants the new business to be responsible and for his liability to disappear Investors may be liable in agency or in contract for pre-incorporation contracts.Investors may also be found to have formed a general partnership pre-incorporation and may be liable on that basis. The extent to which promoters can bind a corporation pre-incorporationDe facto corporation – a court may treat a firm not properly incorporated as though it were a corporation if the organizers:in good faith tried to incorporatehad a legal right to do so (law authorized incorporation by those incorporators)acted as a corporation Corporation by Estoppel – plaintiff has recognized corporation and acted as if it existed Southern Gulf Marine Co. No. 9, Inc v. Camcraft Facts: P purchased a boat from D and signed boat contract in his capacity as president of SG before company was actually formed. Ended up incorporating somewhere other than where contract said would do so)Promoter: Agent for those who want to be invested in company; fiduciary dutiesPersonally responsible if company is never formed; responsible after formation unless third party releases youCorporation only a party to K if it adopts pre-incorporating KsPromoter is the agent had has fiduciary dutiesWhen a party contracts with an organization, it cannot later raise the legal nature of the organization as a defense Corporation by estoppel: One who contracts with what he acknowledges to be and treats as a corporation, incurring obligations in its favor, is estopped from denying its corporate existence, particularly when the obligations are sought to be enforced (aka you already recognized the crop so can’t say it didn’t exist)Exception: Substantial rights affectedPlaintiff has recognized corporation and acted as if corporation existsDefendant informed that not yet a company and that incorporated elsewhere De facto corporation: A court may treat a firm not properly incorporated as though it were a corporation if the organizers (1) in good faith tried to incorporate; (2) had a legal right to do so; and (3) acted as a corporationDuray Development, LLC v. Perrin, 792 N.W. 749 2010Duray is a residential development company, sole member is Robert Munger. Sept 30 - Entered into a contract with Perrin to excavate property, Perrin signed for himselfOct 27 – new contract/same language intended to supersede the old one, BUT between Duray and Outlaw (Perrin’s new company that was not formed at the time of the first contract)Made the new contract at the time they thought Outlaw was a valid LLC, but it did not obtain filed status until Nov 29, so it was not valid Perrin signed the new contract on behalf of Outlaw and held himself as the owner Contract continued with Outlaw as the contractor Outlaw did not perform on time, Duray sued for breach of contractHeld: De facto corporation doctrine applies to Outlaw, therefore it is liable for the breach. ALSO corporation by estoppel CAN apply to LLCs as well. Similarities between Business Corporation Act and LLC Act supports the conclusion that the de facto corporation doctrine applies to both Always make sure to have a paper trail De Facto corporation doctrine: 4 elements Proceeded in good faith Under a valid statute For an organized purpose Executed and acknowledged articles of association pursuant to that purpose Corporation de facto instantly comes into being Piercing the Veil and Limited Liability A Creditor of the corporation sues the shareholder personally for the debt the corp owes If the separate existence of the corporation has been respected, then the creditor cannot pierce the corporate veil, disregard the corporate entity, and hold a corporation’s shareholders personally liable for the acts and debts of the corporation If you pierce the parent company, you cannot sue one subsidiary of the same parent company if the two are unrelated Walkovszky v. Carlton, 223 NE2d 6 (1966) P got hit by a cab. D had 10 corporations, each with 2 cabs and only the minimum $10k required liability insurance and had nothing left. P claimed the corporations operated as single entity. Courts said no alter ego/no fraud since he maintained the limited insurance. The law permits the incorporation of a business for the very purpose of enabling its proprietors to escape personal liability, but the privilege is not without its limits.Limit: The court will disregard the corporate forms or pierce the corporate veil whenever necessary to prevent fraud or achieve equityIf you maintain honesty, faithfully the legal corporate existence, separate individuality of the corporation, the shareholder is safe—follow the rules, and keep your records straight with a paper trail to prove itMust be evidence that the owners were merely using the company as a shell Enterprise liability: Go after all of the corporate that this is part of; individual entitles jointly held liable because shared in enterpriseRuns business with 20 cabs as a means of avoiding liability so want to get at enterprise as a whole (wouldn’t help here)Pierce corporation veil: Get through to shareholders to prevent fraud or achieve equity because using corporation as dummy for personal endsEnterprise Liability: ignore the separate existence and go after all the corporations of the joint enterprise; individual entities jointly held liable for other companies in the joint enterprise Characteristics: several related corporations that are all part of the same corporation or two commonly owned corporations (brother/sister) operating as a single enterpriseThis won’t make the shareholders liable: this just reaches the assets of the other corporations that are acting as a single enterprise with the first corporation Distinction from piercing the corporate veil To avoid enterprise liability: keep separate books/bank accounts for the separate corps. And avoid sharing assets, suppliers, and other resources NetJets Aviation, Inc. v LHC Communications, LLC, Court will pierce the LLC veil if: There is overall injustice or unfairness; and The LLC is a mere instrumentality or alter ego of its owner, in that the LCC and the owner operate as a single economic unit NetJets (π) leased to LHC (?) an interest in an airplane for a term of five years. LHC was a limited liability company (LLC) whose only member-owner was Zimmerman (defendant). Zimmerman had sole authority to make all financial decisions with respect to LHC. He often withdrew money from LHC’s account for personal use and transferred money into LHC’s account from his own personal account. Zimmerman did not have any written agreements with LHC regarding this comingling of funds. Many withdrawals from LHC’s account were for personal expenses, including a residence, phone and cleaning bills, a car, and health insurance for his family. He also took them out as loans to avoid taxesMuch of the flight time used by LHC under the lease with NetJets was used by Zimmerman and his family for personal trips. LHC terminated the lease agreement with NetJets and LHC ceased operations, owing NetJets a balance of $340,840.39. Rule: DE law permits a court to pierce the corporate veil of an LLC where there is fraud or where the corporation is in fact a “mere instrumentality or alter ego of its owner” Held: NetJets was entitled to pierce the corporate veil because there was evidence that 1) Zimmerman and LHC operated as a single economic entity and 2) there was an element of unfairnessUnfairness was demonstrated by:Took out the money as loans rather than distributions to avoid tax consequencesPossibly violated DE law:An LLC shall not make a distribution if it would result in all liability of the LLC exceeding the fair value of the assets of the LLC. Ex. He said he could not pay debts to NetJets but was given title to a car of equal value in the same year Ex. Withdrew money as soon as it was paid to the LLCEx. After termination of the contract, Zimmerman withdrew ~$750K more than he put in The withdrawals overall exceeded the deposits by 3MAlter Ego Theory: A P does not have to show actual fraud but must show a mingling of the operations of the entity plus an overall element of injustice or unfairness Analysis: start with corporate operations and D’s relationship with the corporation Was the corporation adequately capitalized? Was the corporation solvent? Were dividends paid? Were records kept?Did officers/directors function properly? Were corporate formalities observed? Did the dominant shareholder siphon corporate funds? Was the corporation simply a fa?ade for the dominant shareholder?No single factor is sufficient, totality analysis – NEED the overall element of injustice or unfairness Terms: Cumulative: with preferred stock, the certificate of preference may contractually provide that unpaid dividend are carried forward and accumulate Classes of stock: corporation may issue different classes of stock that have different rights as per the articles of incorporation and the bylaws Best practices: (Disney) the practices the directors and officers of a corporation would use in the perfect world De facto officer: an individual who has not been appointed as an officer through proper channels, but who acts as an officer with proper authority and the board ratifies this behavior some way or someone who is held out by the corporation to the public as having the requisite authority Overcoming the presumption of the BJR: (Kamin) to overcome the presumption of the BJR, the P must show that the director or directors acted in a self-interested manner or acted without sufficient knowledge or thought about the subject. Have to show fraud, oppression, arbitrary action, breach of trust Compensation committee: (Disney) allows under DE law 141(c) – allows boards to delegate responsibilities to committees. Compensation committee is generally made of independent directors on the board Oversight: (Francis/Caremark) – the board must have a plan in place to actively monitor the activities of the corporations employees Mifeasance by the board: (Francis) the board failed in exercising its duties – the board knowingly did something in violation of their duties Duty of good faith: (Disney) a breach of duty of good faith can be shown: Where a fiduciary acts with a purpose other than that of advancing the best interest of the corporation Acts with the intent applicable positive law Intentionally fails to act in the face of a known duty to act demonstrating a conscious disregard for his duties Sea-Land Services, Inc. v. Pepper Source, 941 F.2d 519 (7th Cir.1991) SL sent peppers and Pepper Source did not pay. SL brought suit against Marchese, the owner for 5 business entities that he owned where he was the only shareholder or 1 of 2 shareholders. Here, debt was the only alleged “wrong” and that is not enough to prove fraud. There was shared control/unity—sole shareholder, no corporate meetings, no articles, no bylaws, all companies ran out of the same office, same phone line, same expense accounts. M also borrowed substantial sums of money from the corporations without interest and used bank accounts to pay personal expenses.A corporate entity will be disregarded and the veil of limited liability pierced when 2 requirements are met: (Van Dorn Test) There must be such unity of interest and ownership that the separate personalities of the corporation and the individual [or other corporation] no longer exist Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice ????????As for determining whether a corporation is so controlled by another to justify disregarding their separate identities, focuses on 4 factors The failure to maintain adequate corporate records or to comply with corporate formalities The commingling of funds or assets Undercapitalization One corporation treating the assets of another corporation as its own Van Dorn Piercing the Corporate Veil TestFormalities Requirement - Unity of interest and ownership that the separate personalities of the corporation and the individual shareholder (whether individual or corporation) no longer exist Unity of Interest Factors:Failure to maintain adequate corporate records/comply with corporate formalitiesCommingling of funds or assetsUndercapitalization One corporation treating the assets of another as its own Fairness Requirement - Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injusticePromoting injustice: some element of unfairness, fraud or deception or the existence of a compelling public interest must be present to disregard the limited liability of the corporation Company not being able to pay debt is not sufficient Roman Catholic Archbishop of San Francisco v. Sheffield –Alter ego Alter Ego Theory of Piercing the Corporate Veil: Where there has been an abuse of corporate privilege because of which the equitable owner of a corporation will be held liable for the actions of the corporationsIndivid/parent corp may be held liable through piercing the corporate veil for the acts of its subsidiary if the subsidiary corp is so controlled as to be the alter ego of mere instrumentality of the parent corp/stockholder. The corp form may be disregarded and liability imposed on the individual/parent corp where separateness of entities has ceasedThe corporation is not only influenced and governed by that person or other entity, but there is such unity of interest and ownership that the individuality or separateness, of such person and corporation has ceased, and the facts are such that an adherence to the fiction of the separate existence of the corporation would, under the particular circumstances, sanction a fraud or promote injusticeFactors:Commingling of funds and other assets of the two entitiesThe holding out by one entity that is liable for the debts of the otherIdentical equitable ownership in the two entitiesUse of the same offices and employeesUse of one as a mere shell or conduit for the affairs of the otherEven if you pierced the corporate veil to the parent company, can’t then go back down and pierce into other subsidiaries (can’t go up and down—can pierce up to the parent, but not to the brother/sister companies)In re Silicone Gel Breast Implants Products Liability LitigationPeirce the corporate veil up to the parent, not the owners the parent and subsidiary share a unity of interest and control, such that the subsidiary corporation is essentially the “alter ego” of the parent, and that, absent piercing, some form of “injustice” will result.Unity of Interest/Substantial Domination FactorsCommon directors or officersCommon business departmentsConsolidated financial statements and tax returnsParent finances the subsidiaryParent caused the incorporation of the subsidiary Subsidiary operates with grossly inadequate capitalParent pays salries/expenses of subsidiary Subsidiary receives no business except that given to it by the parentParent uses the subsidiary’s property as its own Daily operations of the two corporations are not kept separateSubsidiary does not observe the basic corporate formalities Keeping separate books/record and holding shareholder/board meetingsFraud or injustice – in tort cases, as opposed to contract cases, a showing of fraud, injustice, or inequality is not necessary A subsidiary cannot be held liable for the actions of a sister subsidiary – you have to go to the parent and then back down to the other subsidiaries through enterprise liability No one has ever pierced to the corporate shareholders in a public company Limited Liability PartnershipsOrganized for profit, permits investors to invest money and they will only risk losing their investments and nothing else No individual is liable for the debts of the partnership Form of tax shelter organization: meaning investments that show losses for tax purposes even though the company may be successful economically LL partnership allowed investors to claim their pro rata share of the artificial losses of the partnership on their individual tax return Not possible in the corporate forum The basic partnership allowed this tax benefit BUT the limited partnership gave the limited partners the corporate advantage of limited liability Limited partnerships must have a general partner with unlimited liability – a corporation as that general partner works Frigidaire Sales Corporation v. Union Properties, Inc., 562 P.2d 244 (1977) Frigidaire entered unto K with Commercial where Commercial was the limited partner and Union Properties was the general partner. General controlled management and day to day activities of Commercial. Mannon and Baxter were officers and directors of UP and controlled Commercial through UP. Commercial breached K and P sued Mannon and Baxter as individuals.Limited partners do not incur general liability simply because they were officers, directors, or shareholders in the corporate general partnerLimited partnerships must have a general partner with unlimited liability and a corporation can be the general partner (under WA law where this case was)Once limited partners operate day to day operations, they become general partnersThe corporate directors of a parent corporation that exerts control over a subsidiary do not incur liability for the subsidiary for acting in their role as directors Once someone filed bankruptcy, all litigation is stopped Terms: Structural Bias: term used to refer to the tendency of a board to act unanimously and to protect the members of the group Classified: the corporation has separate classes of stock (eg. Class A, Class B, etc) and each class votes on a separate slate of directors so that Class A is voting for XYZ and Class B is voting for TUV Staggered: can be a classified board, but the directors are voted in a rotating manner so that only a portion of the board is elected each year. Preemptive (Benihana): a right to purchase stock in proportion to the stockholder’s current ownership interest whenever the corporation issues new stock Entire fairness: (Sinclair) in a situation where the director is self-dealing, that director must show that the deal was made through fair dealing and fair price Entrenchment: (Benihana) when the board of directors makes decisions based on preserving their place on the board. This will usually involve the inside directors Preferred: type of stock that is a hybrid between bonds and common stock. It will generally be guaranteed a dividend, but is only worth the face value of the stock. Preferred stock will often carry other rights such as rights of conversion and redemption depending on statute, corporate charter, and bylaws. Usually, preferred stock does not have the right to vote Book value: value of all assets and liabilities as stated on the books of the company as of a particular date – normally prepared by an independent accountant Market value: what someone on the street is willing to pay Public v. private company: common distinction made between companies which are traded “publicly” and those which are owned “privately”. Public companies are normally thought of those registered under the ’33 and ’34 Acts Executive committee: the board can form committees to delegate certain tasks toCalled: some securities are issued subject to the provision that they may be called or redeemed by the issuer after a particular interval and at a specified or pre-determined price Shareholder Litigation Against Corporate Entities“The business and affairs of every corporation… shall be managed by or under the direction of a board of directors ….” DGCL § 141(a)Overview: Grimes: distinguishing derivative from direct claims; excusing demand for demand futility Auerbach: using special litigation committees (SLC) to obtain dismissal of derivative litigation Zapata: refinement of SLC analysis to 2-step test: (1) committee independent, good faith, reasonable investigation; (2) court’s independent inquiryDirectors owe their corporation fiduciary duties of loyalty (candor) and careIn any such suit, unless you can show that a directorhad a duty to disclose something and didn’t,stood on both sides of a transaction with the corporation and failed to disclose this, orimproperly seized a corporate opportunity for herself, and so on,All you’re left with is a claim that a director made a really, really bad decision.We call these latter claims regarding bad decisions alleged breaches of the duty of care.Example: Hiring a president who turns out to be terrible.Example: Making an extraordinary dividend distribution without thinking about the terrible tax consequences, thus costing the corporation tens of millions for no good reason.IndemnificationDirectors are?indemnified?against most liabilities, which means the corporation will reimburse them if they are held liable for an action;But are?not indemnified?against breaches of?duty of loyaltyBusiness Judgement Rule: Directors and officers will not be personally liable to the corporation for their decisions, so long as their business judgement was not tainted by a breach of the duty of loyalty or care The BJR?means that?courts will not second-guess directors’ disinterested, informed, good faith exercises of business judgment.Courts do not have the authority to substitute judgement for the judgement of the BOD as long as the BJ was not tainted by a breach of duty of loyalty or gross negligence/malfeasance In DE – it is a rebuttable presumption that if the directors have avoided any conflicts of interest and if they have carefully gathered all reasonably available information and thought about the problem at hand (full informed), then courts will not second guess the decision, even if it is bad BJR is rebutted when the decision:Lacks a business purposeIs tainted by conflict of interest or is self-interestIs so egregiously stupid that there is something else going on BOD did not inform themselves of “all material information reasonably available to them”In general…Burden of persuasion on plaintiff to rebutIntrinsic fairness Used when parent has received a benefit to the exclusion of the minority shareholders of the subsidiary at the expense of the minority shareholders of the subsidiary Burden of persuasion on defendants who have a conflict to show transaction was fairRemember: BJR does not apply to duty of loyalty allegations Types of Shareholder suits Derivative Suit – seeks to require the corporation to bring a cause of action on behalf of the corporation against a third party or directorGrimesStanding: nominal plaintiff must have contemporaneous ownership with breach of fiduciary duty and a continuing interest throughout the lawsuitTypical Derivative ClaimsMisfeasance or misappropriation of corporate propertyEnforcement of corporate contracts with third partiesActions against corporate directors for competing with corporation / appropriation of corporate opportunityExcessive salary suits (e.g.,?Disney)Third party torts against the corporationCorrection of false entries in corporate records by directorsDirectors owe their fiduciary duties to the corporation as a whole, not to the shareholders individually. This concept works most of the time, but not alwaysA derivative suit is one the shareholder brings in the name of the corporation to protect a right of the corporation against the directors.All recoveries go to corporation, not shareholder.Successful plaintiff entitled to recover legal expenses from corporation (lawyer’s suit)“Double Derivative” Actions – Shareholder of a parent corporation suing derivatively to enforce a right of a subsidiary corporation Direct Suit - The shareholder has suffered a direct injury Typical Direct ClaimsInterference with the right to voteInterference with preemptive rightsDilution of voting rightsEnjoin improper voting of sharesCompel dividendsImproper uses of corporate machineryCompel dissolutionChallenge improper expulsion of shareholdersCompel holding shareholder meetingsDerivative litigation process Is the litigation derivative or direct?Demand by shareholderTwo types of jurisdictions“Demand futility” - demand is made; directors have reasonable time to analyze demand and respond.Decision is analyzed under the BJR unless there is a breach of duty of loyalty“Universal demand”Possible rejectionIf the business judgment rule applies, rejection of demand is an absolute bar.Plaintiff can try to show that decision to reject demand was self-interested, made in bad faith, or uninformed.How can a corporation protect itself from truly unworthy derivative actions?Special Litigation CommitteesDerivative Action is consequence of the fact that a corporation has a separate corporate identity; it is a legal person in the US (but not everywhere else).A derivative suit is a suit in equity against a corporation to compel it to sue a third party to enforce a right held by the corporation.E.g., – suit by shareholder to force corporation to sue director for stealing a corporate opportunity (or just plain embezzlement).Equity steps in and allows shareholder to stand in the corporation’s shoesWas the injury to the corporation (derivative) or to the shareholder (direct)?What is a derivative suit? Derivative suit asks the corporation to seek recovery for a wrongful act that depletes corporate assets and thereby injures shareholders indirectly through the injury to the corporation.The shareholder’s injury “derives” from the injury to the corporation.What is a direct suit?Wrongful act seen as separate and distinct from corporate injuryDenies or interferes with the rightful incidents of share ownership (which are few)Derivative ActionsDerivative v. Direct:Two Prong Test:Who suffered the harm?Who would receive the benefit of any recovery or remedy?Direct: Shareholder suffered a direct injury—wrongful act seen as separate and distinct from corporate injury that denies or interferes with the rightful incidents of share ownershipEx. Interference with right to vote, compel dividends, interference with preemptive rights, compel dissolution, compel holding shareholder meetingsDerivative: P seeking to require the corporation to bring a suit in equity on behalf of the corporation against a third party or director to enforce a right held by the corporation—all recoveries go to the corporation and successful P entitled to legal fees recovery (and must have contemporaneous ownership with breach of fiduciary duty and continuing interest throughout the suit)Ex. misfeasance/misappropriation of corporate property, enforcement of corporate Ks, actions against directors for competing or appropriation of corporate opportunity, excessive salary, third party torts against corp, DemandShareholder must make demand on board to pursue corporation rightsIf you make demand, you concede it was necessary and can’t later claim futilityIf the board rejects demand, the BJR apples and acts as an absolute bar unless P can show decision to reject demand was self-interested, bad faith, uninformedDE requires stockholder filing derivative suit to show—board rejected demand or it was futile.Futility/ExcusalPlaintiff must allege with particularly reasonable doubt that either:Majority was dis-interested or independentEx. Majority of board has material financial/familial interest or majority of the board is incapable of acting independentlyIt wasn’t a valid exercise of business judgmentUniversal Demand Jurisdiction: Must make demand on directors beforehand in every caseNew York: Demand futile if: 1) majority are interested/not independent, 2) failed to exercise BJR, or 3) directors failed to inform themselves to a degree reasonably necessary about the transactionDelaware: Stockholder filing derivative suit must allege either that 1) board rejected his pre-suit demand, or 2) allege with particularity why stockholder was justified in not having made an effort at demandDemand excused if there reasonable doubt exists as to board’s independence or business judgment (once interest established, BJR inapplicable and demand excused)Derivative Cases:Cohen v. Beneficial Industrial LoanFacts: P brought suit alleging that the board was diverting $100 million. Suit brought in NJ where a state statute said corporation could require a bond from the P to bring a suit where he had minimal shares. D made demand and board rejected it. Court held NJ statute applies to federal courts and state could impose the bond.Bonds scare away strike suitsConfirms that corporation is a separate legal entity that can be sued.Security was a mandatory forum rule—if you bring a suit in a jurisdiction that requires the bond, then you have to pay itTooley Test: Who suffered the harm: corporation or shareholders? Who would receive the benefit of a recovery: corporation or individual shareholder? Demand requirement on Directors: Demand: shareholder must make a demand upon the board to pursue corporation rights If derivative: demand required unless P pleads particularized facts raising reasonable doubt directors would be disinterested and independentEisenberg v. Flying TigerFacts: P was a stockholder for FT. FT organized a subsidiary FTC. FTC organized a subsidiary FTL. FT shares were converted unto FTC rather than FTL so P had no control over operations of the company, only control over the controlling company. P argued he had a direct action so didn’t have to pay.If direct action, do not have to pay the securityThe right to vote is insidiously protected by courts.Grimes v. DonaldFacts: P brought suit alleging the board abdicated its duties and breached fiduciary duties by failing to exercise due care and committing waste. Company allowed CEO total control and he would get a ridiculous severance package. D said impermissible delegation of duties to one person. P made demand, which was refused, then tried to claim demand was excused.An informed decision to delegate a task is not abdication of duties.The board, in good faith, decided to give large compensation for an individual they want—protected by BJR even if that means the company will have to pay him a lot if they disagree with his decision.Abdication is a direct claim, not a derivative claim. But board did not abdicate, they just made a decision.Rule: A shareholder must make a demand for a derivative suit, unless the demand is futileDemand gives the company the right to sue by a decision of the BOD to sue the problematic partyDE Test for “Excusal” of a DemandDemand is futile if plaintiff establishes there is a reasonable doubt that the board is capable of making an independent decisionMajority has a material financial or familial interestMajority is incapable of acting independently – possibly domination and controlMarx v. AkersFacts: P brought derivative suit against IBM without demand asserting waste due to excessive compensation of executives and outside directors.Court: Internal directors compensation within BJR, but outside directors could allow excused demand.HAS to be a majority of the board to be an interested decision—“backscratching” alone not enough to make demandBusiness Judgment RuleComes from 141(a): Buisness and affairs of every corporation shall be managed by or under the direction of a corporate board of directorsA rebuttable presumption that the board acted properly.Directors and officers will not be personally liable to the corporation for mere mistakes in judgmentIn practice—If a director avoids any conflicts of interest (duty of loyalty issues) and acted on an informed basis (duty of care), courts will not permit plaintiffs to second guess that decision if it turns out badTo take advantage of this presumption, Board of directors must act:On informed basisInformed: Directors have informed themselves prior to making a business decision of all material information reasonably available to themWith good faithWith honest belief that action was taken in the corporation’s best interestBJR rebutted where decision:Lacks a business purposeIs tainted by conflict of interest or is otherwise self-interestedWaste/Is so egregiously bad that it amounted to a no-win decision (very rare); orResults from a conscious failure to exercise oversight and supervisionPractical reason for BJR: Courts are not well-equipped to make business decisionsF. Special Litigation Committee (SLC) composed of disinterested, outside directors who were not involved in the wrongdoing. Determine whether dismissal of derivative litigation by corporation is appropriate Corporate board creates special litigation committees of disinterested or independent directiors and will delegate specific authority to them141c: It is possible for the board to create a committee that can have all the power of the board and delegation is permissible under the BJRAuerback v. BennettFacts: 1975 GTEC got reports that some companies made contributions to public officials. Board had audit committee conduct a report finding that $11 million was paid. Shareholders brought suit for breach of duties. 1976 board formed SLC and found company would not benefit from suit and rejected demandCourt may still inquire as to independence of board and SLC with BJR protection so long as there is disinterested independence. Can review procedure, but not substance of decisionRule: Decision by the SLC to dismiss a derivative suit is protected by the BJR but:Court should inquire into the independence of the committee and adequateness of its investigation BOP on π to prove SLC members weren’t independent, disinterested, and the investigation was inadequate Rebut the presumption by showing 1) no rational business purpose (bad faith) or 2) BOD/SLC was not fully informed in making their decision based off the reasonably available material (adequacy of investigation)Court will only review the process of the decision not the substance Zapata Corp. v. MaldonadoCourt held: The committee can dismiss suit and even a tainted board can delegate to an independent committee so long as the committee is independent and the court has the power to review this independence in a two-step inquiry What if the board is comprised of all bad guys?Independent Investigation Committee—comprised solely of two new directorsBJR is not usedIndependent committee may cause its corporation to file a pretrial motion to dismiss based on the best interests of the corporationTwo-Step Test:Independence, good faith, and a reasonable investigationThe Court should determine, applying its own independent business judgment, whether the motion should be grantedZapata Two Step 1. Inquire into the independence/good faith of the committee and adequateness of its investigation SLC has BOP of proving committee was indep/disint and investigation was adequateDisinterested – no material financial or familial interest Independent – not controlled by someone who is interested 2. Court uses independent business judgement to determine whether or not it is in the corporation’s best interest to dismiss the suit. Is it reasonable?Director IndependenceBoard is selected/nominated by the CEO and other directors Stock holders then elect from the slate nominated So there is truly “independence” Delaware County Employee Retirement Fund v. SanchezFP: Transaction between a private company wholly owned by Sanchez family and a public company in which the largest shareholder block is the Sanchez family. The plaintiff alleges the private company received a “gross overpayment.” On the BOD – 2 Sanchez’s, Jackson, and two disinterested directors.Jackson has been friends with the chairman for 5+ decadesMost of his wealth comes from business interests that Sanchez has a lot of influence over Issue: did the plaintiff have to make a demand on the board because Jackson claims to be independent and therefore a demand should have been made on the board because the majority is independent/unbiasedHeld: There was a reasonable doubt as to Jackson’s independence Rule: this is a “totality of the circumstances” analysis and facts cannot be viewed categorically See also NYSE Definition of “Independent” In re Oracle FP: Derivative action against 4 BOD for insider trading, BOD elected SLC of 2 members who were not on the board at the time of the alleged insider trading, SLC made an 11K page report about investigation/decision. Defendant was a fellow professor with SLC member at Stanford Defendant was a major contributor to Stanford where SLC members were profs and would gain from staying in his good gracesHeld: the SLC was not independentRule: if the BOD is comprised of all “bad guys” the BOD can appoint a clean SLC that is indep/disint that has the full power to make the decision to dismiss and it will be protected by BJRLaborers’ Local v. Intersil FP: Derivative action against BOD for excess executive compensation. One of the directors was an executive whose salary would be increased. Interstil hired outside compensation consulting firm who recommended 41% increase in exec salaries. Dodd Frank Act – company must conduct a non-binding shareholder vote to increase executive salary, 56% said noMajority of the disint/indep BOD approved the salary increase Rule: adverse shareholder say-on-pay vote does not give rise to a breach of fiduciary duty claim and is not a sufficient basis to overcome the BJRAronson Futile Test – to excuse demand is to plead with particularity why its futile A majority of the BOD or SLC must not be disinterested and independentThe challenged act was not a product of BOD valid exercise of BJPresumption can be rebutted by showing it cannot be attributed to any rational business purpose (bad faith/waste) or the BOD was not fully informed in making their decision based off reasonably available materialDuties of Officers, Directors, and Other InsidersTerms: Duty of care Duty of loyalty: Candor Undisclosed conflicts of interest Taking advantage of a corporate opportunityThe duty of a fiduciary to act on behalf of the beneficiary and to place the beneficiary’s interests ahead of the interests of the fiduciary. This may be described as a duty to avoid self-dealing or appropriation of opportunities of the principal. The agent is liable to disgorge any/all secret profits obtained from a transaction that breaches the duty of loyalty – if the transaction is a loser, the agent is on his own Duty of candor: duty to provide information to the beneficiary; this is often not clearly expressed as a subset of the duty of loyalty but can best be understood this way Duty of good faith and fair dealing: no one has a clue how to define this in a helpful way we not have 102(b)(7), through which the certificate of incorporation can eliminate or limit personal liability for director breaches of the duty of good care, but cannot eliminate liability for breaches of duty of loyalty or acts/omissions not in good faithThe (Phantom?)Duty of Care(1) Procedural due care – the process used in reaching a rational decision Directors must make a good faith decision based on all the reasonable available information – must be fully informed Board is entitled to rely on experts (2) substantive due care – was the actual decision substantively rational Director entitled to protection of BJR as a shield from liability Whether the complaint states a claim of waste of assets (i.e. whether thKamin v. American Express Company, 86 Misc.2d 809 (1976) AE acquired 1.9 million shares of DLJ stock for almost $30 million and dropped to a value of $4 million. AE’s board decided to give it as a special dividend to the shareholders. P?brought suit claiming that if the board sold the shares they could claim a capital loss of $25 million for an $8 million tax savings. Issue whether P?can challenge action for being less lucrative.Dividends other than surplus fall under BJR No evidence of fraud or oppression here or bad faith where all information reasonable available was considered BOD can make a decision not in the short-term best interest of the shareholders if they are fully informed when they are making the decision.Smith v. Van Gorkom, 488 A.2d 858 (1985) – procedural duty of care – 102(b)(7) fixed this case, there is not long a duty of care claim Shareholder brought a derivative suit against BOD after the board approved a merger with MaramomLeveraged buyout – acquiring company buys out shareholders of a target company funded with borrowed money secured by assets of the target company The current market price of the company’s stock was $38VG CEO went to the controller of the company and asked him to compute the stock buyout price - $50-$60 and VG split the price and picked $55 out of thin airThis is not the correct method to compute a merger price VG met with Pritzker and offered him a deal to buy the company for $55 a sharePritzger agreed to buy the company for $55 per share with the condition that it was accepted in 3 days, company cannot publicize any information of the company to solicit other bidders, and lockup agreement Lockup agreement – target company issues stock options to bidder 1 at a discount so if they are outbid in the merger by bidder 2 they can make bidder 2 issue the stock and buyback at a higher priceVG held a meeting with the BOD to vote on the mergerVG gave a 20-minute presentation about the merger and valuation of the company NO copies of the merger were reviewed or passed out to BOD before the voteMerger was passed by the BOD and shareholders approved by 69%Held: Merger decision was not protected by the BJR because the BOD failed to inform themselves of all information reasonably available to them about the merger. They were personally liable to company.No inquiry into the substantive decision of the BOD, but inquiry into the procedure BJR was rebutted because the directors did not make a fully informed decision based on the material that was reasonably available Rule: directors who act grossly negligent in failing to inform themselves of all material information reasonably available to them breach their fiduciary duty of careFactors:No paper trail/recordsNo independent evaluation of company worth BOD did not read the merger agreement Relied upon one 20-minute oral presentation on the proposal and valuation of the company No inquiry into the adequacy of the $55 merger price – no formal reports/expert evalCourt rejected:That magnitude of premium over market price justified the decision The collective expertise of the directors and long involvement with the company meant they knew what it was worthBoard needs to have outside advice – board protect themselves by bringing in outsiders to value the company investment bankers will make sure directors are not being held personally liable 102(b)(7): if you’re a director and you breach a duty of care, we won’t hold you personally liable if this is in the charter The determination of whether a business judgment is an informed one turns on whether the directors have informed themselves prior to making a business decision of all material information reasonably available to them There is no personal liability for a director if you put that iun the charter that a breach of care means no personal liability: still liable for: A breach of loyaltyActs of admission not in good faith Or for international misconduct for a knowing violation of the law Van Gorkom Rules: Duty of Care: All the information reasonably available Adequate time for board consideration Paper trail – complete minutes Outside experts = best practice Board may rely on “reports” DGCL 102(b)(7) exculpation DGCL: §102(b)(7) Statute that allows term to be placed in corporation’s certificate of incorporation that directors are not personally liable for breaches of duty of care as long as they acted in good faith Do not apply to duty of loyalty or actions taken not in good faith Even if duty of care is breached the directors have the affirmative defense that the fully informed shareholders ratified or decision was entirely fair Board of DirectorsInclude some inside and outside officers of the company Executive committee – men and women who are regularly at the company Audit committee – controlled who inspects the company Compensation committeeCompliance committeeRelative Power of the Directors and the ShareholdersBoilermakers Local 154 Retirement Fund v Chevron Corporation,Board may be authorized to enact Bylaws Bylaws generally control internal procedures and affairs of the corporation Bylaws may affect shareholder rights Shareholders always have the power to impose bylaws on the board which the board may not change Terms:Leveraged Buyout (LBO): Derivative: make a demand unless it would be futile, then can have it excused Demand Demand futility: Demand excusal: standard in DE for demand excusal is reasonable doubtPractice in DE: do not make a demand In Re the Walt Disney Co. Derivative LitigationSubstantive duty of care will fail because of BJREisner was temporarily CEO of Walt Disney and was seeking to find the succeeding president and recruited his friend OvitzAfter negotiation between Eisner and Ovitz, Ovitz left his employment as a talent agent at CCA where he stood to make 150-200M over the next five yearsAfter 14 months Ovitz was not working out and was fired for no-fault and received 140M severance package Shareholders filed a derivative suit claiming breach of fiduciary duty of loyalty, care (good faith and fully informed) and waste of corporate assetsOvitz has a very lucrative employment contract that entitled him to 140M if he was fired for no-fault within 5 yearsDuring his time at the company the Disney stock only went up $2/shareBJR – for the directors to be protected by the BJR they must make a good faith determination based on all the reasonable available information BOD was fully informedCompensation committee who consulted with an outside compensation expert and were fully aware of Ovitz compensation agreement and severance packageThe court said that the “best practices” would have been if the company printed off a spreadsheet that showed what Ovitz would have made off his severance package under different scenarios but this is not required Directors do not have to do everything conceivable in their decision making to satisfy the duty of careBad Faith Defined:Intentional dereliction of duty – Subjective want to do harm (evil)Conscious disregard for one’s responsibilities as set out in a positive lawDeliberate indifference and inaction in the face of a duty of act (gross negligence)Where one FAILS TO ACT with a conscious disregard for his duties[1-2] : “faithless conduct”“The duty of good faith includes not just duty of care and loyalty but also ‘all actions required by a true faithfulness and devotion to the interests of the corporation and its shareholders”Not a fiduciary duty itself, but a piece of the fiduciary duty of loyalty If the directors do not act in good faith, then they violate the duty of loyalty and are not protected by the BJRGross negligence by itself does not amount to bad faithThree standards of bad faithSubjective – actual intent to do harm to the company Intent to violate a positive applicable lawIntentional dereliction of duties – intentionally fails to act in the face of known duty Footnote 112 – issue of good faith as a separate actionable duty was not before the courtWaste of Corporate AssetsWhen the exchange is so one sided that no person of ordinary sound judgement could determine the corporation received adequate consideration This is a very high standard - $140 million severance was not waste Court said there was no waste because there was a rational business purpose behind the transaction – to persuade Ovitz to leave CCA and work for Disney “payment of a contractually obligated amount cannot be ‘waste’”Plaintiff claims that Ovitz breached his duty before he was an employee of Disney when he negotiated his contract De facto fiduciary duty – fiduciary duty before you become an employee of the company Court denied this – persons does not owe any fiduciary duties to the company until he started his employmentDGCL § 102(b)(7)Prohibits indemnifying a director for “acts not in good faith, or involving intentional misconduct or a knowing violation of the law” Best Practices – court describes what the minutes should have looked likeCompensation committee minutes did not have a spreadsheet with alternative cost scenarios Crystal the consultant told Slate he wished they had a complete spreadsheet with all options laid out (not in this opinion)Give the spreadsheet ahead of time BUT – the standard is not BEST practices but REASONABLE practices Disney on Good/Bad faith ConductResultmotivated by actual intent to do harm Bad faith; clear liability dispite 102(b)(7) Conscious disregard; intentional dereliction of duty Bad faith; no indemnity under 102(b)(7)Gross negligence – no bad intent NOT bad faith, protected by 102(b)(7) Waste: an exchange so one sided no business person of ordinary sound judgment could conclude the corporation received adequate consideration How to overcome BJR: duty of care breached by gross negligence BJR: presumption that the board acted (1) on an informed basis (2) in good faith (3) in the honest belief that their action was in the best interest of the corp Presumption is overcome ifBreached care – 102(b)(7) Breached loyalty Acted in bad faith The intentional dereliction of duty – subject evil want to do harm Conscious disregard for one’s responsibilities as set out in a positive law Deliberate indifference and inaction in the face of a duty to act – gross negligence Francis v. United Jersey Bank, 432 A.2d 814 (1981) D inherited 485 interest in P&B from her husband and her sons ran the company that was a reinsurance broker (took money from insurance company to be assigned to another company along with a share of the premium). The sons took loans form the corporation totaling $12 million and company went bankrupt. D was a director but never red financial statements and was not involved in the business at all. P?(trustee in bankruptcy) sued to collect the money from her estate. Court held D had a duty to protect clients against misappropriation and breached that duty by failing to cat to stop the corruption – facts over rules – EQUITYDirectors have duty to generally monitor corporate affairs and policies and know what is going on with the businessNot knowing or not looking will not save youDuty to prevent misappropriationUpon discovery of illegal course of action, you have an obligation to object and possibly resign—must record objection to be free from liability Directors have: duty to stay informed, duty to object, duty of oversight BJR does not protect non-feasance (not doing anything) Need to inquire upon suspicion of wrongdoing Not a piercing the corporative veil issue: going after a director not a shareholder 2 situations implicating duty of care: (1) monitoring a corporation (Auerbach)—you have to stay aware of corporate affairs and have in place a reasonable information generation/management scheme Reasonableness depends on the scope of the corporation Small family shop does not require a department of internal accounting Adequacy of monitoring is judged by “reasonable care” standard (2) Discrete decisions: Exercise BJR in making discrete decisions Don’t violate duty of loyalty and make your decision on an informed basis Gross negligence or malfeasance standard of care “Directors have a duty to exercise reasonable care in their oversight of the corporation’s affairs and when making discrete decisions; they have a duty to place the best interests of the corporation above their own person interests; and they have a duty in some circumstances to disclose information to other directors or the shareholders” Model Business Corporation Act §8.30(a) Requires a director to step down in good faith 1) with the care an ordinary person would use in a like position [same job] 2) under similar circumstances 3) in a manner objectively in the best interests of the corporation This is especially for banks and insurance companies In Francis, there was a duty NOT ONLY to shareholders but also insureds that have a claim to the reserves of the company Small corporations generally require less work to stay informed and to monitorLarge corporation OR a small corporation dealing in an enterprise requiring a great deal of trust or money (bank, brokerage, trust company, etc. requires a lot more work to satisfy reasonable care) In Re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (1996) –another issue of oversight Should the board affirmatively “monitor” the operations of the corporation? Caremark sold medicine and entered into agreement with hospitals and doctors (research agreements, consultation etc.) with physicians who recommended Caremark products. In 1991, HHS investigated and found that a physician had gotten $1.1 million in kickbacks. In 1989 Caremark had policy that no payments for referrals would be made and in 1993 devised an internal plan to assure compliance with its policy not to pay management fees to physicians. It also hired PWC to do an audit and started and Ethics Committee both of which said there was no weakness in the control structure. After indictment, Caremark gave a guilty plea to mail fraud and paid $250 million but did not admit to kick backs. Π?brought shareholder suit claiming breach of duty of care by failing to adequately supervise. Court held there was a low probability that the directors of Caremark breached any duty to monitor and supervise.Only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith necessary for liabilityA failure to act in good faith requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of careBecause of the structure of the business, they should have known what is going on DCGL 141(a) The duty of care include the duty to monitor and requires active involvement in the activities of the company Rule: for the protection of the BJR the BOD must act on a fully informed bases – and to be fully informed the company needs an oversight system Must consider good faith or the rationality of the process (never to be determined by reference to the content of the board decision)Caremark factors that will subject the BOD to liability:The directors utterly failed to implement any reporting or information system or controls Having implemented such a system controls, consciously failed to monitor or oversee its operationsGood Faith“where a claim of direct liability for a corporate loss is predicated upon?ignorance?of liability creating activities …,?only a sustained or systematic failure?to exercise oversight, such as an utter failure to attempt to assure a reasonable information and reporting system exists?– will establish the lack of good faith?that is a necessary condition to liability.”You need to have a view on this standard – BeanJudicial review of Board attentiveness The court affirms that there is no such thing as substantive due care – only procedural due careMust have an adequate compliance system in place to be fully informed There is no duty to inquire absent suspicion Duty of Care: Includes the duty to monitor and requires active involvement in the activities company Federal Laws FCPA – need a system of internal accounting controls sufficient to provide reasonable assurances that 1) transactions are executed in accordance with management’s authorization 2) transactions are recorded as necessary to permit prep of financial statements pursuant to general accounting principles, and 2) maintain accountability for assets SOX – establishing and maintaining an adequate internal control structure and procedures for financial reporting SEC – management must establish and maintain an adequate internal control structure and procedures for financial reportingGraham v. Allis Chalmbers: red flags Rule: absent suspicion or grounds for suspicion to suspect deception, neither corporate boards no Sr. officers can be changed with wrongdoing simply for assuming the integrity of employees and the honest of their dealing on the company’s behalf there is no duty to inquire Monitoring is required; constant attentiveness; duty to be informed Under Delaware law, corporate directors and officers will not be held liable for losses resulting from their failure to supervise and manage the business, so long as those directors and officers reasonably relied on the honesty and integrity of their subordinates.Van Gorkom: what it is Pritchard: duty to be involved Caremark: duty to monitor Directors presumed to concur in board action at which they’re present unless they dissent on the record Recap: Disney: know the description of good faith Francis: a director’s duty of care includes knowing what is going on monitoring If you’re a director have to get involved enough to know what is going on general monitoring Caremark: where do we find a lack of good faith? Sustained or systematic failure to exercise oversight An utter failure to attempt to assure a reasonable info and reporting system existsDistinguish: Nonfeasance Misfeasance Malfeasance BJR yields to the rule of undivided loyalty 4 ways to overcome BJR: Fraud Improper motive Personal interest Unusual and exceptional Duty of Loyalty – Directors and Managers A directors duty not to engage in self-dealing or otherwise use his position to further personal interests rather than the interests of the corporation Directors and managers: person transactions can produce conflict. Burden is on the director to prove good faith and inherent fairness to the corporation once the P brings the complaint Bayer v. Beran, 49 N.Y.S.2d 2 (1944) Wife of a director was an opera singer, used her in a commercial Directors have an obligation not to put their own interests before the interests of the corporation Personal transactions of directors with their corporations may tend to produce a conflict between self-interest and fiduciary obligations are examined with the most scrupulous careAny evidence of improvidence or oppression/unfairness or undue advantage will void the transaction Burden on the director to prove good faith and show inherent fairnessCourt must NOT find that the action of the directors was intended or calculated to serve some outside purpose, regardless of consequence to the company, and in a manner inconsistent with its interestsHeld: No breach of fiduciary duty, no evidence that the radio program “fostered or subsidized the career of Ms. Tennyson.” Her prestige being enhanced is of no consequence if the ad served a legitimate/useful corporate purpose. DGCL 144(a)(a)?No contract or transaction between a corporation and 1 or more of its directors or officers, or 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.Provides a safe harbor for interested transaction if “the material facts as to the director’s relationship or interest are disclosed or are known to the board of directors, and the board in good faith authorizes the contract or transaction by an affirmative vote of the majority of the disinterested directors”Basically, if the directors know about the conflict, and the majority of the ones unconflicted still vote to allow the transaction, then it is protected by the BJR and not a breach of duty of loyaltyIf there is a conflict, and the BOD does not have the protected of the BJR and the burden shifts to the BOD to show disclosure of the conflict (paper trail), everyone knew about the conflict, not everyone knew but it was still a fair deal Lewis v. SLE Property: BEAN SAID THIS COULD BE A GOOD EXAM QUESTION Rule: BJR does not apply when directors decide to enter into a transaction which a director has a COIBOP shifts to BOD (paper trail) to prove the board has been cleansed by:Disclosure of the conflict of the BOD (paper trail), or everyone knows about the conflict, and majority of disinterested directors approved the transaction Not all directs know about the conflict, but the decision was intrinsically fair Could still argue duty of care violation that the directors did not inform themselvesDuty of Loyalty – Corporate OpportunitiesTest: A corporate fiduciary agrees to place the interests of the corporation before his own in appropriate circumstances in which:Corp is financially able to undertake opportunityIt is in the line of the corporation’s business and is of practical advantage to itIs one in which the corp has an interest or a reasonable expectancyEmbracing the opportunity would create a conflict between director’s self-interest and the corporation’sBroz v. Cellular Information Systems, Inc., 673 A.2d 148 (1996) Facts: Broz was the president of RFBC, which operated a cell area, MI 4. Mackinac was selling MI 2, which was adjacent so contacted a broker who contacted Broz but not CIS because CIS was going through financial difficulty and selling other cell systems. Broz was an outside director of CIS and talked to the CEO and other directors about the opportunity and they all said even if CIS could buy it they didn’t want it. June 1994 PriCellular entered an agreement and would tender offer all of CIS shares but it got delayed until Nov. PC made an offer of $6.7 million to Mackinac where Mackinac could accept an offer $500,000 better so Broz offered $7.2 and closed on Nov. 14th. Nov. 23 Pricellular closed tender offer for CIS. PC brought suit alleging Broz breached duty of loyalty by taking corporate opportunity b/c PC was negotiating with CIS. Court held Broz did not breach fiduciary duty to CISBroz got the opportunity in personal capacity When opportunity came, CIS did not have an interest – he disclosed to the board Rule: If the corporation CAN undertake an opportunity (financially) and it is in the line of business and is a practical advantage and the corporation has an interest . . . the law will not permit a director to seize the opportunity for himself if he has a conflicting self interest Corporate Opportunity TestThe corporation is financially able to take the opportunity The opportunity is within the corporation’s same line of business The corporation has an “interest or a reasonable expectancy” in the opportunity If the director or officer were to embrace the opportunity there would be a conflict of interest In Re eBay, Inc. Shareholders Litigation, 2004 WL 253521Facts: E-Bay got Goldman Sachs to underwrite its initial IPO and E-bay took off going from $18 to $175 per share. GS was the lead underwriter for the second offering at $170 per share and worked on Paypal acquisition. GS buys shares, so has equity in the company. During this time GS was rewarding individual Ds with thousands of IPO shares of other companies at the initial offering price. Stockholders brought suit claiming directors were seizing a corporate opportunity because E-Bay could take the stocks and profit. Court said claims withstood summary Judgment.No matter what the rule is, we will have exceptions. In equity, so will make a decision that is more likely to help everyone.Applying the Corporate Opportunity TesteBay could financially undertake the transactionit was in eBay’s “line of business” because it routinely invested in marketable securitiesInvesting in the IPOs was of interest to eBayConduct placed the directors in conflict with their duties to the corporation – the only reason that the directors were offered the IPO’s was because of their position with eBaySection 144aCleanse the interested Board of Directors:Approved by a majority of the fully informed, and disinterested directorsStill could argue duty of care violationAs long as they took steps to inform themselves of the situation and there is no fraud, illegality, bad faith, egregious decision—BJR would protect voteRatified by informed shareholdersCould still argue a duty of care violation because didn’t inform themselvesShown to be intrinsically fair (price and terms of the deal are analyzed)Switches burden of proof to the board of directors to show that the judgment was fait in dealing and price because it was in the best interest of the shareholderIf any of these apply, it would be cleansed and duty of loyalty would be eliminatedThe essence of BE: The principles that animate DE’s regulation of the fiduciaries who govern corporations are to: Give fiduciaries the authority to be creative, take chance, and make mistakes so long as their interests are aligned with those who elect them, but When there is a suspicion that there might be a conflict of interest, use a variety of accountability tools that draw on our traditions of republican democracy and equity to ensure that the stockholder electorate is protected from unfair exploitationTerms: 102(b)(7) Best practices De facto officer Define “good faith: Dividend in kind LBO/MBO – leveraged buy out – borrowing a ton of money to buy a company Lock up Misfeasance: oops I made a mistake Malfeasance: I know what the right thing is, but I’m going to do that other thing Nonfeasance: I’m just going to drink in bed for 6m and not do anything Doesn’t get BJR Oversight: board is responsible for what is happening in corporations (Caremark) 141(e) reliance on experts Executive committee: subset of the board that has the full power of the board between board meetings: decisions get ratified at the board meeting Executive session: when the board meets and excludes all the insiders Entire fairness: 144(a)(3) Inherent fairness: 144(a)(3) Classified board – different shares vote for different board members Staggered board: like congress elections – hard to change the board quickly Convertible preferred Preferred stock: subset of equity, it’s a contract – normally don’t get to vote on the board Subordinated Debt Secured debt: secured by assets Subordinated debt: when it goes to shit, everyone gets paid before you Debenture: debt instrument, insecured Capital structure: what there is in stock/debt/loans Harris: Guth 4 part test for corporate opportunities Conflict of interest --whether taking up the corporate opportunity creates a conflict of interest or competition with the firmFinancial ability: whether the firm has the financial ability to exploit the opportunity in the first place Reasonable expectancy: whether the firm as a reasonable expectancy in the transaction Disclosure: whether there has been a disclosure to the board Broz and Guth Directors and others may be protected from liability under corporate opportunity doctrine by disclosing the opportunity to members of the board Inside directors held to a higher standard of good conduct in respect to such opportunities Intersection of Loyalty and Good Faith A breach of good faith is a necessary condition to a breach of loyalty – loyalty can be breached by a breach of good faith Duty of loyalty includes: Conflict of interest analysis Corporate opportunity Good faith Stone v. Ritter, 911 A.2d 362 (2006) Amsouth had a wholly-owned subsidiary AmSouth Bank and AmSouth Bank paid $50 million in civil penalties and fees for violating money laundering and Suspicious Activity Report requirements. Amsouth had 600 branches and 11,000 employees. Am South hired KPMG to do an evaluation and review of compliance program. Directors can be liable for failure to engage in proper corporate oversight if they fail to implement any reporting or information system, or having implemented such a system, consciously fail to monitor or oversee its operations Only a breach in the duty of care OR loyalty may result in liability; but failure to act in good faith may do so, but only indirectly Duty of loyalty is not limited to cases involving conflict of interest BUT it encompasses cases where the fiduciary fails to act in good faith The Court found that there are two conditions necessary for liability under the standards set by Caremark:The directors utterly failed to implement any reporting or information system or controlsHaving implemented such a system or controls, consciously failed to monitor or oversee its operationsGood faith for reporting requires assurance that a reasonable oversight procedure is in place, and cannot be measured by post-hoc second guessing after the employees’ misconduct takes placeBasically, if the company has a system in place to prevent employee violation of federal/state laws it is not a violation of good faith A bad result ≠ bad faith Rule: good faith is not a fiduciary duty in itself; good faith is part of the duty of loyalty This case discusses what it takes to have a demand excusedGives us the supreme court saying we have had this best practice stuff but now it is the lawDominant ShareholdersMust have a dominant shareholder – usually a parent-subsidiary relationship where the parent controls the subsidiary and is therefore on both sides of the relationship Otherwise shareholders don’t have fiduciary duties towards each other Overlapping directors – most of the directors of the parent company are likely to be directors on the subsidiary and creates a conflict because they have a duty to serve interest of both corporationsConflict would only arise when there are minority shareholders in the subsidiary (not wholly owned by the parent)Remember that a dominant shareholder does not have over 50% interest in the corporation – just needs to have substantially more stock than other shareholdersRemember that just because a minority shareholder does not like a transaction is not enough – must show some form of harm Not a case of corporate opportunity, new type of “conflict”The majority (or parent) has the right to control. But it occupies a fiduciary relationship toward the minority as much as the corporation itselfBurden is on the director or shareholder to prove the good faith of the transaction and to show its inherent fairness from the view of the corporationIntrinsic Fairness Standard:Applies only when fiduciary duty accompanied by self-dealingWhen the situation involves a parent and subsidiary, with the parent controlling the transaction and fixing terms, the test of intrinsic fairness, with its resulting shifting of the burden of proof, is appliedHigh degree of fairness & shift in burden: the burden is on D to prove, subject to careful judicial scrutiny, that is transaction is objectively fairSelf-dealing required: the situation when a parent is on both sides of a transaction with its subsidiaryWhen the parent, by virtue of domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority shareholders of the subsidiaryIf it is not self-dealing, BJR applies.Sinclair Oil Corp. v. Levien, 280 A.2d 717 (1971) Sinclair owned 97% of Sinven’s stock and controlled the board. From 1960-66 Sinven paid out $108 million in dividends, $38 million in excess of its earnings for the same period (had saved earnings to do this legally). Sinven also had to contract with International (another Sinclair wholly owned subsidiary) and International didn’t meet its minimum purchase requirements under the K and would pay late. P claimed the dividends were paid to prevent Sinven from expanding – breaching duty of loyalty. Sinclair wanted the money because it found land and oil and Sinven said it was entitled to this opportunity. Dividends fall under BJR and Intrinsic Fairness Standard can’t be applied to themNo self-dealing because shareholders and Sinclair both got dividends equallySinclair didn’t take corporate opportunity of Sinven. It was Sinclar’s business judgment to decide which subsidiaries to expand. Opportunity came to Sinclair, not Sinven.BUT breach of K claims still allowed.It was self-dealing not to require K fulfillment from another subsidiary. Had to show that not enforcing the K was intrinsically fair and could not do this. So breach of duty to minority shareholders. Rule: when the parent company has received a benefit “at the expense of the subsidiary with minority shareholders” it does not get the presumption of the BJR and has the burden of proving the transaction was intrinsically fair”Sinclair BOD decided to declare really high dividends for shareholder of Sivens because Sinclair needed money There was not self-dealing because the parent did not receive anything from the subsidiary at the detriment of the minority shareholdersSinclair declared dividends for all shareholders, so the BOD did not abuse the minority shareholders, so the decision is protected by the BJRDirectors have the power to declare dividends, but they can only pay them out of earner profits Rule: shareholders normally act in their own best interest, but when there is a dominant shareholder they have an obligation to act in the best interest of the minority shareholdersNOTE: Sinclair could dividend out all the revenue of Sinclair because it is a 100% owned subsidiary i.e. – no minority shareholders NOTE: Pepper v. Litton – director is a fiduciary and so is a dominant or controlling shareholder, their powers are in trust – if any K/engagements are challenged the burden is on them to show good faith and inherent fairness from the point of the minority shareholders.Zahn v. Transamerica Corporation, 162 F.2d 36 (1947) Facts: Zahn owns 80% of AFT class A stock. There was a spike in tobacco prices so Transamerica, who owned a majority of the voting stock and appointed the BOD, decided to liquidate AFT and its tobacco (AFT paid 6.3M for its tobacco inventory and sold it for 200M)Preferred Stock - $100 par value (what is bought for), 6% guaranteed dividend, and $105 liquidation dividend Convertible Class A common stock – means that the stockholders can convert it from class A to class B and were guaranteed an annual dividend of $3.20Class B common stock – gets guaranteed $1.60 annual dividend and gets to voteThe class A stock was callable – meaning the company can recall the stock at anytime from the stockholders and pay a certain priceAfter tobacco price spike, BOD recalled all class A stock at $60 a share and then liquidated the assets of the company without disclosing the increased value of the tobaccoRule: A majority shareholder has fiduciary duties to the monitory shareholdersTransamerica was majority shareholder and therefore owned a fiduciary duty of candor to the minority shareholders to disclose the value of the tobacco and liquidation plan Transamerica cannot steal the corporate opportunity to liquidate the company (can’t hide the ball from class A stockholders about the increase in the price of tobacco so they won’t convert to class B and take a share of the money in the liquidation)Directors had an obligation to all the shareholders even though their livelihood was in class BMinority shareholder can be self-interested, but majority or director cannotShould have called class A stock and disclosed liquidation so A could convert to B and get proceeds from liquidation.Ratification DGCL 144: transaction not void for interested director or officer if material facts disclosed or known to shareholders and the contract is approved in good faith by vote of the shareholder Shareholder ratification of an interested transaction shifts the burden of proof to the shareholder to demonstrate the terms are so unequal as to amount to waste—atmosphere refreshed where formal approval given my a majority of independent fully informed shareholders.Shareholders can ratify any decisionFliegler v. Lawrence, 361 A 2d 218 (Del. 1976) Facts: Lawrence was president of Agu Mining Co. and in his individual capacity purchased a piece of land with potentially valuable mineralsLawrence offered the land to Agu BOD, but they did not want it because it was prospective BOD of Agu formed the USAC who bought the land and offered it to Agu at a certain option priceUSAC sold the land to AguBOD of USAC and BOD of Agu were the same people – SO conflict of interest and self-dealingShareholder brought a derivative action claiming that there was a conflict of interest in the transaction and therefore it was not protected by the BJR and the burden was on the BOD to prove fairness of the transaction However, the shareholders ratified the transaction Rule: shareholder ratification of an interested transaction shifts the BOP to an objecting shareholder to demonstrate that the transaction is unfair The transaction needs to be ratified by a majority of disinterested shareholders In order to cleanse the interested BOD: (DGCL §144)(1) Approved by a majority of the fully informed, and disinterested directorsStill could argue duty of care violation As long as they took steps to inform themselves of the situation and no fraud, illegality, bad faith, egregious decision – BJR would protect vote(2) Ratified by informed, disinterested shareholdersCould still argue a duty of care violation because didn’t inform themselves(3) Shown to be intrinsically fair (price/terms of deal analyzed)Switches burden of proof to the BOD to show that the judgement was fair in dealing and price because it was in the best interest of the shareholder (4) The affected director could rescue himself from the decision making and thus not taint the disinterested directors’ action If any of these apply, it would be cleansed, and duty of loyalty would be eliminated Indemnification and insurance ONLY FOR DUTY OF CARETypes of liability may vary; DE applies only to “liability of a director to the corporation ot its stockholders for monetary damages fore breach of fiduciary duty as a director.”Section 145(a): corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to lawsuitIndemnification: Pay the liabilities of the director when expenses incurredSection 145(f): advancement of expenses for litigation costsSection 145(g): Corporation has the right to insure or indemnify officers, directors, and employees of the corporation (except in bad faith and breach in duty of loyalty)Corporation may pay legal fees, and also may advance those fees if so approvedAdvancement: corporation pays out first for litigation, hotel expenses, etcBe sure to expressly state indemnity rights in articles, because DE ruled that indemnity rights can be taken away if new board of directors amends the bylawsExpenses that will be indemnified must be reasonableDelaware Code §145 – can be for the duty of care of loyalty (a) Corporation may indemnify present or past director, officer, employee or agent of the corporation who is threatened to be made a party to a proceeding, whether civil, criminal, administrative or investigative (other than a derivative action) for attorney fees, judgements, fines and amounts paid in settlement actually and reasonably incurred if the person (1) acted in good faith and in a manner the person reasonable believed to be in or not opposed to the best interest of the corporation, and (2) with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful Judgement, order, settlement, conviction, or plea of nolo contender shall not itself create a presumption for the person did not act in good faith(b) Former or present officer or director shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred if they are successful on the merits or otherwise (does not need to be successful on the merits – i.e. settlement)(f) this section allows the corporation to have a separate agreement that grants more indemnification rights Under (g) the corporation can purchase insurance to protect the director, officer, employee who does not act in good faithProblem is insurance company would charge a huge amount of money for this policy NOTE: a corporation can change the indemnity terms in the bylaws and apply them retroactively – so the director, officer, or employer should rely on a separate indemnity contract that cant be changed Waltuch v. Conticommodity Services, Inc., 88 F.3d 87 (1996) Facts: Waltuch was the VP of Conti and was a metal trader who pushed the price of silver up, sold to investors, and then the market crashedInvestors and federal agency brought suit against Waltuch and ContiFTC settled with Conti and Waltuch, but he still paid 2.2M in legal feesConti settled the suit on Waltuch’s behalf and he made no contribution to the settlement payment Waltuch stipulated that he did not act in good faith and therefore lost 145(a) indemnification nHeld: Waltuch settled the case without a judgement against him and was successful on the merits or otherwise and is therefore indemnified under 145(c), as long as he acted in good faith The company settling the lawsuit on Waltuch behalf was still a success on the meritsAny reason for success on the merits entitles the director or officer to indemnification – court won’t consider the reason whyA director of officer who is successful on the merits must also act in good faith for indemnification Citadel Holding Corporation v. Roven, 603 A.2d 818 (1992) Facts: Roven was director of Citadel. Citadel and Roven enter into an indemnity agreement which included Citadel’s obligation to indemnify Roven against any threatened or actual suit to which he is a party, except for actions brought pursuant to 16(b). Roven violates 16(b), and Citadel sues him. Roven sues to have advancement of legal fees and wins§ 16(b) assumed that directors of a corporation have inside information about the company and cannot buy or sell securities within 6 months16(b) of the 1934 Act is an administrative rule that prohibits insider trading and buying/selling within 6 monthsIf a director buy and sells within 6 months, the profit from the sale goes to the company as the penalty A corporation may advance a director the cost of defending a lawsuit. Although it is permissible, the agreement can make it mandatory Way to be indemnified: state laws, bylaws, corporate charter, indemnity insurance, or sign a special indemnity agreement Although you can indemnify directors for anything it’s bad public policy to do soRoven has an indemnification agreement with Citadel granting him the right to advanced payment for legal fees The agreement said that the company was required to prepay legal fees, and if the director was found to not qualify for indemnity then he would have to pay them back Held: the indemnity agreement entered by the parties did not require the director to qualify for indemnification in order to be granted the advance legal fees (rather it required that if he did not qualify for indemnification, he would pay the company back)Disclosure and Fairness Securities Exchange Act of 1933/1934 If you’re going to sell securities to the public you need:Registration statement that meets SEC requirements (risk factors and detailed disclosure of financial structure) or be exempted from registration Prospectus – financial statements of the company audited by an outside auditorLiability under the actMaterial misstatement or omission in the registration statement or in connection with the purchase or sale of any security “Material” – matters that an investor needs to know before making an intelligent and informed decision before purchasing a security Rule: if you disclose it in the registration statement, you’re okayRule 10b-5Jurisdiction – it is illegal to use interstate commerce or national security exchange to Devise a scheme to defraud Make any untrue statement of material fact or to omit a material fact in connection with the purchase of sale of any security with a duty to speak*Plaintiff must actually buy or sell sharesFor a 10b-5 violation the plaintiff needs… [*duty to speak was violated]Economic lossSpecial relationship that gave rise to a duty to discloseIntervening events have made past statements materially false unles the maker of the statements issues a coercive statement Statutory reporting requirementsScienter (knew what you were doing was wrong – knowledge and up mens rea)Material misrepresentation or omission (with a duty to speak)In connection with the purchase of sale of a security Material misrepresentation was the proximate cause of the lossReasonable and detrimental reliance on the material misrepresentation Parties who are liable for registration statementAnyone who signs the registration agreementExperts who assisted in the preparation of the registrations statementUnderwriters of the registration statement Securities exchange act of 1933Shareholder remedy, backbone of this law is full disclosureEmphasis on primary and subsequent offerings of securities for sale by an insurer Requires disclosure and reporting and provides specific private cause of action No merit requirement Can offer any level of risk in security Registration requirement Every issuer no specifically exempted by statute must file a registration statement Escott v. BarChris Construction Corp., 283 F.Supp. 643 (1968) –section 11 of the ’33 act Facts: BarChris was in the business of building bowling alleys and solicited a registration statement and IPO because they had a liquidity problem (needed cash)BarChris solicited a 5.5 (every $100 you invest you will get a 5.5% interest) convertible 15 year debenture Pay back principle and interest in 15 years ConvertibleSubordinated – other creditors may be paid first18 months after BarChris filed its registration agreement investors brought debenturesBarChris filed Chapter 11 BankruptcyThe company had a liquidity cash problem – their current assets could not cover their current liabilities, but they had long term liabilities owed to them Plaintiffs sued claiming that BarChris registration agreement contained material misstatements in violation of 10b-5Anybody who signed the registration agreement is liable (underwriter, auditor of the prospectus, BOD)§11(a) – liability if any part of the registration agreement contains material misstatement or omission of a material fact§11(b) – due diligence defense to avoid liability for any person other than the issuer (BarChris) if they made a reasonable investigation of non-expert material misstatements and reasonably believe that the misstatements were true Reasonable investigation – investigation a prudent person who would have made in the management of their own affairs (own money)Rule: if there is non-disclosure or a material misstatement in the registration statement, to avoid liability under the 11(b) due diligence defense you have to show you conduxcted a reasonable investigation and did not know about the misstatement or omission Securities Exchange Act of 1934 (after IPOs) Prohibits fraud and manipulative devices “in connection with the purchase or sale of a security”Focuses on secondary marketsDisclosure and regulatory provisionsMust disclose anything important Securities fraud (§10(b) §10(b)-5)Ban on short swing profits by a corporate insider Material Omission A substantial likelihood that would have been 10(b) and 10b-5Shall not make a material a material statement or omission in connection with a purchase and sale Basic v. Levinson Facts: Basic and Combustion, Inc. had preliminary negotiation about Combustion buying and merging with BasicWord got out and Basic publicly denied the merger 3 times over 2 yearsThere was a viral stock tip of the rumors of the merger and Basic stock prices started to riseThe media called Basic and it denied the merger because an increase in the stock price negatively affected the premium of the mergerOnce Basic announced the merger its stock price rose significantly Shareholders who sold before Basic admitted the merger sued The denial of the merger was a material misstatement But I would be hard for every shareholder to prove their reliance on the material misstatement Fraud on the Market Presumption Reliance: disclosing or withholding of information affects the price of the stock in the market, and investors rely on the market price as a reflection of the stock’s valueBefore presumption, the plaintiffs would need to show that each class member actually considered (and believed) the alleged fraudulent statements when buying or selling its shares Don’t need to prove actual reliance; just need to prove there was public misrepresentation and an efficient marketNOTE: In small, inefficient markets with few participants, the burden of proof stays with the plaintiff to show actual reliance.Defendants can rebut the presumption by showing no actual reliance (i.e., misrepresentation) did not affect the market price, plaintiff would have bought or sold regardless of disclosure (was forced to, bankruptcy, etc.)The causal connection between the defendants’ fraud and the plaintiffs’ purchase of stock under this theory is no less valid than in a case of direct?reliance?on the misrepresentation.Note: silence, absent a duty to disclose, is not a misstatement or omissionDuty to disclose – if you have already commented or said something, you have a duty to update itHalliburton Co. v Erica P. John Fund, Inc. 134 SCt 2398 (2014) Facts: Fund brought class suit against Halliburton alleging that it made misrepresentations regarding its revenue, a prospective merger, and potential liabilities and affected investors that bought Halliburton common stock during the time periodHalliburton said the misrepresentations had no impact on the price of Halliburton stock Said the misrepresentations had no impact on the price of Halliburton stock, which rebuts the Basic presumption that investors rely on company misstatements in the buying and selling of the company’s stock Essentially asked them to overturn BasicHeld: the court declined to overturn Basic. Rule: Investors must establish reliance on a company’s misrepresentation in order to recover Can do this by invoking the Basic presumption (stock prices reflect all public material information, including misstatements, and therefore anyone who buys or sells a stock effectively relied on those misstatements)The defense is showing a lack of price impact (can be done at the class certification stage)Santa Fe Industries, Inc. v. Green, 430 U.S. 462 (1977) – Liability under rule 10b-5 of ’34 act Facts: Santa Fe owns 90% of stock in Kirby and 10% of Kirby stock is owned by minority shareholders Santa Fe wants to buy out 10% of the minority shareholdersSanta Fe enters into a short form merger – where the parent company could pay cash to buy out the minority shareholders Short Form Merger – permits a parent corporation owning at least 90% of the stock of a subsidiary to merge with that subsidiary on approval by the parent board and to make payment in cash for the shares of the minority stockholdersDoes not require consent, or advance notice to the minority shareholders Santa Fe hired Morgan Stanley to conduct an appraisal of what company’s shares were worthThe state law allowed the shareholders to contest the appraisal of the stock price in the court of chancerySanta Fe appraised the stock at $125 and bought out the minority shareholders at $150.The minority shareholders appraised the stock at $772Kirby monitoring shareholders bring a 10b-5 claim of fraudulent appraisal of the stock Plaintiffs were claiming that the state law that allows short form mergers was a violation of federal statute 10b-5Held: No – the federal 10b-5 law was not meant to overrule the state short form merger lawNo 10b-5 – there was full disclosure and shareholders had an adequate remedy at state law where they could contest the appraisal price Short form merger was not fraud (violation of 10b-5) because the state law explicitly allowed itBreach of fiduciary duty does not give rise to a 10b-5 claim For 10b-5 there must be a material misrepresentation or material failure to disclose in connection with the purchase or exchange of a security Insider Information / Insider Trading Goodwin v Agassiz, 283 Mass. 358 (1933) –directors are not trustees Facts: Goodwin was a stockholder in Cliff, a mining company. There was an attempt to find copper deposits, and directors learned of a geologist’s theory as to the existence of copper deposits in another part of Cliff’s propertyThe initial investigation was unsuccessful and stoppedSimultaneously, Goodwin sold his stock in Cliff The defendant directors bought the stockGoodwin brought suit on the grounds that the defendant’s nondisclosure was improper It didn’t harm Cliff, but Goodwin claimed he would not have sold if he had known about the geologist’s theory Held: No finding of fraud, just an unproven geological theory known to the defendants that they did not discloseDisclosure would not have harmed or helped Cliff Rule: a corporation’s directors do not occupy the position of trustees toward individual stockholders in the corporation. They do not have to inform stockholders of everything they know. Sale of stock is largely impersonal Undue burden on a director to require him to seek out the individual in each transactionSecurities and Exchange Commission v. Texas Gulf Sulphur Co., 401 F.2d 833 (1969) What is “material information” Facts: TGS began drilling in Canada and found high mineral content, kept it quiet. When it started to get out, they released a statement saying the reports were exaggerated and the reports of the content were inconclusive. Between the statement and the official announcement, the secretary, director, and engineer all bought TGS stock Held: the inside information about the specifics of the drilling site discovery that the defendants withheld from the public was material because the high mineral content of the site is information a reasonable investor would have liked to have known, and, if known would have certainly affected the price of the stock. Because it was material, defendants were not entitled to acquire stock until public disclosure This was a trading violation of Rule 10b-5Rule: Individuals with knowledge of material inside information must either disclose it to the public or abstain from trading in the concerned securities while such information is undisclosedMateriality depends on the significance that a reasonable investor would place on the withheld or misrepresented information Dirks v. Securities & Exchange Commission, 463 U.S. 646 (1983) Facts: Former officer of Equity Funding told Dirks that Equity Funding assets were exaggerated due to fraudulent corporate practices. Secrist told Dirks to verify the fraud and disclose it. Dirks investigated and discussed his findings with various investors A few sold the stock after they spoke with DirksAs a result, Equity Funding’s stock fell abruptlySEC found that Dirks had aided/abetted insider trading Held: A tippee does not violate a fiduciary duty to the shareholders from a tip received from someone who did not derive a benefit of any kind. Secrist’s motive was exposing fraud not personal benefit Rule: A tippee assumes a fiduciary duty to the shareholders not to trade on the material nonpublic information only when the insider giving the tip has breached his fiduciary duty to the shareholders by disclosing the information to the tippee, and the tippee knows or should know that there has been a breach. An insider breaches that duty only if he gives the information to personally benefit from it (directly or indirectly)If the insider does not violate any fiduciary duty, tippee cannot be deemed to violate a fiduciary duty Distinguish: US v. Newman Facts: fund managers several levels removed form the disclosing insiders received and traded on information. Knew the insiders as family friends, casual acquaintances, or fellow business school alumni. The insiders received nothing in exchange for their information to the defendants. Government could not show any evidence that the information they traded on came from insiders or that the insiders received any personal benefit Held: the information was too attenuated to be in violation of 10b-5United States v. O’Hagan, 521 U.S. 642 (1997) Misappropriation theory is still a 10b-5 violation Facts: O’Hagan was a partner in the law firm that represented Grand Metro PLC in its tender offer of Pillsbury common stock. The possibility of the tender offer was confidential until the offer was made. O’Hagan used the information to purchase call options and general stock in Pillsbury. Tender offer went public and stock prices went way up O’Hagan sold his shares for $4 million Held: O’Hagan breached his duty – used confidential information to purchase stocks Rule: A person is guilty of fraud when he misappropriates confidential information for trading purposes, in breach of a duty to the source of the information. Misappropriation Theory of Insider Trading:Misappropriation of material nonpublic information for tradingIn breach of a fiduciary duty to the source of the information Essential: deception in the form of feigning fidelity to the source of the information Classical Theory of Insider Trading:Corporate insider misappropriates material nonpublic information for the purposes of tradingin breach of a fiduciary duty to shareholders Both theories satisfy a 10b-5 violation (deceptive practice in connection with purchase of securities)Deal in deceptionFeign loyalty to the principal while using private info to buy stocksSalman v United States, 137 S Ct. 420 (2016) – don’t tell your relatives Facts: Maher, investment banker in Citigroup’s healthcare investment banking group & responsible for highly confidential information. Confided said information in his brother Michael, asking for help with scientific concepts. Michael began using the information to insider trade, and Maher eventually joined him. Salman was informed by Michael, traded on it, and ended up making 1.5 mil in profits. Held: Salman was charged with securities fraudMaher would have personally benefitted had he traded on the information Effectively achieved the same result by disclosing to Michael This is prohibited by Dirks He breaches his duty of trust and confidence to Citigroup and clientsSalman also breached when he traded Rule: Under Dirks, a tipper breaches fiduciary duty by making a gift of confidential information to “a trading relative”Problems of Control – proxy fights § 14 of ’34 – Private Actions If you have a public corporation with a large number of shareholders, you are not going to have an annual meeting with all the shareholdersThe ’34 act allows the company to inform the shareholders and allows the shareholders to vote by proxy The corporation must provide a proxy statement to eligible voting shareholders with material required by the SECEvery corporation is required to have an annual meeting specified by state law, articles of incorporation, or bylawsA shareholder may give a proxy to someone else to vote for their shares. Proxies may provide specific instructions on how the shares are to voted or allow the proxy holder to vote however they wantThe BOD determines its slate of director nominees (incumbent group)Shareholders can propose their own, separate slate of nominees (insurgent group)Before a person makes a solicitation they must provide the person being solicited with a proxy statement that cannot contain materially misleading statementsShareholders vote onBOD electionsMergers Amendment to Articles of Incorporation Liquidation of the company Today, most shares are held by institutional investors and management of the companyRule 14a-9 prohibits materially false or misleading statements or omissions in a proxy statement; courts have held that a private cause of action is implied under §14A private right to action exists under Section 27 of the ’34 act for violations of section 14(a)Section 14(a) – makes it unlawful for anyone to solicit proxies in respect to any security contrary to SEC rulesRule 14a-9 requires no false or misleading statements, no omissions of material factsJ.I. Case Co. v. Borak, 377 U.S. 426 (1964) Facts: JI case co entered into a merger with American Tractor. The proxy statement contained a misleading statement in violation of § 14(a)All the court decides a violation of 14(a) gives a shareholder a private right of action to bring suit under federal law §27 does not explicitly grant a private party the right to bring a lawsuit for the use of a proxy statement alleged to contain false and misleading statements violating §14The court creates a judge made rule that gives a private right of action for a 14(a) violation Rule: shareholders may sue the corporation if they receive a proxy solicitation that has materially misleading or omitted infoThis is to encourage the company to be careful and fully disclose all information and make no misrepresentations in the proxy statement Private individuals will monitor the proxy statement more carefully than the SECLimited Liability CompanyOrganizing an LLCLLC is a creature of contract. Delaware law does not create LLC, the contract creates the LLCFiduciary duties in LLC can be expanded or eliminated in the operating agreement, but good faith and fair dealing cannot beMust file a certificate of formation and then create operating agreement, not articles of incorporation Pros v. Cons.ProsRemoves a lot of the formalities of a partnershipVarying methods of management and ownership rightsPerpetual existence that doesn’t dissolve when owners dieLimited liabilityFinancial structure is very flexibleCan have statutory dissolution, if unreasonably practicable to carry on the businessFiduciary duties can be eliminated Can choose to be taxes as a corporation or a partnershipConsNew form of business that has different rules in different jurisdictionsMay be subject to increased tax burdens in some jurisdictionsCan pierce for liabilityFiduciary duties owed to membersPass through taxationManagement: Any form of management is permitted Member managed is more like partnership than corporate manager managed All have a say in the decision-making power and input on any business decisions Manager managed – manager may be a member or someone else, but duty to the members vest all powers into 1-2 members or hire a new manager and the non-manager members become passive investors Piercing the LLC VeilLLCs will be treated no differently than corporations when it comes to liability Same as piercing corporate veil: just similar interests and promote injusticeIf members and officers fail to treat LLC as a separate entity, by converging personal/ownership interest, AND allowing shield of liability would promote fraud or injustice (unjust enrichment, something fore than failure to collect debts)—then members are personally liableComments: By nature, LLCs are more flexible with less corporate formalities and this affects the analysisFiduciary ObligationsIn a LLC, like a partnership, the members have a fiduciary duty to each other; members of LLC owe one another the duty of utmost trust and loyalty. Taken from partnership law.However, this obligation may be removed through the LLC operating agreements, and parties may contractually agree that no fiduciary obligations exist.Can’t eliminate good faith and fair dealingCan have a LLC opportunity claim (did one of the limited partners take an opportunity from the LLC)—See McConnell v. Hunt SportsMember’s inspection rightsMembers of an LLC can have access to documents that are “reasonably related to the member’s interest as a member of the limited liability company”Rule: DE has not clarified that the default is that LLCs DO have default dutiesDE Code §18-1101 (b)?It is the policy of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements.(c)?To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member's or manager's or other person's duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.(h)?Action validly taken pursuant to 1 provision of this chapter shall not be deemed invalid solely because it is identical or similar in substance to an action that could have been taken pursuant to some other provision of this chapter but fails to satisfy 1 or more requirements prescribed by such other provision.Any provision of DE laws has equal dignity with any other provisionParts of an LLC Member managed Manager managed Certificate of formation Operating agreement Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970) Facts: Auto Lite merged with Mergenthaler Auto Lite’s BOD sent out proxy statement recommending the merger Auto Lite did not disclose that Mergenthaler owned 54% of Auto Lite (so they controlled the BOD)Shareholder brought a derivative action claiming the proxy statement was misleading because it failed to disclose Auto Lite BOD was controlled by the target company MergenthalerA 2/3 vote was required for a merger, so Mergenthaler (who has 54% of the shares) needed other shareholder votes to approve the merger There is no way to determine is the shareholders would have relied on this material omission Issue: if the plaintiff proves that the proxy solicitation contained materially misleading statements of fact, must the plaintiff also prove that he relied on the contents in the proxy statement and that such reliance caused his injury (i.e. caused the plaintiff to vote as he did)?Held: petitioner established a cause of action by showing the shareholders were materially affected by the recommendation of an interested BOD and the court refuses to rationalize the misconduct simply because the merger was fair. The shareholders cannot be cut out of the voting process. Rule: to bring a claim under 14(a) there needs to be a material false of a misleading statement in the proxy statement and a showing of causation (meaning a proxy vote was needed, not actual reliance)Basically, once it has been shown that a false statement is material (meaning that it is the kind of thing that might make a reasonable shareholder vote a different way), then there must also be a showing of causation, meaning that the vote is requiredIf Mergenthaler had owned more than 66% of Auto Lite’s stock (and could therefore approve a merger without any other shareholder consent), then would be no causation.Attorney Fees: a successful plaintiff in a case of violation of section 14(a) is entitled to reasonable costs and attorneys’ fees when the action is brought on behalf of class and benefits all members of the class. This is a court-made rule. The class is all shareholders of the defendant. The benefit is the exposure of the deceit practiced on all the shareholders. Seinfeld v. Bartz, 2002 WL 243597 (2002) Facts: Plaintiff was a shareholder in Cisco and brought a derivative suit based on a proxy statement that solicited more options for directors in their compensationProxy failed to include value of option grants for directors based on the Black-Scholes option pricing modelBOD had the right to buy $30K worth of shares for a life of 10 years at the strike priceShareholder claimed that it was a material misrepresentation not to include in the proxy statement the value of the options that were given to the BOD in addition to their salary It is well settled that the BOD salary must be put in the proxy statement director salaryRule: Black-Scholes valuation of options are not material for purposes of Rule 14(a)SEC rule 14(a) prohibits solicitation of proxy by a statement containing 1) false or misleading declaration of material fact 2) omission of material factShareholders are smart enough to know that based on the volatility of the stock price, the value of the option may not be worth much at allAny value of the options is based on speculation Just because the options turned out to be worth 1 million this was not a material misrepresentation because the options value are based on speculation Terms to KnowStock - share in the ownership of a company representing a claim on the company's assets and earningsOption - formal contract for the right (but not the obligation) to buy-and-sell a security at a fixed price (called exercise price) on or up to a fixed dateCall - buyer's right to purchase a specified number of certain asset or security at a specified price by a fixed datePut - if a store or company goes out of business or is put out of business, it has to stop trading because it is not making enough moneyThe limited Liability Company – you better state what you want in your agreement LLCs are creatures of contract; the statutory scheme allows virtually unlimited discretion to define the terms of the operating agreement DE courts employ an objective theory of K interpretation with LLCsExtrinsic evidence is excluded if there is an obvious answer from the plain reading of the KDE law allows members to structure their business through a written, implied, or oral operating agreement Oral contracts must be proven by clear and convincing evidence If evidentiary burden is not satisfied – court will look to DE law for the operating agreement Olson – oral operating agreements that cannot be performed within one year must be in writingMembers may limit or eliminate traditional fiduciary duties and liabilities But if the provision is not unambiguous the court will assume traditional duties as a default mechanism Right of dissolution – member must establish that it is not reasonably practicable to carry on the company’s business in conformity with its operating agreement Fisk Ventures – court identified three factual circumstances that the court should considerExistence of board deadlockAbsence of a mechanism in the operating agreement to circumvent the deadlockInability of the company to operate given its financial condition Arguably – should consider whether the company is operating within the scope of the business purpose stated in the operating agreement A member can waive his or her right for dissolution, but cannot waive another’s right to seek judicial dissolution on behalf of the member The waiver statutory rights are permissive not mandatory and cannot be waivedNo express prohibition of waiverPermissible language Intent that the sections could be modified by the members in their agreementStatutory rights were not intended to protect third parties Elf Atochem North America, Inc. v. Jaffari, 727 A.2d 286 (1999) Facts: Elf and Jaffari created Malek LLCPublicly filed in DE, so internal affairs doctrine says DE law controlsOperating agreement had an arbitration clause – all disputes arbitrated in CAElf brought a derivative action against JafariJafari claims the suit must be brought in DE under internal affairs doctrineHeld: the LLC term in the operating agreement that was a forum selection clause to litigate all disputes in CA trumps the state statute that requires all lawsuits to be brought in DE under the IADRule: the terms of the operating agreement are the terms that the partners in an LLC are stuck with – terms of the operating agreement trump default state law McConnell v. Hunt Sports Enterprises, 725 N.E.2d 1193 (1999) Facts: McConnell and Hunt Sports formed CHLLC to bring an NHL franchise to Cbus Nationwide insurance agreed to invest and finance the building of the hockey arena and lease the arena to CHLLCHunt rejected the offer because of the terms, so Nationwide approached McConnell McConnell formed another LLC to lease the arena from NationwideCHLLC operating agreement – “allows members of CHL to compete with CHL in any other business venture of any nature, including any venture which may be competitive with the business of the company”Held: the court enforced the terms of the operating agreementRule: you can put in the operating agreement whatever you want, and unless it violates good faith or fair dealing it will be enforced You can contract away duty of loyalty in LLC operating agreements (the agreement here allowed competition, which is normally a breach of loyalty, but the court allowed it)The LLC battle is over Battle between 2 prominent DE judges as to the status of fiduciary duties Gatz v. Auriga, Nov 7, 2012 The court affirms the case below in the entiretySteel belives that the case should have been determined as a contract issue and therefore they are all stuckAll of the discussion about LLC is dictaAuriga Capital Corporation v. RooneyFacts: Peconic Bay LLC was formed to establish a golf course, Gatz LLC, controlled by William Gatz, who was the manager of the LLC.Peconic Bay is member managed:All members participate in the decision-making process of the LLCSelf managers (who can be members) or an outside management company to manage the LLCThe company hired to manage the golf course appeared as if it were terminating its contract with Peconic Bay, and thus Gatz was looking for offers. Galvin offered 4.15 milion that the shareholders rejected. Gatz then created a sham auction where he buys the golf course for himself and sells it to his own LLC to manage (self dealing)Rule: if there is a self-dealing transaction, under 144(c) Gatz has to prove it is a fair deal Held: because 18-1101(c) allows the parties of an LLC to contract out of fiduciary duties to one another, the fact that these can be eliminated implies that they are default duties that applyLLC managers are fiduciaries and therefore owe fiduciary duties of loyalty and care that exist in defaultDE Supreme Court on appeal says that Auriga decision about the fiduciary duties being default was dicta Note: to resolve this issue – explicitly say in the operating agreement that the fiduciary duties exist or are disclaimed can’t eliminate the duty of good faith or fair dealing Shareholder proposals Shareholder Proposals under Section 14 of the Securities Exchange Act of 1934As an alternative to an independent proxy solicitation, any shareholder can petition the board to include terms in the proxy statement to be voted on at the next annual meeting under 14-a8 of the 34 acts. If management omits the shareholder proposal from its proxy statement:It must file reasons for opposing with the SECSEC will review the proposal and give an indication whether it agrees or disagrees with management “No Action” letter – the corporation writes to the SEC and seeks a letter saying they won’t pursue enforcement of Rule 14(a) if they keep the proposal off the proxy statement Refusal is protected by the BJR: corporation may refuse to include a shareholder proposal in the proxy materials being sent in connection with the shareholder meeting Rule 14-a8: board may omit a shareholder’s proposal when:Not significantly related to the business:Accounts for less than 5% of its total assets, net earnings and gross sales for the last fiscal year; andIs not otherwise significantly related to the issuer’s businessProposal “relates to ordinary business operations”May omit a proposal that relates to the “ordinary business operations” of issuer This provision prohibits shareholder intervention in the “minute” matters of daily operation of corporate business Proposal “submitted for non-corporate purpose”If proposal is submitted for primarily “non-corporate purposes” management may omit it (EX: personal claims, matters outside issuer’s control, matters not related to business, election of directors, proposal previously submitted)Burden of Proof: management has burden to show proposal is not proper for any above stated reasons The route to corporate social responsibility Trinity Wall Street v. Walmart Stores, Inc. 792 F3d. 323 (2015) Facts: Trinity owned shares of WalMart. Trinity filed a shareholder proposal - Walmart should adopt a policy to not sell gun with high-capacity magazines. Walmart declined to include in proxy. Trinity brought suit arguing exclusion violated the SEA ’34 Claimed it related to corporate governance NOT being a good corporate citizen Selling the guns would hurt reputation/brand Held: Selling the guns was an issue of significant social policy, but it does not transcend day to day operations (in this case, what WalMart sells), so they were entitled to exclude shareholder proposalHeart of retailer’s business – what it sells It is rare that a social policy matter will transcend something so inherent to retail operationsConsidering consumer/community safety in determining what to sell is intertwined with business operationsRule: A company cannot exclude from a proxy statement a shareholder proposal that focuses on a matter of significant social policy related to the company’s day-to-day business operations if the policy issue goes beyond those operations.Generally, can exclude a shareholder proposal from a proxy if related to ordinary business operations Courts considerSubject matter of the proposalDoes the subject relate to company’s ordinary business operations?Lovenheim v. Iroquois Brands, Ltd., 618 F.Supp. 554 (1985)Facts: Lovenheim was a shareholder of Iroquois corporation Lovenheim wanted to submit a proposal in the proxy materials to form a committee to study whether force feeding geese in the production of pate was inhumaneLovenheim wanted the company to publicize the proposal in the proxy statement at the company’s expense Company dismissed the proposal and seeks a no action letter from the SECThe company claims that under 14-a8 it can exclude a shareholder proposal that related to less than 5% of the total assets, net earnings or gross sales for the last fiscal year and is not significantly related to the issuers businessCourt relies on the “otherwise significantly related to the business” language and requires the proposal to be included in the proxy materialsEconomic impact does not determine whether the proxy topic is significantly related to the business Social and environmental issues are matters of ethical and social significance that are significantly related to the businessRule: matters of ethical and social significance are significantly related to the business and can’t be excluded under 14a-8AFSCME v. AIG, 462 F.3d 121 (2d Cir. 2006) Facts: AFSCME was a union shareholder of AIG and submitted a proposal to amend the bylaws to require the company to publish in the proxy statement the names of shareholder-nominated candidates for director positions together with any candidates nominated by AIG’s board of directors. AIG dismissed the proposal based on the 14-a8 exception because it related to an election for membership on the company BODHeld: the proposal did not relate to an election for a member of the BODSEC interpretation was that “an election” language pertains to proposals dealing with a specific election and not procedures for elections in general Rule: shareholder amendments to bylaw proposals, which relate to election procedures in general, rather than specific upcoming elections, are non-excusable under Rule 14-a8CA, Inc. v AFSCME Employees Pension Plan, 953 A2d 227Facts: AFSCME submitted a proposal to amend the bylaws to require the company to reimburse proxy expenses incurred by shareholder nominated board members, if at least one shareholder nominated candidate won a spot of the BODIf shareholders vote the change the bylaws – generally the bylaws cannot be changed by the BODHeld: the company can exclude the proposals Procedural amendment to bylaws regarding election in general are not excludable (see previous case)But proposal that interferes with the BOD duties to the shareholders (manage the affairs of the business) or fiduciary duties can be excluded The bylaw could require the company to reimburse proxy expenses for controversy over personal (not professional) concerns – and the BOD would be required duty to deny the reimbursement RuleShareholders can propose bylawsBut, this bylaw violates DE law because the board has a fiduciary duty to the shareholders that would prohibit a mandatory reimbursement of certain (personal) proxy costsDE permits shareholders or the board to propose bylaws and the certificate of incorporation may permit Board to amend (sec. 109(a)), though shareholders also retain the right to adopt, amend, and repeal141(a) – business and affairs under board and not shareholders. Shareholders do not have the same broad powers as the board109(b) – bylaws cannot be inconsistent with DE law Shareholder inspection rights – close corps and shareholder agreements DGCL § 220: any [1] stockholder, shall, upon [2] written demand under oath stating the purpose thereof, have the right during the usual hours for business to [3] inspect for any proper purpose, the corporation’s stock ledger, a list of its stockholders, and its other books and records, and to make copies or extracts therefrom. A proper purpose shall mean a purpose reasonably related to such person’s interest as a stockholder.BOP under DE law distinguishes between stockholder lists and other corporate books and recordsWith stockholder lists – corporation must carry burden that stockholder does not have a proper purpose With other books and records – stockholder must carry burden that he has a proper purpose The principle question is “proper purpose” If you seek the shareholder list to sell them to marketers, given them to creditors, or use them for political purposes, that’s not a proper purpose.Seeking the shareholder list to solicit proxies from fellow shareholders, or seeking financial records for the purpose of valuing the investment are proper purposes.Game Plan – Inspection rights Generally: State corporate law always provides that shareholders have a right to inspect certain corporate books and records.Financial Reports: Generally, corporate financial records (at least those required to be filed with the SEC) for public companies are available from the SEC disclosure filings required under the Exchange Act, the Securities Act, and the Sarbanes-Oxley Act.Close corporations generally do not have to publicly disclose their financial statements.The only public notice of the existence and operation of a close corporation is an annual filing with the Secretary of State to identify the corporation and identify its address & registered agent.MBCA §16.20 requires corporations to provide shareholders with an audited annual report of the financial status of the corporation that complies with Generally Accepted Accounting Principles (“GAAP”).Michigan’s Code (MCL § 450.1487(1)) differs, only have to provide shareholders with these same audited financial statements, but only upon a shareholder’s written request.State LawCrane Co. v. Anaconda Co., 346 N.E.2d 507 (1976) Facts: Crane announced proposed offer to exchange subordinated debentures for shares of common stock of Anaconda Anaconda opposed the tender offerCrane owned 11% of the Anaconda’s common stock and requested a list of anaconda’s shareholdersAnaconda refused to provide shareholder list because it claimed that the requires was not for a “purpose relating to the business” Crane buying enough shares to control the company and elect the BODRule: a shareholder can access a shareholder list for the purpose of informing other shareholders of its tender offer (shareholder list for the purpose of soliciting a tender offer is a proper purpose)Shareholder list the burden in on corporation to show improper purposeCorporate books and records the burden is on the shareholder to show proper purpose A shareholder that wishes to discuss relevant aspects of a tender offer should be granted access to the shareholder list unless is sought for an improper purpose Rule: IAD does not apply to shareholder’s list State ex rel. Pillsbury v. Honeywell, Inc. 191 N.W. 2d 406 (1971)Facts: Pillsbury called broker to buy 100 shares of Honeywell stock. He testified that his sole purpose of buying the stock was to change the BOD to stop producing fragmentation bombs used in Vietnam.Pillsbury requested shareholder list and corporate books and records relating to the production of fragmentation bombs Rule: shareholder must have a “proper purpose germane to his interests as a shareholder” for demanding inspection A proper purpose to inspect corporate records must concern an investment returnPillsbury testified that the reason he bought stock and demanded inspection of corporate records was for social and political concernsHe could have got around this by relating his request to and economic interest as a shareholder (e.g. fragmentation bombs lead to bad publicity that drove stock price down, the fragmentation bombs were an unprofitable section of the business)Shareholder Voting ControlShareholders may structure control of the corporate entity however they likeThe basic model is a corporation that only issues one class of common stockMore sophisticated – issuing a class of preferred stock with superior rights to receive dividends but no voting rights plus a class of common stock with inferior rights to dividends but one vote per shareStroh v. Blackhawk Holding Corp., 272 N.E.2d 1 (1971) –stock classes with varying voting power Facts: Action was brought by Stroh (Class A stockholder) claiming that Class B stockholders did not actually hold stock and Class B shares were invalid. Company created two types of stock:Class B stock: has voting rights, but no rights to earnings or assets on liquidation and dividends [$0.25 a share]Class A stock: had voting rights and rights to earnings or assets on liquidation and dividends [$3.40 a share]Promoters of the company bought Class B stock and invited the public to buy Class AThe promoters bought 500,000 shares of Class B stock for $1,200 and had no majority of the voting control over the company Stroh claimed that because all Class B stockholders had was a naked vote (no economic incidents of the stock) it is not stock at allRule: Illinois law permits a corporation may set any restrictions or limitations on its stock, with the exception of restricting voting rights The rights to economic earnings and the right to assets may be removed from stock Only the management rights incident to ownership cannot be removedThe right to vote that came with the Class B stock satisfied state law requirement that stock must have proprietary interest Espinoza v Zuckerberg, 124 A.3d 47 (Del Ch 2015)Facts: Ernesto Espinoza brought a shareholder derivative suit challenging the Facebook, Inc., board of directors’ decision to approve certain compensation to outside directors. Mark Zuckerberg was the controlling stockholder of Facebook, controlling over 61 percent. After Espinoza filed suit, Zuckerberg, in a deposition and affidavit, approved the contested compensation. Zuckerberg had not received the compensation. The directors moved for summary judgment on the ground that Zuckerberg’s approval constituted stockholder ratification of the board’s compensation decision.Held: Failing to adhere to corporate formalities to effect ratifications impinges minority stockholder rights there needs to be transparencyRule: Stockholders of a DE corporation – even a single controlling stockholder – cannot ratify an interested board’s decisions without adhering to the corporate formalities specified in DGCL for taking stockholder action. When directors make decisions about their compensation those decisions presumptively will be reviewed as a self-dealing transaction under the entire fairness standard rather than the BJRControl in Closely Held Corporations A closely held corporation is a firm organized as a corporation with 1) relatively few shareholders (usually 30-50) 2) significant shareholder participation in the operation of the business 3) the shareholders, usually hold officer or other employment position with the firm and expect an active role in management 4) and illiquidity of shares There is no secondary market for the shares (shareholders can’t vote with their feet) and shareholders main concern is maintaining control and avoiding oppression Principle concern in close corps is oppression of minority shareholders by the majority LLCs are preferred over closely held corporations because they are more flexible and parties can contract the preferred rules of governanceIn an LLC the parties can contract out of fiduciary duties that apply in the corporate form Because the principal concern of members of a close corporation is maintaining control and avoiding (being the shareholder subjected to) oppression, a variety of practices have been developed to address this fundamental issue. These include -Straight voting?means that each share gets one vote for each director. In X Corp. with 100 shares (A owns 67, B owns 33) and three directors, A gets to vote 67 shares for each director and thus controls the board by electing all of the directors.Cumulative voting?means that each share carries a number of votes equal to the number of directors to be elected.?In an election for three director positions A would thus have 3 x 67 shares or 201 votes and B would have 3 x 33 shares or 99 votes. A could vote 100 votes for director 1; 100 votes for director 2; and 1 for director 3. B could vote all 99 of his votes for director 4, who would thereby be elected.By concentrating his votes, B is guaranteed at least one director slot.Majority can defeat cumulative voting by amending the articles of incorporation to stagger the election of directors so that fewer directors are being elected each year.For example, if A staggered the terms of the X Corp.’s three directors so they were only electing one director each year to a three-year term, A would always win.Class voting?– The articles of incorporation divide shares into classes and give each class a right to elect a specified number of directors.Voting trusts?-?The underlying agreement provides that legal title to the shares subject to the trust be transferred to a trustee pursuant to a voting trust agreement.Beneficial owners then receive shares in voting trust that can be transferred but cannot affect the voting of the shares in the trustDisfavored – courts have a fetish about the separation of the vote from the stock Must follow the statute – puts other shareholders on notice as to the existence of the trust Vote Pooling Agreements – shareholders agree in advance how they will case their own votesIrrevocable proxy?- Generally shareholder proxies are revocable at any time.Irrevocable proxy permanently “separates vote from the stock”?Shareholder agreements Enforceable if the agreement is for shareholders to elect certain parties to director positionsUsually unenforceable if they contain additional directions to directors (“sterilizing” the board), unless the shareholder agreement includes all shareholders (unity of interest)McQuade v. Stoneham, 189 N.E. 234 (1934)Facts: Giants have 2500 shares of outstanding, Stoneham has 1306, McGraw and McQuade have 70Stoneham, McGraw, and McQuade entered into agreement to vote for each other as directors (this is acceptable because shareholders can pool their votes to elect directors) and when they were directors to vote each other as officers (NOT acceptable because directors must exercise business judgement and cannot be required by an agreement to vote in a certain way)Rule: agreement cannot control how directors vote in their capacity as directorsAgreement can control how shareholders vote in their capacity as shareholdersMinority shareholders have an interest in the company and directors owe a fiduciary duty to the shareholders to exercise their business judgement (which they could not do if an agreement controlled how they voted in their capacity as directors)Any director vote must be exercised with independent business judgement and any agreement that sterilizes that is voidCourt had a problem with the agreement because it interfered with the director’s independent judgement and the minority shareholders still had an interest in the company Public policy: Cannot deprive a shareholder of functions as a shareholder or officer if they were to become oneClark v. Dodge, 199 N.E. 641 (1936) Facts: Clark owns 25% of the pharmaceutical company and Dodge owns 75% of the company Clark and Dodge enter into an agreement for Dodge, in his capacity as a director, to always vote Clark as the general manager. In exchange, Clark would give Dodge the secret medicinal formulaThe agreement was effective because all of the shareholders were part of the agreement and the directors did not owe a fiduciary duty to any other shareholders All shareholders were part of the agreement which controlled how the director acted, so the shareholder agreement can sterilize the director decision Rule: when there is unity of interest (all shareholders were part of the agreement) the agreement can control how directors voteGaller v. Galler, 203 N.E.2d 577 (1964) Facts: Ben and Isadore Galler were each 47% stockholders and Rosenburg owned 6% of the stock when the agreement was created They created an agreement that they would vote themselves and their wives as directors, if a director died their spouse would be able to appoint a director to replace them, a dividend would be paid to the widow of the deceased director so long as the company surplus was 500K (director decision), and the deceased director’s salary would be paid to their widow for 5 years (director decision)Isadore bought out Rosenburg so all of the company shareholders enter into the agreement and there was a unity of interest Ben died and his wife tried to enforce the agreement, but Isadore and his wife as directors refused to give Ben’s widow what they all agreed to in the agreement Held: the court upheld the agreement because there was a unity of interest when the agreement was sought to be enforced A shareholder agreement that controls how directors vote will be enforced where all shareholders of the company were part of the agreement (unity of interest) Abuse of Control in Closely Held and Close Corporations Fiduciary Duties of Close CorporationsClose corporations are like partnerships where there is no separation of ownership and control between shareholders, directors, and officers(1) Massachusetts Rule – close corporations are like partnerships, so the shareholders owe each other fiduciary duties of good faith, loyalty, and candorThis is interpreted to mean that a controlling group of shareholders cannot eliminate a minority shareholder’s reasonable expectations of benefits without a legitimate business purposeBenefits – employment/return on investment Three-part test for improper freeze-out Minority pleads and proves prima facie case of breach of duty of good faith by majorityControl group demonstrates a legitimate business purpose for its actionsBurden then shifts to minority to demonstrate a less harmful alternative(2) Delaware Rule – you chose the corporate form and shareholders do not owe each other fiduciary duties and if you want them contract for it prior to investing There is really no market for minority shareholder in a closed corporation So the only way a minority shareholder gets paid in a closed corporation is through dividends declared by the majority or through a salary from being a director, officer, or employee of the company Closed CorporationFewer than 30 shareholders Shareholders participate in management (director, officer)Corporation is just a form of limited liability, but its really more like a partnership Shares are not freely transferrable Relationship Types in Close Corps Employer/employeeCorporation/ShareholderMajority shareholders/minority shareholdersDuty to SpeakAt arm’s length = no duty to disclose valuable private knowledgeIn close corporations, where the corporation is buying its own stock back from an investor, there is a fiduciary duty to disclose material factsOtherwise, no different than trading by individualsOptions for Exit Articles or bylaws provision for repurchase upon contingent eventInvoluntary dissolution under state statute In a close corporation – over 35 shareholdersLiquidation is reasonably necessary for the protection of the rights/interest of shareholderLiquidation just forces parties back to the bargaining table Appraisal rights or merger, sale of all/substantially all assets or de facto merger Equitable remedies for breach of fiduciary duty by majority to minority Squeeze out – NOT a freeze outWilkes v. Springside Nursing Home, Inc., 353 N.E.2d 657 (1976) - MASS Facts: Wilkes, Richie, Quinn, Pipkin formed a close corporation, and each got 25% interest. They bought land and built a nursing home on the lotQuinn wanted to buy a portion of the land for his separate business, but Wilkes convinced the other shareholders to require Quinn to pay more than he was originally offeredAt this point, Wilkes and Quinn started hating each other Quinn forms a control group with Riche and Pipkin – they decided to pay themselves a salary as directors and decide to cut out Wilkes (no director provision, no officer provision, no salary)Control group has eliminated all the value Wilkes got from being a shareholder Freeze Out – control group eliminates all the reasonably expected value that a minority interest has in the ownership in a corporation Control group eliminates the minority shareholder’s reasonable expected benefit – and judges decided what the shareholders reasonable expected benefit isHow to avoid freeze out:Employment agreement for minority shareholder – guarantees that the minority shareholder keeps employment with corporation Shareholder agreement – guarantees the minority shareholder secures a spot as a director Each shareholder gets a different class of stock that can each elect one director Buyout Agreement Massachusetts Rule: shareholders of closely held corporations owe each other fiduciary duties of loyalty, good faith, and candor (3 part test)Is there a freeze out?Control group eliminates all the reasonable expected value that a minority interest has in the ownership in a corporation If so, the burden is on the majority to show there is a legitimate purpose for its actions?Low burden because its easy to make one up If so, the burden shifts to the minority to prove the goals could the goal have been achieved through less harmful means Remedy for freeze out – what the minority shareholders would have expected if had not been oustedForcing a buyback gives the shareholder a windfall – not a reasonably expected benefitThere is no market for close corporation sharesMinority shares have no control, and their stock are not worth much (minority discount v. majority premium) Ingle v. Glamore Motor Sales, Inc., 535 N.E.2d 1131 (1989) – NY Facts: Ingle was a shareholder and employee of the company. Glamore and his sons formed a control group and voted Ingle out as a director and fired him as an employee (freeze out)Employment agreement – Ingle could be fired for any reason (at will)Shareholder agreement – if Ingle became unemployed for any reason, Glamore had a right to buy back the shares Ingle argues that because he was a minority shareholder, the shareholders owed him a fiduciary duty of good faith and therefore could only be fired for a legitimate business purpose Court rejects and says that the shareholder agreement and employment agreement are separate, and they will respect them independent of each other Rule: if you are a shareholder, other shareholders owe you a duty of good faith, but can be contract out of by an employment agreement (i.e. you can contract to allow a freeze out)Brodie v. Jordan, 857 N.E. 1076 (2006) -- MASS Facts: Walter, Barbuto, and Jordan were the three directors of Malden, an undisputed close corporation (MA corp.) and each held 1/3 of the shares. Walter requested to be bought out but the other two refused. The articles of organization/bylaws did not have a buyout obligation upon request. Walter was voted out as president and director and died 5 years later Brodie inherited Walter’s shares, and the defendants repeatedly failed to provide her with various company information She nominated herself as director, but it was voted down She requested they buy out her shares, they declinedSuit for breach of fiduciary dutyRule: Majority shareholders in a close corporation violated his duty when they act to freeze out the minority Stockholders own one another the same fiduciary duty in operation that partners owe to one another Cannot frustrate the minority’s reasonable expectations of benefit from their ownership of sharesSmith v. Atlantic Properties, Inc., 422 N.E.2d 798 (1981) –MASS – super majority voting requirements Facts: Smith, Zimble, Burke, and Wolfson invested equal sums and were the only stockholders and each held 25%. Atlantics bylaws provided that corporate decisions must be approved by 80% of the stock eligible to vote, effectively giving any one of the original stockholder veto power Wolfson was in the top income tax bracket, so any dividend would have been taxed at an 80% rateWolfson wanted to put his ownership in a tax-free shelter, and the other shareholders denied. In return Wolfson got pissed and vetoed declaring dividendsWolfson wanted to reinvest money into repairs and improvements into properties into properties owned by corporation, and the other shareholders want to declare dividends The lack of good paying dividends caused the company to have to pay IRS penaltiesWolfson violated his fiduciary duties of good faith by unreasonable exercising his veto powerRule: setting up a company to give a minority shareholder the ability to veto director decisions is legal, but the minority shareholder still has a fiduciary duty to do what is in the company’s best interestNixon v. Blackwell –Delaware Note: DE saying you have the right to make any deal you want but you are stuck with it Facts: E.C. Barton & Co. was a closely-held DE corporation Upon founder Barton’s death, all of the class A voting stock passed to employees, and only Class B non-voting stock passed to Barton’s family. Corporation offered to repurchase Class B stock through tender offer and set up an employee stock ownership plan that allowed employees to cash outcorporation could repurchase class A stock on death or termination.Held: Defendants had met their burden of establishing the entire fairness of dealings with plaintiffs, because the record was sufficient to conclude that plaintiffs’ claim that defendant director had maintained a discriminatory policy of favoring Class A employee stockholders over Class B non-employee stockholders was without merit “A stockholder who bargains for stock in a closely held corporation … can make a business judgement of whether to buy into such a minority position, and if so on what terms”“The tools for good corporate practice are designed to give a purchasing minority stockholder the opportunity to bargain for protection before parting with consideration. It would do violence to normal corporate practice and our corporation law to fashion an ad hoc ruling which would result in a court-imposed stockholder buy-out for which the parties had not contracted”Jordan v. Duff and Phelps, Inc., 815 F.2d 429 (1987) –Forced sale agreements Basis for 4 finals Facts: Jordan was a securities analyst employee at will for Duff and bought shares in the company. The company is a closely held corporation Jordan entered into a shareholder agreement that if he was terminated from the company, he would have to sell his shares back to the company for their book value of the previous yearJordan’s wife started having problems with his mother, so he found another job in HoustonDecember 16, Jordan told Duff he was quitting, and he was allowed to work to the end of the year so he could get the book value of his shares for the current year when selling back the shares when he leavesDuff started merger negotiations with Security Pacific, but the deal died Duff did not tell Jordan about the potential merger and the offer to buy for 50 million, which would have appreciated the value of his stock from $23K to $452KHe refused to cash his book value check and demanded the current value of his sharesRule: Under 10b-5 it is a violation to make material misrepresentations or omission in connection with the exchange of a security Jordan claims there was a duty to disclose and the omission was a violation of 10b-5Duty of candor between shareholder of a closed corporation Easterbrook (judge) states that there is a fiduciary duty to disclose talks of a merger in a close corp.Merger that increased the stock price by $432K is material Rule: public firms need not disclose pending merger talks before they agree “on the price and structure of the deal.” BUT a closely held corporation has a duty to disclose a potential merger or buyout when attempting to buy shares from an unwary shareholder, even if the deal has yet to reach an agreement as to price or structure of the deal.Jordan was an at-will employee, but he could not have been fired just to increase senior management gains in the merger (opportunistic firing)By repurchasing Jordan’s stock on the firm’s behalf at book value without disclosing the merger, Hansen violated the “abstain or disclose” rule of 10b-5Dissent – PosnerUnder Basic, silence by itself is not a misstatement or omission Duty to disclose – if you have already commented or said something, you have a duty to update Unlike Basic, the corporation did not deny the merger but was just silent as to its possibility To avoid liability by firing Jordan anytime before Dec 30, therefore – failure to disclose would be immaterial because he could not hold his shares until the merger was effectiveThere is a problem with causation. The corporation did not tell Jordan about the merger with Security Pacific, but it fell through. Jordan would have to show that he would have held on to his shares after the failed merger with Security Pacific until the leveraged buyout from the firm’s senior managers over a year laterAlthough Rule 10(b)-5 mandates disclosure, it mandates it only when an investor can respond to any information he obtains. Because the company could fire Jordan and recall his stock, Jordan lacked a right to respond to any news of a merger.Control, duration, and statutory dissolution Alaska Plastics, Inc. v. Coppock, 621 P.2d 270 (1980) Facts: Stefano, Gilliam, and Crow were the sole shareholder and directors in a closely held corporation and each owned equal 1/3 shares in corporation Crow got divorced and gave half his shares to his ex wife, MuirMuir was not a directorDirectors did not notify Muir of annual shareholder meetingsMuir was minority shareholder who though she was being treated unfairly, and wanted to sell her shares to the company Muir sues derivatively claiming breach of fiduciary duty of careDirectors did not insure the Alaska Plastics plant and it burned downCourt dismissed claim under the business judgement ruleMuir sues claiming that the directors breached their fiduciary duties by oppression of minority Court dismisses this because she was not treated unfairly or differently than any other shareholdersNo dividends were declared in the past, and none were declared to any shareholdersThe fact that the other shareholders were paid for their positions as directors was okay because Muir was not a director and did not deserve to be paid Under Alaska law there are four circumstances when a company is forced to buy back minority shareholder:Term in the articles or bylaws that requires the corporation to purchase the shares contingent on some eventInvoluntary dissolution of the corporation The acts of those in control of the corporation are illegal, oppressive or fraudulent, or that corporate assets are being wasted Because liquidation is such an extreme remedy, courts have recognized less drastic alternative remedies, such as requiring the corporation to purchase the minority shareholder’s shares for a fair and reasonable priceSignificant change in the corporate structure such as mergerEquitable remedy upon breach of a fiduciary duty between directors and shareholdersVoluntary v. Administrative DissolutionUsually need a showing of oppression, fraud, illegality by the majority shareholders towards the minority, waste of corporate assetsMost statutes provide two further groundsDeadlock among directorsDirectors must be evenly divided and unable to make corporate decisionsShareholders must be unable to resolve the deadlock Deadlock must threaten irreparable injury to the corporation or prevent the business of the corporation from being conducted to the advantage of the shareholders Shareholder deadlock Must be evenly divided Because of their division, must be unable to elect a BOD for two years running Oppressive Acts: conduct that substantially defeats a minority shareholder’s reasonable expectationsThe reasonable expectations …Were reasonable under the circumstancesKnown to the majority Central to the petitioner’s decision to join the venture Haley v. Talcott, 864 A.2d 86 (2004)Facts: Haley has experience in restaurant business and Talcott had money to start a seafood restaurantTalcott was the sole owner of the business under the LLC operating agreement Haley was an employee who was paid a salary and received a bonus of ? of the net profitsCourt said that based on Haley’s relationship with the business he was a partnerHaley and Talcott created another LLC where they were both 50% owners that bought the property the restaurant was on Haley and Talcott signed guarantee that they would be personally liable if they could not pay back the loan the LLC got for purchasing the propertyThere is an exit term in the contract that allows either shareholder to be bought out for the fair market value of his sharesCourt can order dissolution if there is a deadlock between two 50% owner of an LLC if it is not reasonably practicable to carry on the businessCourt can order dissolution of an LLC whenever it is not reasonably practicable to carry on the business in conformity with the LLC operating agreement If an equitable exit mechanism to a deadlock had been specified in the LLC agreement, judicial dissolution may not be warrantedWithout relief from his personal loan guarantee, Haley would remain personally liable for the mortgage debt of the LLC, even after his exit and therefore its not a reasonable exit mechanism Court orders dissolution of a joint venture corporation owned by deadlocked 50% owners Pedro v. Pedro, 489 N.W.2d 798 (1992) Facts: Alfred, Carl, and Eugene were brothers that each owned equal 1/3 shares of a closely held corporation, the shareholders entered into an agreement that upon death or when a living shareholder wanted to sell their shares the company would buy back shares for 75% of the book valueAlfred discovered misappropriation of $270K corporate funds, and his brothers told him to drop it or they would fire himThe internal accountant conducted an investigation and discovered there was missing funds, but could not determine whyAlfred pushed for another independent auditor and Alfred was firedAlfred was frozen out of the decision-making process and deprived of his reasonably expected benefits of his ownership share in the corporation Alfred claims his brothers breached his fiduciary duties by firing him Held: Alfred was frozen out and was an employee at will, but because of equity and his life-long employment (45 years his only job) with the company he had a reasonable expectation that he was not an employee at will and was awarded lifetime wagesTransfer of control: mergers, acquisitions, de facto freezeouts Stuparich v. Harbor Furniture Mfg., Inc., 100 Cal.Rptr.2d 313 (2000) Facts: Harbor Furniture Manufacturing was a closely held corporation that was a furniture business and had a subsidiary mobile home business. Malcom Sr. sold his shares to Malcom Jr.Sisters inherited 19% of the voting shares Malcolm Jr. had 51.56% of the voting shares of Harbor FurnitureHarbor Furniture majority controls the furniture and mobile home park The furniture business was losing money and the mobile home park was making more money The furniture business was losing 2.2 million and the mobile home park was generating 5 million, so the company was still producing net profits of 2.7 million Sisters want to liquidate Harbor Furniture so the business stops losing money The sisters claimed that they were being improperly frozen out and deprived of the benefits of ownership, so they sought a court-ordered dissolution of the companyRule: California statute states that the court can dissolve a company if it is reasonably necessary to protect the rights and interests of the complaining shareholder The sale of Malcolm Sr. stock to create a majority shareholder in Malcom Jr. was fineThe [whiney] sisters never participated in running the business and just received dividends The company was still paying dividends to the sisters and therefore their rights and interest in the company were not affected – so dissolution was not reasonably necessaryThe decision to keep the furniture business was protected by the business judgement ruleFrandsen v. Jensen-Sundquist Agency, Inc., 802 F.2d 941 (1986) Facts: merger v. sale of shares case (possible exam question)Jensen Sundquist Holding Company owned majority of stock of First Bank Grant and insurance company as its assets52% of Jensen Sundquist was owned by the Jensen family (majority block)Frandsen owned 8%Frandsen had right of first refusal – if majority block sold their shares they would offer it to Frandsen first so he would not be the minority under strangersFrandsen had tag along right – if the majority was selling their shares Frandsen had the right to sell his shares to the majority at the same price they were selling First, Wisconsin offered to purchase Jensen for cash (merger) and then restructured the agreement to buy all of Jensen Sunquist shares of the First Bank Grant in order to not trigger Frandsen’s right of first refusalRule: the first transaction was not a sale of the majority block’s shares, but it was a merger between First Bank Grant and First WisconsinThe court said the majority block’s shares were not bought, but they were extinguished by the mergerRule: the second transaction was not a sale of the majority block’s shares, but it was a sale of the company’s largest assetThe court said that neither transaction triggered Frandsen’s right of first refusalA merger is not a sale of stock, but a transformation of stock. A merger does not activate the rights that are triggered by a sale of shares Zetlin v. Hanson Holdings, Inc., 397 N.E.2d 387 (1979) Facts: Zetlin owned 2% of GableA group of shareholders (Hanson and Syllvestri) combined their shares 44% to Flink or $15 per share when the market price was $7 per shareZetlin was mad because he could not get premium for his stock priceRule: absent looting of assets, conversion of corporate opportunity, fraud, or other acts of bad faith (abuse by the controllers) the controlling shareholders can sell their shares for a premium Premium price is above the market price because with the majority shares of the company comes the ability to control the company Essex Universal Corporation v. Yates, 305 F.2d 572 (1962) Facts: Yakes was the president of Republic and Essex agreed to buy 500,000 shares (28%) of Republic at $8 per share ($2 over market price)The sale would give Essex control to elect the board members, but there were 3 classes of board members (staggered board) so it would take 18 months for Essex to take control over majority of the boardEssex contract said that with the purchase of the shares a majority of the directors would resign and appoint Essex people as their replacements Yates calls the deal off because he wanted a better price and claimed that the deal was unenforceable because it was illegal to sell corporate officesRule: it is illegal to sell corporate offices or director positions by themselves But a sale for the majority of voting stock can be sold with an agreement to immediately replace directors and control of the boardSelling a corporate office is permitted if it is accompanied by a sale for a majority of the voting stock Mergers, Acquisitions, and Takeovers De facto merger Merger – when two companies come together and one of the original companies survives Consolidation – two companies create a new third companyStatutory Merger – merger conducted as the state statute requiresIf you do something else that adds up with the same result, it could be called a practical merger or de facto mergerIn mergers, dissenting shareholders get appraisal rightsShareholders who exercise their appraisal rights are entitled to the fair value of their interest before the mergerTriangle merger Parent company creates a wholly owned subsidiary who merges with the target company Shareholders of the acquiring company (who is the parent company) votes on the mergerThe BOD of the parent company speak for the sole shareholder of the subsidiary (who is the parent company) and other public individual shareholders of the parent company do not get to vote on the merger or get appraisal rights Appraisal Rights Definition - statutory right of a corporation's minority shareholders to have a judicial proceeding or independent valuator determine a fair stock price and oblige the acquiring corporation to repurchase shares at that price.What triggers minority’s appraisal rights?MBCA – merger, short form merger, sale of assets, charter amendmentsDel § 262 – merger, short form merger During a merger…MBCA – shareholders of the target company are entitled to voteDel § 262 – all shareholders of target and acquirer unless…Whale-minnow mergerMarket out – no appraisal if shares are 1) listed on national securities exchange or 2) held by more than 2000 stockholders and if the shares received have similar characteristics (voting/dividends rights)During a short form merger…Shareholders of the subsidiary only Dissenting shareholders must give written notice of intent to dissent before the meeting and vote against the proposed transaction Corporation must notify dissenters of appraisal rightsDissenters must tender share to corporation and demand paymentDissenters must then sue for appraisalDissenters bear all costs and only receive payment after final orderHariton v. Arco Electronics, 188 A.2d 123 (1963) Facts: Loral acquired all the assets of Arco and in return gave them 283K shares (same as Glen Alden v. List) called a “reorganization agreement” The agreement was approved by Arco shareholders. Hariton, Arco shareholder, brought suit, seeking to enjoin the “reorganization” on the grounds that it was illegal because it resulted in the same thing as a merger, but he was not given a chance to invoke his right of appraisal. Held: the combining of the companies was legal under state statute §271 as a sale of assets Rule: Asset sales statutes and merger statutes are independent of each other, and a corporation complying with one or the other is complying with the law.if the result of the sale of assets and merger are the same, each statute is given equal dignity and there is not a de facto mergerStatues are granted “equal dignity” Delaware does not recognize statutory mergerThe reason companies don’t like appraisal is because the court has to decide what the non-control value of the appraised shares is – which they are not good at doing – and the process takes time and money for litigation Distinguishing Merger and Sale of Assets Merger: target shareholders get cash or other value and only one of the corporations “survives”The survivor gets all assets and all liabilities (environmental, tort, etc.) of the non-survivingSales tax avoided (but could be other tax implications)Licenses, etc. in the surviving entity remain valid, but licenses in the non-surviving may be invalidated Sale of assets: target shareholders remain but their corporation will have only the cash or shares or other value which the acquiring company exchanged for the assets sold. Acquirer has the purchased assets.Sales tax may be due / other accounting and tax implicationsAny time the majority sells its control, the minority shareholders essentially get a new “partner” and are subject to a new master Kahn v. M&F Worldwide Corp. 88 A3d 635 (Del. 2014 Facts: M & F was a 43 percent stockholder in MFW, M & F proposed to buy the remaining common stock of MFW to take the corporation private. The transaction was subject to two stockholder-protective procedural conditions: (1) the approval of a special committee to be appointed by the MFW board of directors, and they approved it(2) the approval of a majority vote of MFW minority stockholders. The minority stockholders voted to approve the merger. Kahn, et al. (plaintiffs) brought suit, arguing that:even both protections combined are inadequate to protect minority stockholders, because directors on the special committee may be inept or timid and MFW minority stockholders may be subject to improper influence. Rule: The BJR standard of review governs going private mergers with a controlling stockholder that are conditioned ab initio on the approval of an independent and fully-empowered special committee that fulfills its duty of care and the uncoerced, informed vote of a majority of the minority stockholdersFreeze-Out Mergers Cash out merger – acquiring company gives the target company shareholders cash in exchange for their shares and the shareholders no longer have any equity in the company Generally, a majority shareholder forces the minority shareholder to sell their stock in a merger with a company owned by the majority shareholder Freeze-out merger – a controlling shareholder seizes corporate value of itself, while cashing out the minority at an “unfair” price (tool to gain 100% ownership Weinberger v UOP, Inc., 457 A.2d 701 (1983) Facts: Signal acquired a 50.5% controlling interest in UOP at $21 a share when the market price was $14. Signal wanted to buy the remainder 49% of the UOP stockTwo directors, who served on the board of Signal and UOP, conducted a feasibility study that said it would be a good investment for Signal to acquire the stock between the prices of $21-$24 per shareThe study was disclosed to Signal, but not to UOPSignal proposed to UOP to buy the stock at $21 a shareUOP CEO Crawford, who was a former office of Signal, approved of the merger price and recommended it to the BODFor the merger the UOP BOD had the financial data of the company, market price information, and Lehman’s fairness opinion letter evaluating the price of the offer But, the feasibility study or the cursory nature of the four-day Lehman Brothers fairness opinion was not disclosed Majority of the minority shareholders voted for the cash out merger because the price offered was $21 and the market value was $14. But, they were not informed that Signal would have considered up to $26Conflicts:UOP board contained interested Directors and OfficersDirectors of Signal were also on the BOD of UOPThe conflicts were disclosed to disinterested directors, which would normally cleanse the conflicts of the BODBut, the disclosure was not adequate because the interested directors did not inform the disinterested directors or shareholders of an important material fact (feasibility report stating that the shares could be bought at $24)The disinterested directors were not fully informed of all material facts and therefore the conflict was not cleansedThe majority of the minority shareholders approved the merger, which would normally shift the burden to the plaintiff to show the merger was not fairBut, the shareholders were not fully informed of all the material factsIf transaction is approved by informed majority of minority shareholders, plaintiff retains entire burden to share unfairnessHere, the shareholders were not informed of the feasibility study stating that the shares could be bought at $24Rule: if there is non-disclosure, misrepresentation, or fraud, or breach of fiduciary duty in the cash out merger the burden is on the directors to show the entire fairness of the transaction Entire Fairness – fair dealing and fair price Rule: court rejects the business purpose test and says there does not need to be a legitimate business purpose for conducting cash out mergerIn DE, you can do a cash-out merger just to get rid of minority shareholders Rule: court said that for the appraisal price – the block method is not the only method to be used, but any valuation accepted in the financial market can be used Duty of Loyalty:Director (individually or through another entity) may not engage in self-interested transactions with the corporation or its shareholders unless:Self-interest is fully disclosed to and approved by a majority of disinterested directors or shareholdersTransaction is entirely fair to the corporation/shareholders at time of executionCoggins v. New England Patriots Football Club, Inc., 492 N.E.2d 1112 (1986) Facts: Sullivan bought all of the voting stock of the Old Patriots Football Company. He then created the New Patriots Company, which consisted of the same BODTo pay for the shares Sullivan took out $5 million in loans from Rhode Island and LaSalle Bank and agreed to reorganize the company to repay the loans In order to use the money from the company to repay his personal loans, Sullivan would need to eliminate the minority nonvoting shareholders, so he could pay his personal debt and not consider the interest of the minority shareholder in the corporation The Old Patriots and New Patriots entered into a merger where the nonvoting stock would be cashed out for fair price of $15 per share, which was approved by majority of nonvoting shares Cash out merger for non-voting shares of stock Rule: court says that there needs to be a legitimate business purpose for a merger Massachusetts accepts the business purpose test that says the merger must further a legitimate business purpose and the transaction was fair to the minority In Massachusetts you can’t do a cash out merger for the sole purpose of kicking out the minority shareholders Sullivan failed to show there was a legitimate business purpose for the merger and the only reason for the merger was so Sullivan could pay his personal debt Rabkin v. Philip A Hunt Chemical Corporation498 A.2d 1099 (1985) Facts: Olin bought 63.4 percent of the outstanding shares of Hunt from Turner for $25 a share. The purchase agreement with Turner required that if Olin acquired the remaining Hunt stock within one year, it would pay $25 per share for that stock as well. Olin had always intended to acquire the remaining Hunt stock, but did not act on that intention until right after one year had passed, thus avoiding the $25 per share requirement in the agreement with Turner. After the year had passed, Olin hired Morgan Lewis to render a fairness opinion on a purchase price of $20 per share. Morgan Lewis agreed that it was fair and Olin’s Finance Committee voted unanimously to propose a price of $20 per share for the remaining Hunt stock. Upon the merger proposal, the Hunt board appointed a committee to review its fairness. The committee’s advisor, Merrill Lynch, found that although $20 per share was fair, it was on the low end as the stock was worth somewhere between $19 to $25 per share. The committee recommended to Olin that it increase its offer, but Olin declined to act on the recommendation. The committee subsequently declared that $20 per share was fair and recommended approval of the merger. Rabkin, et al. (plaintiffs) brought suit challenging the merger. The plaintiffs claim that Olin manipulated the timing of its merger proposal to avoid the one-year commitment price it had agreed to with Turner, thus costing the plaintiffs $4 per share. Held: Plaintiffs’ facts demonstrate unfair dealing by Defendants as majority shareholders to Plaintiff minority shareholders, but Plaintiffs’ unique circumstances (they are trying to obtain a contracted-for price rather than the appraised value) merit an alternative remedyRule: A party alleging unfair dealing should be allowed an alternative remedy to appraisal if the circumstances would require such a result.De facto non-merger Rauch v. RCA Corporation, 861 F.2d 29 (1988) Facts: General Electric’s wholly owned subsidiary Gesub entered into cash out merger agreement with RCA where RCA common stock would get $66 a share and preferred stock would get $40 a shareGE is the parent and sole shareholder and votes to approve the cash out merger with RCARCA shareholders vote to approve mergerRauch was a holder of 250 shares of preferred stock Certificate of incorporation stated that RCA could elect to redeem the preferred shares and would pay $100 a shareRauch argues that he should be entitled to the $100 redeemable value of the shares over the $40 cash out merger valueRauch argues that if his stock was liquidated, he should be entitled to $100Held: the conversion of shares of stock to cash to accomplish a merger is different from a redemption of shares by the company and each process is granted equal dignityAlthough the result was the same, a cash out merger is legally distinct from a redemption GE fully complied with the state merger statute which allows conversion of shares into cashThe state had a separate statute that allows a corporation to have a redemption termEach process is granted equal dignity, so the shareholder is not entitled to his redemption rights under a mergerLLC Mergers VGS, Inc. v. Castiel, 781 A.2d 696 (2001) Facts: Virtual Geosateline LLC has three membersVirtual Holdings, Inc. and Ellipso, Inc. (owned by Castiel and had 75% of the shares)Sahagen Satellite, LLC (owned by Sahagen and had 25% of shares)Castiel has the power to appoint, remove or replace two of the three managers on the BODBOD consisted of Castiel, Quinn (C’s friend), and Sahagen Under the operating agreement, the BOD had authority to act by a majority vote, not by a unanimous vote of the managersSahagen and Quinn come together and by a majority vote as managers decide to merger Virtual Geosatellite LLC into a new company. The new company did not appoint Castiel to the BOD.Duty of the BOD of LLC is to act in the best interest of the investorsSahagen and Quinn though they were acting in the best interest of the investors by entering into the merger and ousting Castiel from control because he was a bad managerIf Sahagen and Quinn gave notice to Castiel of the merger Castiel could have blocked it by removing Quinn and appointing a new friendly managerRule: Sahagen and Quinn owed Castiel a duty of loyalty and candor as an investor and fellow manager and should have disclosed the merger The merger by a majority vote of the managers was in accordance with the operating agreement and the law, but the court says equity prevails The court found that the failure to provide notice was in bad faith, even though under the operating agreement notice was not required Even if a member’s approval is not necessary for the merger to take place, failure to inform a member of a proposed merger can be a breach of duty of loyalty Takeovers, Greenmail, and the “control premium” Friendly takeoverSmith v. Van Gorkom, 488 A.2d 858 (1985) Facts: there were no price negotiations. But if there is negotiation and the price goes up the court would rule differently. It was a cash-out merger.Van Gorkom was not interested in a leveraged buyout by the management of the company and instead offered the company to his friend PritzgerVan Gorkom offered the company to Pritzger at $55 per share Van Gorkom issued the option to Pritzger to buy $1.75 million shares at market price of $38 per shareIn reaction to the merger price of $55 per share, the market price will react and raise to close to the merger price of $55This lockup agreement would fend off other merger offers – if a second company offered to buy the company for more, the first company could exercise their option and buy into the new merger company for low option price102b-7: court will not even consider the duty of careDelaware wants the directors to argue about the price – just don’t accept first offerTakeovers: Directors can’t make takeover decision based on personal interest (they want to get out of the company, they want to keep their jobs)Directors must act in the best interest of the company and the shareholdersGolden Parachute – top level executive gets 3 times their salary and bonus if there is a change in control and they lose their jobs as a resultContracts given to top executives that gives them substantial benefits if the company is taken over by another firm and the executive is terminated as a result of the merger or takeover Pills, Greenmail, control premium, UNOCAL What is a poison pill? The basics: When one company (the “Bidder”) wants to acquire another (the “Target”), it can proceed in one of two ways:A “friendly” deal, in which Target’s board negotiates and supports the dealA “hostile” deal, which Target’s board opposes, and which Bidder tries to ram down Target board’s throat.A proxy fight – since the shareholders elect Directors, just convince them you are right Often Both a Tender Offer and a Proxy Contest Friendly and hostile are not moral terms. Friendly deals are not intrinsically better. In either case, Bidder must offer a merger premium. Size of premium varies greatly. Defensive measures are policies adopted by the Target board to ward off hostile bids.Few hostile deals finish hostile. Many become friendly, after the parties understand their bargaining positionsFriendly merger: To complete a merger, the bidder must sign a merger agreement with the target company’s board; then the agreement must be approved by the target’s shareholders; then a certificate of merger filed with the sec. of state Tender offer – another friendly merger A tender offer is a public offer to buy a specified percentage of the shares of the target, or an “any and all” offer Shareholders who want to sell to the bidder “tender” their shares into the offer. If the offer succeeds, Target becomes subsidiary of bidder The target board is not formally involved in the transaction, although it usually recommends a course of action to the shareholders In a friendly transaction, the board recommends that shareholders tender into the offer A hostile transaction Looks like a friendly tender off but the target board does not want the bidder’s tender offer to be successfulThe target board recommends to shareholders that they reject the offer Because the board’s approval is not required, the bidder can circumvent the board and take its case directly to the shareholders Reasons a board might oppose the hostile bid: “good reasons”The board may believe that the offer undervalues the firm (even with the merger premium) Board may be trying to negotiate with the bidder for a higher price “bad reasons”: Omnipresent specter of entrenchmentDefense mechanism: A defensive mechanism prevents the bidder from having direct access to the shareholders – the tender offer will succeed only if the board approves of it The defensive measure has to be “unlockable” at the board’s discretion. That way, the board can negotiate, blocking shareholder access until the bidder raises its price to an acceptable level. At that point, the board’s posture changes, and the hostile bid becomes a friendly transaction How does this help the shareholders? SHs cannot bargain with a bidder. Their choices are: tender or not.Absent board help, SHs can be “forced” into selling at too-low price. Example:All SHs of T believe stock is worth $60/shareMarket price is $45. Bidder offers $55.Each SH has a choice. Sell for $55, or hold out for $60. But if everyone else sells, then holding out only makes the SH a minority shareholder in what will become a subsidiary.BUT it is ALWAYS better for a shareholder to tender!With a defensive measure, board can protect SHs be subject from this “substantive coercion.” The ULTIMATE defense – the poison pill How it works: board distributed, via dividend, a call option to all SHHs that: cannot be detached from underlying stock confers a right to buy X shares for the price of one if any person owns more then Y% of stock cannot be exercised by a person who owns more than Y% can be redeemed by board for $0.01 or less any bidder who tenders for a majority share will be diluted back to minority status and lose lots of $$example of poison pill: TargetCo = publicly traded firm with $80M of assets. Deploys pill with threshold of 15%, 5 shares for the price of 1. Bidder spends $100M to buy 2M of the 3M outstanding shares. Price = $50/share.Option kicks in. Holders of remaining 1M shares buy 5M shares from TargetCo at $10 per share (5 for price of 1).Now, bidder owns 2M of 8M outstanding shares. Company has $130M in assets. Bidder’s stake worth $130M*25% = $32.5M. Bidder does not have control, and lost almost $70M. After the pill has been triggered and bidder diluted, TargetCo’s board deploys a new pill No pill has ever been defeated head-on The vulnerability of the poison pill Only the board can redeem the pill Thus, bidder can: Launch a tender offer contingent on the pill’s redemption by the board Lobby to elect a slate of directors (at the next annual meeting) who favor the bid and would redeem the pill If the bidder’s slate wins, the bid takes place This is a weakness by design. If the board could block the shareholders from ever considering the bid, the poison pill might have been invalidated as an entrenchment deviceBUT: If the target’s board is staggered, then the bidder must wait two election cycles before its slate can be elected.Bidders often can’t wait that long Nor do they want to. While they are waiting, the target can be doing other things, such as:Taking on lots of debt to pay dividends (dividend recap) or finance new investmentBuy another company that the bidder doesn’t wantFind another buyer more favorable to management (the so-called “white knight”)Sell some assets to such a company (“white squire”)No hostile bid has ever succeeded against the combination of a staggered board and poison pill. Poison pills and fiduciary duties Enhanced scrutiny – UNOCAL Also known as Unocal review or scrutinyNormally, BJR would apply to decisions to implement poison pill and whether to redeem it. Think Lyondell.However, Court perceived that the “omnipresent specter of entrenchment” made BJR scrutiny inappropriateThus, defensive measures – ones that “touch on corporate control” are subject to “enhanced” scrutiny.To avoid fiduciary breach when taking defensive measures, board must show:“Reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of a person’s stockholding”That the defensive measure was proportional to the threat posed.Reasonableness prong is trivial; proportionality is where the action is.(1) reasonableness At least three recognized types of threats:Opportunity Loss: The bid might deprive SHs of a better alternative offered by managementStructural Coercion: The bid is structured to disadvantage non-tending SHs. A single-step tender offer for less than 100% usually meets this test. Mitigated if bidder promises to follow up offer with a merger at same price.Substantive Coercion: The risk that shareholders will mistakenly accept an underpriced offer.“Substantive Coercion” is extremely easy to establish: hire a bank to opine that the offer underestimates the firm’s “true value.” As a result, reasonableness rarely contested(2) proportionality Standard: Defensive measure cannot be “coercive or preclusive,” per Unitrin Examples of preclusive measures:“Dead hand” pill: only continuing directors can redeem pill. This means that electing directors does bidder no good.“Slow hand” pill: only continuing directors can redeem pill for a period of six months. Scares away biddersCoercive measures are ones that force SHs to accept an alternative course. Three relevant time periods or triggers Defensive mechanisms adopted in a decision by the board before a hostile bid BJR Reponses to hostile bidDefensive measures / put company ‘in play’UNOCAL / RevlonActions once company is ‘in play’Revlon / ParamountCheff v Mathes, 199 A.2d 548 (1964) Facts: Holland Furnace Company was approached by Maremont about a potential mergerMaremont wanted to eliminate Holland’s door to door selling strategy and and fire 8500 sales employees Holland wanted to protect their employees and does not enter into merger and tells Maremont to go awayMaremont bought 17% of Holland’s stock Maremont told the directors that he intended to make a tender offer to the company’s shareholders and if he got control of Holland he would merge it into Maremont and fire all the directorsThis is known as greenmailing – purchasing enough shares in a firm to threaten a takeover, thereby forcing the target firm to buy those shares back at a premium in order to suspend the takeover.Holland buys out Maremont’s shares at a premium over market valueHolland’s shareholders, led by Mathes filed a derivative suit for breach of fiduciary duty Under DGCL § 160 a corporation has the power to buy or sell shares of its own stockShareholder argument – the directors bought off Maremont and avoided takeover in order to save their jobs as directors (entrenchment)The BOD was favoring one shareholder over another by offering premium price to Maremont and not other shareholders Directo argument – directors were not entrenching themselves, but were protecting the way the company did business and eliminating a threat to corporate policyHeld: the BOD decision to buy out Maremont in order to avoid takeover was to protect the way Holland did business (corporate policy and effectiveness) is valid business purpose and protected by the BJRHow the company is run is a decision for the BOD Rule: the directors can buy back shares with company money in order to protect the way the company does businessGreenmail was a valid takeover defense by the BODUnocal Corporation v. Mesa Petroleum Co., 493 A.2d 946 (1985) – Enhanced BJR The structure of the bid is the most important fact of this case – need to understand why it is coercive Facts: Mesa held 13% of UNOCAL stock and gave a “two-tier front-loaded cash tender offer” for 37% of the shares of UNOCAL so he could get 50% of UNOCAL to have control. Mesa would buy the first 37% of shares at $54 a share. After Mesa had 50% control, he would enter into a cash out merger for the remaining shares and give second tier shares at $54 in junk bondsIf Mesa shareholders did not take the first offer and sell their shares at $54, Mesa would cash out the shareholders and give them junk bondsUNOCAL directors adopted a defense mechanism offer where if Mesa acquires 51% of the outstanding shares, Mesa would use company funds and offer a self-tender to buy remaining stockholders shares at $72 per share in bonds UNOCAL would have to incur $6 billion in debtUNOCAL excluded Mesa from the offerLower court – tender offer to ALL shareholders / directors have a duty to act in the best interest of the corporation and shareholders – NOT just the shareholders they likeThe BOD can deal with selective shareholders as long as their primary purpose is not to entrench themselvesUNOCAL Advanced Scrutiny TestBecause there is an omnipresent specter [lurking suspicion] that a BOD may be acting in their best interest (prevent a hostile takeover to retain control and keep their jobs) instead of for the shareholders/corporation the following test applies:Two questionsDoes the statute authorize the defense?If it is okay under the statute, does the firm’s charter impose any restrictions?§ 141(a) – the BOD has the broad authority to manage the company’s “business and affairs”In order to get the BJR, directors have the initial burden of proof to show:The BOD had a reasonable grounds for believing there was a threat to corporate policy and effectiveness Satisfied by showing good faith and reasonable investigation of both the perceived threat and the corporation’s possible defensesEast to show – extended discussion of a proposed defensive measure with legal consultants or considering the bidders past actions and takeoversIs reasonable if there was inadequate consideration, the nature and timing of the offer, illegality, impact on constituencies other than shareholders, quality of securities offered, reputation of hostile offeror Directors primary purpose CANNOT be entrenchment – decision was to perpetuate themselves in officeBOD defense mechanism was reasonable in relation to the threat posedDifference between UNOCAL and BJR – UNOCAL places the BOP upon the directors while the BJR presumes this burden in their favor If directors have the BJR, still need to show duty of care and loyalty – directors’ decision was based on all the material information reasonably available If there is a legitimate threat to corporate policy or effectiveness, the BOD can impose reasonable defense mechanisms Scorched Earth – directors implement provisions that make it unattractive to a hostile bidderUNOCAL AppliedThreat to corporate policy and effectiveness?(1) Mesa’s offer is INADEQUATE$54 price offered is less than the value of UNOCAL’s sharesThe junk bonds in the freeze-out offer are worth less than $54, the value received by the UNOCAL shareholders would be less than $54Goldman Sachs estimated the value of a UNOCAL liquidation in excess of $60 per share(2) Mesa’s Offer is COERCIVEThe freeze-out price offered in junk bonds is not worth $54Mesa’s offer is “front-loaded” and will create a stampede or bandwagon of UNOCAL shareholders tendering their shares to MesaWithout a takeover defense, Mesa might be able to acquire the UNOCAL shares even if UNOCAL shareholders agreed that the Mesa offer was inadequate The exchange offer was reasonable in response to the posed threatConditional BJR: “an enhanced duty which calls for judicial review at the threshold before the protections of the BJR may be conferred” Calls for judicial examination at the threshold before the protections of the BJR applyEnhanced BJR: “burden is on directors to show ‘reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another person’s stock ownership”The directors satisfy this burden by showing that defensive measures were adopted in good faith and following a reasonable investigationBOP: initially on BOD, if they carry it, then it shifts back to plaintiff who must rebut the BJRIf not? – the defense must pass muster under the intrinsic fairness standard of the duty of loyaltyRevlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (1985) Maximize shareholder value if company is in playFacts: Pantry Pride approached Revlon with a friendly acquisition and wanted to buy out RevlonPP initial offer was $40-$45, which was above the market price, but Revlon rejected because they thought it was below the company’s inherit valueRevlon creates two mechanisms in response to the takeover threat from PPBuyback of public shares – bought back common stock and issued NotesNotes Purchase Plan (poison pill) – if someone acquired 20% of Revlon stock, the company would issue to the remaining shareholders $65 note with 12% interest of each share of common stockPP offers Revlon $47.50Revlon puts itself “in play” (wall street and the market thinks the company is for sale) and started negotiations with Forstman who offers Revlon $50 per sharePP comes back and offers $56 per share and says that whatever price Forstman bids PP will bid 25? more (fractional bidding)Revlon/Forstman start negotiating and Forstman offers to buy 100% of Revlon stock with a subsequent brake up of Revlon for $57 per share on the condition that the agreement contained a lock up offer, no shop provision, and cancellation feeThis offer would honor the par value of the notes issued to creditors, whose value have diminished and were a threat to Revlon being suedNote holders are now creditors and not equity shareholders, so the BOD cannot consider their interestsCourt said that Revlon consideration of the Note holders interest in selecting Forstman’s bid was a breach of the duty of loyalty Lock up option – if another acquirer got more than 40% of the Revlon shares, Revlon would sell one of its main assets to Forstman at a 40% discount Forstman was a “white knight” – an acquirer who is favorable to management and who is willing to bid against a hostile raider Held: defense mechanisms were okay, but when Revlon negotiated a buyout with Forstman it put itself up for sale Poison pill defense was okay because it was an attempt to prevent a hostile takeover at a price grossly inadequate and below the company’s intrinsic valueBuyback of public shares was okay because it was an attempt to prevent a hostile takeover at grossly inadequate priceRule: when a company puts itself up for sale or a breakup of the company is inevitable – the duty of the BOD shifts from preservation of the corporate entity to a maximization of the company’s sale price in a mergerOne a corporation is “in play” and up for sale, the Revlon duties are triggered, and the director’s duty is to be an auctioneer and drive up the price as high as possible for sale When the sale or break up of the company is not inevitable, the UNOCAL standard is triggered, and directors can create reasonable defense mechanisms to resist legitimate threats to corporate policy In play – when a company looks for or negotiates with other bidders and the sale of the company is inevitable, the duties switch to RevlonWhen the directors go say find someone else to outbid this person we don’t want to merge withDirectors breached their duty to maximize the sale price (Revlon duties) by implementing the defensive measures that prevented shareholders from accepting PP’s higher offerULTIMATE HOLDING: because the directors duties were to obtain the highest price for the benefit of the stockholders it breached its duty of loyalty when they considered the note holders in selecting Forstman for the merger.By preventing the auction between Pantry Pride and any other bidders, the directors did not maximize the potential price for shareholders.In picking the best and highest offer price, directors can only consider the equity shareholders’ interestsJust because a CO. is “in play” does not mean Revlon is not automatically triggered.Paramount Communications, Inc. v. Time Incorporated, 571 A.2d 1140 (1989) Preservation of long-term corporate strategy Facts: Time and Warner enter into a stock merger to create a new company Time-WarnerWarner shareholders would own 62% of the stock in Time WarnerTime directors would control the BOD of Time-Warner to preserve the journalistic integrity of the company Poison pill – if Time was acquired by another firm, Warner could trigger the exchange of shares at a discount and then tender those newly-issued shares of Time to this acquiring firmBefore the shareholder vote on the Time-Warner merger, Paramount offers a cash offer for all outstanding shares of Time at $175 per share when the market price was $126At the 11th hour – Paramount drops a bomb and offers cashThe deal was conditioned on Time terminating the merger with Warner and removing defense mechanismsTime restructures the deal with Warner to form a merger to where Times would acquire Warner and buy its stock for $70 per shareTimes says the Paramount $175 offer was not as valuable as merging with Warner and protecting the company culture and not in the best interest of the companyParamount comes back and raises its offer to $200 per share(1) Court said that Revlon duties are only triggered when a corporation initiates an active bidding process to sell itself (in play) or when there is a reorganization involving an inevitable break-up of the company (change in control)The Time-Warner offer was not a sale of control and breakup of the company, but a continuation of the business and corporate culture Time controls the BOD of Time-Warner, so it was not a change of control(2) Court said that defense mechanisms to Paramount’s offer passed the UNOCAL test Legitimate threat was that the Time shareholders might elect to tender into Paramount’s cash offer in ignorance or mistaken belief of the strategic benefit, which a business combination with Warner might produceTime’s poison pill was reasonable in response to the threatNOTE: if you have a long-term plan for your company in a merger or consolidation – there is not an inevitable breakup of the company or change in control and Revlon is not triggeredCompany must maintain control in order to have a long-term plan Paramount Communications, Inc. v. QVC Network Inc., 637 A.2d 34 (1994) Board not bound by lock-up that violates fiduciary duties Facts: Paramount was owned by a majority of unaffiliated public investors, it began to negotiate a merger with Viacom – controlled by a dominant shareholder [Redstone]After the Paramount – Viacom deal was announced, QVC offers to buy Paramount for $80 per share ($10 higher than the Paramount-Viacom deal) Paramount rejected QVC’s offer and entered into a merger agreement with Viacom with the defense mechanisms of a no-shop provision, termination fee, and stock option agreement No shop- paramount would not solicit, discuss, or negotiate a competing transaction Termination fee – Paramount would pay Viacom a $100 million fee if the merger agreement was terminatedStock Option Lockup Agreement – Viacom has the option to purchase 19% of Paramount’s shares at a discount priceParamount argued that it had a long-term plan for the company (therefore Revlon not triggered) and determined that Viacom was a better strategic alliance than QVCHeld: Paramount did not have a long-term plan for the company because after the merger with Viacom, Paramount would no longer have the ability to control the company Rule: merging with a company that has an individual or group owning controlling blocks of shares triggers Revlon because there is a reorganization involving an inevitable break up of the company (change in control)The controlling interest of Redstone in Viacom would provide him with enough voting power to cause the breakup of the company Corporate defensive measures like poison pills, lock up agreements, and no-shop clauses are generally not enforceable if Revlon is triggered because they interfere with the maximization of shareholder return UNITRIN: board may not adopt and “non-draconian” defensive measure within the range of reasonableness Extension of the UNOCAL/REVLON Framework Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (2003) Facts: NCS was an insolvent healthcare company considering bankruptcy reorganization because of $350 million debtClass A stock – vote per shareClass B stock – 10 votes per share2/4 directors owned 65% of the voting stockIn the hands of the directors, the Class B stock has 10 votes per share, but if they sell it the stock only has 1 vote per share – which is fine under 10b-5 if they disclose itNCS had noteholders and shareholders. Noteholders are debt; shareholders have equityCorporation has duty to equity shareholders If the shareholders pose to get something out of the deal, the corporation can only consider the return for the shareholdersIf company’s liabilities outweigh its assets and the company is in the red, the company can consider the return for the noteholdersOmnicare offered to acquire NCS’ assets for $225 million, then $270 million, then $313 millionNCS rejected the bid because it was less than its outstanding debt which means that NCS shareholder and noteholders woud get nothing In the asset sale Omnicare would acquire the company’s assets but not its libailties (debt)Genesis proposed a merger than would pay off NCS’ debt plus $24 million, which would provide recovery for NCS noteholder and shareholderGenesis wanted an exclusivity agreement with their merger offer where NCS would not discuss a merger with anyone else because they were outbid by Omnicare in the pastGenesis deal was the only offer who got something for the shareholdersOmnicare faxed over an offer to NCS, and Genesis increased their offer, but included protectionsTermination fee of $6 millionNCS agreed to submit the shareholder vote for Genesis merger no matter what“force the vote”Required to submit the agreement to shareholders regardless of whether or not NCS BOD continued to recommend the transaction Shareholder lockup – directors were also shareholders and owned 65% of the voting stock agreed to vote in favor of the NCS merger Majority shareholders had fiduciary duty to minority DID NOT INCLUDE – a fiduciary out clause that would allow NCS board to terminate the merger in the event of receipt of a superior proposal by a third party After announcement of execution, but BEFORE stockholder approval Omnicare offers NCS to pay all their debts plus $3.50 a share, which is a better deal than the Genesis offerRevlon: did not apply because NCS did not put itself up for sale and the NCS and Genesis merger would not result in a change of control Unocal: applied to the defensive mechanisms(1) reasonableness – legitimate threat of losing the Genesis offer and being left with no alternative(2) proportionality – defenses cannot be coercive or preclusiveCoercive – forcing on stockholders a management sponsored alternative to a hostile offerPreclusive – deprives the stockholder from receiving all tender offers or by restricting proxy contestsHeld: the combination of the defensive mechanisms collectively created an “absolute lock-up” Rule: the omission of a fiduciary out clause to an absolute lockup agreement preventing the BOD from exercising their fiduciary duties to the minority shareholdersFiduciary out clause – term that allows the BOD to opt out of an exclusivity agreement if another, better offer comes alongMajority says you can’t have a lock up without a fiduciary out clauseDissentYou CAN have a lockup without a fiduciary out clauseThe clause would have been worthless here because a majority block of shareholders had a contractual agreement to vote in favor of the mergerIn Re OpenlaneOmnicare Issue – how may a target board lock up a merger transaction without violating OmnicareIn re Openlane – court confirms that a “sign and consent” structure does not violate Omnicare Stockholder approval of the merger agreement is obtained by written consent almost immediately after its execution, rather than through a vote at a stockholders’ meeting several weeks/months after execution of the merger agreement Openlane board conducted an adequate sales process despite…Failing to implement traditional value maximizing toolsAuction Negotiating for a “go shop” provision Openlane’s board agreed to a merger with KAR, required…Written consent of the holders of a majority of the outstanding preferred stock and majority of the outstanding capital stock If consent was not obtained in 24 hours, both parties could terminate without feeCondition to closing – waivable by KAR – required holders of at least 75% outstanding shares execute and deliver written consents approving the mergerNo-solicitation clause with NO fiduciary out and agreement that would hold part of the merger consideration for over a year to protect KAR from certain contingencies 24 hours – written consents from the majority AND the 75% provision also satisfiedCourt said this was not a “fait accompli”The no-solicitation clause was reasonable because the board could terminate the merger within 24 hours if there was no consent The merger agreement did not force a transaction on stockholders or deprive them of the right to receive alternative offers Omnicare cautions against a complete lock-out before the time to voteDirectors and shareholders could not consider a superior vote Contractually impossible for the BOD to back out of the merger NOTE: a target board should still be confident that other superior offers do not exist, or the sign and consent structure may still give rise to a Revlon problem Impeccable Knowledge: “if a board fails to employ any traditional value maximization tool, such as an auction, a broad market check, or a go-shop provision, that board must possess an impeccable knowledge of the company’s business for the Court to determine that it acted reasonably” Board did a yearlong targeted market checkSerious pursuit of transactions with two legitimate strategic buyersReceipt of data on the company’s value from a financial adviser Analyzed potential decline in business the company facedIMPORTANT: OPENLANE was “one of the few corporations that is actually ‘managed’ by as opposed to ‘under the direction of’ its board of directors So they will have a lot of knowledge Also it as a smaller company – which made their impeccable knowledge reasonable NOTE: the escrow agreement did not violate the mandatory standard Hilton Hotels Corp. v. ITT Corp., 978 F.Supp. 1342 (1997) Facts: Hilton made a tender offer to buy ITT’s shares for $55 per share. ITT rejected the offer because investment banker said the shares were worth $62 per share. ITT then offered $70. ITT made a comprehensive plan to split into three companies, put majority assets in ITT destinations and create a staggered BOD and 80% shareholder vote to remove directorsStaggered BOD and 80% vote were defense mechanisms to Hilton’s offer and had to be evaluated under UNOCALWith staggered BOD, if Hilton gained voting control it would only appoint 3 directors every year, so it would take 9 years to control the BODUNOCAL There is no threat to corporate policy of effectivenessHilton was going to run ITT in the same way it was being runInadequacy of an offer price is legally cognizable threat – but Hilton’s was adequateITT never even met or talked to Hilton to see if there was a threat – no good faith and reasonable investigation of the perceived threatDefensive mechanisms were not reasonable in relation to the threatPreclusive and coercive taking away of stockholder voteThe classified BOD took away the rights of shareholders to elect the directors of ITTThe primary purpose of ITT’s staggered board was to interfere with the shareholders right to voteIf a classified Board is created by a target corporation in response to a hostile takeover attempt, the Board and management is likely to breach their UNOCAL dutyState/Federal legislation: Williams Act (Found in SEA ’34) Williams Act (found in the Securities Exchange Act of 1934)CTS Corporation v. Dynamics Corporation of America, 481 U.S. 69 (1987) Facts: Indiana passed the Control Shares Law that went above the Federal Williams Act that controls tender offers “if any party acquired a controlling interest in the number of shares, the controlling interest could only acquire voting rights if it was approved by a majority of the minority of disinterested shareholders”Dynamics gained 27% controlling interest of CTS and sued claiming the Indiana law violates the commerce clause and was preempted by the Williams ActHeld: the Williams act did not preempt the Indiana LawThe Act was meant to protect shareholders from takeovers and the Indian statute furthers that intentHeld: the statute did not violate the commerce clauseIndiana law applies equally to takeovers made by in state and out of state corporationsFact that more takeovers come from outside the state does not establish a claim of discrimination against interstate commerceCan the board just say no? Poison Pill – gives the board leverage and the acquirer cannot cross the threshold If the poison pill is triggered, the remaining shareholders get issued additional shares to dilute the company Merger – BOD determines whether to recommend to the shareholder for voteTender offer – BOD has no say, but tender offer cannot go forward if there is a pill put in place by the BOD and the acquirer must get the BOD to pull the pill Some shareholders have a long-term plan for investment Institutional investors and money managers have a short-term plan of quick profit in order to increase their gains and get paid Air Products and Chemicals, Inc. v. Airgas, IncFacts: Oct 2009 AP approaches Airgas with a friendly merger to buy out for $60 a share cash for stock Airgas rejects as an inadequate price and says it is not a good time to sell the company Dec 20019 AP raises to $62 a shareFeb 2010 AP makes a public tender offer to shareholders for $60 a shareMarket thinks the company is in play, but the company has not actually announced that they are in playSame time, AP launches a proxy contest to get their people on the BOD so they can pull the pill AP continues to raise the value and offers $65Airgas has a staggered board, where 3 members could only be voted on each yearAirgas BOD was comprised of 8/9 outside independent directorsAt the annual meeting, AP got the shareholders to vote 3 of their members on the BODSept 2010 – Airgas institutional investors urged the BOD to meet and negotiate with AP. AP made a $70 a share offer, and Airgas said they would begin negotiating at $78Dec 2010 – AP makes the $70 a share offer again and the BOD unanimously rejectsBoth Airgas directors and AP directors on BOD rejected the offer price as inadequateNo Revlon because the company was not “in play” because Airgas said they would begin to negotiate and would sell at $78. The company stated an intrinsic value, and after the acquirer exceed that intrinsic value it will be in play and would then have to remove defensive mechanisms under Revlon in order to fulfill their duty to get the best price for the shareholdersUNOCAL(1) the company had a reasonable belief that there was a threat to the company policy or effectiveness Threat to the company was the offer was undervaluedInadequate price is enough to be a threat under UNOCALThe outside independent financial advisor concluded the offer was undervalued based on long term plans and potential worth of the company in the future Good faith and reasonable investigation that a threat existed(2) defensive measures must be reasonable in relation to the threatThe BOD actions cannot be draconian, coercive, and preclusiveThe court said the defensive measure (poison pill) was not preclusive or coercive because the acquirer’s gaining control in the future was realistically attainableAP could gain control in the future by calling a special meeting and replacing the entire BOD with a 67% vote OR AP could wait until next year’s annual meeting and nominate 3 more friendly directors to BOD and have control of the board A combination of the staggered board plus the poison pill worked only to delay, not prevent, a successful proxy contest for control of the Airgas board All cash deals for all shares can still be a threat to corporate policy or effectiveness and company can sometimes say noReview of the entire corporate world Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (2009) Facts: Basell was interested in buying Lyondell [makes a special chemical product] April 2006 Basell sends a private letter and offers to buy Lyondell for $26 a shareLyondell rejects and says that the price is inadequate and it wasn’t a good time to sell the company May 2007 Basell filed a Schedule 13-D public announcement that Basell acquired the right to purchase 8% of LyondellThe market now knows that there is potential to the merger, so the company is “in play”Lyondell does not respond to the 13-D filing and took a “wait and see approach” to gauge the reaction of the market and see if anyone else would make an offer July 2007 Basell makes an all cash offer to Lyondell for $48 a share, but needed a decision within a week because they were bidding on other companiesBasell BOD meets and decided that it was interested in the offer, obtained Deuche Bank as a financial advisor, and started to negotiate with Basell In 2 days, BOD considered the offer and acceptedThe directors met for only 7 hours to consider Financial advisor said the $48 price was adequate and a “slam dunk”“Fairness opinion”Company had 102(b)(7) and directors could not be liable for a breach of duty of careLower court claimed that Lyondell was in play and breached fiduciary duty under Revlon by not attaining best price for shareholdersLyondell did not conduct a market check and affirmativelty go out and look for other buyers to start a bidding warHeld: Revlon duties to seek the best available price are only triggered when the company embarks on a transaction on its own initiative or in response to an unsolicited offer that will result in a change of controlRevlon duties do not apply when the company is “in play,” but whent eh BOD makes the decision that the company is for sale and begins to negotiate an offer for a change of controlHere, Revlon only triggered when Lyondell responded to the $48 offer and decided to negotiate with BasellTo find that the directors breached their duty of loyalty and did not seek a better price – directors must utterly fail to attempt to obtain the best price The standard for obtaining the best price under Revlon is not whether the directors did everything they could to obtain the best price, but rather whether the directors utterly failed to obtain the best priceThese are not legally proscribed duties to find the best offer price under Revlon The directors do not need to start an auction process and pin bidders against each other in order to attain the best price Once Revlon duties are triggered (BOD makes the decision that the company is for sale and begins to negotiate for a change of control) the directors only violate their duty of loyalty by not getting the best price Bad faith = intentional dereliction fo duty Conscious disregard or utter failure to get the best price (Caremark and Stone)High standardThe facts of this case are very unique –Market was on notice that Lyondell was up for sale and in play – so if someone was going to make an offer they would have already; market check not neededThere were only four companies in the world int eh same line of business, so a limited number of acquirers 1) the directors had reason to believe that no other bidders would emerge, given the price Basell offered and the limited number of companies that might be interested in acquiring Lyondell’s unique assets2) the Lyondell CEO negotiated the price up from $40 to $48 per share, a price Lyondell’s financial advisor opined was fair3) no other buyer expressed interest during the four months between the merger announcement and the stockholder vote ................
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