David Adler
Corporations
Fall 1995

I.	Introduction -- Principal Characteristics
	A.	entity status: a corporation is a legal entity created under the authority of the legislature.

	B.	Limited Liability: as a legal entity, a corporation is responsible for its own debts; its shareholders liability is limited to their investment.

	C.	Free Transferability of Interests: shares, representing ownership interests, are freely transferable.

	D.	Centralized Management and Control: a corporation's management is centralized in board of directors and officers Shareholders have no direct control over the board's activities.

	E.	Continuity of Existence: a corporation is capable of perpetual existence.

II.	Agency
	A. Types of Relationships
		1.	Agent: a person authorized by another (principal) to act for or in place of him; one entrusted w/ another's business.

		2.	Independent Contractor: an individual is hired to perform a designated task but left to his own devices in selecting the means to accomplish the objective.

		3.	Special Principle Agent
			a.	hands on supervision
			b.	employer vicariously liable

		4.	Creation of an agency
			a.	arises by consensual arrangements as the product of a contract of two persons.
			b.	The principal agrees to accept the agent as a legal extension of herself.
			c.	Agent agrees to serve as fiduciary in seeking advantage of the principal w/in scope of that grant of authority.

		5.	Principals are vicariously liable for actions of their agents

	B.	Determining if there's agency relationship -- Who is in charge
		1.	Who is responsible for specific decision which led to problem
		2.	Who is generally in charge -- Courts take this approach
		3.	Who bore the economic loss as a result of the decision -- Adler favors this approach.

	C.	Types of Authority
		1.	Actual or Real: finds the principal liable on a theory of true consent to the terms of a transaction formed by an agent.

			a.	Express: grounded in the literal words of the principal.  Here is the occasion in which the principal delineates to the agent task to be accomplished and provides any instructions as to means authorized in pursuit of that end

			b.	Implied: arises by the inference from the task which she has defined for his accomplishment.

		2.	Apparent Authority: principal engages in conduct that leads a third party to reasonably believe the agent had authority.

			a.	Elements of Apparent Authority
				1).	good faith belief that the transaction in question was within the real authority of the agent.
				2).	Personal belief induced by acts or omissions of betrayed principal & not claims or posturing of faithless agent; &
				3).	the appearance of real authority created by the acts or omissions of the betrayed principal would have deceived a reasonable person.

			b.	How do courts determine if a reasonable person would've believed there was apparent authority.
				1).	Adler places burden to determine if there is apparent authority on who'd be the least cost avoider to avoid the confusion if there was apparent authority.
				2).	McDonald's HYPO
					a).	okay to assume a manager at McDonald's has the right to hire employees.If he does not then the owner has a duty to let third parties know.
					b).	not okay to assume a manager McDonald's has authority to sell the store.

	D. Fiduciary Obligations
		1.	Agents owe a duty of loyalty to their principals.
			a.	relationship between the principal and agent
			b.	Agents generally can not compete with a principal in areas that the principal shares with the agent.

		2.	Trade secrets 
			a.	Is it okay to take information from a company to use for ones own benefit?
				1).	Town & Country v. New Berry: not ok
				2).	Corroon v. Hosch: ok
					a).	Court assumes since companies need customer lists they will have them regardless if the court protects them.
 					b).	Adler, the flaw in the court's reasoning is that companies may never be formed if there is no protection.
			b.	the court must determine if it is a trade secret
 				1).	one factor is do all employees have access to information.
 				2).	want to protect trade secrets because we want people to develop new things and they need the protection has an incentive to do the hard work.

			c.	Companies can contract that you cannot compete when you leave.

			d.	Possibilities for a default rule
 				1).	can't use any information
 				2).	can steal anything
 				3).	Adler, the rule is somewhere in the middle, if employee did not know it was a secret then s/he can use the information as long as s/he didn't go out of his way to steal information

III.	Partnerships
	A. Characteristics of a partnership
		1.	partnership is an association of two or more persons who are engaged in business as co-owners.  Does not matter if they specifically intended to be partners if they appear and act like partners courts will treat them as partners. UPA §6.1
 
		2.	Unlimited Liability: every partner is subject to unlimited personal liability for all debts of the partnership.  Partners are liable for all partnership debts

		3.	Transferability of interests
			a.	a partner cannot transfer his partnership interest in such a way to make the transferee member of the partnership, except with the consent of all the remaining partners.
			b.	a partner can assign his interest in the partnership

	B.	Duration: unlike a corporation, a partnership isn't capable of perpetual existence.  A number of circumstances will result in dissolution.  Default rule is that any partner can wind up but usually contract around it.  Every time partner leaves it is dissolved but it's usually not wound up partnership continues

		1.	rightful dissolution: a partnership is terminable at will unless a definite term is specified or can be implied.

		2.	wrongful dissolution: in contravention of the agreement between the partners by express will of any partner at any time or by court, where a partner has:
			a.	been guilty of conduct that tends to prejudicially affect the carrying on of the business.
			b.	willfully or persistently committed a breach of partnership agreement.
			c.	otherwise so conducted himself, in matters relating to the partnership business, that it is not reasonably practicable to carry on business in partnership w/ them.

	C.	Management and Control: unless other prescribed UPA §18
		1.	every partner has a right to participate in the management of the partnership business. §18(e)

		2.	any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of partners, with each partner having one vote regardless of the relative amount of his capital contribution.
 
		3.	extraordinary matters require approval of all the partners

		4.	National Biscuits v. Stroud: the court noted that in a two-partnership Stroud and Freeman were equal.  As such, Stroud had no legal right to forbid Freeman from taking an equal role in the conduct of the firm business.  The status quo could only be amended by majority rule.

		5.	Day v. Sidley Austin: Partner in law firm alleges he would not have voted for the merger b/c assumed he be able to continue to run  D.C. office. 

			a.	all partners have equal right and this was not an ordinary decision.

			b.	They contracted around this default rule, the executive committee made decisions.

	D. Authority
		1.	every partner is an agent of the partnership for the purpose of its business. UPA §9

		2.	The act of every partner for apparently carrying on, in the usual way, the business of the partnership binds the partnership, unless the partner so acting in fact has no actual or apparent authority.

	E.	Questions of Compensation: no partner is entitled to compensation for acting in the firm business.

		1.	partner is entitled to reasonable compensation for services provided in winding up the business of the partnership.

		2.	Courts may imply an agreement that the active partners be compensated in the form of a reasonable salary.

	F.	Property rights and the partnership
		1.	the partner's right in specific partnership property

		2.	the partner's interest in the partnership

		3.	partner's right to participate in management of firm's business.

	G.	Fiduciary quality of the partnership relation: partners owe fiduciary obligations between & among themselves and to firm.

		1.	In Meinhard v. Salmon the court held co-partners owe to one another, while the enterprise continues, the duty of the finest loyalty.
 
		2.	in any given fact pattern, it will be for the court to determine whether a particular transaction or opportunity exploited for personal benefit fell within the embrace of the fiduciary  obligations owed to the partnership.

		3.	factors which indicate the partnership nature of a given opportunity.

			a.	If the partners have actively discussed a possible transaction which is thereafter secretly exploited by a partner, it is virtually certain that proof of active contemplation will persuade a court that the opportunity belonged to the firm.

			b.	If the partner who discovered it should have reasonably appreciated that it would be needed in order to develop the firm's existing business.

			c.	any opportunity discovered while a partner is on firm time or expending firm resources must be disclosed to the other partners and can be selfishly exploited only if they have rejected the opportunity.

		4.	generally post-dissolution opportunities belong to the individual partner

IV.	Corporate Promoters
	A.	Forming a Corporation
		1.	Pick up an application which includes:
			a.	name of the corporation
			b.	purpose of the corporation i.e. make money by any lawful means
			c.	authorizes the number of shares to be issued
			d.	other things which may want to include

		2.	once approved either called the charter, certificate of incorporation or Articles of Incorporation.

		3.	While at this point incorporated but need money and employees, what's next.
			a.	put in place directors
			b.	establish corporate by-laws
			c.	corporations may sell shares in order to raise capital
			d.	hire employees -- officers

	B.	Hierarchy of Corporate Law - Governance Structure

				U.S. Constitution

						9

			Federal Securities Laws

						9

				State Corporate Law

						9

		Certificate of Incorporation	rules may be included & binding unless inconsistent with above
						9				i.e. # of directors or may put in that only shareholders can amend; generally put more flexible rules in by-laws.

					By-Laws				for most part anything that can be in certificate can be in by-laws (usually easier to amend).
						9				Some states certain things may only be in certificate of incorp. ie in DE to divest powers of Directors better be in certif.

					Directors			if they can amend by-laws they may be higher; start by being appointed by incorporators then
 						9				elected by shareholders. inside director: director/ officer 
										outside director: director not an employee of the corporation.
					Officers

	Shareholders are missing --	once established elects directors
		1.	not part of the governance
		2.	unless state corporate law or certification of Incorporation gives power very rare, i.e. to liquidate.
		3.	indirectly, they have all the power 
			a.	elect directors
			b.	may amend by-laws
			c.	may amend certificate of incorporation

	C.	Why Corporations incorporate in Delaware?
		1.	it is a small state and needs money
		2.	less competing interests & incorporation fee is substantial & greatly affects state budget. Enables corporate interests to influence legislature to have more favorable laws.
		3.	since most corporations do not operate in Delaware they can make laws favorable to corporations without effecting other special interests in Delaware i.e., labor unions.
	D.	Is it good that we allow Corporations to shop around 
		1.	race to the bottom -- laws easy for the corporation
			a.	states will make laws hard for shareholders to discipline directors and officers.
			b.	make it easy for corporate officers to block a take-over

		2.	race to the top -- laws better for shareholders
			a.	rational is that shareholders will not invest if the laws are to favorable to the corporation and an entrepreneur in the need of money with a good idea would prefer to have laws which encourage shareholders investment.
			b.	i.e., cannot steal from corporation or difficult to block take-overs.

		3.	Fighting issues
			a.	a good law for corporations is one that tort victims can not pierce corporate veil (most state have this)
			b.	ability to control directors

		4.	What is Delaware -- there are elements of both race to the top and race to the bottom.

			a.	in the early stages DE created laws which favored corporations this led to the following.

				1).	a sophisticated bar with knowledge of corporate law and low levels of the bench specialized in corporate law.
				2).	huge body of law to indicate how courts will react do not need to contract.

			b.	once these factors were in place DE was able to have laws favoring shareholders because the benefits of 1). and 2). outweighed any specific law.

	E.	Promoters
		1.	a promoter is a term of art for one who 
			a.	participates in the formation of a corporation
			b.	usually arranges compliance with the legal requirements to form a corporation
			c.	secures initial capitalization
			d.	enters into necessary contracts on behalf of the corporation before it is formed

		2.	during formation the promoter is an agent of the corporation and thus owes fiduciary duties.
			a.	the legal fiction sometimes gets in the way in determining when the promoter stopped owing a duty to the corporation.

			b.	that is did the promoter sell his shares prior or post to making a deal with the corporation.(Sometimes the courts will look at the substance of the deal)

			HYPOS (assume sells land for $200,000 worth $75,000:
				1).	A forms C; C sell shares to A; A sells land to C; A sell shares to X.  X has a claim
				2).	A forms C; C sell shares to X; A sells land to X; X sells land to	3.  X doesn't have claim since A is not X's agent
				3).	A forms C; C sells share to A; A sells land to C; A sells shares to X.  in formality A disclosed to (C)orp but court may go beyond the formality.

		3.	prior to formation of the corporation, the promoters are regarded as joint ventures (similar to partners) and for that reason owe to each other a duty of full disclosure or fair dealing as to all matters pertaining to the corporation.

		4.	A corporation can be held liable or contracts negotiated on its behalf by its promoters prior to incorporation, but only if the corporation ratify's or adopts the contract.The ratification may be express or implied.

		5.	Southern-Gulf Marine v. Camcraft courts look at substance over formality

V.	Limited Liability
	A.	Introduction
		1.	in general since a corporation is a legal entity distinct from its shareholders, the rights and obligations of a corporation are normally separate from those of the shareholders.

		2.	courts may disregard corporate fiction when suits by corporate creditors to impose liability on shareholders for corporate obligations.  Creditors are able to pierce the corporate veil.

		3.	Two prong test to determine if should pierce the veil
			a.	unity of interest & ownership such that separate personalities of corporation & individual no longer exists.

			b.	Adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice
				1).	since always find injustice when creditors are not paid there must be more.
				2).	shareholders must be in control

			c.	empirically courts rely more on unity and lack of formality then on part two of test.  Adler has a problem with this.
				1).	some courts do look at second part
				2).	Adler believes courts should be concerned w/ 2nd part.

		4.	factors courts consider
			a.	insufficient capitalization for the purpose of corporate undertaking.
			b.	failure to observe corporate formalities
			c.	nonpayment of dividends
			d.	insolvency of debtor corporation at time of transaction
			e.	siphoning of funds by dominant shareholder
			f.	non-functioning of other officers and directors
			g.	absence of corporate records
			h.	existence of corporation as merely facade for individual dealings.

	B.	Tort victims versus Contract claims
		1.	tort victims are involuntary creditors
			a.	look at capitalization at time of formation

			b.	must also look at failing to observe corporate formalities or of abusing the corporate personality.

			c.	Walkovszky v. Carlton
				1).	the plaintiff was injured by a taxicab owned and operated by one of seven single-shareholder corporations used by the defendant to deploy and service a small taxi fleet.
				2).	The court held that in the absence of allegations that the defendant had abused this arrangement by refusing to observe formalities or treating the corporate assets in a manner indistinguishable from his funds.

			d.	Adler would like the courts to always pierce the veil in these cases because it would give an incentive for controlling shareholder to run the business in a safe way.
				1).	social welfare analysis
				2).	insurance only spreads risk doesn't eliminate costs.

		2.	contract claims; consensual, voluntary nature of relationship strongly reenforces the presumption of limited liability.

			a.	Adler would argue consensual creditors should never be able to pierce the veil because interest should have accounted for the risk.

			b.	reasons you may want to allow
				1).	consensual creditors may not be able to calculate true risk
				2).	controlling shareholder may lie about corporate net worth. (do not need in this case have fraud doctrine)
				3).	if we always put the burden on the shareholder loans become very expensive.

			c.	Sea-Land Services v. Pepper Source court pierced corporate veil b/c Pepper failed to observe corporate formalities & due to unjust enrichment of shareholders and their intentional manipulation of corporate forms to avoid personal liability.

			d.	Kinney Shoe v. Polan 
				1).	applied Laya test that banks & lending institutions are sophisticated and should not be able to pierce.
				2).	pierced corporate veil where shareholder contributed 0 capital to ) corporation, followed no formalities, & deliberately used corp. to shield himself and another of his business entities from liability.

	C.	Factors against corporate veil piercing
		1.	to little economic activity -- Adler says OK

		2.	people are risk averse
			a.	they may overestimate the costs and not enter the market
			b.	at the margin overestimitation will harm society

		3.	externalities
			a.	while there are negative externalities in running a business and piercing the veil would internalize, there are also positive externalities.

			b.	Very difficult to calculate the positive externalities and if they equal or are greater than negative the business would have a positive benefit on society.

	D.	Enterprise Liability
		1.	a plaintiff with a claim against one corporation seeks to satisfy the claim against the assets of an affiliated corporation under common ownership.

		2.	some opinions suggest this kind of aggregation may be permitted where each affiliated corporate entity is not a free-standing enterprise, but only a fragment of an enterprise that is composed of all affiliated corporations.

		3.	rational is in permitting incorporation & limited liability legislature contemplated incorp. of business enterprises  The separate incorporation of enterprise fragments was not within legislative intent in granting limited liability.

		4.	Adler would only let when the third party was confused and believed that they were the same corporation.

	E.	Defective Incorporation
		1.	in some jurisdictions if you try to form a corporation and acting in good faith, make mistake such incorporation is defective the court may treat as if a corporation.

		2.	If try to incorporate properly but fail, while you may get the benefits of limited liability, if the court however determines that even with proper incorporation the veil would be pierced than, the veil will still be pierced.

VI.	Derivative Suits
	A.	General terms
		1.	derivative suits: if management (or a third party) has abridged a duty owed to the corporation (e.g. officers loot the corporate treasury, or customer falls to pay for goods purchased from corporation), and the corporation fails to enforce its cause of action, a shareholder may bring a suit on behalf of corporation.
 
			a.	only permit in actions against directors because in case of employee or officers the directors can bring the suit.

			b.	in general, any recovery of damages in a derivative suit will be paid to corporation since the suit is brought in the name and on behalf of corporation.  Exception, court may in its discretion order that judgement must be paid to shareholders who were indirectly harmed by the wrongdoing, if:

				1).	would not adequately compensate the injured shareholders
				2).	would provide a windfall to controlling shareholders who caused the harm to their successors.

			c.	Alford v. Shaw: held derivative A shouldn't lose standing due to acquisition of their shares in a cash-out merger, where A's suit challenged conduct relating to the merger itself.
 
		2.	Direct (individual suits): when management has abridged contractual or statutory duty owed directly to the shareholder as an individual (e.g. directors refuse to permit shareholder inspection of corporate records), the shareholder may bring a suit on his own behalf
 
			a.	If the alleged misconduct effects the rights of a number of shareholders, the suit may be maintained as a class action in which case the individual shareholder sues as the representative of the class of shares that has been damaged.

			b.	Eisenberg v. Flying Tiger: SH complains of reorganization allegedly diluting his voting influence in the corporation.  Significance of the decision was that Eisenberg was not required to post a security bond for litigation expenses.
 
	B.	Arguments as to why we do not need derivative suits
		1.	vote directors out
			a.	new directors sue on behalf of the corporation
			b.	problem is that small stockholders do not care enough to determine if directors were dishonest to vote for new ones.

		2.	takeovers
			a.	buy up shares, force directors out & then sue on behalf of the corporation
			b.	prospect of takeovers help shareholders in first instance by discouraging directors from stealing in first instance.
			c.	only works when directors have stole a lot of money.

	C.	Problems with derivative suits
		1.	directors may be concerned about being second guessed
			a.	Delaware corporations can insulate directors §102(b)(7) so can't be held liable for bad business decisions.
			b.	insulation does not insulate against injunctions and does not insulate for allegations of disloyalty

		2.	lawyers are the only one who really benefit by strike suits an underemployed lawyer sees a some transaction is bad or directors are dishonest; confident corporation will settle

	D.	Protection against suits
		1.	require that a stockholder own at least 5% of the company before permitting suit or require the stockholder to put up a bond to pay for lawyers fees for defendant if plaintiff loses.  problem w/ bond to little protection for shareholders

		2.	Prerequisite to suit - exhaustion of corporate remedies.  The plaintiff must first show that he has exhausted the remedies within the corporate structure.This is an essential element of the plaintiff's cause of action and must be specifically pleaded and proven.  Plaintiff must either

			a.	make demands on director to bring suit 
				1).	problem w/ this is it usually means shareholder is admitting that directors interest equals corporation
				2).	can only argue that directors decision not to sue is grossly negligent.

			b.	allege with specificity demand is futile
				1).	will not be shown by merely by the fact that a majority of directors 
					a).	are named as defendants in the derivative suit
					b).	were nominated or selected by persons who have been named as defendants.
					c).	approved or failed to object to the transactions challenged by the complaining shareholder.

				2).	Instead under the Aronson test the shareholder's derivative complaint must contain detailed allegations of particularized facts

					a).	concerning a lack of independence, conflict of interest, or other breach of fiduciary duty involving at least a majority of the directors.
					b).	sufficient to create reasonable doubt that the transaction was a product of a valid exercise of business judgement i.e. grossly negligent decision
				3).	Business Judgement Test: a court will not interfere with a good faith exercise of discretion by the board elected to make business judgements for the corporation.
					a).	the presumption is in the managements favor
					b).	needs to be gross negligence

				4).	courts could have only let derivative suits when boards are disloyal.
					a).	eliminates cases of allegations of laziness and stupidity.
					b).	what if only one or two are interested?  do not trust to sue colleagues -- structural bias argument
 
	E.	Cleansing and Litigation Committees
		1.	where the derivative suit alleges wrongdoing by a minority of the directors, the suit may be barred if the disinterested director majority makes a good faith business judgement that the suit is not in the corporation's best interest.  Serves as a cleansing vote.

		2.	a board of directors (a majority of which may be interested) may appoint a special committee of disinterested directors, which may be advised by special counsel, to determine whether the suit would be in the corporation's best interest.

			a.	the committee has authority to make a disinterested and independent decision on behalf of the corporation, even if the committee was appointed by directors who are disabled from acting themselves.

			b.	Auerbach v. Bennett New York more lenient standard
				1).	most courts have held that the good faith decisions of such committee to terminate the suit is similarly governed by the business judgement.
				2).	court will examine
					a).	whether the members of the committee were disinterested and independent.
					b).	whether the committee has conducted a reasonable and good-faith investigation into shareholder's claims.
				3).	once the court determines that the committee's decision was disinterested, independent, and made a good faith after a reasonable investigation, the decision will be upheld under the business judgement.

			c.	Zapata Corp. v. Maldonado - Delaware
				1).	the burden of proving independence, good faith, reasonableness of investigation and reasonable bases for the special committee's conclusion on the corporation seeking to dismiss the derivative suit.
				2).	court may also apply its own independent business judgement as to whether termination of derivative suit is in the corporation's best interest.
		3. §144 Interested directors transaction not voidable if:
			a.	noninterested directors ratified
			b.	noninterested shareholders ratified
			c.	defendant can show the deal was fair to the corporation.

	F.	Types of stock
		1.	common equity: get residual affect after debt paid, no right to get money out like creditors

		2.	preferred -- between common equity and creditors
			a.	promised dividends while at discretion they get paid before common equity.
			b.	liquidation preference before common equity

VII.	Corporate Role
	A.	General Rule
		1.	Objective of the business corporation is to conduct business activity with view to corporate profit and shareholder gain.

		2.	Dodge v. Ford Motor Co.
			a.	The Board acting at the discretion of Ford announced that no further special dividends would be paid in spite of Ford's large profits.

			b.	It appeared Ford was motivated by his desire
				1).	to reduce the price of his cars to benefit the public, even if price reduction would result in lower prices.
				2).	to deny substantial shares to the Dodge brothers.

			c.	actually never gave a plausible story he was more looking to serve his political agenda.  Had one since not a nice person and wanted to remembered in history as the guy who gave everyone a car, could have said investing in future.

	B.	Traditional View
		1.	precluded to use corporate resources by donation or otherwise for educational, philanthropic, or other public activities.

		2.	Use of corporate assets could be used for educational, philanthropic, or other public activities if justified on traditional profit grounds (e.g. on the ground that it increases good will.)

		3.	The strict position was modified by cases holding that a corporation could use its resources for such purposes if use was likely to produce a direct benefit to corporation.

	C.	Modern View
		1.	Modern cases do not require a direct benefit 
		2.	Some cases reach this result by treating such uses as profit-maximizing even where the evidence looks the other way Shelensky v. Wrigley
			a.	Wrigley was traditionalist who believed in day baseball
			b.	nobody believed that he'd maximize profits without lights
			c.	defendant only needs to tell a plausible story
		3.	Other cases, A.P. Smith MFG co. v. Barlow, take the more direct approach that the use of corporate resources for such purposes is a legitimate end in itself, on ground that

			a.	activity that maintains a healthy social system necessarily serves a long-run corporate purpose.
			b.	there is an independent social policy to maintain diversified centers of charitable, educational, etc., activity, and full effectuation of that policy depends upon, and therefore justifies, corporate support.

		4.	Corporations ability to make donations is not unlimited.  Modern cases have invoked a limit of reasonableness on the use of corporate resources for public welfare, educational or philanthropic purposes.

		5.	Summary of the law
			a.	some jurisdictions simply permit donations
			b.	DE and some other states require Corporations to show donations will benefit corporation
				1).	protected by business judgement rule generally
				2).	concerned if appears charity is pet charity of directors.
			c.	since we do not want courts to be second guessing business decisions defendants only need to tell a plausible story.

VIII.	Duty of Care
	A.	Introduction
		1.	Directors occupy a fiduciary relationship to the corporation and must exercise the care of ordinarily prudent and diligent persons in like positions under similar circumstances.

		2.	"business judgement rule" establishes a presumption that, in making a business decision, directors of a corporation have acted on informed basis, in good faith, and in honest belief that their decision is in best interests of company.

			a.	unless the presumption of an informed and good-faith judgement is rebutted by a complaining shareholder or other plaintiff, the decision of the board of directors will not be "second-guessed" by the courts.

			b.	the presumption can be rebutted if the plaintiffs shoes that the directors did not use due care in informing themselves concerning a decision.

	B.	Amount of care required
		1.	The standard of "reasonable care and prudence" is often difficult to apply to the judgmental decisions on "business risks" which directors are often called upon to make.Courts recognize that

			a.	since potential profit often corresponds to potential risk, shareholders often assume the risk of bad business judgement.
			b.	after-the-fact judgement is a most imperfect device to evaluate business decision

			c.	if liability were imposed too readily, it might deter many persons from serving as directors.

			d.	Most courts conclude that a director cannot invoke the business judgement rule if he has not been "reasonably diligent" as here he knew or should have known that he did not have sufficient facts to make a judgement, yet failed to make reasonable efforts to inform himself.

		2.	Presumption applies unless their is an allegation which makes us suspicious such as self-dealing

	C.	Two major allegations Plaintiffs must make
		1.	directors failed to inform himself -- Francis v. New Jersey
			a.	Mrs. Pritchard, the widow of the founder, continued to serve as a director following her husbands death.

			b.	She failed to attend board meetings, to review corporate financial statements or take any active role.

			c.	She failed to take any action to prevent her sons from bankrupting the corporation by taking large amounts of money in the form of shareholder loans.

			d.	the court held
				1).	she's personally liable for losses caused by her sons' wrongdoing because of likelihood that any reasonable degree of oversight on her part would have deterred her sons from continuing their improper conduct.

				2).	the standard of reasonable care is breached if the directors are negligent in informing themselves.

			e.	The presumption of business judgement was applied but her behavior was so bad it did not matter what the presumption was, she failed to meet it.

			f.	this case is not helpful because it is so easy, she did nothing to inform herself.

		2.	Directors can not make a decision that is a No Win Situation --Kamin v. Amex

			a.	The directors of AEC authorized a distribution of shares it owned of another corporation to AMEX's shareholders.

			b.	Minority sued alleging directors acted negligently in approving the distribution because if AMEX sold the share directly AMEX would have been entitled to a substantial tax saving, which was loss by giving the shares directly to their shareholders.
 			c.	AMEX said they considered the saving but concluded that the distribution of the share because it would avoid a 25MM reduction in AEC's net income a thereby prevent a decline in the market value of AMEX's stock.

			d.	The court accepted AMEX's reasoning 

			e.	Adler's points
				1).	shareholders care most about the money in their pocket
				2).	thus potential loss will be reflected in stock prices
				3).	does not think there is anything to the no win doctrine since this is a clear example of it
				4).	court ignores the possibility of allegation of disloyalty because officers compensation may be based on performance.
 
	D.	Extent of Liability
		1.	A director is liable for the wrongful acts of other officers and directors only if he participated therein, was negligent in failing to discover the misconduct (general standard of care above), or was negligent in appointing the wrongdoer.

		2.	Graham v. Allis-Chalmers
			a.	Defendant was organized in a decentralized manner into groups, divisions, and departments.
 
			b.	Employees of the power equipment division began to engage in price-fixing activities with respect division's products.

			c.	The directors did not become aware of the price-fixing activities until 1959, when newspaper reports were published and the Justice Department issued subpoenas.

			d.	The directors then immediately implemented a compliance program to cooperate with the Government's investigation and to prevent further violations of the antitrust laws.

			e.	court held that the directors did not violate their duty of care b/c they had no reason to suspect illegal activities until 1959.  When directors did learn of illegal price-fixing they promptly took appropriate steps to cure the problem.

			f.	some ignorance is not enough must be grossly negligent 

			g.	Directors are generally entitled to rely on the presumed honesty and competence of the corporation's officers and employees until directors have reason to suspect otherwise.

		3.	Many state statutes permit the articles of incorporation to limit or eliminate the directors' liability for breach of the duty of care -- apart from action bad faith, intentional misconduct, or knowing violation of law.
	E.	Gross Negligence Standard
		1.	Some courts have stated that "gross negligence is the standard for determining whether a business judgement reached by the board of directors was an informed one.

		2.	Smith v. Van Gorkom
			a.	Facts
				1).	Van Gorkom, CEO of Trans Union Corp (TUC), approached Pritzker with a proposal to sell TUC at $55 per share.
				2).	Pritzker responded w/ offer at $55 per share, contingent upon approval of the TUC's board within 3 days.
				3).	Van Gorkom gave a 20-minute oral presentation to the board outlining the basic terms
				4).	Outside counsel advised the board it was not required to obtain a fairness opinion from an investment banker or any other outside valuation before selling TUC.

			b.	Holding
				1).	directors were grossly negligent in informing themselves.
				2).	The board did not inquire into the type of valuation study done by the CFO

			c.	Court accepts this as shareholder suit because directors owe special duty to shareholders when there is a cash out.

			d.	Why the $55/share does not reflect value of company
				1).	with the investment tax credits and a lot of income company is more valuable
				2).	tax credits are worth more than the asset.

			e.	Dissent argued the majority ignored the directors considerable business experience.

			f.	Questions about the case that Adler asks
				1).	Van Gorkom only cares about getting a good price for his shares, so if he thinks it is a good deal for him why is it not a good deal for all.

				2).	does not believe that it was stupid for Van Gorkom to be concerned that Pritcher may leave.
					a).	did not give secret info to other potential buyers
					b).	gave a lockout so if another buyer came along somewhat more expensive to buy but not substantially

	E.	Directors owe a duty to shareholders when there is a merger

IX.	Duty of Loyalty
	A.	Duty of Loyalty in General
		1.	As a further consequence of their fiduciary relationship with corporation officers and directors are held to a duty of loyalty in all dealings with the corporation -- i.e., duty to promote the interests of corporations without regard to personal gain

			a.	duty of loyalty requires directors to act in good faith and in the best interests of the corporation.

			b.	Directors may not, therefore, place themselves in a position where their personal interests would prevent them from acting in the best interests of the corporation.

		2.	conflict of interests issues arise whenever a corporation contracts directly with one of its officers or directors, or with a company in which the officer or director is financially interested.

			a.	A director's interest is clearly adverse to corporation if the director enters into a direct transaction with the corporation. Fliegler v. Lawrence (p. 4-17)

			b.	A director's interest is likely to be adverse to the corporation where the corporation enters into a transaction with another business entity in which the director has a substantial interest.
 
			c.	A conflict of interest may also arise where the same person serves as a director of two corporation which enter into a transaction with each other.

		3.	Effect of Director's self-interest in rendering transaction violable by corporation

			a.	strict view: common law rule was that any contract in which a director is financially interested is voidable at option of the corporation -- w/out regard to fairness or whether the director's adverse interest was disclosed in advance to directors who than approved transaction.

 			b.	modern view: following this view, it has been held that failure of an interested director to make full disclosure to an independent board respecting the transaction is in itself "unfair" to the corporation.

				1).	disclosure requirement: following this view, it has been held that failure of an interested director to make a full disclosure to an independent board respecting the transaction is in itself "unfair" to the corporation.

					a).	full disclosure: requires that the director inform the board as to all matters affecting the value of the property involved and perhaps also the amount of the director's profit.

					b).	independent board: a majority of the directors are not under the control of the interested director.

				2).	fairness requirement
					a).	burden on interested director to prove fairness
					b).	where disclosure to an independent board is not possible dealings between the corporation and an interested director will be upheld as long as the interested director proves that the transaction was unfair and reasonable to the corporation.

				3).	effect of shareholder ratification
					a).	unanimous ratification: if after full disclosure the shareholders unanimously ratify the corporation's dealings with the interested director, the corporation will be estopped from later challenging the transaction.

					b).	same cleansing effect if a majority of disinterested shareholders ratify the corporations dealing.

			c.	Statutes: Delaware law §144 is illustrative, such transactions are not voidable by the corporation for conflict of interest if

				1).	the material facts as to the director's interest and the transaction were disclosed or known to the board and the transaction was nevertheless approved in good faith by disinterested majority of the board.
 
				2).	the same information was disclosed or known to the shareholders, and a majority of the shareholders approves.

				3).	transaction is fair to corporation -- Bayer v. Beron
					a).	burden is on the defendant to show transactions involving self-interest that the deal does not harm the corporation.
					b).	court found for defendant even if directors were not informed, self-dealings is permitted without cleansing if the defendant bears the burden to show it is a fair transaction to the corporation.
 
		4.	Determining whether a director is "disinterested," the courts evaluate
			a.	whether director has a personal interest in transaction.
			b.	even if that director has no personal interest, whether she is subject to the dominating influence of an interested director.
	B.	Corporate Opportunity Doctrine: a director is barred from taking advantage or business opportunity that properly belongs to the corporation.  As to any such opportunity, a director owes the corporation at least right of first refusal.

		1.	What constitutes a corporate opportunity: depends upon whether, under all the circumstances it would be unfair for the director to exploit the opportunity. 
 
		2.	If opportunity was discovered by the director in her capacity as a director of the corporation, it is a corporate opportunity.

		3.	Directors may take advantage of corporate business opportunities of which the corporation is unable to take advantage.

		4.	why it usually is an officer? because they get the information from working for the corporation.Outside directors are not usually in a position to exploit corporate opportunity.

		5.	Energy Resources Corp v. Porter
			a.	Howard University was trying to get a grant, but needed an expert Porter.
			b.	Rather than informing ERCO, he quit and took the opportunity for himself.
			c.	they wanted Porter, thus he could not have lost
			d.	Porter should have to ERCO the truth because he would have been willing to be fired over this.
			e.	Courts are hesitant to accept an argument that exploiter did not disclose because he knew the corporation was unable to exploit b/c the only way to be sure is to give the corporation the opportunity.
			f.	Adler is confident if he disclosed and quit he would have won

	C.	Competing with Corporation
		1.	A director (or officer) who obtains a financial interest in a business that competes with that of the corporation puts herself in a conflict of interest situation -- even where the competing business is not a corporate opportunity.

		2.	Depending on all the circumstances, competition by a director or officer may be held breach of fiduciary duty, in which event she may be barred from such competition or held liable for damages.

	D.	When parent owns majority of subsidiary 
		1.	In transactions between a parent corporation and its majority-owned subsidiary, the parent corporation may not exert its control or manipulate the transaction so that parent receives a benefit at the expense of its subsidiary.

		2.	If the parent corporation receives a self-dealing benefit, it will be liable to the subsidiary unless the transaction is fair to the subsidiary.

		3.	If, however, the parent receives no self dealing benefit in the transaction, its actions will be tested under the more lenient standard of the business judgement rule.

		4.	Sinclair v. Levin
			a.	Sinclair owned 97%of the stock of Siven

			b.	A alleged dividends were excessive and unfair and that dividends certain business opportunities to itself or other subsidiaries instead of assigning them to Sinclair

				1).	Sinclair did not act unfairly in causing Sinven to pay large dividends, and the minority shareholders of Siven received their proportionate share.

				2).	Plaintiff did not show that Sinclair had diverted any business opportunities that rightfully belonged to Siven. Sinclair followed a consistent policy of allocating business opportunities to its subsidiaries based on their geographic location.

			c.	Sinclair caused Sinven to enter into contract with SIOC, who it also controlled, which it then did not enforce.

				1).	By causing Sinven not to enforce the terms of its contract with SIOC, Sinclair received a benefit at the expense of Sinven's minority shareholders.

				2).	Because of the self-dealing benefit derived by Sinclair from its failure to cause Sinven to enforce the contract, Sinclair could not rely on the business judgement rule and was held accountable to Sinven's minority shareholders under the stricter fairness standard.

 		5.	Santa Fe Industries v. Green
			a.	Short-firm merger: if parent owns enough stock it can merge without talking to its shareholders.

			b.	there is a concern that the minority gets its fair share
				1).	minority is entitled to appraisal rights
				2).	then why permit minority the right to challenge
					a).	burden is different
					b).	type of damages may be different

	E.	How do we resolve who bears the burden of determining if the transaction was fair

		1.	Treat as a sale and use §144
			a.	essentially derivative suit and sue subsidiary's Board of Directors.
			b.	if the Board is independent, then Board gets the benefit of the Business Judgement but if it is not independent then it does not get the benefit of Business Judgement.
			c.	What Parent/Subsidiary relationship if parent dominates the subsidiary then the parent owes the subsidiary a fiduciary responsibility as in Sinclair.

		2.	Kahn v. Lynch
			a.	The parent owns only 43% of the subsidiary

			b.	Defendant must show price is fair under §144
				1).	the traditional view 
					a).	was that when deal between directors/officers of the corporation and corporation then the deal was void on its face.
					b).	problem was sometimes deal is good but directors/ officers won't enter fear court will overturn.

				2).	modern view
					a).	deal may deemed void/voidable unless independent directors or disinterested shareholders vote with full information.
					b).	effect of cleansing vote
						(1)	shifts the burden back to the plaintiff since not as suspicious of a transaction.
						(2)	A must prove decision was grossly negligent

			c.	Court rejects defendants argument that burden should be w/ plaintiff b/c they constituted an independent committee.
 
				1).	even after cleansing does not return to business judgement all plaintiff must show is that the price is not fair, not gross negligence.

				2).	Court questions if the committee was truly independent Adler disagrees
					a).	committee was financially independent
					b).	why did not opinion of Committee count
						(1)	they were forced to surrender even if they owed nothing to defendant
							(b)	if committee had no ability to say no, why did ) raise price three times.
							(c)	the committee perceived defendants threat as real and then did what was in the best interest of the shareholders.
					c).	only rationales is that the court did not like the fact that defendant was hostile, almost as if the court says any time committee get what it wants it has been dominated.
		3.	In Re Wheelabrator Technologies Inc.
			a.	Kahn says can't cleanse deal plaintiff only needs to show that the deal was unfair not defendant was grossly negligent.

			b.	allegations
				1).	duty to disclose: court found fully informed vote of disinterested shareholders.
				2).	duty of care: like Van Gorkom made a quick decision
				3).	duty of loyalty: board was dominated by the purchaser of assets, self-dealing

			c.	§144 implies an interested transaction loses its taint with a cleansing vote.

			d.	Court says never can extinguish a duty of loyalty claims but a cleansing vote can extinguish a duty of care vote.

			e.	Adler thinks the court missed the boat and a truly informed cleansing vote will extinguish duty of loyalty vote and does not think there can be a middle ground.

	F.	Summary of Duty of Care and Duty of Loyalty
		1.	Shifting the Burden of Proof to Directors: if the business judgement rule is rebutted because the plaintiff's has shown either a breach of duty of care or a duty of loyalty the burden is placed on the directors to prove that the challenged transaction is fair to the corporation

			a.	The test of fairness to the corporation is one of "entire fairness" and requires the directors to establish both "fair dealing" and fair price.

			b.	If the business judgement rule is rebutted and the directors are unable to prove that the challenged transaction is fair to corporation, transaction is voidable at the option of corp

			c.	the Directors are subject to personal liability for the difference between the value actually received by the corporation in the transaction and the price that would have been "fair" to the corporation.

		2.	Restoring the Presumption in Favor of Directors through Shareholders Ratification: The directors can shift burden of proof back to the plaintiff by showing that the challenged transaction was approved by a majority of the disinterested shareholders after receiving full disclosure of material facts. 

			a.	In order for shareholder approval to shift burden back to the plaintiff, a majority of the shares that are held by shareholders who have no personal interest in the transaction must be voted in favor of the transaction.

			b.	In addition, shareholders approval of the challenged transaction will not shift the burden of proof unless the directors have made full disclosure to the shareholders of all material facts, including all material facts relating to the directors' failure to use due care or their conflict of interest or self-dealing in the challenged transaction.

			c.	If the directors are able to show that the challenged transaction was approved by a fully informed, majority vote of the disinterested shareholders, the burden of proof will be shifted to the plaintiff, who must then show that the transaction was irrational.  In other words, the plaintiff will have to show that the transaction was so arbitrary & unreasonable as to constitute gross negligence

		3. The rationality standard under the Business Judgement Rule
			a.	If the plaintiff is unable to rebut the presumption of the business judgement rule, the decision of the directors will be "upheld" unless it is irrational.

			b.	Even though the directors' decision is not "reasonable" the decision will be held as rational so long as the decision is supported by "any rational business purpose" and the result is not arbitrary or capricious to constitute gross negligence.

X.	INSIDER TRADING
	A.	Introduction and Common Law
		1.	Purchase and sale of a corporation's stock by a director, officer, or other insider raises important and complex issues of fiduciary responsibility. 

		2.	The basic problem is possibility that an insider has an unfair advantage because he knows facts about the corporation that are not known to those with whom he deals, and he knows those facts only because of his fiduciary position, not because he exercised skill or diligence.

		3.	It was clear at common law that a director/officer could not make misrepresentations, or even state half-truths, in connection with the purchase or sale of a stock.However, the courts were split concerning the duty officers and directors to make affirmative disclosures.

			a.	majority rule there's no duty of disclosure to shareholders regarding any information that might affect the value of shares, because officers and directors owed fiduciary duties only to corporation, not to individual shareholders.

			b.	Under minority rule, insider was considered fiduciary for the shareholders as well as corporation and was required to disclose any material information he had obtained as an insider that might affect the value of the shares.
		4.	2 Ways to commit common law fraud
			a.	lie by issuing a statement which is a lie with the goal to get the other side to rely on the lie.

			b.	Failure to disclose information which have a duty to disclose.  Goodwin v. Agassiz shareholders was unable to recover damages in "faceless" transactions effected through brokers on the securities markets.In such transactions, because the purchaser and seller did not have direct contact with each other, it was difficult to argue that the insider owed a fiduciary duty to disclose information.
 
		5.	Traditional arguments could make in State Court
			a.	corporation was injured as a result of directors actions 
			b.	one problem is damages would go to corporation where is the incentive to sue
			c.	directors exploited a corporate opportunity by buying shares that the corporation could have bought.

	B.	Section 10(b) and Rule 10b-5
		1.	§10(b) of 1934 Act makes it unlawful to "use or employ... any manipulative or deceptive device" in contravention of SEC rules in connection with the purchase or sale of any security
 
		2.	To implement section 10(b), the SEC promulgated rule 10b-Under rule 10b-5, it is unlawful, in connection with the purchase or sale of any security, by use of the mails or any means of interstate commerce, to:
			a.	employ any device, scheme or artifice to defraud
			b.	make any untrue statement of material fact or omit material fact necessary to make the statements made not misleading
			c.	Engage in any act, practice, or course of business that operates as fraud or deceit upon any person.

		3.	Rule 10b-5 applies to nondisclosure by directors or officers, as well as to misrepresentations.  Any person who makes a misrepresentation in connection with the purchase or sale of stock may be liable under rule 10b-5.

		4.	Fault Required - Scienter: A material misrepresentation or omission will not violate rule 10b-5 if the defendant was without fault or merely negligent.

			a.	Liability can be imposed under rule 10b-5 only if the defendant had scienter.
			b.	Under tort law, scienter is satisfied by an intent to deceive, to mislead, or to convey a false impression.

		5.	Materiality: a misrepresented or omitted fact is "material" for  the purposes of Rule 10b-5 if there is a substantial likelihood that reasonable investor would consider that fact to be important in deciding whether to purchase or sell the security in question.
	C.	Causation and Reliance: the plaintiff in rule 10b-5 case must prove that the rule 10b-5 violation caused her a loss.In theory, this means that the plaintiff must prove that she relied on the defendant's wrongful statement or omission.In practice, however, the reliance requirement has been greatly attenuated.

		1.	All that is necessary is that the facts withheld be material in the sense that a reasonable investor might have considered them important in the making of her decision.

		2.	In an action based on face-to-face misrepresentation, the plaintiff has the burden of showing reliance.

		3.	"Fraud on the market": where securities are sold in a well-developed market, a plaintiff may be able to prove reliance on a misrepresentation by alleging that she relied on the integrity of the market.

			a.	In an open and well-developed securities market, material misrepresentations generally affects the price of the stock.  Since purchasers rely on the price of the stock as a reflection of its value, they may be defrauded even if they do not directly rely on the misstatements.

			b.	The effect of the fraud on the market theory is to create a presumption of reliance.  Defendant can rebut presumption by showing, for example, that a misrepresentation in fact did not lead to a distortion of price, or that individual plaintiff traded or would have traded despite knowing the statement was false, or that before the plaintiff traded, the information credibly entered the market.

			c.	Basic v. Levinson
				1).	During 14-month period in which defendant Basics was discussing a possible merger with another company, Basic issued three public statements denying that merger negotiations were occurring and stating that Basic was unaware of other corporate developments that would account for unusually high trading volume

				2).	If court determines the undisclosed merger discussions were found to be material, Basic had violated Rule 10b-5 by issuing affirmatively misleading statements.

				3).	a person violates Rule 10b-5 if she makes an affirmative misstatement of material fact in connection with the purchase or sale of any security.

				4).	The courts have recognized that a corporation may properly withhold disclosure of material information for a valid business purpose.

				5).	presumption of reliance created by the fraud-on-the-market theory can be rebutted if defendant shows that.
					a).	market professionals were aware of true facts
					b).	plaintiff did not rely on the presumed integrity of the market because she did not believe in the misrepresentation and was not deceived by them.
					c).	other unrelated factors caused the plaintiff to trade without regard to the particular market.
 
				6).	recent empirical studies have tended to confirm Congress premise that the market price of shares traded on well-developed markets reflect all publicly available info. 

			d.	The law says any lie that affects stock price is a violation.  Adler would argue that the court should look at the purpose of the lie, if it was to cause the change in price or the change in price was just a an effect.

			e.	The best course to take is never lie and never deny or confirm when questioned.

	D.	When Nondisclosure Constitutes a Violation
		1.	Rule 10b-5 is clearly violated when a person makes a misrepresentation or states a half-truth in connection with the purchase or sale of stock.

		2.	More difficult issues are presented, however, where the defendant is claimed to have violated rule 10b-5 not by a misrepresentation or half-truth, but by failure to make a disclosure.

		3.	Non-disclosure of material non-public information violates rule 10b-5 only when there is a duty, independent of rule 10b-5, to disclose.

		4.	Insiders (that is directors, officers, controlling shareholders, and corporate employees) violate rule 10b-5 if they trade on the basis of material non-public information that they obtained through their positions.

		5.	SEC v. Texas Gulf Sulphur Co.
			a.	President of (D) instructed company not to disclose info about substantial corporate opportunities.  Several employees purchased stock based on the info. When info revealed the market price of the stock doubled.

			b.	the court held
				1).	purchases of stock & options by personnel prior to public disclosure of drilling results violates 10b-5
				2).	the fact that insiders with knowledge of the drilling results made large purchases of TGS stock confirmed the materiality of those results.
				3).	TGS official were required to wait at least until news of drilling tests were broadcasted to market.
			c.	Court hasn't gone so far to say w/ holding information is a fraud.  To be a fraud there must be a violation of duty.  The fraud is failure to disclose information when have a duty to do so.

	E.	Tippee and Tipper Liability
		1.	A tippee is a person who is not an insider, but who trades on information she has received from an insider.

		2.	The basic principles of tippee liability were laid down by the Supreme Court in Dirks v. SEC

			a.	Dirks discovered EF was committing massive fraud.  After his investigation he provided information to the SEC and WSJ concerning EF's fraud.  Dirks also informed a number his clients, who promptly sold their EF stock.

			b.	Court in Dirks rejected broad rule that person would be liable, as tippee, solely b/c knowingly received material non-public information from insider & traded on it

			c.	tippee liability based on fiduciary obligations of tipper
				1).	a person who receives information from an insider and trades on it is liable if - but only if- she receives the information improperly because the insider breached a fiduciary duty in communicating the information, and the tippee knows of the breach.
				2).	Primary test for determining whether communication of info. by insider constitutes a breach of fiduciary duty is whether insider realized a gain or advantage.

			d.	Because tipper violated no duty, Dirks was not subject to tippee liability.

 		3.	Carpenter v. United States
			a.	USSC upheld a 2nd Circuit decision

			b.	WSJ reporter who wrote widely read and influential column, participated, in violation of WSJ's rules in a scheme in which he provided two stockbrokers with securities-related information that was scheduled to appear in his column.

			c.	Based on this advanced information, the two brokers would buy or sell the securities before the column appeared, and sell immediately there after.

			d.	The reporter was found guilty of criminally violating rule 10b-5 of criminally violating rule 10b-5, based on the misappropriation theory.  It was affirmed by an equally divided court.

			e.	Held that the interest of WSJ's owner in confidentiality of the WSJ's contents was a property right, and that by using information for his own purposes, reporter had obtained "money or property" from WSJ by fraud.
		4.	United States v. Chestman
			a.	Loeb, the nephew-in-law, of Waldbaum CEO told his broker Chestman he received information about Waldbaum's sale.  Chestman bought stock.

			b.	Court held that neither Chestman/Loeb violated Rule 10b-5 because evidence was insufficient to establish a fiduciary relationship between Loeb and the Waldbaum family.

		5.	Insider trading cases are about determining if fraud occurred with the purchase of securities.  Is a fiduciary duty needed.

			a.	Second Circuit says yes: any sale/purchase of securities on non-public information if it has been misappropriated.
				1).	breaching trust of WSJ there is a fiduciary duty
				2).	breaching trust of spouse there is no duty

			b.	Fourth Circuit says NO

	F.	Is Insider Trading An Act we want to punish
		1.	Why it may be OK
			a.	companies usually issue officers stock options.
				a).	encourages officers to work harder
				b).	money comes from shareholders

			b.	What is the difference between options and insider trading
				1).	Money of insider trading coming from few stock holders w/ options it is being spread across all shareholders.
				2).	In simple model, people do not just own one stock, while the individual stock holder may lose in the situation where he sells his shares to the insider. Overall his portfolio does not change.

		2.	Why insider trading is bad
			a.	the problem is that with options officers may sell short and push the price down it is easier to destroy a company.
				1).	sell short
				2).	don't want to allow but could permit rule against this

			b.	with options there is a limit to the number of shares entitled to.  With insider trading there'd be no limit.

			c.	Real problem with insider trading is perception that it is not fair.  With balanced playing field people invest more.

	G.	Simple Rules
		1.	can not trade on any inside information got in connection to a corporation with the fiduciary duty.

		2.	If misappropriate theory is correct can not trade on private information which is misappropriated.
			a.	Chestman has language which requires a breach of fiduciary duty for there to be a misappropriation.
			b.	Adler believes if there was a bugler who stole information and then traded on it there is a misappropriation.
XI.	Proxy Votes
	A.	In General
		1.	In publicly held corporations, almost all shareholders vote by proxy.  Typically, the management of a publicly held corporation solicits proxies from the shareholders, both for reelection of directors and to approve various types of actions that require shareholder approval. 
 
		2.	Federal Proxy Rules §14(a) of the 1934 Act
			a.	Provides that it's unlawful for any person, in contravention of SEC rules and regulations to solicit any proxy with respect to any security registered under §12 of the 1934 Act.

			b.	Requirement of full disclosure
				1).	forbids misstatements or omissions of material facts in proxy solicitations.
				2).	requires all persons soliciting proxies to set forth fully and completely in the proxy statement all pertinent facts regarding the matters to be voted upon and the identity of all participants in the proxy contest.
				3).	require disclosure of the compensation to five highest paid directors.

		3.	Proxies are used when shareholders vote
			a.	regular meeting - elect directors
			b.	special meetings for monumental events
				1).	mergers
				2).	amendments to certificate of incorporation
				3).	dissolution
				4).	sale/lease of all assets

	B.	Shareholder Proposals
		1.	corporation must include shareholder proposals in corporate proxy materials, provided certain conditions are met. §14(a)

		2.	exceptions: the corporation is not required to include a shareholder proposal if  --- §14(c) 
			a.	under the laws of the state in which the corporation is incorporated, the proposal is not a proper subject for action by the shareholders.
			b.	the proposal would require the corporation to violate state or federal law.
			c.	the proposal or supporting statement is false or misleading
			d.	the proposal concerns the redress of a personal claim or grievance against the corporation.
			e.	The proposal relates to operations that account for less than 5% of the corporation's total assets and less than 5% of its net earnings and gross sales.
			f.	The proposal deals with a matter beyond the registrant's power to effectuate.
			g.	the proposal deals with a matter relating to the conduct of ordinary business operations.
	C.	What we know is the law
		1.	If corporation states that the price is high, did not believe the price was high and price is low there is clear liability.

		2.	Defendants may argue that plaintiff did not rely on statement
			a.	would have voted a certain way regardless of the false statement.
			b.	courts say all need to show was that vote mattered.

		3.	motives of directors don't matter when vote Virginia Bankshares

		4.	Who pays for proxy contests
			a.	corporations always pays for the incumbents regardless if they win the competition.  Since they are in control want to be able to encourage them to defend the corporation and not fear they were be personally liable in case they lose.

			b.	the corporations pays for the insurgents only if they win.  Do not want to always be able encourage insurgents to mount proxy fights.

		5.	Adler would argue that can't lie but if meaningless will not bother with it

XII.	Shareholder Control
	A.	it is possible for entrepreneur to vest difference between control and ownership

	B.	it is ok but people need to know this when going in and need to know rules of changing situation §102(a)(4) (certificate of incorporation needs to say if can issue more than one class of stock) and §242(b) (amending certificate of incorporation) -- DE Corp Law.

	C.	Stroh v. Blackhawk
		1.	gave up 50% of economic interest but contained a substantial majority of control
		2.	IL statute required every share of stock have equal voting power regardless of class
		3.	the law was about formality
		4.	formal compliance is enough as long as not done secretly and everyone understands the distribution

XIII.	Closely Held Corporations
	A.	In General
		1.	Depending on the jurisdiction may either be defined by statute or judicial decision

		2.	Distinguishing traits
			a.	a small number of shareholders
			b.	absence of any ready market for corporation's securities.
			c.	the aspiration by all or a substantial majority of the shareholders to play an active role in the management, direction and operation of the business.
		3.	Courts which have recognized the close corporation have done so for two reasons
			a.	facilitate a relaxation of strict compliance with the typical statutory norms for corporations
			b.	to promote standards of good faith and fair dealing between or among the participants.

		4.	Characteristics for statutory definitions and formation of a close corporation
			a.	definition requires that in order to qualify as a "statutory close corporation," the corporation must
				1).	identify itself as such in its article of incorporation
				2).	include certain limitations in its article of incorporation as to number of shareholders, transferability of shares or both

			b.	Delaware Statute -- §218(a)
				1).	maximum number of shareholders- DE is 30
				2).	a provision making all of the stock subject to a restriction on transferability
				3).	corporation shall make no public offering of its stock
				4).	a statement that the corporation is a close corporation

	B.	Voting Alliances at the Shareholder level
		1.	Pooling Agreements 
			a.	Ringling Bros-Barnum & Bailey v. Ringling
				1).	Delaware courts proved sympathetic to shareholder agreements that sought to do no more than to unite the participants in casting their votes in board elections. 
				2).	courts held
					a).	the agreement was valid
					b).	the agreement did not include an irrevocable proxy

			b.	Abercrombie v. Davis
				1).	court drew bright line which shareholders were can't cross.  If in their quest to put teeth and performance into their alliance, shareholders attempted to vest the right to vote their shares in some nominee or nominees, the result was a voting trust which was void unless it conformed to the requirements of statute
				2).	statutory features §218(a)
					a).	trust can't last for a period longer than 10 years
					b).	a copy of the trust agreement must be filed with the secretary of the corporation and open to the inspection of any shareholder.

			c.	§218(d) says irrevocable proxy not a voting trust but court treats as if it is.

		2.	permanent dominion over board elections can be achieved by share classification which vests the right to elect certain directors in holders of specified classes of stock
	C.	Shareholder Agreements seeking to control discretion of directors
		1.	Courts have been highly suspicious of shareholder agreements which seek to bind the signatories in their capacity as corporate directors.

		2.	The objectives of such an agreement run contrary to the legal assumption that corporate directors are fiduciaries owing a duty of care and loyalty to the corporate entity and not shareholders who voted their election.

		3.	To extent that a shareholder agreement seeks to predetermine director action respecting the selection of officers or their salaries, courts have applied a strict level of scrutiny to determine whether the agreement is contrary to public policy.

		4.	McQuade v. Stoneham
			a.	Courts tend to invalidate agreements among the shareholders of a close corporation that curtailed the powers of board
			b.	Adler says does not matters even if non-signing member votes to enforce agreement because we do not like these agreements and should discourage them

		5.	Clark v. Dodge
			a.	agreements among all the shareholders of a close corporation that invoked a slight impingement on the statutory norm were generally upheld.
			b.	corporation is just a fiction and thus there is no harm since all shareholders agreed

		6.	As a safeguard if you permit sterilization agreements require disclosure, this permits knowledge so you know what you are getting into
 
		7.	Employment Contracts with the Corporation Long-term employment contract between an individual and a corporation arises in two situations
			a.	contract concluded with a shareholder, which seeks to assure her of continued managerial status granting long-term employment
			b.	contract between a corporation and a non-shareholder involving a delegation by the board of its powers to control and manage corporate business matters.

	D. Delaware Law
		1.	§141(a) business affairs ran by board, shareholders can not take power away from board unless in the articles of incorporation.
		2.	§350 seems to limit §141(a) to Closed Corporation.

XIV.	Abuse of Control
	A. In General
		1.	in a closely held corporation it is hard to know what are the implicit terms of the corporation.
		2.	there is a question of how much of a duty the majority owes to the minority

	B.	Obligations to a minority
		1.	Shareholders in a close corporation owe each other an even stricter duty than controlling shareholders in a publicly held corporations

		2.	Donahue v. Rodd older case
			a.	It has been said shareholders owe each other the same duty of utmost good faith and loyalty that is owed by partners to each other.

			b.	The Court held the controlling shareholders of a close corporation who cause the corporation to acquire some of their shares must see that minority shareholders have an equal opportunity to sell a proportionate number of shares to the corporation at an identical price.

			c.	Adler says the court went to far and did not actually means that partnership = corporation

		3.	Legitimate Business Purpose -- Wilkes v. Springside Nursing Home
			a.	the majority shareholders of a close corporation cannot sever a minority shareholder from the corporate payroll, or refuse to reelect him as a salaried officer and director, without a legitimate business purpose.

			b.	The court recognized that corporations function with centralized management, a norm which requires a certain degree of deference to concepts of majority rule.

			c.	Court held that discrimination against minority was to be viewed w/ judicial suspicion but also w/ the understanding that the corporation, as a distinct legal entity, had purposes to be served and that the majority had "certain rights to what has been termed 'selfish ownership' in the corporation which should be balanced against the concept of their fiduciary obligation to the minority.

				1).	burden is upon complaining shareholder or shareholders to establish that corporate decisions have been implemented which treat them in manner unlike majority with respect to rights of participation or income.

				2).	a minority which has met the burden is entitled to relief unless the defendants can justify disparity by showing that the discriminatory treatment was a by-product of a majority decision aimed at securing a valid business purpose of the corporate entity.
				3).	Faced with proof of a valid corporate business purpose, the defendants are entitled to judgement unless the complaining minority can demonstrate that the business could have been achieved by other less burdensome or discriminatory ways.

	C.	Freezeouts
		1.	A must allege intentional unfair treatment w/ either
			a.	salary will eat profits but assets will remain or
			b.	defendants want to get plaintiffs shares for less.

		2.	What's the problem with freezeouts
			a.	there must be no implicit employment contract
			b.	A's normal protection is that he is treated ratably.
			c.	the problem rises when defendants are in a different situation than plaintiff either they are wealthy or b/c they're receiving a salary from the corporation they are in a position to wait to take dividends in corporation.
			d.	when plaintiff is no longer able to wait for dividends he has know option to sell his shares to )'s at a loss. 

		3.	thus plaintiff must allege the purpose of the freezeout is that defendant wants to get his shares for less than their true market value and since there is no market for his shares he has no option but to sell.

		4.	it is not the actual freeze out that is being challenged but the decision that caused the freeze out.  

	D.	Obligation of minority shareholders -- Smith v. Atlantic Properties, Inc 
		1.	a minority shareholder in a close corporation cannot use a veto power unreasonably, as by refusing to vote for dividends when the accumulation of undistributed earnings will lead to a foreseeable tax penalty to the corporation.
		
		2.	Adler does not see why the court sided with the majority since they both were being obstinate

	E. Burden of proof
		1.	generally speaking firing of employees and majorities decision not to pay dividends is usually not classified as a self-dealing transaction.

		2.	exception in closely-held corporations the courts are suspicious and the burden on the plaintiff is relaxed.
				how much the burden shifts depends on the case 

		3.	Wilkes shows not business judgement but defendants need to show a legitimate business purpose.

		4.	Sugarman v. Sugarman
			a.	generally it isn't sufficient for a minority shareholder to prove that majority shareholder has taken excessive compensation or other payments from the corporation.

			b.	also not sufficient to allege that majority shareholder has offered to buy to buy stock of a minority at an inadequate price

			c.	in a close corporation, however, a minority shareholder who merely receives an offer from a majority shareholder to sell stock at an inadequate price, but doesn't accept that offer, can still seeks damage if the shareholder can prove that the offer was part of a plan to freeze the minority shareholder out of the corporation.

	F. What are minority's options
		1.	court could create a rule that allows minority to liquidate-at-will like in partnerships but there are serious disadvantages to the corporations since it will not be able to be managed efficiently with such a rule.
		2.	law protects minority in that majority can not try to steal minorities shares.
		3. contract

	G.	Deadlocks
		1.	deadlocks often occurs in closely held corporations because of the closed nature; the common use of greater than majority voting requirements at the shareholder or board level to enhance minority status Smith v. Atlantic.

		2.	the ideal situation would be for people to contract for it but they do not because they believe they will always get along.  One party sets the terms the other gets to decided to buy or sell

		3.	Courts will not generally look at motivations of shareholders but in Smith court shows in deadlock may get involved.

		3.	§226 of Delaware provides for the appointment of a custodian.
			a.	a judicially appointed custodian takes the control and management away from the board and exercises those functions pursuant to the appointing court's order.  
			b.	the argument for this is that nobody wants a deadlock
			c.	against this is that only one party wants the court to find a solution the other believes they can win eventually.

XV.	Duration  -- Alaska Plastics
	A.	statute in the case: the minority may bring an action for liquidation if actions of directors or controlling shareholder is oppressive, fraudulent, or when corporate assets are being misapplied or wasted.

	B.	why apply remedy when assets are being wasted?
		1.	usually when deadlock since courts won't second guess business decisions
		2.	designed for more extreme cases

	C.	why apply when assets are being misapplied
		1.	could always bring a derivative suit 
		2.	under this statute awards go directly to the plaintiff which makes sense when the corporate fiction is not believable. (i.e. why send damages back to corporation when they are being controlled by misapplier)

	D.	courts not likely to liquidate if a bonafide dispute. 

XVI.	Control Transfer
	A.	Looting
		1.	controlling shareholders breach their fiduciary duties to the minority shareholders if they transfer their controlling shares to a person or group whom they know or have reason to know will deal unfairly with the corporation.

		2.	the principal type of case in this category is a sale of controlling shares to a purchaser whom the controlling shareholder knows or has reason to know intends to loot the corporation

		3.	the problem is proving the majority had knowledge.

	B.	usually a purchaser of only a majority stake in a corporation does so either because 
		1.	he plans to increase the value of the corporation but does not have enough capital to buy the entire corporation (minority benefits)
		2.	he plans to loot the company by depleting the value of the minorities interest.

	C.	contract for take-me-along provisions Frandsen v. Jensen
		1.	if contracted for a take-me-along provision serves to protect the minority.  The provision provides the minority has either the option 
			a.	to give permission to majority to that can sell control and leave minority behind or
			b.	minority can sell their shares to majority at the price per share minority is get from the purchaser.

		2.	in this case if minority takes the take-me-along provision majority will only make deals to sell control where the believes the purchaser does not want to loot because he will be left behind.

		3.	while their are arguments set above that this should be the default rule there arguments in the other direction when majority just wants to get out, thus court are very hesitant to install such provisions requires minority to contract for the right.
	D. Majority Rule -- Zetlin v. Hanson
		1.	the general rule is that a controlling shareholder has the right to sell his controlling stock at a premium over market value, and such shareholder is not required to share that premium with the minority shareholder. 

		2.	"absent looting of corporate asset, conversion of a corporate opportunity, fraud or other acts of bad faith, a controlling stockholder is free to sell, and a purchaser is free to buy, that controlling interest at a premium price."

	E. Minority Rule -- Jones v. H.F. Ahmanson
		1. Facts
			a.	the were very few share of corporation but since very expensive.
			b.	majority owned 85% and formed holding company sold many share to holding company -- broke up large shares
			c.	minority not able to sell their shares because they were not broken into smaller shares 

		2.	the California Supreme Court held that controlling shareholders were under a duty to act toward minority shareholders with "good faith and inherent fairness...in any transaction in which control of the corporation is material.

		3.	the fiduciary obligations owed by a controlling shareholder may apply, even where he does not cause the corporation to do anything, where an act he takes in his shareholder capacity benefits himself at the expense of the minority shareholder. 

		4.	in any transaction in which control of the corporation is material, the controlling shareholders must act with "good faith and inherent fairness" toward the minority. 

		5.	Adler does not believe that stock could not be sold before it was broken up some investors have a lot of money.  Majority's plan was really to sell economic interest without giving up control

		6.	Adler thinks what was wrong with this case is that majority used its position to provide information to the market (but minority gets the benefit).  Ultimately okay to play with control but if using corporate information must split the stock first.  

	F.	Spectrum
		1.	Delaware Rule: generally minority must contract for protection but in an extreme freeze out will find fiduciary.

		2.	California Rule: generally will protect minority but there are some transactions where majority need not offer same opportunity to minority.

XVII.	Mergers
	A. In General
		1.	a merger generally requires shareholder's approval

		2.	short form merger: special rules for the approval of a merger between a parent and a subsidiary in which the parent owns a designated percentage of the stock.

		3.	appraisal rights: enables shareholders to dissent from mergers and other fundamental corporate transactions and to receive the fair value of their shares in cash

			a.	only occurs when the shareholders of the surviving corporation are entitled to vote on the transactions.

			b.	state laws that authorize statutory share exchanges generally provide appraisal rights to the shareholders of the company whose shares are to be acquired but not to the acquiring corporation.

		4.	Delaware Statute
			a.	§251 Merger or Consolidation of Domestic Corporations
				1).	(c) if there is a merger get to vote.
				2).	(f) exceptions to (c)
					a).	the agreement of the merger does not amend in any respect the certificate of incorporation
					b).	the type of shares are not changing or altered
					c).	no more than 10,000 new shares are being issued or not more than 20% of the company.

			b.	§262 Appraisal rights: generally get appraisal rights under mergers
				1).	generally do not get for public corporations.
				2). exceptions to §(1) for all but the following
					a).	get stock of the surviving corporation
					b).	get stock from another corporation
					c).	cash instead of fractional shares			
					d).	combination of shares and cash instead of fractional shares
				3). for the most part cash gets you appraisal remedies
				4). short-form merger get you appraisal

	B.	Defacto Doctrine
		1.	to protect the rights of shareholders in stock-for-assets and stock-for-stock combinations, many courts hold that a transaction has the effect of a merger is deemed to be a merger for purposes of voting and appraisal rights.

		2.	Under this doctrine if 1 corporation acquires substantially all of another's corporate assets in exchange for stock that's distributed to the transferor corporation's shareholders, the transaction will require the approval of the acquiring corporation's shareholders and will trigger appraisal rights for those shareholders.

		3.	The same rule would apply to any acquisition of another corporation's majority stock in exchange for a majority of the acquiring corporation's stock.

		4.	the test is whether the transaction has "all the characteristics and consequences," or the "indicia," of a merger

		5.	the courts have applied in cases where, following the transaction, the shareholders of the nominal surviving or acquiring corporation
			a.	are in a minority position
			b.	have lost a substantial part of the investment value of their shares
			c.	find themselves as investors in a fundamentally different enterprise.

		6.	Farris v. Glen Alden Corp
			a.	Glen Alden was to acquire List for which List stockholders would hold 76.5% of the combined company
			b.	Glen Alden stock value higher than combined and List lower.
			c.	the transaction was enjoined as a defacto merger in which Glen Alden was actually the acquired corporation.
			d.	the practical effect was
				1).	former Glen Alden shareholders and directors would lose control over the corporate enterprise.
				2).	the value of the stock held by the former Glen Alden shareholders would decline substantially.
				3).	the nature of the corporate enterprise would be fundamentally changed.

		7.	Hariton v. Arco Electronics, Inc.
			a.	Loral much larger corporation was purchasing Arco's assets
			b.	Arco voted for the sale but the statute did not provide appraisal rights
			c.	dissident Arco shareholder filed suit argued transaction was defacto merger & that Arco's shareholders therefore should have been granted merger appraisal rights.
			d.	the court held the sale of assets was properly accomplished under §271 and that the statute did not require the granting of appraisal rights.
			e.	There was no facts suggesting a de facto merger because no material change occurred with respect to the control or essential nature of Loral.
			f.	While the nature of the investment held by Arco's former shareholders had changed this was a risk of which they should have been aware, in view of terms of §271. 

		8.	In Delaware no appraisal when sale of majority of assets

	C.	Freeze-out Mergers
		1.	Delaware Approach no business purpose -- Weinberger v. UOP
			a.	parent company negotiated with subsidiary to enter into a "squeeze-out merger," whereby parent would acquire all of the shares of subsidiary that it did not own in exchange for cash paid to the minority.

			b.	Certain directors of parents also served as directors of subsidiary and participated in negotiations.

			c.	The court held because the persons who were directors of both didn't abstain completely form merger transaction, needed to fulfill their loyalty to both corporations.

			d.	the common directors breached this duty when they didn't disclose to their colleagues on subsidiary's board significant information they received from parent.

			e.	The Court held that is a self-interested transaction involving a controlling shareholder, the controlling shareholder has a duty of complete candor.

			f.	Delaware don't require business purpose, entire fairness.

			g.	If a minority shareholder in a subsidiary challenges a squeeze-out merger, the shareholder has the initial burden of alleging specific acts of fraud, misrepresentation, or other misconduct to demonstrate unfairness of the merger to the minority shareholders.

		2.	Business Purpose -- Coggins v. New England Patroits
			a.	parent corporation must show that a proper business purpose of the subsidiary corporation is furthered by cashing out the subsidiary's minority shareholders in a squeeze-out merger.

			b.	business purpose test was not satisfied where the sole reason for the squeeze-out merger was to enable the dominant shareholder of the parent corporation to repay a personal debt.

			c.	Normally the business purpose test requires a showing that eliminating the minority shareholders will increase corporate income or assets i.e., will make the pie bigger, rather than simply redistributing the value of the enterprise from the minority shareholders to the controlling shareholders. 

		3.	When a parent corporation violates its duty of fair dealing price, the court will generally award either an appraisal remedy or rescissionary damages to the minority shareholders if it is too late to enjoin the merger and too difficult to rescind and unwind the merger.

			a.	appraisal remedy: provide the minority shareholders with fair value of their stock as of date of the merger, together with interest since that date.  no burden

			b.	rescissionary damages: intended to put the minority shareholder in the same economic position that they would have occupied if they had not been wrongfully cashed out.  The burden is on defendant to show price is fair.  They may provide a larger recovery to the minority shareholder than appraisal remedy in case where

				1).	substantial period of time has elapsed between the merger and the trial and
				2).	the value of the subsidiary's stock has increased significantly during that time period.

			c.	Rabkin v. Philip A. Hunt Chemical Co.
				1).	Any self-interested combination must meet the standard of entire fairness.
				2).	The Delaware courts recognize that although monetary remedies should be confined to appraisal proceeding, the appraisal remedy may not be adequate in certain cases, particularly where fraud, misrepresentation, self-dealing, deliberate waste of corporate assets, or gross and palpable overreaching are involved.

		4.	when the procedure is unfair become skeptical that the price is fair.
 
	D. De-facto Non-merger Doctrine -- Rauch v. RCA Corporation
		1.	A urged adoption of de-facto non-merger but court rejected
		2.	transaction took the form of a merger but the plaintiff argued that in substance it was the sale of assets followed by redemption.
		3.	If the sale-of-assets route had been followed, then, in the absence of any change in the redemption price of the preferred shares would have been entitled to $100 per share, plus any previously unpaid dividends.
		4.	Adler thinks case was wrongly decided not argued well forgot de facto rights being altered.

XVIII. Acquisitions

	A.	Introduction
		1.	Tender Offers: an offer to shareholders of a corporation ("target corporation") asking them to tender their shares in exchange for either cash or securities.  A tender offer is usually made by another corporation (the "bidder" or the "raider").  A tender offer almost invariably invites the tender of at least a majority of the target's shares, and frequently invites the tender of all the target's shares.

			a.	typically terms of a tender offer provide that the bidder will acquire the shares that are tendered only if certain conditions are met. The most important of these conditions is that some specified minimum of shares must be tendered.
			b.	Tender offers are classified as friendly or hostile.  A friendly tender offer is an offer that is supported by the target's board.  A hostile tender offer is an offer that is opposed by the target's board.

		2. Cheff v. Mathes
			a.	the court held the board of directors, based upon investigation, receipt of professional advice, and personal observations of the contradictory action of Maremount and his explanation of corporate purpose, believed, with justification, that there existence in its present form, by the plan of Maremount to continue building up its stock holdings.

			b.	if the directors cause the corporation to purchase shares from a shareholder who otherwise threatens to seize control; or the directors cause the corporation to purchase shares of other shareholders to prevent the "raider" from obtaining the must show corporate purpose.

			c.	If the purchase are made solely for the purpose of perpetuating the officers and directors in their jobs, this is not a bona fide corporate purpose.

			d.	If there's reason to believe that the corporate takeover by the "raider" would jeopardize the interests of the corporation generally, the repurchase may be justified.

			e.	a corporate purpose must be shown when a corporation purchases the shares of a "corporate raider" to prevent his obtaining control.

			f. Adler's perception
				1).	doesn't like analysis that court accepts rational to pay more for control premium but empirical evidence suggests future price is reflected in current price.
				2).	less of a reason to trust Cheffe -- lots of taint.
				3).	burden isn't on business judgement shifts somewhat.

	B.	Development
		1. defensive tactics
			a.	often the board of a target company takes some defensive action to ward off a takeover.

			b.	it may seek to combine with an alternative corporation ("white knight") or may agree to sell the business to management ("a management buyout"), or may give a third-party or management an option ("lockup").

			c.	They are generally reviewed by an immediate standard that is between the relatively clear they will be reviewed by an intermediate standard that is between the relatively strict duty of loyalty rule and the very liberal business judgement rule.  

			d.	The standard in Delaware is that such an action must be "reasonable in relation to the threat posed."

			e.	non-preclusive defensive tactics: shareholders can always vote out directors and remove defensive tactics and then sell. Unocal

			f.	preclusive defensive tactics: shareholders do not have option to effect deal.  Revlon, QVC, Time-Warner

		2.	Delaware has adopted an enhanced fiduciary standard which must be satisfied by target company directors before they can rely on business judgement rule to justify response to takeover attempt.  Burden somewhere in the middle. 

		3.	Target company directors have affirmative burden of showing that they complied with their enhanced fiduciary duties.

		4.	Unocal Corporation v. Mesa Petroleum Co.
			a.	facts
				1).	Mesa offered a two-tier coercive tender offer much higher price for first 50.1% of shares and second after having control would purchase remaining shares for less.  (price must always be fair)
				2).	management as a defensive tactic made a self-tender offer but excluded Mesa.  Once Mesa got close to 50.1% they would offer a substantial premium for remaining shares.  Mesa would get the company but it would be worthless.  
				3).	Unicol said scorched earth would never happen since Mesa would never continue with tender offer.

			b.	Court accepts Unocal's argument that defensive tactic was a delaying tactic in order to get additional offers.

			c.	Directors of a corporation who authorize defensive measures against a takeover attempt must show that:
				1).	they had reasonable grounds for believing, based on good-faith and reasonable investigation, that danger to corporate policy and effectiveness existed.	
				2).	the defensive measures adopted were reasonable in relation to the threat posed by the takeover.

			d.	said it was okay to consider other constituencies.

		5.	Revlon, inc. v. MacAndrews & Forbes Holding, Inc.
			a.	PPI launched a tender offer for all of the stock of Revlon which was determined to be inadequate and defensive tactics were put in place.

			b.	PPI made second offer but Revlon went into deal with "white knight"

			c.	"White Knight" insisted on a defensive tactics
				1).	lock-up allowing them to purchase key Revlon assets at favorable prices if PPI or another person obtained 40% or more of Revlon's shares.
				2).	Revlon agreed not to seek any other bids no-shop agreement
				3).	and allow White knight to cancel the agreement and receive a $25 million if anyone got 20%.

			d.	When it becomes evident that control of the corporation will be sold either to the bidder or a white knight.  In that event, the role of the target company's directors change from serving "defenders of the corporate bastion to acting as auctioneers charged with getting the best price for the stockholders at a sale of the company.

			e.	court very hesitant to accept target's reasoning that white knight had better financing

			f.	Directors duty of loyalty requires them to maintain their primary focus on welfare of the shareholders as a whole.  Directors may not seek to advance or protect interests of non-shareholder constituencies unless there are rationally related benefits accruing to the stockholders.

		6.	Paramount Communications v. Time Incorporated
			a. facts of the case
				1).	director's of Time approved a merger with Warner after extensive consideration that such a merger would in the long-run benefit Time. Adler but a better offer came along
				2).	the merger included some defensive tactics even though a second bidder wasn't contemplated.
				3).	Paramount launched a tender offer ultimately at $200 per share.
				4).	Time's directors concluded Time/Warner combination offered greater potential in the long run.

			b.	The court placed great emphasis desire of Time to protect its culture.  ADLER THINKS THIS IS RIDICULOUS.  Court can't possibly mean okay to protect culture just for the sake, must be linked to bottom line

			c. significant factors
				1).	unlike Revlon time was not up for liquidation
				2).	2nd way to consider case not about defensive tactics rather Time just wanted to buy an asset (Warner) and Paramount could always purchase the combined company but Adler has trouble reading the case this way.

			d.	after extensive deliberations and the receipt of detailed advice form financial advisors, Time's directors reasonably determined.
				1).	was in best long-term interests of Time's shareholders
				2).	while Paramount's offer was higher not in long run.  
			e.	Time's switch from a merger to a two-tier acquisition was a reasonable response.  

			f.	this is a preclusive-defensive tactic case and shareholders have no protection if Time paid to much for Warner.

		6.	Paramount Communications Inc. v. QVC Network, Inc.
			a.	whenever the control is transferred, the target's remaining shareholders have a vital interest in receiving a "control premium" and/or special protective measures from the acquiror. 
 
			b.	Court state two things made it different then Time
				1).	Paramount Viacom merger amounted to a transfer of control over Paramount, while the Time/Warner merger did not cause a change in control of Time.  Adler thinks this is ridiculous the fact Redstone was getting control was just part of the mix and the offer was so good worth taking the chance. 

				2).	Paramount/Viacom merger was agreed to in the face of QVC's expressed interest in making an offer for Paramount, while Time was not confronted with a potential hostile takeover at the time it agreed to merge with Warner.

			c.	The directors failed to meet the Revlon test because they did not make reasonable efforts to secure the highest possible value for Paramount's shareholders and instead agreed to a "lockup option" and a "no-shop" provision, which gave a decisive advantage to Viacom.

	C.	State and Federal Legislation
		1.	Delaware Statutory Defensive Tactic -- §203 
			a.	designed to require a bidder to reach a friendly agreement with the target company's incumbent board before he launches his takeover or persuade the other shareholders that his take-over is reasonable

			b.	the only way in which the bidder can avoid these requirements.
				1).	acquire 85% of the target's voting stock held by non-insiders in the front-end tender offer or
				2).	wait three years thereafter before accomplishing the back-end merger.

			c.	can opt out of §203 in Certificate of Incorporation. 

		2. Williams Act -- procedural statute for tender offers
			a.	a person who has acquired beneficial ownership of more than 5% of the stock must register.
			b.	must leave tender offers open for certain period of time
			c.	must accept share ratably.

		3.	CTS Corporation v. Dynamics Corporation of America
			a.	Supreme Court upheld a control share acquisition statute adopted by Indiana which was limited to targets incorporated in Indiana.

			b.	The statute applies whenever a person acquires "control shares" (i.e. 20%, 33.33% or 50%)

			c.	An acquiror that passes such a threshold cannot vote the acquired stock unless voting rights are approved by a majority of all disinterested shareholders voting as the next regularly scheduled or special meeting of the shareholders.

			d.	The Court found that the Indiana statute was consistent with the Williams Act's purpose of protecting investors.  By giving the disinterested shareholders the collective right to determine whether a takeover offer was fair, the Indiana statute reduced the coercive pressures placed on target company shareholders by two-tier takeovers.  In addition, the Indiana statute did not prevent a bidder from complying with the procedural requirements of the Williams act.

			e.	the court also concluded that the Indiana Statute did not violate the commerce clause, because it does not discriminate against interstate commerce and does not subject activities to inconsistent regulation.

		4.	Amanda Acquisition Corporation v. Universal Foods Corp.
			a.	the 7th circuit upheld a Wisconsin anti-takeover statute against challenges under the Williams Act and the Commerce clause.
			b.	The law was similar to but somewhat more stringent to §203 of Delaware. 

		5.	Critics of state anti-takeover laws
			a.	contend these statute shield inefficient companies and complacent managements from the market discipline exerted by takeovers.
			b.	takeovers generally increase shareholder welfare by providing shareholders with a higher price for their shares and by replacing incompetent or inefficient management.
			c.	state anti-takeover laws primarily favor non-shareholder constituencies over shareholder welfare.

		6.	as long as state statute does not make it impossible to comply with federal statute; state law is okay.

XIX.	Corporate Debt
	A.	relationship b/w creditors and firm isn't an agency relationship it is purely contractual.  Creditors can't sue directors for breach of loyalty.  Directors have a duty to do whatever the law permits to hurt creditors for the benefit of the shareholders.

	B.	if people were risk neutral and there was time factor there would be no need to distinguish between debt and equity.  Thus the traditional notion that the advantage of debt is that corporation will get benefit if get profit beyond debt is false.  
	C.	in debt the rate of return needs to be a combination of
		1.	r which is the rate of return one could get on treasury bonds where there is no risk

		2.	$ which is riskiness of assets compared to the whole economy.

	D.	So why have debt
		1.	tax incentive debt payments are deductible

		2.	when corporation sells shares the new equity holder may interfere with the operation of the firm.  managers have a greater incentive to work with more debt than equity.

		3.	as a sister explanation if you've got a lot of debt chance company will fail and management will lose their jobs thus they'll work hard not to lose their job.

	E.	cost of debt: equity and debt holders come into conflict equity holders are gambling with debt holders money.
	
	F. debt holders need to create covenants to protect themselves

	G.	Sharon Steel creditors put into contract to reduce ways equity holders could put company at risk.

	H.	RJR Nabisco shareholders change risk of creditors by removing the equity cushion

	I. LBOs only work where there is a change in the equity cushion

	J.	with existing loans outstanding -- 2 things can change value
		1.	prospects of the firm change where it is no longer likely they can pay back loan.
		2.	economy changes such that little r is different.

	K. Exceptions to debtor non-protection
		1.	Francis Case when firm sinks into insolvency courts are split as to whether directors should at this point owe a duty to debtors can't gamble money just at expense of creditors.  

		2.	§170 Creditor Protection Provision debt covenant built in as a default rule.  Can't drain dividends below stated capital provides a cushion for debt.  Not much protection because can change stated capital.