Corporations Hell - Reorganized
Miller – Fall 1999/Spring 2000

I.	Agents and Employees
A.	What kind of organization is it?
1.	Cts look at both form and substance - Fowler v. Penn Tire Co.  
2.	Look at the relationship – duration, control, risk of loss and return
B.	Employee Versus Independent Contractor and the Exercise of Control
1.	Determining Agency
	a. Elements of an agency relationship: A. Gay Jenson Farms
	(1) Principle consented to agency relationship (includes implicit consent)
	(2) possible agent acted on behalf of the principle
	(3) The principle exercised control over the possible agent
2.	When it’s formally an independent contractor relationship (K)
a.	Employer may be liable for the contractor’s torts if it exercises substantial control over their operations (substance of the relationship). Humble Oil & Refining Co. v. Martin
b.	Deciding substantial control:
(1)	contractor has little control over anything but hiring and firing (Humble)
(2)	in tort – standard is a lot lower – look at reasonable expectations of the person (name was the same etc) (Humble)
(3)	not substantial control where the contractor has control of day to day operations (Hoover)
(4)	look at how much leverage company has over contractor – like whether contractor has to report to employer (Hoover)
(5)	Murphy v. Holiday Inn – if form gives control of day to day operations (very specific regulations about how to do everything) – then it’s agency 
(6)	Murphy v. Holiday Inn - if form doesn’t give control, but if the substance is that company has power over day-to-day operations – still agency
(7)	Creditor who assumed control of operations of the debtor’s business? – need de facto control over debtor’s conduct not just veto power – then agency relationship A. Gay Jenson Farms Co. v. Cargill, Inc.
(8)	If a franchise agreement gives franchisor control over the day to day operations of the franchise, an agency relationship exists Billops v. Magness Construction Co.
(9)	
C.	Types of authority
1.	Actual authority – company actually says that someone has the power to do something for company
2.	Apparent authority – person acts in a way that makes the other side reasonably believe that she has authority; and the principal somehow manifests agreement (can be by inaction) 
a.	Policy – if the principle had to directly do everything, it would be impossible
3.	If actual, always apparent also. Can have apparent without being actual 
	4. Ways that actual or apparent authority can come about:
a.	Implied – agent without express statement by principle acts or is recognized so that they have authority;
b.	Inherent – agent has a position that is known to carry with it certain powers (the other side assumes that the person has certain abilities because of their role) (principal doesn’t necessarily have to manifest agreement);  
D.	Deciding if there’s apparent authority
1.	Person who deals with apparent agent has to reasonably believe someone has the authority to do something for the principle to be bound by the apparent agent Lind v. Schenley Industries, Inc.
2.	If a salesperson agrees to a sale in a way that leads the buyer to reasonably think the sale is done, the employer is bound (if employer doesn’t do anything to dispel the belief); Three-Seventy Leasing Corp. v. Ampex Corp.
3.	In an analysis of authority, ct will decide if there’s apparent authority and stop – no need to decide if there’s actual Three-Seventy Leasing Corp. v. Ampex Corp.
4.	When a franchisor exerts a lot of control over the franchisee so that a third party reasonably believes they are the same entity and so relies on that, the doctrine of “apparent agency” is applicable and the franchisor is bound Billops v. Magness Construction Co. (hilton)
5.	This vs. Holiday Inn case – in Hilton, ct didn’t look to reliance of third parties (“apparent” aspect supporting finding “apparent agency” – just looked for agency and stopped)
E.	Inherent Authority
1.	If person has a position that makes a third party reasonably believe they can do certain things, employer is bound by what employee does Watteau v. Fenwick (person probably has apparent authority also)
1.	Restatement 2nd of Agency §194
a.	an undisclosed principal is liable for acts of an agent “done on his account, if usual or necessary in such transactions, although forbidden by the principal”
2.	Restatement 2nd of Agency §195
a.	An undisclosed principal who entrusts an agent with the management of his business is subject to liability to third persons with whom the agent enters into transactions usual in such business and on the principal’s account, although contrary to the direction of the principal
3.	An agent acting within the usual boundaries of his role binds his principal even if the details of the transaction to which he agrees were not authorized. Just has to be within the general scope of the business entrusted to his care Kidd v. Thomas A. Edison, Inc.

4.	Nogales Service Center v. Atlantic Richfield Company
a.	A principal can be bound by a general agent based on his position as such, even if he lacks express or apparent authority for the commitment at issue. (inherent authority)
5.	Restatement 2nd of Agency s161 (inherent authority)
a.	a general agent for a disclosed or partially disclosed principal subjects her principal to liability for acts done on his account which usually accompany or are incidental to transactions which the agent is authorized to conduct if, although they are forbidden by the principal, the other party reasonably believes that the agent is authorized to do them and has no notice that she is not so authorized
6.	Restatement 2nd of Agency s161 Comment b (inherent power distinguished from apparent authority)
a.	The Rule in this Section applies to cases in which there is apparent authority, but includes also cases in which there is no apparent authority. Thus, the principal may be liable upon a contract made by a general agent of a kind usually made by such agents, although he had been forbidden to make it and although there had been no manifestation of authority to the person dealing with the agent.
7.	Agency in partnership
a.	Partners are agents of the partnership – can incur obligations on behalf of the partnership and are liable as principles 
F.	Fiduciary Obligation of agents
1.	General Automotive Manufacturing Co. v. Singer
a.	An agent who draws business away from her principal for her own enrichment is liable to the principal for her profits therefrom.
b.	An agent has a fiduciary relationship to the principal. 
c.	(includes duty not to do anything to the financial detriment of the principal) (here, taking potential customers away from his boss in favor of his own business)
2.	Bancroft-Whitney Company v. Glen
a.	An executive who recruits co-employees to join him in moving to a competitor breaches his obligation to the former company.
b.	(just talking to another company to get a new job for yourself – not a breach)
c.	If you permit employees to do whatever they want (negotiate with competitors and recruit co-employees):
(1)	you would be losing training expenses, their accumulated expertise, etc.
(2)	But you would be able to recruit from other places and the employees would probably be happier
3.	Guth v. Loft
a.	Corporate officers and directors are not permitted to use their position of trust and confidence to further their private interests. While technically not trustees, they stand in a fiduciary relation to the corporation and its stockholders.
4.	Town & Country House & Home Service, Inc. v. Newberry 
a.	Former employees may not use confidential customer lists belonging to their former employer to solicit new customers.
b.	Common law protects trade secrets.
c.	A customer list is, insofar as it contains information not readily available to the general public, a trade secret.
5.	Corroon & Black-Rutters & Roberts, Inc. v. Hosch
a.	It is not unfair competition for an insurance agent to use his former employer’s customer list to direct clients to the agent’s new insurance agency
b.	Difference between this and the previous one – 
(1)	insurance agent was taking his own customers – in the other, the employees were taking customers from the whole company 
(2)	Also, could be a policy reason because insurance agents are brokers and have a fiduciary duty to their clients to provide the best service possible – so you want to be able to let the agent continue that relationship (allowing the customers to continue to get the best service)
(3)	The other case – a service that only a select few would want – so the customer list took effort to get together (by stealing the customer list, the former employee is stealing the effort as well); insurance is different because everyone wants insurance – that list took no effort to compile
1.	agent’s fiduciary obligations to principal when leaving current employment
a.  applicable e-es 
1. applies to specially skilled employees or those in mgt
2.   doesn’t apply to lower employees 
•	rationale - they don’t have access to confidential info or have special skills & can be easily replaced
b.  preliminary negotiations 
1.  permissible while still working for current e-r w/out informing current e-r
2.  can go on company time as long as not abuse
•	if rule was that e-e can’t look while still employed, current e-r would benefit
a.  more ex post bargaining power
b.  would enjoy stability, training & recruiting expenses saved, clients retained, intellectual property security, reputation 
c.  employer might take greater risks in other areas
•	if rule was that e-e could look while employed benefits employee 
a.  higher salary, better job, relocation opportunity
b.  society would benefit b/c more productive employees b/c more satisfied
c.  other e-r would benefit b/c they could recruit
c.  informing co-workers - more muddled
1.  can inform them intending to leave
•	rationale - more team-oriented work groups so will come up during work day, client works w/group & not just one person
•	also support for argumt that e-e shouldn’t be allowed to discuss w/co-workers b/c potentially more harmful to e-r
2.  can’t try to recruit co-workers for new e-r - unclear where line is but definitely crossed in Bancroft-Whitney
•	Bancroft-Whitney Co. v. Glen - while still employed by principal agent negotiates w/principal’s competitor & then jumps ship taking top mgrs w/him, court holds agent liable to principal as breach of fiduciary duty to principal, no hard & fast rule
d.  taking from current e-r
1.  can take skills developed at existing e-r even if e-r has expended resources to train
2.  can take general info of firm but not firm specific knowledge
3.  can’t disclose confidential info like trade secrets - usually in service industries
a.  includes files, customer lists, other
b.  liable for tort of stealing if disclose
c.  trade secret status
1.  when service provided is route where there is room for only 1 supplier vs. nonroute where there is room for more than 1  limited mrkt
•	Town & Country House & Home Service, Inc. v. Newberry - former home service e-e can’t solicit business from customers of e-r
•	Corroon & Black-Rutters & Roberts, Inc. v. Hosch - insurance agent can take customer files & solicit from them after he leaves e-r
2.  issues
a.  e-r wants to encourage strong ties btwn e-e & client but runs the risk that e-e may take client w/him when leaves
b.  covenant not to compete not a satisfactory solution (about who bears risk of uncertainty of duration of employmt)
1.  overinclusive
2.  social interest in competition ex post
3.  but enforced when reasonable in geography & time
e.  goal of rule - want rule where harm to employee equals harm to employer
f.  characterization of breach of fiduciary case - hybrid of K & tort case
•	K - implied in employmt K
•	tort - tortious interference w/e-e, punitive damages available
g.  issues to consider
1.  is there an explicit agreemt?
2.  is there employer consent?
3.  what are interests of parties ex ante & ex post?

III.  Partnerships
i.  Intro
1.	definition 
a.	association of 2 or more persons (including fictitious) to carry on as co-owners a business for profit
b.	partnership agreements are often negotiated to avoid default state rules – agreement will win unless it’s against public policy
c.	determining whether a partnership relationship exists: elements (listed in Fenwick)
1.  capital contribution
2.  profit sharing 
•	doesn’t have to be 50/50 split but 99/1 makes it look like something other than partnership
3.  control sharing
4.  liability sharing
5.  right to assets upon dissolution
•	Frank v. R.A. Pickens & Son Co.- partner Frank is kicked out by the general partner; He wants dissolution (what would happen absent an agreement) – (dissolve the partnership and receive his % share of the liquidated value) – they  had an agreement not to dissolve the partnership but to pay him his share of the book value; (Ct honors that agreement)
•	benefits to partnerships of determining how much to pay upon dissolution by book value
a.  book value is easier to determined - reflects cost basis, depreciation & adjusted for inflation
b.  incentive for other partners to remain in partnership otherwise would get shortchanged when leaving (book value is less that liquidated value)
c.	partnership may not have sufficient liquidity to pay the liquidated value
d.	more $ left in pot for everyone
e.  can save on estate taxes when pass to children b/c will pay taxes on lower value than on higher real value
•	power given to general power to unilaterally kick out another partner
	a.  more efficient if 1 person in control
	6. language in partnership agreement 
1.	intention of parties (the partnership agreement is evidence of intention of 
the parties but not dispositive)
8.  conduct toward 3rd parties (tax returns, public, etc.)
•	Fenwick v. Unemployment Compensation Committee- partnership agreement between hairdresser receptionist & owner is not a partnership b/c does not contain elements of partnership other than  profit sharing & calling it a partnership (case about paying unemployment benefits - (don’t have to if partner but do if e-e))
•	if case came out other way, e-rs would make all e-es partners to escape paying unemployment insurance
•	Martin v. Peyton - lending $2.5million to partner of bank does not make lenders partners who would be liable for bank’s debts b/c issue of degree
a.	had some control (monitoring their investment), contributed money, were to receive profit – really it was just a loan 
b.	Clearly did not intend to become partners
c.	They could not make management decisions
d.	Policy – if you made the bank a partner and therefore liable, people wouldn’t want to invest in failing businesses – don’t want businesses failing left and right
•	Kaufman-Brown Potato Co. v. Long - They didn’t want to be partners – wanted to be considered creditors so that they could collect from the bankruptcy estate – too bad – it’s a partnership
a.	parties are partners here:
b.	agreement calls for repayment of their investment before division of sales receipts – consistent with a partnership
c.	terms of the agreement – looked very much like a typical partnership agreement – shows intent to form a partnership
d.	their labor and skill that the 4 contributed can be considered their capital contribution
2.	Types of Partnerships
a.  general
1.	can be accidental by nature of business relationship
2.	can be anyone – a person, a corporation, another partnership
3.	is liable for everything
4.	management
b.  limited - investment vehicle where there is a general partner & limited partners
1.  limited partners provide capital 
2.  limited partners are shielded from liabilities of general partnership
3.  limited partners not liable beyond amount invested 
5.	limited partners only have an investor relationship to partnership - don’t have management control although, depending on partnership agreement, they may be able to choose the general partner

ii.	Partnership by Estoppel
a.	Even if there’s no partnership in fact, if you represent to other parties that you are a partnership, you will be considered one
•	Young v. Jones - there is no partnership between US Price Waterhouse & Bahamas Price Waterhouse even when 3rd party claims that it relied on existence of the partnership – doesn’t work because the law is narrow and applies only when people hold themselves out as a partnership and money is lent to either of them in reliance on existence of the partnership; Case says for partnership by estoppel, have to have:
1.	holding out as a partnership
2.	in reliance by third party on existence of the partnership:
3.	credit is given to the partnership (to either of the parties holding themselves out as a partnership)
•	wouldn’t this have been better as an agency case?
iii.  Fiduciary Obligation of Partners
1.	partners can’t make other deals in the same line of business as existing partnership w/out first consulting w/existing partners 
•	Meinhard v. Salmon- Cardozo – 2 partners – Managing (Salmon) and inactive (Meinhard); they renovate and run a building as partners; that lease is about to expire (and the partnership will end because it was a partnership just to run that building) – Salmon is approached with a new lease on more property – he lets the old lease run out (and the partnership lapse); then he takes the new lease by himself. 
•	The opportunity came to the partnership. Salmon had a fiduciary duty to tell Meinhard about the deal so that Meinhard could have an opportunity to compete for it. (he didn’t have to include Meinhard in the deal as their partnership was ending); Cardozo’s solution (because Salmon took the deal during the old partnership without informing Meinhard) - creating a new corp whose asset is this second lease & split shares 50/50 to the partners but gives 1 extra share to managing partner (Salmon)
•	rationale 
a.	continue original partnership arrangement - where Salmon makes all decisions
b.	Rewards salmon for doing all the management duties, thereby bringing in the new deal
•	potential problems
a. Salmon can decide not to pay any dividends - to himself or Meinhard
c.  Salmon can pay himself a salary & other perks
d.  societal interest would potentially be harmed b/c of waste that would tend to occur – no incentive for Salmon to run the hotel profitably because he doesn’t want to pay half the profit to Meinhard
•	potential remedies
a.  judicial auction - better to dissolve partnership when lots of potential conflicts
c.	Meinhard could sell to Salmon b/c he would be at disadvantage in valuing business or running it 

2.	Partners can’t lie when asked if they are leaving partnership by other firms
a.  potential options
1.  affirmative duty to full disclosure when plan to leave becomes concrete
•	not fair to departing party b/c plans change & old firm may try to harm the person
2.  don’t have to disclose
3.  ok to mislead/lie
b.  issue
1.  did old firm have a fair chance to compete for business? (from Meinhard v. Salmon)
•	Meehan v. Shaughnessy - 2 departing partners of law firm breached fiduciary duty to firm when they denied that they would be leaving to other partners; also they sent out lots of one-sided letters trying to steal clients – this was gross negligence – violated §404©
3.	departing partners can take clients w/them - just inform the law firm & then solicit the client’s business after they have left employment of previous e-r (meets all of 404 and Meinhard – safest thing to do)
4.	§404 General Standards of Partner’s Conduct
(a)	the only fiduciary duties a partner owes to the  partnership and the other partners are the duties of loyalty and care set forth in (b) and (c)
(b)	duty of loyalty is limited to:
(1)	to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partnership
(2)	refrain from dealing with the partnership in a way that conflicts with the partnership
(3)	refrain from competing with the partnership
(c)	duty of care is a standard that your conduct can’t rise to the level of gross negligence or recklessness

5.	Meinhard compared with Meehan – in Meinhard, there was an affirmative duty to inform – whether asked or not; while under UPA 404(b) and (c) codifies the fiduciary duties that a partner owes the partnership.
6.	issues to consider when fashioning a remedy to fiduciary duty breach
a.  what do partners bring into partnership
b.  how is this valued
c.  how is this compensated
7.	potential problems for partnerships
a.  partners can leave whenever - barring other K arrangements
b.  partners can take clients w/them
8.	special fiduciary duties of general partner to partnership
a.  general partner liable to partnership when he fails to protect interests of partnership
•	Bassan v. Investment Exchange Corp - general partner is liable to partnership when he sells property to partnership at profit for himself w/out informing the limited partners of the profit he’s making – for them to approve or disapprove. (in the past, the limited partners had agreed after each past sale with the profit he made – no course of dealing to rely on though because he didn’t take a consistent amount of profit each time) – so the ct took the profit away
•	issues
a.  involves strict duty of loyalty – high fiduciary duty to limited partners because they have less knowledge of what’s going on
b.  did not have consent of other partners as to formula of compensation, not even a constructive one based on course of dealing
•	argument for no general partner liability
a.  limited partners were aware of general partner’s profits from financial statements
b.  limited partners were doing well
c.  sale price from general partner to partnership was reasonable
d.  course of dealing provided formula (he gave the limited partners the same amount each time)
d.	limited partners were taking advantage of general partner’s ability to acquire property below FMV  court reasons that sales prices to partnership may not all have been at FMV or below b/c how general partner could acquire property each time below FMV b/c sellers are not all dumb
Note – when a partner breaches the partnership agreement in some way – remedies	
a.	contract remedy – partner/s could get damages
b.	equitable remedy – dissolution and an accounting 
iv.  Rights of Partners in Mgmt
1.	in 2 partner partnership, partners have equal power in management of partnership unless otherwise stated in partnership agreement
•	National Biscuit Co. v. Stroud - nonconsenting partner is liable to 3rd party via partnership b/c such partner does not have the power to prohibit other partner from doing business w/3rd party b/c both have equal power in management (there are only 2 partners – so they both have equal authority – doesn’t matter if one tells the other not to do something) (if there had been 3 partners – they could have voted against the other and prevented his actions)
•	one partner can drive up liability of partnership but will be constrained by 
a.  course of business (if the action was outside normal partnership business practices) look to trade & course of conduct
b.  UPA default rule - purpose of partnership – partners are jointly and severally liable for obligations incurred on behalf of the partnership
•	potential protective measures by nonconsenting partner
a.  dissolve partnership w/notice to 3rd party
a.  other potential rules
1.  all actions of partnership require consent by all partners
a.  advantage - one partner will buy out other, partner who values it more will end up w/business 
b.  disadvantage - high transaction costs when only 2 parties are involved
2.	in voting on management issues – if you need the consent of all partners – one partner could cause deadlock; if you allow consent by a majority – the majority can dominate the others
3.	under UPA, consent of all partners necessary to amend partnership agreement unless provision in agreement specifying otherwise.  
a.  if partnership agreement contains a provision about how to amend the partnership agreement, it will control
•	Day v. Sidley & Austin - partnership is not liable to Day when it decides that Day has to share chair position of DC office & relocate offices b/c there has been no violation of any of Day’s legal rights (required for a fraud claim), Day claims fraud b/c merger was presented in the light that no one would be worse off
•	reasons
a.  mgt committee has authority under the partnership agreement to make such decisions, Day’s one vote would not have change result
b.	Day didn’t suffer any real injury
c.	The court respected the partnership agreement (if there’s a written agreement  - the court will respect it)
d.	The merger was not a fundamental change – so after the merger, the agreement still was in effect (didn’t revert to the default rule requiring unanimous decisions)
b.  rationale 
1.  other uninformed partners may be relying on written agreement
v.  Dissolution Solution
1.	intro
a.  any departure of a partner from partnership dissolves partnership but partnership agreement provides for instant reorganization of partnership along same terms
b.  potential problems:
1.  when there is no written partnership agreement that covers what happens when partners departs
2.  when agreement doesn’t anticipate extreme good fortune or big prblms
2.	ways to dissolve
a.  in water
b.	partnership agreement can specify terms of dissolution
1.  the agreement about dissolution will trump statute (UPA) – unless a partner violates the terms of the dissolution agreement (then it reverts to statute)
•	Pav-Saver Corp. v. Vasso Corp. – 
a.	agreement between PSC and V – permanent partnership - to dissolve only on mutual agreement; If that was done, PSC would get its patents back.
b.	PSC said they were unilaterally terminating the partnership
c.	Then, V owner takes over running the business. 
d.	PSC wants their patents back an liquidated damages - in accordance with the partnership agreement’s terms of dissolution
e.	Ct says no 
(1)	PSC wrongfully terminated the partnership so the terms of the dissolution would be the terms specified in the statute 
(2)	so V had a right to continue the partnership business (and to continue to use the patents – because they were instrumental to continuing the business) (statute – UPA §38 (2)(b)) 
(3)	V didn’t have to pay PSC for the patents because they are part of the “goodwill” of the business – and goodwill is not considered (by statute) in valuing the wrongfully-dissolving partner’s interest in the business (statute UPA §38(2)(c)(II)
(4)	V also had a right to receive liquidated damages for PSC’s breach  - according the contract (said if someone breaches, the nonbreacher gets liquidated damages); 
(5)	PSC gets only the value of his interest in the partnership at the dissolution (not the value of the patents) (-) the damages owed to V (statute – UPA §38(2)(c)(II)) 
2.  partnership can expel members
a.  limitations
(1)	race, ethnic, gender
(2)	other public policy reasons
(3)	if you have no agreement – terms of termination covered by statute
•	Lawlis v. Kightlinger & Gray - law firm terminates an alcoholic partner; agreement has termination at will provision; (state law  - IN’s adoption of the UPA - says there has to be good faith reason for firing someone – trumped by the agreement) They can terminate for any or no reason; Good faith requirement applies to wind up – have to treat the expelled partner fairly; It would have been a bad faith termination if they had withheld money or property that was rightly his. 
c.	Self help in cases where agreement (does specify the length of the partnership but) doesn’t specify terms of dissolution
1.	partners can agree amongst themselves over whether to dissolve or not
2.	a partner can dissolve by brute force (breach the partnership agreement)– but they can be liable to the other partner/s for damages
3.	if a partner materially breaches the partnership agreement – the other partner/s are free to dissolve – but that opens them up to suit about whether or not the other partner breached first (get a judicial decree to be safe – d below)
d.	agreement specifies length of partnership but has no provision in the agreement covering how to dissolve before that (like in c above), court can order dissolution
1.  rule is that minor disagreements that cause no permanent mischief will not give court authority to dissolve partnership but will when those disagreements are of such a nature that inhibits functioning of partnership 
a.  dissolution seeker has to have clean hands
b.  dissolution can’t be sought opportunistically
1.  justifications
a.  concern over strategic opportunistic behavior of partner who wants out
b.  concern over protection of interests of 3rd parties & substantial disruption of commerce
c.  potential high costs of dissolution when partnership is very profitable
d.  conforming to intention of parties
•	Owen v. Cohen - court dissolves partnership where 2 partners cannot work together (have a “serious” disagreement) & have no provision in partnership agreement covering dissolution
a.  isn’t it already a serious disagreement when one partner wants out?
b.  isn’t it unfair to split profits when defendant is forcing an end to a profitable partnership by his offensive behavior that prevents plaintiff from working w/defendant?
•	Collins v. Lewis - court will not dissolve partnership on request of Collins who provides capital against the interests of Lewis the other partner who manages the cafeteria business – partner who has not fully performed the obligations required by the partnership agreement may not obtain an order dissolving the partnership
a.	Failed dissolution – trying to get a judicial decree saying that Lewis breached so Collins had a right to dissolve 
b.	Court said no – Lewis didn’t breach so Collins can’t dissolve the partnership
c.	Collins’ only recourse was to use brute force, breach himself and subject himself to liability 
2.  Reasons not to have default rule of dissolution whenever one partner wants out
a.  interests of other parties may be at stake
b.  there may be undue bargaining oppression in dissolution process (one partner could threaten to dissolve the partnership to get what they wanted)
3.  under  32(e) of UPA– when a court will dissolve a partnership
a.  if partner is a lunatic like Don
b.  if partner is incapable of fulfilling duties
c.  if partner’s conduct tends to prejudicially affect carrying on of business (asshole provision – like if you had to work with Don)
d.  if partner willfully or persistently breaches agreement
e.  if partner acts in manner that does not make business sense
f.  if business can only be carried on at loss
g.  for any other equitable reason
e.	Absent agreement provision as to the length of partnership, courts will find partnership at will that allows dissolution by parties 
1.  when there’s been a freeze-out
•	Prentiss v. Sheffel - partnership to build & run shopping center; minority partner claims that 2 majority partners wrongfully attempted to squeeze him out, court finds partnership at will - terminable at any time; ct finds that squeezing him out effectively ended the partnership at will; 
•	Minority partner didn’t want the inside partners to be able to bid on the partnership in the judicial sale – they could bid the amount of their stake in the business plus actual money – so they would be able to bid higher than outsiders, while putting in less actual cash. Minority partner wants outsiders only to bid – because that way he will get more cash out of it and because the majority partners acted wrongly.
•	Ct disagrees – doesn’t exclude the majority partners from the sale; ct says that the presence of the majority partners in the bidding (since they’re able to bid more) will drive up the price of the partnership (thereby giving the minority partner more money for his part); 
•	Ct did not find that the majority carried out the freeze-out in bad faith (for the purpose of dissolving the partnership and buying him out). They just voted against him in a continuing difference of opinion. (If they had frozen him out in bad faith – the court might have excluded them from bidding in the sale) the existing partners are not excluded from judicial sale
2.	Requirement of good faith in partnership at will
•	Page v. Page - there is a partnership at will between 2 brothers where there is no partnership agreement in linen supply business that has been losing $ for long time & turning around now; even so, ct permits brother who gave $47k loan to partnership payable on demand to call loan & push brother out b/c he cannot pay up – effectively dissolving the partnership and allowing the lending brother to buy the business; 
a.	If there is no express term or agreement, it’s a partnership at will that can be dissolved by any partner at any time, subject to good faith (UPA)
b.	Court could have found bad faith here – but didn’t
( below - listed in Page)
•	A partner at will is not bound to remain in a partnership, regardless of whether the business is profitable or unprofitable
•	A partner may not, however, by use of adverse pressure “freeze out” a co-partner and appropriate the business to his own use.
•	A partner may not dissolve a partner-ship to gain the benefits of the business for himself, unless he fully compensates his co-partner for his share of the prospective business opportunity
2.  consider intention of parties at time made agreement & not currently
3.  damages available to innocent partner being pushed out for any breach of fiduciary duty in dissolution process
e.  court ordered dissolution results in judicial sale
1.  existing partners are not excluded (good faith?) from judicial sales after termination of partnership at will - but damages are available against them for any breaches
a.  justification - don’t want to cut out people who value asset most or who have most business know-how
2.  potentially unfairly advantageous for majority partners 
a.  b/c don’t have to put up as much $ up front in bid b/c can use their partnership interest as collateral
b.  outsiders will know this insider ability to outbid them so assets will be sold at lower price, giving minority less for his share
c.  as insiders majority can make assets look more valuable if they don’t want them or less valuable if they do want them
d.  disguised ploy by majority to really squeeze out minority party
3.  not necessarily unfair 
a.  b/c that investment may have been for real value
b.  majority has ability to outbid outsiders so higher price may be paid, giving minority more for his share
•	Prentiss
f.  under UPA, automatic dissolution if:  31(b)
1.  partnership becomes unlawful
2.  partner dies
3.  partnership becomes bankrupt
4.  court order dissolution,  32(e)
g.  relationship between dissolution & breach of partnership agreement
1.  can have dissolution w/out breach
a.  partners can agree
b.  partnership at will
c.  agreement can contain term of dissolution
d.  partner can be expelled
2.  can have dissolution w/breach
a.  can dissolve by breach but have to pay damages
1.  measure of damages will be K but since in equity court, courts generally award whatever seems right to them (ex. Meinhard)
2.  may also implicate tort damages depending on cause of action
•	Collins v. Lewis
3.  can have breach w/out dissolution
a.  confusion when partnership agreement calls for dissolution if there is a breach
3.	winding up process
a.	dissolution is only beginning of ending partnership, still requires winding up of business
b.	fiduciary duty of partners extends to after winding up process
•	Monin v. Monin - milk hauling brothers agreed to end partnership & auction off assets of partnership (assets were trucks and contract to haul milk) w/ implied covenant not to compete, losing brother breaches this agreement & bids against brother for new hauling contract.  Court holds that this brother wronged other brother b/c there is a fiduciary duty between the partners after dissolution – until the end of wind up of the partnership affairs. Appropriate measure of damages here - lost profits.
•	Otherwise, would have been no reason to value the hauling contract in the first place
•	could have resolved as breach of K case b/c cheating brother breached the implied covenant not to compete (implied from fiduciary duty)
vi.  Special Problems of Law Partnerships
1.	issues upon dissolution
a.  what to do w/assets
c.  what to do w/inventory of cases
1.  default rule is to require sharing net fees (overhead expenses already taken out) w/old partners under old partnership interest arrangement
a.  fair
1.  would be same result as if under old partnership agreement (partners would get the same share of profits they got during the partnership)
2.  all partners required to share w/each other
3.  prevent unhealthy competition for most profitable/lg cases during life & death of firm
4.  doesn’t affect client’s absolute right to counsel b/c if partner does bad job client can fire or partner can decline to take case
b.  unfair
1.  client will lose out b/c partners will prefer to work on new cases rather than old b/c don’t have to share w/partners he no longer works with
2.  one-time clients lose more than regular clients b/c potential to attract more business
3.  valuational problems if use different fee system (contingency vs. other basis)
4.	there may be race to avoid inventory cases b/c they may be more trouble than they are worth
5.	incentive for partner working on old cases to drive up the cost of overhead so they don’t have to share as much with old partners
•	Jewel v. Boxer - when law firm breaks up w/out agreement designating what will happen to current cases, default rule (UPA) is one of sharing according to their right to fees in the former partnership regardless of which former partner provides the legal services in the case after the dissolution – (not quantum meruit rule)
a.  quantum meruit - old value belongs to old firm whereas new value belongs to new firm (complicated plan – some money is shared as it would have been during the partnership, the rest is paid according to who did the work when)
1.  fair
a.  departing partners get all benefits of their future efforts
b.  this approach encourages client’s absolute right to chose counsel
c.  doesn’t instigate race to avoid inventory cases
2.  unfair
a.  complicated method
b.  would lead to competition for most profitable cases during life & death of firm
2.  partners can agree in partnership agreement to permit removal of cases brought in by that partner for a fair charge which includes those cases not brought in by the partner
a.  partner is compensating firm for generating this asset
b.  partner is compensating firm for services & expenditures in connection w/this asset
c.  partner then receives allocation of this fair charge according to his partnership interest
d.  partner may have to pay damages if there has been a breach of fiduciary duty (like in Meehan)
•	Meehan v. Shaughnessy- law firm partnership agreement can designate right of partners to remove cases for fair charge to firm for those cases brought in by their own efforts as well as those not brought in by that partner, departing partners wrongfully solicited inventory cases
b.  what to do w/reputation - principal asset of firm that is usually responsible for attracting new business, very little law
1.  name 
a.  person who has name can probably take it
b.  murky beyond that
2.  future business 
a.  when particular partner brings in business not very problematic 
b.  problematic when business comes in b/c of general firm reputation
2.	items that partner receives upon departure/dissolution
a.	capital contribution - amount put into partnership + share of any profits of partnership that have not been paid out
b.	share of net income - part of current account receivables
c.	portion of unfinished business/inventory cases – (profits paid according to agreement – ex. can keep future profits but have to pay a fair charge)
vii.  Limited Partnerships
1.	intro
a.  reasons to be limited partner
1.  want portion of profits whereas lenders only limited to certain % on loan amt
2.  want to be shielded from liability beyond amt of contribution
3.  may also convey tax benefits
2.	extent of control of limited partners if sufficient will make them liable as general partners to 3rd party creditors  substance > form
a.  power to draw $
b.  extent of control over operations
•	Hozman v. De Escamilla - limited partners of farm partnership are held liable as general partners b/c of the extent of control they exercised over funds & partnership operations
d.	advising & consulting w/general partner is insufficient to make liable as general partner 
•	Revised Uniform Limited Partnership Act - RUPLA  303
d.  apparent authority will also make limited partner liable as general partner 
•	RUPLA  303 (liable only to persons who transact business with the limited partnership reasonably believing, based on the limited partner’s conduct, that the limited partner is a general partner)
3.	another view of limited partner liability - Mt. Vernon S & L v. Partridge Associates 
a.	limited partner liable for actions when exercising less than general partner authority – if third party (plaintiff) knows that the limited partner acted as more than a limited partner
b.	limited partner liable as general partner if the limited partner behaves as a general partner even if the third party (plaintiff) doesn’t know that the limited partner acts like the general partner (not apparent authority)

*IV.  Nature of Corporation 
i.  Promoters & the Corporate Entity
1.	promoter - person who identifies a business opportunity & puts together a deal, forming a corporation as the vehicle for investment by other people
a.  fiduciary obligations to corporation
1.  estoppel - if A treated B as a corporation to put together a deal, can’t come back later & use it as a defense saying that K btwn them is void b/c B was not fully incorporated at time of deal unless A’s substantive rights have been affected in some way
•	Southern-Gulf Marine Co. No.9 v. Camcraft, Inc. - plaintiff created corporation to purchase ship from defendant but was not fully incorporated at time of K creation between them & defendant proceeded to breach K, court held that lack of incorporation at time of K cannot be used as a defense to make K void when defendant treated plaintiff as corporation 
•	defendant wanted out of deal b/c ship became more valuable than what it was contracted for – too bad
b.  obligations to 3rd parties
•	consider
a.  legal doctrines
b.  planning issues
c.  how corporation affects relationships among individuals
ii.  Corporate Entity & Limited Liability
1.	Ways to go when you want to sue something/someone more than just the immediate corporation
a.	enterprise liability
b.	agency theory (respondeat superior) – claim that the immediate corporation is an agent of the parent corporation or a controlling stockholder – that the injury occurred within the scope of that agency relationship (especially good for a tort claim)
c.	piercing the corporate veil
2.   Piercing the corporate veil
a.	if individual/shareholder uses corporation for his own benefit (rather than for the corporation’s business), then he will be liable for commercial debts & negligent acts of corporation (Walkovsky)
b.	if larger corporation uses corporation for its own benefit, then larger corporation will be liable for commercial debts & negligent acts of corporation (but individual shareholders will not be liable) (Walkovsky)
•	tension - such liability theory works against purpose of having limited liability, precisely to protect shareholders
•	Walkovsky v. Carlton - plaintiff is injured by cab in a fleet ownership structure (multiple corporations pool their cabs together & incorporate w/assets of 2 cabs & minimum $10k insurance coverage/car), plaintiff wants to hold stockholders liable based on fraud theory (defendants intentionally undercapitalized corp to avoid liabilities – each corporation had no money and only the cab as an asset)(also, each was only minimally insured), ct said that defendant followed the law in setting up the corporations (if the insurance was too little, that’s the legislature’s fault in only requiring that much) – he’s within the law to set up a corporate system to limit his liability – or however he wants; if he’s not using the corporate form improperly, they won’t pierce the corporate veil; 
•	dissent - shareholders should be held liable here b/c of abuse - limiting assets to avoid liability; this could not be intent of legislation of minimum insurance; rule should be that participating shareholder of corporation is vested w/ a public interest; if it’s organized w/ capital insufficient to meet liabilities which are certain to rise in ordinary course of business – they may be held personally liable  this would hold participating/controlling shareholders liable - ordinary shareholders do not have to fear
c.  2 prong test - most states have some version of it (Sea-Land)
1.	first prong – there must be such a unity of interest and ownership that the separate personalities of the corporation and the individual (or other corporation) no longer exist - minimum test where all factors are weighed together (Sea-Land)
a.  failure to maintain adequate corporate records or to comply with corporate formalities (separate shareholder meetings, papers)
b.  comingling of funds or assets - personal & corporate assets
c.  under-capitalization 
1.  issue of what is adequate capital 
(a)  enough to cover debts expected to arise in ordinary course of business
(b)	but companies do go bankrupt b/c they don’t have enough to cover their debts – so companies actually don’t always have enough capital 
-	suits often happen at insolvency – every company involved in such suits will be undercapitalized – or there wouldn’t be a suit
d.  one corporation treats assets of another corporation as its own
•	Miller thinks that none of these requirements have any bite save for undercapitalization aspect but has problems w/that as well - all are just formalities that if observed will let the guilty party off
d.	factors to consider listed in In re Silicone Gel Breast Implants for considering unity of interest between a parent and a subsidiary (alter ego, substantial domination):
(1)	parent (p) and subsidiary (s) have common directors or officers
(2)	p and s have common business departments
(3)	p and s file consolidated financial statements and tax returns
(4)	p finances s
(5)	p caused the incorporation of s
(6)	s operates with grossly inadequate capital
(7)	p pays salaries and expenses of s
(8)	s doesn’t observe corporate formalities
(9)	s gets all its business from p
(10)	p uses s’ property as its own
(11)	daily operations are not kept separate

2.  second prong – circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice (Sea-Land)
a.	P has to show some other wrong committed by D other than P inability to collect its debt where observing corporate form would sanction fraud or promote some injustice
•	may be attempt to distinguish injuries from which K creditors may have been able to protect themselves via reasonable care & other injuries they could not have reasonably protected themselves against (those that result from fraud or injustice)
b.	What does the second prong require? (SeaLand)
(1)	some element of unfairness
(2)	akin to fraud or deception
(3)	compelling state interest
(4)	has to be some wrong beyond the creditor not being able to collect (that’s allowed under bankruptcy law)
(5)	like unjust enrichment
•	Sea-Land Services, Inc. v. Pepper Source - Judge Bauer individual creates corporation but doesn’t observe corporate formalities & then reneges on K to pay; 2 prong test explained – 1st part is satisfied, but there has to be some injustice beyond the creditor’s inability to collect (that’s the only injustice here) – so tough shit
•	Perpetual Real Estate Services, Inc. v. Michaelson Properties, Inc. - 2 corporations form partnership to develop properties, one corp held by Michaelson (MPI) which distributes all corporate assets once business purpose terminates; (other corp (PRES) is held by a bank – that sets up a corporation that it uses to do real estate development); partnership is then sued for breach of warranty on property & other corp (PRES) settles & tries to go after sole shareholder of its partner (MPI) for indemnity, court holds:  “too bad, so sad” b/c passes all tests & PRES was aware of MPI’s corporate structure even though jury returns verdict for PRES
-	there is no injustice because creditor was aware of MPI’s structure and did business with them anyway; 
-	MPI’s structure was not a sham to disguise wrongs (would be injustice)
-	no injustice because this is just a creditor’s inability to collect a debt
-	Also, doesn’t satisfy third prong - PRES is a sophisticated lender – so they had a duty to protect themselves – voluntarily did business with a corporation with insufficient assets to cover lawsuits like this – (third prong would require a further wrong for the bank to recover – something they couldn’t have protected themselves from)
•	PRES other options
a.	sue lawyer for malpractice - failure to protect it under these circumstances
b.	sue contractor if there was one, whose fault suit is 
b.  tort creditors may not have to prove inequity if veil is not pierced
•	In re Silicon Gel Breast Implants Products Liability Litigation - see below
2.	potential third prong - distinction between K creditors & tort creditors 
a.  K creditors will be subject to a higher standard for corporate veil piercing than tort creditors – if the creditor could have reasonably protected itself (like a K creditor usually can/should), veil will not be pierced
•	Kinney Shoe Corporation v. Polan - Kinney leases space to small corp that in turn subleases to another small corp – basically corporate shells; both small corps were held by single shareholder Polan; lessee defaults on lease & Kinney tries to go after Polan via veil piercing; 
(1)	? to ask when deciding whether to apply the third prong: under these circumstances – is it reasonable for the party to have conducted an investigation into the credit of the corporation prior to entering into a contract? 
(2)	court of appeals declines to apply the high standard applied to sophisticated corporate lenders (the third prong) – (i.e. finds that it wasn’t reasonable to expect them to investigate in these circumstances) & permits veil piercing in this case
(3)	district court follows Laya - K creditors will not be permitted to pierce veil when they could have reasonably protected themselves (exacting personal liability) (high standard applied to sophisticated corporate lenders)
b.	Also Perpetual Real Estate - above
c.	Tort creditors in a consumer context are more protected & if there is any detrimental reliance or “apparent authority”, veil may be pierced
(4)	In re Silicon Gel Breast Implant Products Liability Litigation - class action applying law of 50 states against Bristol & other defendants for product liability of breast implants; Bristol is sole shareholder of MEC (parent & subsidiary relationship) that manufactures breast implants; Bristol essentially controls MEC; Bristol’s motion for SJ is denied & judge hints that Bristol may be liable in order to push for settlement b/c Bristol placed logo & trademark on literature of MEC to induce public to buy MEC where public may have trusted in Bristol’s quality
(a)	corporate formalities observed & normal for parent to dominate subsidiary in this way
(b)	unclear if hinting at liability meant that tort creditors did not have to prove inequity or that this reliance factor was the inequity
(c)	Also stands for idea that you have to look at the totality of the circumstances
(d)	Miller - cases like Silicon Gel push theory of piercing veil

c.  veil will not be pierced even where in partnership, limited partners are officers of corporate general partner  permitted these days via limited liability companies
1.  limited liability co. - structured as partnership for tax reasons, states way of protecting against federal taxes
2.  still protected as individual
3.  can still exercise control over co.
(a)	Frigidaire Sales Corp. v. Union Properties, Inc. - limited partners of partnership who are also officers (on the board) of corporate general partner will not be liable beyond their limited partner capacities
(1)	the partners, as agents of the corporation, kept themselves separate from the corporation itself. (that’s the only way a corporation can act – through its agents – if you only looked at control, there would never be limited liability)
(2)	not unfair – petitioners were not led to believe that partners were acting in anything other than in their corporate capacities
iii.  Shareholder Derivative Actions
1.	intro
a.  structure of corporation 
1.  shareholders - hold shares & vote for directors
2.  mgt (directors & high officers) - manage
b.  remedy for mismanagement by mgrs
1.  decrease in stock price b/c of poor performance - to certain extent mgrs & stockholders’ interests are alligned
2.  shareholder derivative 
2.	shareholder derivative actions
a.  characteristics
1.  not action by shareholder directly but representing corporation & other shareholders & their rights against anyone who has harmed corporation, usually mgrs
2.  asserting rights on behalf of the corporation & shareholders 
3.	recovery goes to corporation but portion will be paid to shareholders indirectly via dividends & appreciation of stock value
4.	plaintiffs must have owned share/s when the wrong happened and when they bring suit
5.	Delaware chancery court has the power to filter out the cases they don’t like or don’t want to take – use lack of demand/ lack of excuse as a reason to throw cases out if they don’t want to hear them
b.  security for costs statutes to limit shareholder derivative actions 
1.  statutes require a bond to cover reasonable expenses and attorney’s fees of the defense if the complaint fails – and entitle corporation to require security for their payment
2.	limits attorneys who want to instigate suits for entrepreneurial reasons
(b)	Cohen v. Beneficial Industrial Loan Corp.- 1949, Jackson, diversity case w/sm shareholder, held that NJ statute that penalizes unsuccessful shareholder derivative actions (requires posting of bond at beginning & then paying defense attorney fees if unsuccessful) applies to federal case in diversity via Erie (and here’s a little Civ Pro lesson – it’s because it was a substantive law. Think about it.)
(c)	can avoid these statutes by not filing in jurisdictions w/such statutes
2.  harder to kill suits if characterized as a direct suit asserting personal rights & not derivative rights
a.  asserting rights of shareholder
b.  recovery goes to shareholder - may not always be monetary
(d)	Eisenberg v. Flying Tiger Line, Inc. - shareholders claim that they have been deprived of rights b/c only have shares in holding co. whereas before had shares in operating co. (operating co. created subsidiary which created subsidiary, operating co. merged w/grandchild which became the operating co. & 1st subsidiary just became holding co. & shares in original co. transferred to it), NY security for costs statute, court held direct suit so no application of the statute
(e)	shareholders can still maintain control over operating co. via holding co. which controls operating co. so unclear why shareholders are so upset
(f)	Gordon test – what makes something a direct suit (when you can avoid paying security) or derivative 
(1)	Direct - object of lawsuit is to recover upon an action belonging directly to the stockholders (they sue on their own behalf), don’t ask for a judgment in favor of the company
(2)	Derivative – brought on behalf of the corporation for a judgment in its favor
(3)	Look at the face of the complaint  to decide which it is – so in deciding which suit to bring, try to word it in a way that makes it look direct (to avoid having to pay security when your state has a security law for derivative suits)(also cts are leary of letting derivative suits go forward because that gives shareholders a managerial role)
(4)	probably derivative suit here but characterized as direct suit so case wouldn’t get killed (security requirement)
c.  demand required before can bring shareholder derivation action 
1.  It is assumed that the company is managed by people who want to help the company and want to rectify harm so:
2.	rule - requirement that shareholder has to go to the directors, tell them about the harm, and ask them to investigate/file suit (“demand”)(problem that defendants are usually mgt/directors) (demand is actually almost never made)
3. exception
a.	can be excused if futile 
(1)	Heineman vs Datapoint Corp.
(a)	futile = not impossibility but where there is a reasonable doubt as to whether the board is disinterested (lack of independence, conflict of interest)
(b)	or reasonable doubt that the board were exercising reasonable business judgment in the transaction in question (incompetent)
(c)	Here, district court did not excuse demand & since plaintiff failed to make demand, dismissed case for failure to state a cause of action, appeals court reverses on abuse of discretion standard saying that district court should have excused demand anyway b/c there was reasonable doubt as to board’s independence 
(d)	See below – pleading rules
(2)	Aronson – when demand on the board is futile, demand requirement is excused
3.  Aronson pleading rules – have to make a pleading with particularized facts that establish reasonable doubt as to whether
1.  directors are disinterested & independent, or
2.  transaction was not product of valid exercise of business judgment 
(3)	seems inconsistent b/c particularized facts (have to put in a lot of facts) is high burden of proof while reasonable doubt is low burden of proof
3.	Heineman v. Datapoint Corp. – 4 causes of action 
a.	in two of them, the majority of the board was interested in the deals in question
b.	But in the other two, only the chairman of the board was interested
c.	Can’t get demand excused for the second two because you have to show more than the fact that just the chairman has an interest (because the board could still act disinterestedly and file suit) You’d have to show that a majority of the board has an interest or that the chairman dominates the board. (cts often do accept more than this)
d.	So appeals court accepts the first 2 claims but not the ones that only involve the chairman.
4.	Pleading rules are a problem b/c can’t get particularized facts until have discovery but can’t have discovery until present particularized facts
4.  appeal standard of trial court decision to excuse demand - abuse of discretion standard
5.	Miller thinks that there is an inconsistency b/c a. is low burden & b. is high burden
5.  purpose 
a.  want concrete facts before letting case go forward
b.  gives court discretion to kill or let cases go forward
6.  possible scenarios
a.  make demand & get rejected – court takes the fact that you made the demand as an argument from you that the board is not interested; court will review the board’s denial under business judgment rule so they will always win
6.	Speigel v. Buntrock - if you make demand, there is inference of board independence so you have waived any future objection to having to make the demand (can’t argue to get demand excused)
7.	Kamen – Supreme Court says there is no universal demand – you don’t always have to exhaust your intracorporate remedies (i.e. make demand); Demand may be excused.
b.	make demand & accepted - corp takes over case & squeezes original P out
Point – never make the demand.

d.  role of special litigation committees (SLC)
1.  In response to a derivative suit, SLC appointed by board of directors (to investigate and decide if the lawsuit is in the best interests of the company); They generally decide no and go to court to get the case thrown out – that decision is judged by the business judgment rule (looking to the business judgment of the committee/deferential) unless: the shareholder can: (NY):
a.  show non disinterested nature of members of the special litigation committee
c.	show lack of good faith of procedure of investigation - that procedures were inappropriate or inadequate
If the SLC passes this test, then the derivative suit gets thrown out – when plaintiff appeals, the only issue will be the business judgment (or good faith or whatever) of the SLC’s decision - precludes judicial review of actual derivative suit. (Auerbach v. Bennett)
2.  in interest of balancing shareholder’s interest (power to bring corporate causes of action w/out getting trampled on by board of directors) & corp interest (ridding itself of detrimental litigation), have to pass both in order to be granted SJ motion for dismissal of shareholder derivative action (DE)
a.  defendant’s burden of proof to show independence & good faith of SLC in investigation process  may require limited discovery
b.  court of chancery can make independent business judgmt as to whether SJ motion should be granted considering all factors that may be involved including corp interests, public policy  court of chancery has expertise in this area
c.  other rules still standing
1.  court will respect SLC decision to refuse to pursue litigation unless such act is wrongful
2.  demand requirement excused if futile
3.  tainted board of directors can appoint nontainted SLC
8.	Zapata Corp. v. Maldonado – DE
(a)	Maldonado brought shareholder derivative suit against officers/directors of Zapata Corp for breach of fiduciary duty & didn’t make demand b/c of futility before bringing suit
(b)	board of directors appointed independent investigating committee composed of 2 new directors who decided to dismiss all such actions
(c)	new standard for DE courts in SJ motion: when assessing a SLC’s motion to dismiss a derivative action, a court must:
(1)	determine whether the committee acted independently, in good faith, and made a reasonable investigation, and if that’s satisfied, then 
(2)	apply the court’s own independent business judgment
-	they consider the corporation’s compelling interest and public policy
-	this second test is used when the court can’t find any of the stuff in part one – but smells something sketchy and doesn’t want to grant summary judgment
(3)	1 is a more stringent requirement (harder to prove) – so if the decision gets passed 1, it will probably get by 2
(d)	When SLC/defense is trying to get the case dismissed, they have to prove that 1 and 2 above are satisfied – this process requires that there is limited discovery (give some info/evidence to P about what D is trying to prove) 
9.	Alford v. Shaw – North Carolina - allegations that board of directors looted corp, court claims that it’s using modified Zapata rule (judicial review of merits of SLC recommendation) but sounds just like Zapata rule
10.	These cases signal a shift from pro-SLC to pro-shareholder
iv.  Role & Purposes of Corporations
1.	corporate charitable donations
a.  rule governed by state law
b.  issues w/corporate donations
1.  corp managers giving away $ that is not theirs
2.  unclear if such donations adds anything of value to corp & their owners
c.  arguments in favor of corporate donations
1.  good for corp - PR, creating good business environment, good for executive training
2.  good for society - survival of capitalism (contributing to education), etc., etc.
3.  corp duty to serve public - historical
a.  past - corp were monopolies so had this obligation to serve public
b.  present - corp hold all the $ so same obligation to serve public
1.  assumes low shareholder liquidity
2.  assumes high degree of mgr freedom from shareholder supervision
4.  tax reasons - $ gets taxed only once
a.  corp donations - taxed once when corp earns $ & then gets deduction for donation
b.  shareholder donations - $ gets taxed twice once when earned by corp & again when distributed to shareholders & shareholder gets deduction for donation
5.  more $ would be donated if corporate donations are allowed
a.  lower transaction costs to solicit from corp than from individuals
b.  easier to give away other people’s money than one’s own
c.  greater amts would be donated b/c higher concentration of wealth at corporate level as opposed to individual levels
d.  want equal forcing of contributions b/c more would likely contribute if knew that others were also contributing
11.	A.P. Smith Mfg. Co. v. Barlow - 1953, 
a.	fire hydrant manufacturer donates $1500 to Princeton University
b.	corporation brings suit for declaratory judgment to preempt shareholder derivative action protesting the gift, 
c.	There was a statute saying that a corporation can give up to 1%. The corporation was chartered before that statute.
d.	court holds corporate contribution is ok because state legislation adopted in the public interest can be constitutionally applied to preexisting corporations under the reserve power; 
e.	The corporate charter didn’t expressly authorize such donations – but since they were made under the statute (which was enacted with public policy in mind) – the donations were fine. (that’s why it doesn’t violate ultra vires)
if 1) the corporation has a charter that expressly limits it powers or 2) if the charter is silent on those powers and the state has not yet revised its statute giving the corporation all lawful powers where the charter is silent, the shareholder may sue for an injunction on an ultra vires theory 
D.	business plans can have incidental humanitarian benefits but cannot be primary purpose (would be ultra vires if it was the primary purpose)
1.	Dodge v. Ford Motor Co. – 
(a)	 A corporations primary purpose is to provide profits for its stockholders, not to engage in charitable contributions.
(b)	Ford wanted to forego paying lg special dividend to 2 shareholders (also competitors) claiming that he wanted to save for expansion (bldg smelting plant) & for decreasing price/unit as charitable gesture for benefit of public; 
(c)	He couldn’t forego paying dividends in favor of making cheaper cars (for charitable purpose); 
(d)	court holds that Ford still has to pay special dividend because it won’t interfere in its expansion plans and will still have more than enough $
(e)	Ford probably wanted to engage in predatory pricing & avoid paying Dodge lots of $ to keep Dodge competitors out but had to come up w/another justification why he wasn’t paying lg special dividend
(f)	Key – try to make up a reason for what you’re doing that looks like a valid business reason (that the exclusive purpose is good), rather than charitable
e.  courts will stay out via business judgment rule when decision does not involve fraud, illegality or conflict of interest & especially when majority shareholder has considerable stake in his actions
(g)	Schlensky v. Wrigley - minority shareholders want to force Cub owner to install lights in stadium & hold night games to make more $, court holds for Cub owner who says that it would be bad idea to install lights & hold night games b/c that would deteriorate the neighborhood around it - then people would not want to come to games in a bad neighborhood, court doesn’t want to get involved in business decision making especially when Cub owner already owns 80% of stock & so would have enough of stake in co. to justify his decisions
(h)	if shareholders can more easily leave then less of need to have strong shareholder derivative suit rules
f.  potential rules for charitable contributions
1.  require shareholder approval for contributions above certain amt
2.  require release to shareholders of justifications for contributions
a.  where easy exit for shareholders
3.  no corp contribution unless business purpose

V.  Duties of Officers, Directors, & Other Insiders
i.  Obligations of Control:  Duty of Care
1.	introduction
a.  managers owe 2 duties to corporations
1.  duty of care - mgrs almost always win against challenges
2.  duty of loyalty - mgrs often lose
b.  cases often have elemts of both
1.  considerations
a.  reviewing other people’s decisions - expertise, proper realm of authority
b.  risk of error - ruling no negligence when there is, ruling negligence when there isn’t
(i)	Miller - better to have continuum instead of strict dichotomy
2.	duty of care
a.  rule - courts give extreme deference to mgrs via business judgmt rule
1.  not liable
a.  not liable for mere negligence - not going to impose liability on bad business judgmt ex post; has to be gross negligence
b.  will be liable if mgrs put corp into a no win situation where decision made is clearly worse than another available (managers lose when there’s an alternative with higher return and lower risk, higher return and the same risk, or the same return and lower risk) – hard to prove (only when manager is really far off balance with risk and return will they lose)
(j)	Kamin v. Amercian Express Co. - corp invests in some stock that then loses lots of its value in 3 years; Instead of giving a dividend, they distribute shares of the stock; shareholders say they should have sold the stock, realized the loss & taken the tax deduction; They said not selling the stock was breach of duty of care; Ct says no – one choice isn’t clearly better than the other; Manager would have had to put the corporation into a no-win situation to have violated the duty of care
(1)	court is assuming that mrkt didn’t already know that American Express sustained this loss – (if the public hadn’t known, then avoiding taking the loss would have been a good idea – to avoid making the company look bad to the market) – but probably not likely
2.  liable
a.  4 part test for mgr liability (any one of: ) (Joy v. North)
-	no business purpose
-	conflict of interest
-	no-win situation
-	obvious or prolonged failure to exercise deliberation or oversight
(k)	Joy v. North – 
(1)	Classic business judgment successful case – case with a dominating figure
-	cts tend to believe that a group decision (rather than that of a single, dominating individual) is less likely to be silly or self-interested
-	this decision was self interested to some extent because it involved making crappy loans to the employer of the dominating figure’s son (considerations of duty of loyalty are seeping in here – North seemed pretty self interested and disloyal)
-	also, lack of deliberation for the group’s decision b/c they were dominated by North and North didn’t give them enough information to make a careful decision
-	courts are less likely to find self dealing in decisions by outside directors – more likely to find willful blindness
(2)	shareholder derivative action should not have been dismissed via SJ for D b/c directors of bank made a series of bad loans to a real estate dev co. breaching their duty of care to bank’s shareholders (joint venture to share risk but not in profits)
b.  directors have a duty of care to corp & shareholders to use reasonable prudence & good faith (depending on corp size & resources) in getting acquainted w/business & make reasonable attempts at prevention of illegal conduct of other mgrs
(l)	Francis v. United Jersey Bank - corp was a reinsurance broker who acted as the middleman for insurance co. & new insurance co. & held in trust the money transferred btwn these parties 
(a)	2 directors embezzled money & other director failed to get involved in business b/c lack of knowledge, her failure was no defense to the breach of duty of care to corp, its shareholders & to its clients for whom $ was held in trust
(b)	ct found director guilt of willful blindness; Ways for directors to avoid willful blindness:
-	keep informed
-	don’t shut eyes
-	have rudimentary knowledge of the company
-	perform reasonable monitoring 
-	be familiar with the company’s financial statements

c.  directors are entitled to rely on honesty & integrity of subordinates until something occurs to put them on notice that there is something wrong
(c)	Graham v. Allis-Chalmers Manufacturing Co.- 
(1)	Employees were price-fixing
(2)	derivative action by shareholder of corp claiming that consent decrees made a long time ago regarding co. violation of anti-trust laws put mgrs on notice 
(3)	so they had an affirmative duty to prevent all future anti-trust activity & failure to do so was violation of duty of care (mgrs indicted & plead guilty on recent violation of anti-trust laws)
(4)	court holds that this is not a violation of duty of care b/c mgrs are entitled to rely on subordinates until there is reason not to (problem in the past wasn’t reason to think there was a problem now – and no connection between current board and the past event; Also, the company was so decentralized, it would have been virtually impossible all the individual parts of the company – they didn’t have a duty to do that anyway unless they had some reason to think they should)
d.	violation of duty of care when there is a taint of self-interest in addition to failure to carefully consider details of selling a lg concern
(business judgement rule shields directors and officers from liability only if, in reaching a business decision, the directors or officers acted on an informed basis, availing themselves of all material info reasonable available.)
(d)	Smith v. Van Gorkom – 
(1)	Facts part one:
i.	D’s were the dir3ectors of TU corp, including its chairman/CEO, Van Gorkom (V)
ii.	TU was publicly held and V held a sizeable but minority stake.
iii.	V was near retirement age and wanted to sell his shares before retirement
iv.	He had his CFO compute the price at which a leveraged buyout could be done (didn’t want to tell anyone else because he doesn’t want the price to be driven up)
v.	The CFO concluded that at $50 a share, the corp’s cash flow would easily support a buyout, but at $60 a share, the cash flow might not be sufficient
vi.	V then, without consulting anyone else in senior management, proposed to his friend Pritzker, an acquisitions specialist, to sell him the co. for $50 a share.
vii.	The company’s price on the NYSE had recently fluctuated between $29 and $38 and in its history had never been higher than $39.5.
viii.	P agreed to the $55 per share buyout price proposed by V. 
(2)	Where V fucked up (facts part 2):
i.	V did not attempt to get any other offers for the company, nor did he ever commission a formal study of the company’s value. Instead, he went to his board and asked them to approve the sale at $55.
ii.	He didn’t invite the co.’s investment bankers to the meeting.
iii.	He told the board that P was demanding an aswer within 3 days. Most members of the senior management opposed the deal b/c they thought the price was too low.
iv.	The board was not shown the proposed merger agreement or any documents concerning the value of the company.
v.	They relied on only 3 things: V’s oral presentations, the CFO’s statement that the price offered was in the low range of acceptable prices, and an outside lawyer’s advice that the board might be sued if they failed to accept the offer.
vi.	On this basis, the board approved the buyout at $55.
(3)	Holding/discussion
i.	Ct held that the directors had been grossly negligent in failing to inform themselves adequately about the transaction.
ii.	The majority seemed especially influenced by 4 things:
-	It was V and not P who promoted the deal and named the eventual sale price – and the board never found out about that
-	The board made no real attempts to learn the intrinsic value of the company
-	The board had no written documentation before it and relied mostly on V’s little speech.
-	The board made its entire decision in a 2 hour period, with no advance notice that a buyout would be the subject of the meeting, and in circumstances where there was no real crisis or emergency.
iii.	The board claimed that it reserved the right to take a higher offer – but the ct found that this reservation was bullshit because of the limitations that the pritzker agreement placed on the board’s ability to do so.
-	In any event, the two other bidders who came forward never made a serious offer because of the restrictions that the P agreement contained.
iv.	Ct may not have liked the fact that the directors gave in to an autocratic leader instead of making the decision in a cooperative manner
v.	Ct didn’t like the self-interested elements of the deal
-	V was close to retirement and wanted to get the sale through to push the value of his shares up to sell them 
-	The lawyer told the board that they could be sued if they didn’t take the deal (yucky)
vi.	Miller – even though it wasn’t a bad deal in the end – the duty of care was trampled on along the way – if they had taken care during the process, it would have been ok – ct is making a statement that process is especially important in obtaining the benefit of the business judgment rule
vii.	DISSENT
-	The directors should be protected by the business judgment rule – they are sophisticated parties who are very well-informed about the company
(4)	What to do to protect yourself in a merger situation (as a director)
i.	Take more time to investigate and consider the deal (especially, like here, where there’s no emergency conditions)
ii.	Don’t execute merger agreements in social situations – where it looks like you’re not serious or careful about what you’re doing
iii.	Avoid making it look like you’re trying to under-inform directors or senior management
iv.	Read the agreement, get the board of directors to read the agreement
v.	Hire an investment bank to get a fairness decision
vi.	Let the buyer make an offer of price first (rather than suggesting one)
b.  justifications for the business judgment rule
1.  business decisions are more difficult to review b/c lack of expertise - courts do it all the time
a.  assumption that more costly to impose liability when no negligence than to not impose liability when negligence
2.  going to increase costs of doing business w/out improving efficiency (if you didn’t have the rule)
a.  transaction costs
3.  don’t want to deter the best people from becoming mgrs - mgrs have liability insurance
4.  shareholders assumed risk of mgrs negligence
a.  extent of assumption industry-specific
b.  shareholders want more risk
1.  b/c there is no ceiling on gains but floor on loses (value of their stock) 
(e)	depends on capital situation of corp
2.  shareholders can diversify away risk
5.  shareholders have other remedies - can sell, can vote mgrs out
6.  gatekeeping function to keep out frivolous suits
ii.  Duty of Loyalty  
1.	duty of loyalty - directors & mgrs
a.  higher scrutiny but it’s not always case that violation will be found (most rigorous scrutiny – higher than business judgment rule)
	b.	where there is a relationship btwn parties involved in a transaction, courts will apply this higher scrutiny
(f)	Bayer v. Beran - celanese rayon manuf co. sponsors radio show to promote its product but one of the performers was co. president’s wife, invoking the higher standard 
-	but no violation found b/c there was no preferential treatment – she was qualified and didn’t get any special treatment
-	The case would have been under the business judgment rule if there had not been the question of self-interest 
(g)	approval by each member of the board separately is ok but it’s better have meeting of the whole board
1.	more potential for debate to lead to rejection or modification of proposal
2.	dissenters may be more willing to come forward if there are allies
c.  where there is self-dealing, D party has to show that deal was fair (when duty of loyalty is called into question – when there is an appearance of self-interest or impropriety – burden is shifted to the co. to show its good faith and transaction is examined with strict scrutiny)
1.  substantive - review of transaction on fairness basis
2.  procedural - burden on D
(h)	Lewis v. SL&E, Inc. – 
(1)	Where the directors of a corp. are engaged in a transaction with an entity in which the directors have an interest, the burden of proof rests on the interested directors to show that the transaction was fair and reasonable to the corp.
(2)	Leon Sr. transferred ownership of SLE (lessor) to children, some of them owned LGT (lessee), non-LGT SLE owners to sell their SLE shares to LGT at book value but book value was low b/c LGT rented at low lease rate so unfair to SLE owners, so violation of duty of loyalty of LGT owners to SLE
(3)	classic case of self-dealing
d.  remedy - transaction will be voidable at option of non-conflicted party if the deal was bad when made – with burden on conflicted party to show that the transaction was fair – cts also ask if the transaction was approved by the nonconflicted partyafter disclosure of the conflict
(1)	Lewis v. SL&E, Inc.

a.  Corporate Opportunities
1.	intro 
a.  where corp opportunity intercepted by employee of firm
1.  breach of fiduciary duty?  yes
2.  costs & benefits
a.  benefits – party with the opportunity gets most for its opportunity b/c employee is willing to pay more than employer for it (otherwise she wouldn’t get the opportunity when bidding for it), society is better off for it
b.  costs – In reality, it’s not really a free bidding situation - employer doesn’t get full info so no real competition, employer won’t be able to operate efficiently b/c they distrust employees, unjust enrichment for employee
3.  courts will balance
a.  find breach where benefits would have been realized by the employer (would the employer have taken the opportunity if given the chance?)
b.  not find breach where benefits would not exceed costs (probably wouldn’t have taken the opportunity)
b.  at armslength deals, one firm can divert opportunity from another firm
2.	doctrine
a.  what is opportunity?
b.  did opportunity knock at employer’s door?
1.  consider how opportunity came to attention of employee
(2)	American Law Institute - if opportunity offered to sr mgt of employer to engage in business area of employer, then considered to be employer opportunity  harsh on employee
(3)	If the opportunity comes to the employee at work or by virtue of his job at the company, it’s generally considered to be the employer’s vs. if it comes to the employee through outside contacts
c.  would/could employer have let it in?
1.	look at line of business of e-r & opportunity
2.	look at the risk of the project compared to the company’s past risk profile (is the project riskier than something the employer would take on)
2.  look at financing requirements & potential
(4)	courts less likely to accept this as defense b/c most e-rs can get financing & potential conflict of interest of e-e trying to secure financing
(5)	Energy Resources Corp. v. Porter - e-r ERCO, e-e Porter, Porter works w/Howard University to get grant from DOE where Howard is applicant & ERCO subcontractor but Howard decides it wants minority subcontractor, so Porter starts EEE & becomes subcontractor & then later quits when grant comes in w/out telling e-r why didn’t get deal & lied about why quitting
-	Porter found liable; violation of duty of loyalty
-	had a duty to inform ERCO that Howard wouldn’t work with them – if he was going to take the deal himself then (like Meinhard v. Salmon)
-	(on the other hand, Porter brought the deal in , don’t know if ERCO ever would have had the opportunity if Porter hadn’t cooperated)
-	If Porter wants to invoke Howard’s refusal to deal as a defense, he must first disclose the refusal to the corporation along with a statement of Howard’s reasons for the refusal.

b.  Dominant Shareholders
1.	intro
a.  does dominant shareholder have fiduciary duty to corp.?
(6)	exception to rule to no fiduciary duty by shareholders (ordinarily shareholders can vote their stock however they want, even if their self interest)
b.  fiduciary duty to minority shareholders
1.  duty of care
a.  business judgment rule
b.  burden on P
2.  duty of loyalty
a.  fairness doctrine
b.  burden on D 
2.	doctrine
a.  dominant shareholder causing the corporation to pay large dividend to self  is ok as long as other minority shareholders share proportionally - there is no breach of fiduciary duty
(7)	Sinclair Oil Corp. v. Levien - dominant shareholder is parent co. of subsidiary, parent caused subsidiary to pay lg dividend so foreclosed subsidiary from taking on other profitable ventures & forced subsidiary not to enforce terms of K it had w/parent, court holds dividend payment is not breach of fiduciary duty but nonenforcemt of K is - so subsidiary can get damages but probably won’t be very much
-	parent probably didn’t want to keep lots of $ in Venezuela (subsidiary) in case of expropriation of $ by government (that’s why he paid the huge dividend)
b.  dominant shareholder causing corp. not to enforce K against the parent (in the self-interest of the dominant shareholder) is breach of fiduciary duty
(8)	Sinclair Oil Corp. v. Levien
c.  dominant shareholder has to disclose all material info to other minority shareholders if going to significantly influence their decision
(9)	Zahn v. Transamerica Corp. – 
(a)	class A & B stock: where class A has higher dividends, receives more assets upon dissolution, convertible to B stock at a 1-to1 ratio, can be called by the company for $60 a share (company can buy the shares); B stock has voting rights (but no call or conversion features, no dividends); dominant shareholder Transamerica holds 2/3 of the A stock and 4/5 of the B stock. They know they are going to liquidate the assets which have greatly increased in value; A stockholders don’t know this; instead of giving the A stockholders a chance to realize the liquidation value of the asset or convert to B stock, dominant shareholder called the stock and just payed out the $60 a share (a lot less than they would have received had they known what was going on) 
(b)	Court says that majority shareholder has a right to control but that comes with a fiduciary duty to the minority shareholders (like a board member would have to the shareholders); When a controlling stockholder is voting, she violates her duty if she votes for her own personal benefit at the expense of the stockholders
(c)	The only thing they did wrong was not telling the stockholders what they were going to do to give them options
(d)	Relief – ct makes A shareholders share equally with the B shareholders in the liquidation 
c.  Ratification
In re Wheelabrator Technologies, Inc. Shareholders Litigation - not breach of duty of care to make merger decision in 3hrs but really a ratification case
e.	§144 DE statute – a properly ratified contract between a corporation and one of its directors is not necessarily void or voidable because of a conflict of interest.  It will not be voidable if :
(1)	material facts (as to the transaction and the director’s relationship or interest) are known to the board of directors
(2)	the board authorizes the contract in good faith
(3)	and there is an affirmative vote of the majority of disinterested directors
OR
(1)	material facts about the transaction are disclosed or known to the shareholders entitled to vote on the issue
(2)	and approved in good faith by a majority of disinterested shareholders
OR
(1)	the contract or transaction is fair to the corporation at the time it is authorized, approved or ratified by the board, a committee or the shareholders
f.	Interested director transaction approved by a majority of disinterested shareholders or disinterested directors – is then judged using the business judgment with the burden on the challenger to show the transaction was not fair
g.	Controlling shareholder interested transaction – ratification by a majority of disinterested shareholders – the transaction is judged using the entire fairness standard with the burden on the defendant (due to the risk of manipulation by the controlling shareholder)

d.  Federal Law
1.	fiduciary duty not federalized so state law to govern
a.	Santa Fe Industries, Inc. v. Green –
(1)	 DE law allows dominant shareholder, who owns over 90% of shares of a subsidiary, to squeeze out minority shareholders by purchasing their shares (regardless of consent) (this is to deal with the holdout problem where a minority shareholder could refuse to sell out and demand a huge amount)
(2)	D exercised their rights under the statute and offered $150/share to minority shareholders; Under statute, if the minority doesn’t like the price, they can ask the DE court for a fair appraisal. Minority here didn’t want to do that. 
(3)	They thought the price was totally unfair. (investment bankers valued market share at $125/share, liquidation value after paying creditors would have been $772/share), so they wanted to go straight to federal court characterizing the offer as violation of security regulation Rule 10b-5  (which deals with employment of manipulative or deceptive devices)
(4)	court dismisses case – didn’t want to federalize breach of fiduciary duty cases
a.	SC won’t interpret 10b-5 to cover this transaction
b.	B/c the company was acting under the statute and did not violate it
c.	And the cts recognize that DE has formed a remedy (appraisal) so the stockholders can use that
d.	If you could show that they intentionally manipulated the stockprice, they might be able to bring a 10b-5
(5)	Santa Fe only bars a 10-b action when there is no deception by an insider. If, as part of the insider’s violation of his fiduciary obligations to the corporation and its shareholders, he deceives the corp., its board, or its minority shareholders, then a 10b-5 action will still be available despite Santa Fe
a.	This exception is especially likely to be invoked where a majority or controlling shareholder causes the corp, to sell stock o him or buy stock from him and the controlling shareholder does not make full disclosure. (classic 10b-5)
(6)	reasons for going to federal court
a.  forum shopping - federal court vs. state court, different districts NY vs. DE
1.  better damages in federal court
b.  appraisals are expensive
c.  lawyers were probably security lawyers
1.  don’t have class action in appraisals in state court but in federal court
(4)	majority permitted to squeeze minority out in corp context as opposed to real property context
a.  implied terms of corp K
b.	consistency w/expectations - not expected in real property but in corp setting
(6)	What could they have argued in DE state court
a.	That Don is a big ass – that argument always wins
b.	Mismanagement (asset value is being lost – shown in the big difference between the liquidation and the fair market value)
c.	Argue entire fairness of the deal (which could apply because it’s a controlling shareholder situation)– but it’s unclear if you could do that -because the merger statute is in place to provide a remedy for those situations
iii.  Inside Information
1.	Rule 10b-5 
a.  10b - Manipulative & Deceptive Devices
-unlawful for person directly or indirectly to use any form of interstate commerce, mail, national securities exchange to:
(b)  use in connection w/purchase or sale of any security registered on national securities exchange or any other security, manipulative or deceptive device in contravention of rules & regulations of Commission necessary or appropriate for protection of investors
b.  Rule 10b-5 - Employment of Manipulative & Deceptive Devices
-unlawful ....
(a)  to employ any scheme, etc. to defraud,
(b)  to make any untrue statement of material fact, to omit a material fact necessary to not make statements misleading in light of circumstances under which they were made, or
(c)  to engage in any act, etc. which operates or would operate as fraud or deceit upon any person
c.  2 grounds for liability under this rule
1.  misleading statement to market rule
2.  insider trading rule - need sale or purchase of security
a.  intro
(1)	relatively new doctrine but taken seriously & monitored heavily 
(2)	general rule based on Rule 10b-5 - disclose to trade or tip or abstain
(5)	SEC v. TX Gulf Sulphur Co. - common law creation b/c rule doesn’t explicitly cover this area
d.	misleading statement rule
1.	corporation has made a statement or an omission that is materially misleading 
	 (a)	misleading
(1)	statement is misleading when reasonable investor would find it such even though it may not have been factually incorrect
i.	SEC v. TX Gulf Sulphur Co.
(2)	if reasonable investor would trade based on this info then this requirement is satisfied
(e)	material
(1)	test is whether reasonable person would think info important in deciding to buy or sell - material if (P x M)/S > the threshold for materiality
i.	consider probability of occurrence of event in question & magnitude of effect of the event (PxM)
(A)	more important events will become material earlier on than less important events 
-	If the M is bigger, it doesn’t take much of an increase in the P to cross the materiality threshold (if the event is going to occur - probability goes up over time as more info is known); Therefore, with an important event, the info is material sooner.
(B)	will know if decision is more important if there is indication of interest at highest corp levels
-	Basic – company was trying to downplay the idea that there was a possible merger; however, high level people in the company were discussing the merger with a possible partner  - that shows that the magnitude could be high
(C)	Consider the effect of understating the probability of an event - TX Gulf Sulphur
ii.	consider size of corp. (S)
iii.	up to jury to decide
(A)	Pommer v. Medtest Corp. - corporation lied to  that corp already secured patent & merger w/bigger co. was almost a done deal, court holds that jury is entitled to conclude under reasonable person standard whether 2 misleading statements were material
(B)	Using formula
(I)	probability was represented by the management as high; the magnitude of the event was very large (huge drug patent); the size of the company was small; so the importance (materiality) of the event was huge for the company
iv.	under common law, when insiders buy/sell stock on basis of “nebulous” theory then no violation b/c not considered to be material
(A)	Goodwin v. Agassiz - court declined recovery for P who sold his co. stock based on news release that explorations were unsuccessful while an insider bought stock based on nondisclosed unproven geologist’s theory that area may contain high concentrations of minerals (D stopped drilling, D issue statement that exploration was unsuccessful, D purchased land in surrounding area via another co. name, D purchased lots of their co. stock)
-	No fraud here – for fraud, you’d have to have intent to mislead, reliance, damage and a misrepresentation of  material fact
-	10b-5 does cover material omissions but here the omission is considered not to be material because it’s not certain (probability was low enough that it wasn’t material)
-	The fiduciary obligations of directors are not so onerous as to preclude all dealing in the corp.’s stock where there is no evidence of fraud
-	Face-to-face vs. impersonal transactions (like on the stock market) – different burdens
(a)	impersonal – Goodwin says that the insider who buys silently on the exchange simply has no commonlaw liability to the other party to the trade.
(b)	Face-to-face – there is no affirmative duty of disclosure and no liability if a trader simply remains silent subject to certain exceptions – like fraud or misrepresentation (or special facts that make the situation unfair – e.g. special discrepancy in bargaining power or a big difference in the amount of info the parties have – like if one party is a director)
2.	state of mind of  - scienter that requires recklessness as to the falsity of the information 
(a)	justification 
i.	want to maximize amt of info going to mrkt & so don’t want to chill info that is simply negligent (even if some negligent parties will get away as a result)
ii.	If you held people liable for info that they thought was true but turned out to be false – they would be afraid to say anything 
3.   plaintiff has to trade based on the information (not necessarily the defendant) 
(reliance) (“in connection with purchase or sale of a security”)
(a)	transaction based on the information needs to involve a security to qualify under 10b-5 - potential issue of what qualifies as security in gray areas
(b)	Blue Chip - have to connect misleading statement w/purchase or sale of  
security for liability (10b-5 extends only to purchasers and sellers of a corp’s securities – can’t recover by saying “I would have bought or sold if not for the misleading statement”)
i.	doesn’t cover insider who decides not to sell or refrain from buying b/c of inside info
ii.	just covers those who sell or buy b/c of inside info
(c)	standing - reliance & injury
i.	SEC - automatic
iii.	private parties who sell or buy shares on basis of this materially misleading statement & are injured
(1)	Deutschman v. Beneficial Corp. - option holders have standing to sue for misrepresentations under Rule 10b-5
iv.	someone who would have bought or sold if info were correct does not have standing to bring suit
v.	statute doesn’t provide cause of action but common law created it (TX Gulf Sulphur) & was endorsed by Congress in later statute
vi.	omission cases - reliance assumed
vii.	class action cases - fraud on market theory – idea that the market reflects the false info, investors rely on the market and so are harmed; This is hard to prove so there is a rebuttable presumption of investor reliance on market info (market reflects information provided by corporations and individual investors rely on market information – difficult to prove that each investor relied on corporate information so they make a connection through the market to show their reliance)
a.  assuming that market is semi-strong form efficient (means that market price reflects all information that’s publicly available and at least some private info) 
b.  rebuttal of assumption of individual investor reliance on corporate information (burden on defendant to show they didn’t rely)
1.  individual  didn’t rely on the behavior of the market or the actual disclosure (trade occurred for reasons outside market behavior or the disclosure – like some analyst’s prediction)
2.  misrepresentation had no effect on market price
3.  can show that market is not efficient (absorbing and reflecting info efficiently– smaller exchanges than NYSE and NASDAQ might not do this); Evidence of that:
a.  volume of trade (low trading volume shows the market isn’t responding to the information)
b.  opinion of experts (who testify as to the efficiency of markets)
c.  how shares are traded (how fast trades can be seen by others so they can rely on what’s going on)
-	ex.	Basic Inc. Levinson – illustrates fraud on the market theory of recovery; because the corp. lied (saying there was not going to be a merger), they artificially deflated their market price; Individual investors relied on this market price as efficiently reflecting information; So Basic was guilty of misleading statements to individual investors;
-	damages awarded to P = difference between the (deflated) market price they sold at & what the market price would have been had the corp. given truthful info.
e.	insider trading rule - liable if you trade yourself or tip someone else & they trade, unless you publicly disclose the information
(1)	elements
i.	has to involve the purchase or sale of a security
ii.	inside information has to be material 
iii.	insider involvement
(A)	classic insiders - officer, director & probably employee
	(I)	have certain duty to corp that is violated by inside 
	trading (in general, an insider must abstain from trading on information that is not publicly available (OR) must disclose such information)
(B)		tippers
a.  someone who discloses material inside info to another party – the tippee (either an insider or a constructive insider, which is someone who is in the type of relationship with the corp. where they have access inside info)
c.	insider or constructive insider is liable if (Dirks): 
(I)	the breach a fiduciary duty to shareholders by disclosing to tippee
(a)	insider or constructive insider breaches the duty if they benefit personally directly or indirectly from tipping
i.	problems
-	vague what duty or personal benefit is
-	personal benefit can be through monetary benefit or giving a gift to someone 
-	disclosing the info for altruistic reasons is not personal benefit
-	mixed motives
(C)		tippee
a.  liable if (Dirks) has or should reasonably have knowledge that the tipper has breached her fiduciary duty to shareholders (by giving the info to the tippee as a gift or by personally benefiting) and then trades on the information 
i.	chain of liability only begins when there has been an initial violation of duty
ii.	only carries from a tipper to a tippee when the tipper breaches the duty (gains from the info or intends the info to be a gift) and the tippee knows or has reason to know the tipper breached; Then that tippee has a fiduciary duty and cannot trade
iii.	A fiduciary duty can also be created (and the chain continued) by the tipper making an agreement with the tippee that the tippee will not tell anyone (Chestman)
viii.	US v. Chestman - Ira tells sister (insider) of tender offer, sister tells daughter and says tell no one but your husband (duty passes to daughter); daughter tells husband and then later tells him not to tell anyone; before she says that, he trades & tells his broker who trades, (no fiduciary duty passed to the husband because the wife did not make an agreement for him not to tell and did not benefit by telling him –  husband and broker then have no liability)
ix.	have to know that you’re a tippee to be held liable
x.	if you hear something by chance, no duty passes to you because the tipper hasn’t breached any duty – you can do whatever you want with the info (even if you know the tipper was breaching when they were talking to someone else – they have to have breached the fiduciary duty by telling You)
xi.	difficult to police b/c not certain when tip is a tip
(D) misappropriator
a.	under misappropriation theory of securities fraud liability, fiduciaries’ undisclosed self-serving use of principal’s info to purchase or sell securities, in breach of duty of loyalty and confidentiality, defrauds principal of exclusive use of that information; (O’Hagan) (stealing info from someone who has a right to it) 
b.	(unlike tipper-tippee situation, where the tipper would have to benefit for the tippee to be liable)
c.	look for a duty between the defendant and the original source of the info (fraud on the source = misappropriation) and also between the defendant and the party that had a right to the information (the law firm, the newspaper) (breach of duty of loyalty that could result in conviction for mail and wire fraud statute) (and also under misappropriation if you consider tat party the source of the information)
d.	Key – argue that the party with the right to the info (the law firm or whoever) is the “source” 
xii.	US v. O’Hagan - law firm partner trades based on tender offer info of client, liable under misappropriation theory
-	violated duty of loyalty to law firm (by using info, obtained by the law firm, for personal benefit – and to the detriment of the firm) 
-	also violated duty of confidentiality to client (the source of the info) – even though defendant did not work with this client, as a lawyer, he also had a duty to this client
xiii.	Carpenter v. US- WSJ writer tips friends on contents of article using info that belongs to the WSJ
-	violates duty of loyalty and confidentiality to employer (party who had a right to the information) – steals the info for his own benefit in violation of an agreement not to tell 
-	If you consider the WSJ to be the source
-	unsure whether writer has duty to the source of the info (who he talked to on behalf of WSJ) (ct might find that the reporter-source relationship is like a fiduciary relationship – in which case, writer would be liable for fraud on the source)
(E)	thieves are not considered insiders
	i.	Chiarella v. US - printer who figured out target company of 
	an acquisition traded & benefited from that info didn’t violate this rule b/c had no duty to target corp.
a.	future warning that  who misappropriates inside info may breach duty to employer & so be liable as a misappropriator
b.	where employer would be the considered the source of the information
(F) securities analysts are not insiders
	a.	Dirks v. SEC-  finds out from insider that co. is engaged in fraud & investigates on own but doesn’t trade on this info nor does his firm, tells clients who do,  is not liable b/c insider didn’t breach an initial duty
(G) accidental/intentional eavesdropper is not insider (see above under tipper-tippee)
iv.  state of mind of  - negligence standard
1.  justification
a.	more difficult to prove that insider really didn’t know that it was inside info (liable if they knew or should have known)
b.	also tippee can’t be willfully blind – liable if they knew or should have known that tipper was breaching a duty  
v.	in connection w/purchase or sale of security (can’t be abstaining from a sale)
vi.	standing - reliance & injury
1.  reliance by  assumed
vii.	damages
3.  rules of disclosure
a.  timing - have to wait for disclosure to widest possible audience before trading on the information
	SEC v. TX Gulf Sulphur Co. - insiders issued PR saying that exploration was inconclusive & indicated that it was unsuccessful, then disclosed complete info (in press conference, private wire, then general wire) that co. made a huge strike, all the while engaging in inside trading, court holds Rule 10b-5 to apply to inside trading, that its first Press Release was misleading & that it is ok to trade once info has been disclosed to widest possible audience to ensure mrkt has chance to digest info
i.	medium - if reach fewer people, then have to wait longer
ii.	Miller – if you disclose to a large enough medium – then 30 minutes is ok
iii.	If you don’t wait for the info to get out, you are still taking advantage of inside information
b.  justification for this rule
1.	protects insiders – defines when they can trade so that they are able to avoid liability
2.  protects shareholders
3.	protects uninformed investors who have no access to this (inside) info
4.	protects mrkt efficiency
d.  mining situation
	high importance in this area
1.	radical outcome of value of stocks depending on situation - minerals or none
2.	exploration not observable by public - remote areas & underground
iv.  Protection of Option Holders
1.	option holders have standing to sue for misrepresentations under Rule 10b-5
	Deutschman v. Beneficial Corp. 
v.  Short-Swing Profits
1.	 16(b) 
a.  16(b) - Directors, Officers, & Principal Shareholders
(b)  Profits from Purchase & Sale of Security W/in 6 Mos.
-to prevent unfair use of info that may have been obtained by beneficial owner (of 10% of any class of stock), director or officer via his relationship to issuer, any profit realized by him from purchase & sale or sale & purchase of any equity security (options, stocks) of issuer (other than exempted security) w/in period less than 6mos., unless acquired in good faith in connection w/debt previously contracted, shall be recoverable by issuer regardless of intention of insider to hold or not resell until after 6mos.
-suit to recover profit may be instituted at law or in equity in court of competent jurisdiction by issuer, owner of security of issuer in name & on behalf of issuer if issuer fails to bring such suit w/in 60days after request or fails to prosecute diligently
-time limit on such suit is 2yrs after date profit was realized
-this section not to cover transaction where beneficial owner was not the owner both at time of purchase & sale, or sale & purchase of security, or transaction that Commission via rules & regulations exempt as not w/in purpose of this section
b.  requirements
1.  applies to beneficial owners (10% or more), directors or officers
a.	person has to be a beneficial owner at the time of both the purchase and the sale 
-	Reliance Electric Co. v. Emerson Electric Co. – Emerson acquires 13.2% of Dodge in tender offer in hostile take-over at $63/share, failed b/c Reliance merges w/another corp, Emerson sells shares at $68/share to brokerage house to be 9.96%, then sells remainder all w/in 6mos, court holds that while sale 1 is covered by 16(b) (liability), sale 2 is not b/c wasn’t 10% owner at time of sale 2
-	Foremost - McKesson Inc. v. Provident Securities, §16(a)(2)(codifies this case) – In Reliance, lower ct said that Emerson would be considered a 10% owner “at the time of purchase” because he became a 10% owner through his purchase – that issue was not appealed so SC did not clarify; This case says that you have to be a 10% owner before the purchase in question and at the time of sale to be covered by §16(b).  
b.	For director or officer – only need to be a director or officer at the time of the purchase OR the time of the sale to be liable
2.  equity security
3.  applies to corporations whose stock is registered w/SEC
c.  rule - any profit realized by such party from purchase & sale or sale & purchase w/in 6mos. period shall be recoverable by issuer (corp)
1.  court will consider purpose of rule in applying to certain cases – special rules cover unorthodox transactions like those related to mergers (these aren’t like simple cash buy and sell situations)
a.  those trying to exit failed hostile take-over tender offer will not be covered
	potential tension btwn rule & free mrkt of take-overs otherwise
b.  transactions w/single purpose will still be considered separate transactions ex. Reliance Electric Co. v. Emerson Electric Co.
c.  option sale is not considered sale
	Kern County Land Co. v. Occidental Petroleum Corp. - White, Occidental in take over bid buys more than 10% of Kern shares (this counted because it was before §16(a)(2)), White knight company traded its shares for all the Kern shares (defensive merger) and frustrated the takeover attempt; Occidental wanted out so (still within the 6 month period) it gave the white knight company an option to buy that was exercisable after 6mos. period expired, Occidental profits $19.5 million, court says transaction is not covered by 16(b); Kern tried to say te giving of the options counted as a sale – ct says no
	-	would have been easier if Occidental got waiver of §16(b) from Kern or 
	Tenneco (to avoid the lawsuit)
-	Results in a 2 part for determining whether an unorthodox transaction like a merger will be not deemed a sale for §16(b) purposes:
(1)	that the transaction was essentially involuntary (ex. Occidental didn’t want to end up with a bunch of Tenneco shares)
(2)	AND that the transaction was a type in which the defendant almost certainly didn’t have inside information
2.  strict liability
3.  enforceable by corp or shareholders
4.  pros - profits taken away due to policy considerations by courts
a.  puts people on notice - foreseeable
b.  avoids overdeterrence & underdeterrence – because it’s really clear
c.  easy to enforce & administer
d.  avoids disputes - efficient
5.  cons - profits taken away due to policy considerations by courts
a.  underinclusive - more precision means that sometimes it will not cover things w/in purpose of rule
b.  overinclusive - more precision means that sometimes it will cover things outside purpose of rule
c.  encourages people to engage in lawyering ex ante (strategic behavior)
	(w/vague rule - costs would be ex post)
2.	compared with pros and cons of Rule 10b-5
a.	pro
(1)	maps better – more flexibility - its not a bright – line rule so courts can apply it on a case-by-case basis - avoids over and underinclusiveness
(2)	not subject to strategic behavior (efforts to get around the rule)
b.	cons
(1)	higher litigation risk
(2)	overdeterrence (vagueness creates fear of liability)
(3)	makes it difficult to plan conduct
(4)	hard to enforce
(5)	inefficient – leads to many disputes
vi.  Disclosure & Fairness
1.	security definition
a.  statute definition is in example form
(1)	cons
(a)	never exhaustive
(b)	what about new things that develop?
(3)	If the security existed at the time the list was made and isn’t on it – it shouldn’t be considered a security
(4)	Basically – any note, stock, treasury stock or bond – but not currency
b.  Family resemblance test - 
1.	looks at the attributes of the thing – does it have attributes that make it look like other securities?
2.	Weaknesses – may not find a common attribute for all things – (but if you had specific attributes listed, people would just avoid those attributes)
2.  factors to consider (Reves)
a.  motivation of parties
1.  seller - to raise $ for general use
2.  buyer - to share in expected profits
b.  plan of distribution of instrument - common trading for speculation or investment
c.  reasonable expectation of investing public (that it is a security)
d.  whether there are other regulations that significantly  risk; whether SEC is necessary for protection of public investors
-	ex. Reves v. Ernst & Young - demand note w/variable interest higher than those offered by local banks advertised as an investment scheme (public expectation of regular folks) and not covered by other regulation (not FDIC protected) -  is a security covered under SEC rules & regulations 
c.  alternative per se approach – used in the past
1.	stock is security if it acts like a security “If it looks like a security, it’s a duck”
(a)	like a functional approach – looks at the way the thing behaves -  negotiable, capital appreciation, dividend payments, residual claim to assets, voting rights - Landreth Timbers
c.	investment vs. commercial approach – (where an investment is a security and if it’s commercial, it’s not) – notes issued in an investment context vs. note issued in a consumer or commercial context - problem – not a sharp distinction; 
d.	Howey approach – look at what Congress defined as an investment contract (because that is a specific definition); rejected – underinclusive 
e.	Courts use a combination of family resemblance test and investment vs. commercial approach
2.	exemptions from SEC regulation
a.  test for whether issuing of stuff is a public offering of securities (and so covered by SEC) (not a public offering – exempt §4)
1.  factors to look at
a.  # of offerees - more makes more likely that it is public offering
b.  relationship between offeree & issuer – to be allowed it to be considered a private offering)
1.  offerees have to have info or access of info to the type of info that would registered with the SEC for a public offering
2.  sophistication of offeree is not substitute for access to info
3.  knowledge of offerees is key
c.  # of units
d.  $ size of offerings
e.  manner of offering
2.  purpose - don’t have to protect investors who can protect themselves
(b)	Doran v. Petroleum Mgt Corp. - court remands case to decide whether  had info or access to info that would have been registered w/SEC in case where  invested in limited partnership to drill & operate wells & now wants recission remedy under §12
3.	issuing securities in a public offering
a.  purpose
1.  to raise money
2.  so insiders can cash in
b.  method
1.	registering w/SEC
(a)	“gay?”
(b)	§5(a) – can’t sell a security unless a registration statement is in effect
(c)	§4 - §5 doesn’t apply to transactions by a person other than an issuer, underwriter or dealer – or to stuff not sold by the issuer in a public offering
(d)	when registering:
a.  decide kind of security, rights & duties, needs of parties
1.  to do that, involve underwriter, their counsel, own counsel, mgt
b.  drafting registration statement – put in description of uses for $, business, disclosure of risks, financial statemts, mgt, key events:
1.  involves underwriter counsel
2.  corp submits preliminary statement w/out price
3.  SEC approves subject to price amendmt
4.  issuer amends registration w/price
5.  SEC generally approves
c.  auditing
1.  involves corp treasurer, underwriter
d.  due diligence - to make sure all info correct
1.  involves underwriter counsel
2.  exemptions
a.	Regulation D – SEC regulation creates a series of safe harbors from §5 requirement to file – 
-	people use these because using §4(2) private offering exemption has uncertain outcomes – don’t know if you’ll be exempted or not
-	Also, if you violate §5 filing requirement – there’s no intent requirement – even if you didn’t intend to violate it and used care – too bad
b.  Regulation S – uh..ok
4.	liability
a.  all signatories, underwriter, auditors and directors  are all potentially liable under §11(a)
1.  pros
a.  potentially all could have been involved & difficult to prove
2.  cons
a.  cost of repetitive due diligence requirement as to non-expertised portions (can’t rely on other people about things you could figure out yourself – you could be liable)
(c)	Escott v. Barchris Construction Corp. - 1968, misstatements in registration of bowling alley bldg corp., under 11(a) liability for materially false, misleading statement, or omission - w/due diligence exception under 11(b)(3), all signatories, underwriter, auditors held liable because each had to do due diligence 
b.  defense of due diligence §11(b)(3) - different standard for different parties
1.  For the portions requiring no expertise – everyone has a duty:
a.  affirmative due diligence - higher standard
(1)	reasonable investigation
a.  prudent person standard similar to negligence standard
c.	scope not clearly defined in statute but well-established in industry
(3)	after due diligence, have to have reasonable belief that statements are true & not misleading
2.	For the portions require expertise 
(financial statements – accountants; any engineering reports dealing with stuff 
like structural soundness – engineers; appraisals of property – appraisers)
a.	experts – have affirmative due diligence requirement  
b.	non-experts – negative due diligence
1.	no reasonable grounds to disbelieve
2.	you’re screwed if you knew or should have known it was messed up
(d)	ex. Escott v. Barchris Construction Corp.
vii.  Indemnification & Insurance
1.	intro
a.  risks
1.  litigation - attorney’s fees
2.  liability - judgment
2.	ways for corp to ensure that officers won’t be deterred from serving for corp b/c of potential liability
a.  insurance
(1)  will bundle risks 
a.  will control litigation to try to protect itself from liability
b.  will protect itself from moral hazard (insured people are more reckless because they’re insured) via
1.  deductibles
2.  exclusions
3.  monitoring
4.  premium policy - increase premium or cancel
5.  will limit exposure of liability in policy (policy ceilings)
2.  pros
a.  induce people to work by lowering their exposure
c.	reduce risk avoidance behavior
d.	cheaper because you can buy it in bulk
e.	not counted as income for executives (for tax purposes)
3.  cons
a.  costly
b.	moral hazard - insured will be less careful
c.	insurance company has control over the litigation
b.  indemnification
1.	rule under DE general corp law,  145 (a), (b), (c), (e)
-	in any case, corporation may grant director an advance to pay legal fees – director has to agree to repay the expenses if it’s found that she’s not otherwise entitled to them under §145 (a) or (b) §145(e) (see Citadel case below)
a.  civil action other than derivatives
1.  if the individual loses the suit, corp can indemnify unless the individual was acting in bad faith or not in the best interests of the corporation -  145(a)
2.  if person wins, corp shall indemnify expenses -  145(c)
3.  if person wins some & lose some counts in action, then have to allocate fees accordingly §145(c)
b.  criminal
1.  if person loses, corp may indemnify but person must have acted in good faith and in the bests interests of the corporation – and they must have had no reasonable cause to believe that their conduct was unlawful -  145(a)
2.  if person wins, corp shall indemnify expenses -  145(c)
3.  if win some & lose some counts in action, then have to allocate fees accordingly §145(c)
c.  derivative
1.  if directors lose, corp can only indemnify expenses & not for judgment -  145(b)
3.	if directors win, corp shall indemnify expenses -  145(c)
4.	if the case is settled – the directors get paid as if they had lost the case (expenses only)
d. corp interpret agreements between parties related to indemnity & §145 to cover only suits reasonably related to employment as director (no indemnity for a simple assault case)
(e)	Citadel Holding Corp. v. Roven - corp sues  director for  16(b) short-swing profits violation &  wants advance for attorney’s fees per indemnification agreement; agreement specifies that it covers any civil or criminal action threatened by reason of his service as a director (so it seems to include short-swing profit actions); court holds that there is reasonableness requirement in agreement & statute – it’s reasonable for them to advance the costs (the action is related to the business) - so  entitled to advance per agreement (advance & later  may have to return if decided that not covered) 
2.  ways that indemnification to deal w/moral hazard
b.  mgt controls
c.  limitations on indemnification in agreement
d.  monitoring
3.  pros
a.  potentially better at assessing risk than insurance co.
1.  not subject to adverse selection problem for insurance co. - those who want insurance are more likely to make claims
2.  may have more pertinent info than insurance co. on e-es
3.  know better tendencies of e-es
4.  can better monitor behavior of e-es
4.  cons
a.  agency costs – employees more likely to take chances
b.  potential illogical result in derivative suits where  would have to pay $ back to corp but corp would reimburse  for costs

VI.  Problems of Control
i.  Proxy Fights
1.	intro
a.  issue is control of corp.
	i.	shareholders have right to elect directors but don’t have right to control 
	daily operations
(a)  one-party state 
(1)  incumbents usually win
(2) usually uncontested
(b)	 voting is not individual
(1) proxy votes
(2) sm # of shareholders actually vote
(c) not too concerned about effectively limited voting rights
(1) can easily exit - voice less important when exit is easy
(2) entrance is voluntary
2.	proxy fights
a.  proxy solicitation over which SEC rules & state rules apply
i.	SEC definition - any communication to security holders reasonably calculated to result in procurement or w/holding of proxies – very broadly defined – any communication with shareholders could be considered a solicitation
c.	Miller – if you can get proxy control of 20% of the votes – you can probably get de facto control of the corporation
c.	paying expenses of proxy fights
i.	expensive - mailings, PR, attorney’s fees, etc.
ii.	you don’t get paid if you are doing it for spite
ii.	potential rules
(a)  everyone pays themselves
(1)  only wealthy will engage in proxy fights
(2) no one would want to work for firms if they can be challenged & kicked out any time or incur cost to stay in
(b) everyone doesn’t have to pay
(1) incentive to bring lots of proxy fights b/c outsiders have nothing to lose
(c) insiders get paid & outsiders don’t
(1) perpetuates status quo b/c there won’t be any proxy fights
(d) insiders don’t get paid & outsiders get paid
(1)  incentive to bring lots of proxy fights b/c outsiders have nothing to lose
(2) no one will want to work there if they can get kicked out – or pay to try to keep their jobs
(e)  winners get paid
(1)  incentive to increase cost of proxy fights
(f)  losers get paid
(1)  nonsensical
(g)  get paid according to # of share votes received
(1)  incentive to increase costs of proxy fights (spend more to win more votes)
(2) incentive to discourage those w/out enough $ to ante up
(h)  get paid according to # of shareholder votes received
(i)	qualify expenses that are reimbursable – pay only certain expenses to everyone - ie, exclude unreasonable expenses
a.  Strategic Use of Proxies/Reimbursemt of Costs
	(1)	insiders get paid regardless if win or lose as long as shareholders are fully informed 
	and costs associated with the proxy are reasonable Levin v. Metro-Goldwyn-Mayer, Inc.
(a)	shareholders can sue mgt for overspending but not likely to win
	ex. Levin v. Metro-Goldwyn-Mayer, Inc.  – P argued that D directors couldn’t use corporate funds to defend in a proxy fight – ct says no (rule above)
(2)	outsiders can also be reimbursed if they win, provided that decision to reimburse is ratified by shareholders
	(a)	Rosenfeld v. Fairchild Engine & Airplane Corp. - shareholder sues mgt to 
	have funds used for proxy fight returned to corp. – ct says no – it was reasonable and ratified by the shareholders
b.  Private Actions For Proxy-Rule Violations
	(1)	Rule 14a-9  prohibits false & misleading statements in proxy solicitations 
-	 14(a) - Proxies
(a)  Solicitation of Proxies in Violation of Rules & Regulations
-unlawful for any person to use mail, interstate commerce or national securities exchange in contravention of rules & regulations as Commission may prescribe as necessary & appropriate for protection of public interest or investors, to solicit or permit use of his name to solicit proxy or consent or authorization for any security (other than exempted securities) registered under 12
-	Rule 14a-9 - False or Misleading Statements
(a)  no solicitation subject to this regulation shall be made via proxy statemt, form of proxy, notice of mtg or other written or oral communication, 
-containing any false or misleading statement with respect to material fact at time & circumstances in which it was made, 
-or statemt omitting material fact necessary
-to make it not misleading or false or
-to correct any statemt in earlier communication with respect to solicitation of proxy for same mtg or subject matter which has become false or misleading
(b)  fact that proxy material has been filed w/ or examined by Commission not to be deemed:
-finding by Commission that material is accurate or complete, or not false or misleading or,
-that it has passed on merits of or,
-approved any statement contained or any matter to be acted upon by security holders,
-no representation contrary to foregoing to be made
c.  misstatemts of motivation only - insufficient for liability 
1.  mgt can lie about motivations
2.  shareholders can verify facts for themselves & decide own opinions
3.  mix statemt of fact & opinion - separate fact & opinion
	3 types of statemts - pure opinion, pure fact, mix of fact & opinion
d.  there has to be an essential link between misstatement & harm - causation
	VA Bankshares, Inc. v. Sandberg - bank holding co. holds majority of shares in a bank - wants to squeeze out minority shareholders & so issues proxy statement of proposed merger between bank & holding co.; statement says that $42/share is high value (opinion) - and has omissions & misstatements as to why bank thinks merger is good (its motivations – high price is not the reason), shareholder sues but loses b/c while there is a possibility that the proxy statement contained misleading statements that could have been actionable – there was no essential link between the proxy statement and the merger (that caused the harm) – the transaction could have gone through without their votes under state law – so the misleading proxy statement cannot be said to have caused the harm to them (causation under 14a-9).
	-	this type of misstatement – if not for the causation problem - would have been 
	actionable under §14a-9 – even though the misstatements were opinions – because the co. knew that the facts did not back up those opinions (knowledge that they were making an affirmative misrepresentations)
e.  shareholder who doesn’t rely on misstatements have standing to bring suit
1.  reliance element from common law no longer very important in personal security mrkt
2.  correct under policy considerations - mrkt theory of providing accurate info to mrkt
	3.	Stahl v. Gibraltar Financial Corp. – even thought the guy didn’t vote in 
	shareholder’s meeting based on the proxy statement – b/c he thought something bad was going on – he still has standing to sue
d.  Shareholder Proposals
1.	Rule 14a-8 - mandatory inclusion of shareholder proposal in mgt proxy materials
a.  Rule 14a-8 - Proposals of Security Holders
(a)	if any security holder of registrant notifies registrant of intention to present proposal for action at upcoming security holders’ mtg, registrant shall include proposal in proxy materials 
(b)	If they want to exclude, they have the burden to say why it should be exclude
§14a-8(c) registrant can omit under following circumstances
(1)  proposal is not proper subject for action by security holders under laws of registrant’s domicile
(2)  if proposal if implemented would require registrant to violate state or federal law of US or other foreign law registrant is subject to, provision not to apply if compliance w/foreign law would violate any US law
(3)  if proposal or supporting statement is contrary to Commission rules & regulations prohibiting false or misleading statements in proxy materials
(4)  if proposal related to redress of personal claim or grievance against registrant or any other person, or if designed to result in benefit to proposer or to further his interests not shared by other security holders at lg
(5)  if proposal relates to operations accounting for less than 5% of registrant’s total assets at end of most recent fiscal yr, & for less than 5% of net earnings & gross sales for same period, & is not significantly related to registrant’s business
(6)  if proposal deals w/matter beyond registrant’s power to effectuate
(7)  if proposal deals w/matter relating to conduct of ordinary business operations of registrant
(8)  if proposal relates to election to public office
(9)  if proposal is counter to proposal to be submitted by registrant at mtg
(10)  if proposal has been rendered moot
(11)  if proposal is substantially duplicative of another submitted for same mtg
(12)  if proposal deals w/substantially same subject matter as prior proposal sent w/proxy materials in preceding 5 calendar yrs
(13)  if proposal relates to specific amts of cash or stock dividends
b.  qualification requirements
1.  owner of $1k worth of shares
2.  for 1yr
c.  exceptions 14a-8c
1.  corp can refuse if laws of registrant domicile permit exclusion
2.  corp can refuse if deals w/ordinary business operations
a.  issues of employment policy are not ordinary business operations so can’t be excluded
	Amalgamated Clothing & Textile Workers Union v. Wal-Mart Stores, Inc. - union shareholder wanted to include EEO & affirmative action proposals in corp. proxy materials for annl shareholders’ mtg, court holds that corp has to include b/c it doesn’t fall under the ordinary business operations exception; Gives deferrence to SEC interp rule that says you can exclude something if it relates only to day to day operations and if it doesn’t involve any substantial policy considerations;  SEC had issued a no action letter in another case (Cracker Barrel) saying that it would take no action against a company for excluding such matters from its materials. D here tries to rely on that. Ct gives deferrence to interpretive rule and not to no action letter (no action letters aren’t intended to be binding as precedent in future cases)
b.  SEC enforcement of this interpretive rule had been all over the place – so ct doesn’t rely on recent applications of the rule
	3.	NYC Employee’s Retiremt System v. Dole Food Co., Inc. 
a.	Dole tries to argue business operations exception, insignificant relationship exception and beyond the power to effectuate exception
b.	Ct says no - issues of national health care are not ordinary business operation so must be included
c.	The proposal relates to Dole’s policy-making on issues of social significance – Dole uses more than 5% of its income doing that
d.	Dole can effectuate it through lobbying
3.	Austin v. Consolidated Edison Co. of NY - proposal for retirement after 30yrs of service regardless of age, current policy for retirement only if age + yrs of service = 75yrs, ct says issues of retirement policy can be excluded as part of ordinary business operations exception b/c collective bargaining by the union already deals with this issue – allowing this would just give them another forum
4.	SEC involvement in exclusions process
1.  requires corp to send materials & reason for exclusion to SEC
2.  SEC provides no action letters to corp to say that it won’t pursue matter
a.  calls for some deferrence by courts
3.  position that broad social issues can be excluded – social issues cannot be excluded when they are specific to the corporation – constitute a policy consideration for the co.
a.  S.Ct. holds that courts owe deference to latest agency decisions even if they are political and inconsistent over time
b.  administrative agency acts are entitled to deference unless patently wrong
2.	issues
a.  why does federal security rule intrude into relationship btwn shareholders & mgt (by allowing shareholders to make proposals)?
b.  seems inconsistent w/traditional rule that shareholders share hold & mgrs manage
d.	why does mgt oppose so vehemently b/c even when forced to include, shareholder proposals usually lose by wide majority? (bad PR)

e.  Shareholder Inspection Rights
1.	intro
a.  2 parts to shareholder’s right 
1.  specific right to inspect shareholder list
2.  general right to inspect corp. books & records
b.  used to be based on common law but has been codified
1.  different requirements, etc. in different states
2.	to inspect shareholder lists
a.  requires proper purpose
1.  all things that affect corp. = proper purpose
a.  attempts of hostile takeover
b.  attempts at replacing directors in proxy contest
d.	Crane Co. v. Anaconda Co. - Crane wants Anaconda shareholder list in conjunction w/its hostile takeover bid of Anaconda
(1)	ct says – taking over the company through a tender offer is a proper purpose for getting the shareholder lists
(2)	But can’t be for an objective adverse to the company or its stockholders
(3)	This case also subject to NY law requirements
1.  shareholder of record for at least 6mos, or
2.  own at least 5% of any class of stock
2.  has to be germane to interests of shareholders (probably economic interest)
a.  hearing about social policy of war is not in DE
(4)	State Ex Rel. Pillsbury v. Honeywell, Inc. - not proper purpose when shareholder buys stock only to enable him to get the shareholder list and voice his opinion of this corp. participation in Vietnam War
-	this case is under DE law – which is more generous than NY as far as its requirements to get the list (just being a shareholder is enough) but they’re probably more restrictive about someone’s reasons for getting the list – to balance it out
3.	to inspect other lists
a.  CEDE list - shareholders don’t want identity revealed so brokerage buys shares & sends to depository - registered under their name instead of the individual person’s name
b.  NOBO (non-objecting beneficial owners) - Trustee is legal owner so listed under trustee’s name but beneficiary is real owner 
1.  shareholder can get these lists too in hostile takeover attempt even if not readily available
(5)	Sadler v. NCR Corp. - AT&T wanted to take over NCR; They couldn’t just do a tender offer because there was a poison pill in place; so they needed to replace the directors through a proxy contest (so that the directors would then remove the poison pill); They wanted the CEDE and NOBO lists so that they could get the names of the actual stockholders to get enough of a proxy to have a special meeting and then elect new directors; they had to have a special meeting rather than trying to elect all new directors at the next scheduled election – because the elections were staggered – only a few directors were elected at a time; There’s a conflict between NY and MD law (they had connections to both) about whether they can get the lists; Under the internal affairs doctrine – the chartering state’s law would be the one that governs (would be MD – wouldn’t get it). However, ct holds that for foreign corps (chartered outside NY), there is an exception regarding shareholder lists – so local law applies (NY) – they get the list.
ii.  Shareholder Voting Control
1.	general rule
a.  state & federal law – interested in protecting voting rights of shareholders 
b.  corp. can lawfully limit all other rights
1.  can refuse to pay dividends, etc.
(6)	Stroh v. Blackhawk Holding Co. – corporation can have any kind of restrictions on their stock that they want – just can’t restrict voting rights
iii.  Control in Closely Held Corp.
1.	intro
a.  characteristics of shareholders in closely held corp.
1.  substantial capital contribution
2.  few shareholders
3.  rare that others buy into or existing shareholders sell
4.  shareholders are often directors & officers
b.  problems of closely held corp.
1.  dominant shareholder can engage in unfair behavior at expense of minority shareholder
2.  potential deadlock when shareholders are of equal power
3.  can’t sell out easily
c.  comparison to lg corp.
1.  problems
a.  collective action – have to get a bunch of shareholders together to vote on stuff
b.  misalignment of interest between mgt & shareholders
2.	ways to protect minority shareholder
a.  law
1.  can’t separate voting from ownership  - but exceptions
a.  justification - want economic interests aligned w/ownership
b.  exceptions
1.  voting trusts – an agreement establishing a trust whereby shareholders transfer their title to shares to a trustee who is authorized to exercise their voting powers (state statutes usually limit their length)
2.  voting via proxy
a.  shareholder usually tells proxy what he wants
b.  most are revocable
c.  those that are irrevocable are permitted only if voting right given to proxy is coupled w/interest
(7)	lender taking stock as collateral & attendant voting rights
2.  concerns/purpose of law
a.  If you don’t protect minority voting rights in lg corp. - separation of ownership & mgt creates problem of mgt agency costs (mgt protecting its own interests instead of that of the ownership)
b.  If you don’t protect minority voting rights - in sm corp. oppression of minority interests by dominant shareholders
(8)	Miller opinion that protections for minority shareholders are not perfect – if you don’t enter into trusts or take other action – the minority will get screwed 
1.  shareholders can vote any way for any reason
2.  dominant shareholders (if they hold 51% or more) can elect directors who are subject only to:
a.  duty of care - director usually wins 
b.  duty of loyalty - tough for  win if shareholders can ratify director decisions
b.  K btwn shareholders
1.  general terms - doesn’t really work to protect minority shareholders
2.  specific terms - have to be careful that it doesn’t look like shareholders are trying to get involved in management (beyond voting for directors)
a.  ex. agreement between shareholders not only that we’re going to elect this group of people as directors but that those directors will choose a certain person as president – not ok
b.  ok if involves in way shareholders vote
b.  works if all shareholders agree – if not, you run into problems
3.	voting trusts upheld
a.  makes trustee a fiduciary to vote shares - to ensure shares vote as a block
b.  sometimes statutory time limit imposed
(1) to deter over concentrations of power for long periods of time
(2) allow realignment of interests btwn shareholders & trustee – make sure the shareholder’s interests are still represented by the trustee
4.	shareholder agreemts upheld
(1)	Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling - shareholder agreement btwn 2 shareholders that obligates them to vote same way (creates cumulative voting power – protects interests of the minority – like a voting trust but the parties retain title to the stock and just agree to vote together), if parties can’t agree on who to vote for – it goes to an arbitrator & shareholders are supposed to abide by her decision; Here, arbitrator told D to vote for same people as P – D didn’t do it; court holds for  by throwing out all of D’s votes that weren’t in accord with the arbitrator’s decision;  
(2)	Most courts now would order specific performance – forcing D to vote in accord with the arbitrator’s decision
c.  shareholders can make agreements as to mgt control when there is no potential of harm to anyone (all shareholders agree so no risk of shareholders getting screwed and board’s power is not overly impaired)
(1)	Clark v. Dodge - 1936, minority shareholder  fired (after sharing trade secret to ‘s son) breaching agreement between  &  majority shareholder of corp. in business of manufacturing medical preparations; shareholder agreement calling for continuing service by  as director & mgt position as long as faithful, efficient and competent is not violation of public policy b/c there is no potential for harm to anyone
-	a shareholder’s agreement is valid as long as it’s agreed to by all shareholders and doesn’t sterilize the board (impair their powers in a significant way)
(2)	old rule that shareholders can’t agree amongst themselves to control mgt (apt of mgt)
-	McQuade v. Stoneham - 1934, majority shareholder of baseball teams sells some shares to  & another party w/agreemt to keep them all directors & officers of co. and receive a certain salary but  is fired; provisions of keeping them officers at certain salary is illegal as to public policy although shareholders may combine to vote a certain way (for directors, etc.)
-	Distinguish from Clark: in that minority shareholders could be hurt by this agreement (wasn’t ratified by everyone) (in Clark, there were no minority shareholders)
-	Also, the board appears to be sterilized in this case – actually dictated what the board had to do
(3)	More modern liberal rule - Galler v. Galler - 1964, shareholder agreement between only 2 shareholders in wholesale drug co. (duration of agreement lasting until death, calling for election of certain persons to office, purpose of agreement to protect families of shareholders, dividend payment agreement, salary continuation to widow of shareholder in event of shareholder death) upheld b/c there is no harm to public, other minority shareholders or creditors
-	more liberal because it allows the agreement to infringe on the board’s powers 
-	ct may have upheld this agreement because they knew a buyout was going to happen anyway
-	More conservative rule has been made into law (statute) in many states – that’s the more likely outcome
(4)	justifications for shareholder’s agreements in closely held corp. setting
1.  few shareholders
2.  rare that others buy into or existing shareholders sell
3.  can’t sell out easily
4.  shareholders have made substantial capital investments
5.  shareholders are often directors & officers
6.  shareholder agreements are necessary in this context
b.  don’t have to qualify as closely held corp. to engage in these types of shareholder agreements
(5)	Ramos v. Estrada - 1992, shareholder agreement calling for all shareholders to vote shares according to decision of majority of shareholders (to prevent shifts of power in a newly merger corporation); restricting sale or transfer of shares & forced sale at certain price for violation upheld even though not close corp. 
-	recently, cts are respecting shareholder agreements much more as long as they don’t sterilize the board
c.	summary
(1)	For medium sized companies, Miller likes the McQuade rule because it insists that managers manage – keep shareholders out of the management of the company without infringing the rights of the minorities
(2)	Small corps – Clark rule
(3)	Large corporations – shareholders agreements are impractical 

iv.  Abuse of Control
1.	majority shareholders owe minority shareholders in close corp. fiduciary duty of utmost faith & loyalty  like partners do to each other; to be balanced against majority selfish ownership
2.	Fiduciary duty in a closely-held corporation
(1)	Usually, shareholders are allowed to be selfish and their decision about whether to keep directors will usually be judged by the business judgment rule; Massachusetts has recognized that close corp are similar to partnerships so they find a similar fiduciary duty; 
(2)	(Mass.) Donahue – stockholders in a close corp. owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe each other
(3)	(Mass.) Wilkes v. Springside Nursing Home, Inc.- 4 shareholders agree to own & operate corp. equally; W’s relationship w/others deteriorates to until the 3 stop paying him salary, fire him, don’t re-elect him as director; court finds fiduciary duty between majority shareholders & minority shareholders & subsequent breach so W wins
(a)	Wilkes test for breach of fiduciary duty in a close corp. freeze out
-	1st P must allege freezeout and must establish a prima facie case of freezeout
-	Then, burden shifts to D to show business purpose
-	Even if business purpose is shown, P will then have the opportunity to show less restrictive means could have been used (could have accomplished the same thing without freezing P out)
(b)	Other claims Wilkes could have made include
-	breach of implied contract based on course of dealing
-	breach of implied shareholder agreement
(c)	equity considerations - in how D treats P
1.  W’s idea for corp.
2.  3 try to buy W off at unfair price
3.  W got corp. better deal 
4.  no evidence of failure of W duties
5.	no evidence that 3 considered W’s interests
(4)	Cts don’t apply the full fiduciary duty of partnerships – they balance the fiduciary duties of partnerships with the business judgment rule of corporations – to try to find a middle ground between oppression and deadlock
(5)	Ct tries to strike a balance between fairness and allowing entrepreneurship
(6)	If you want to do something in a close corp, needs to appear that you’re being fair (create a record of fair behavior)

b.  where don’t have employmt K & is fired requiring reliquishing of stock per employmt K, fiduciary duty of majority to minority shareholders is not implicated
(d)	Ingle v. Glamore Motor Sales, Inc.- G hired I w/out employment K & executed a shareholder agreement that included provision stating that should employment end for any reason, G would have to option to buy back all stock at set price, court holds no duty btwn majority & minority shareholders where it was employment at will & shareholder position dependent on employment status
-	equity – appearance that I was paid off at a fair price
-	Mass. Would probably find a duty
3.	test of majority liability
a.   prima facie case - closed corp., allege freeze out or oppression
1.  excessive compensation to majority & not to minority, or offer to buy out at low price alone insufficient to establish breach of duty – you have to also prove that majority is draining corp. assets to freeze-out minority or that their actions are part of a plan to freeze out minority 
(a)	Sugarman v. Sugarman- 4 brothers in partnership to sell paper products reorganize where closed corp. owned 61% by majority & 22% by minority shareholders, claim by minority that majority is attempting to squeeze them out by refusing to employ them, paying excessive compensation to majority camp & having policy of no dividends, court holds that here indeed majority was attempting to squeeze out minority & therefore violated its fiduciary duty to minority  
(b)	Adds to requirements of Mass. Law from Wilkes
b.   affirmative defense - demonstrate legitimate business purpose for actions
c.   rebuttal - show that there was less harmful means to minority shareholders to achieve same purpose
(c)	Wilkes v. Springside Nursing Home, Inc. (if they had a business purpose to get rid of this guy, they didn’t have to treat him so badly to accomplish that)
d.  problems w/this approach
1.  focuses court attention on equities
2.  dichotomy of results dependent on whether it is a close corp. or lg corp.
a.  problem then is what constitutes a close corp.
3.  doesn’t address when parties can’t get along (people won’t want to act for fear of breaching fid. Duty so bad relationships will fester)
a.  best way to handle this problem is to establish record of attempts to remedy & then take it to court for equitable solution
4.	minority also owes such a fiduciary duty to majority when it has power 
a.  not as stringent as reverse
b.  minority actions subject to reasonableness test
(d)	Smith v. Atlantic Properties, Inc. - 4 shareholders @ 25% each, articles of incorp. required at least 80% approval for decisions (effectively unanimous), W founder refuses to approve declaration of dividends leading to tax penalties & legal expenses, court holds that minority also has fiduciary duty to majority to act reasonably where minority can work to oppress the majority
5.	overlay of Rule 10b-5
a.	default rule where “knowledgeable insiders: in close corp. have duty to disclose to outsiders events substantially affecting the value of the stock 
1.  outsider is employee of insider employer & quits - relinquishes his stock to employer per employment agreement which allows buyout at book value
(1)	Jordan v. Duff & Phelps, Inc. - 1987, Easterbrook, e-r didn’t inform him of pending merger that would increase value of his shares to $600k, court holds default rule of duty of insider to disclose material facts affecting stock under Rule 10b-5 
(a)	dissent - Posner, there should be no such duty – viper in the nest problem – when person knows they’re leaving, they don’t care any more – don’t want to make them stay
b.	duty wouldn’t exist in cases where the K specifically says that no information need be disclosed
c.	other considerations 
1.	how parties would have K-ed about this issue
2.	purpose of employment agreement
3.	would  really have stuck around - yes here
6.	sum
a.  in close corp have to be careful that not abusing minority
1.  make things clear at beginning
2.  try all options available to remedy situation, document, & then take to court to try to oust him

VII.  Mergers, Acquisitions & Takeovers
i.  Mergers & Acquisitions
1.	intro
a.  merger - bringing together group of assets
2.	mere buying & selling of assets - not considered merger
a.	reasons
1.  economy of scale/scope
2.  mrkt extension
3.  overcoming regulations
4.  tax reasons
5.  hubris - mgt like bigger co. for ego
6.  self-interest of mgt - higher compensation possible if bigger co.
3.  methods
(1) statutory - regulated by explicit state codes
1. basically buying out the stock of the other company so it ceases to exist
2. rights & requirements
a.  requires board approval by both
b.  requires shareholder approval by both
1.	shareholders can participate in decisions that fundamentally affect property
2.	interested parties may be excluded from voting (someone who has shares in both)
c. stockholders who dissent have an appraisal remedy (saying that when their shares were bought out, they weren’t paid enough)
a.  classic way to form 3rd co. that will acquire assets of 2 
b.  3rd co. can acquire assets of 2 for stock
(1) freeze-out (a subset of statutory merger) 
1.  no vote by the minority – a forced sale of shares
2.	rights & requirements
a.	need a certain % of shares under statute to freezeout the minority
b.	dissenting shareholders have appraisal rights (can go into ct and have them say what the stock should be worth if you think you weren’t paid enough)
2.  3 possible ways to do acquire enough shares to freezeout the minority
a.	buy shares on the market – unlikely b/c buying causes the price to go up
b.	stock tender offer (stock exchanges for stock)
c.	cash tender offer (stock exchanged for money)
3. ex. parent merges w/subsidiary
 (3) asset acquisition
a.  
example
1.  A acquires all asset of B for cash, B dissolves by distributing cash to shareholders in a liquidating dividend (B and its stock cease to exist)
b.  problem – what happens to B’s liabilities?
1.	A may assume all or part of B’s liabilities
(4)	Share acquisition– can be effectively same as merger
a.	stock tender offer- targets shareholders directly
b.	exchange offer - bidder offers shares in its own firm for shares in target
1.  ratio & price btwn 2 matters – has to be fair value to work
	c.	common in banking world only
	d.	shareholders don’t like this type of offer
1.	dilution effect, etc. – company who’s making the offer has to issue more stock to do it, makes the value of the outstanding shares go down
d.	cash offer - bidder offers cash for target shares 
	e.	most cases in this area - include hostile takeovers – don’t need approval 
	f.	most expensive 
	g.	leads up to merger
2.	de factor merger doctrine (very small minority of states have ever accepted it)
a.  in PA, ct said - can’t disguise de facto merger as sale of assets to avoid appraisal rights of dissenting minority shareholders (PA statute later says a sale of assets is a sale of assets – not a de facto merger subject to merger laws)
1.	case goes w/substance over form to find de facto merger Farris v. Glen Alden Corp
(a)	PA sale of assets law gives no appraisal remedy but their merger law does
(b)	Ct finds that sale of assets here was a de facto merger so merger law should apply – merger law does give an appraisal remedy
(c)	PA then makes law saying a sale of assets is never a de facto merger such that merger law should be applied.
b.  in DE, even though a sale of assets looks like a merger, the sale of assets statute still applies (not the merger statute) Hariton v. Arco Electronics, Inc
1.	going w/form over substance
2.	gives deference to the legislature – a sale of assets may very often look like a merger – but the legislature made a separate statute – they must have meant for it to be different
	3.   less concern for minority shareholders b/c all voted in favor – made decision easier for the court
	---------------------------------------------
3.	freeze-out mergers - usually cash-out mergers
a.  have to comply w/law
b.  have to pass entire fairness test - DE
1.  fair dealing - procedure
a.  considering overall course of conduct in merger 
b.  timing, hierarchy, disclosures at various levels
1.  manipulation of timing of acquisition even when conform to all laws & agreemts will fail fair dealing
	Rabkin v. Philip A. Hunt Chemical Corp. - Olin satisfies stock purchase agreemt & all other legal provisions in merging Hunt w/Olin, Olin purchased majority share from majority holder in Hunt for $25/share w/agreemt stating that if purchased remainder of shares w/in 1yr would do so at $25/share, Olin waits until 1 yr expires & then purchases remainder at $20/share after fairness opinion from investmt bank & negotiation w/Hunt board, court holds that this is manipulation of timing of purchase 2 violates fair dealing part of entire fairness test
	stock purchase agreemt purpose - to protect majority sellers against liability from minority shareholders (looks like made effort to protect them)
	investmt bank opinions - questionable objectivity
a.  telling corp. what they want to hear, hence provides range
c.  no overlapping loyalties, conflicts of interests, strong-arm tactics
e.	duty to disclose all relevant info
-----------------------------------------
2.  fair price in freezeout mergers- substantive
a.  factors to consider
1.  premium over mrkt
2.  fairness opinion by investment bank
b.  methodologies to consider
1.  DE block - looking at overall value after weighing assets, mrkt price, etc.
2.  comparables - looking at price of similar deals in similar/same industry
3.  discounted cash flow - looking at existing cash flow as annuity & extrapolating into future
	Weinberger v. UOP, Inc. - Signal becomes majority owner of UOP after tender offer & then decides to merge w/UOP by buying all of its shares, offers $21/share to UOP mgt, both boards approve, both shareholders approve, merger is deemed unfair to minority interests b/c fails fair dealing (doesn’t disclose A-C report & their conflict as UOP directors & Signal officers, rush on investmt bank opinion, push on UOP pres & director), court holds shareholder vote invalid b/c not informed, remedy in damages
	options for Signal - could’ve reached same result by taking more care that things appear more fair
a.  had UOP appoint independent committee of its directors to negotiate deal
b.  negotiations w/UOP over price
c.  proper business purpose test
1.  DE - don’t have to pass business purpose test (Singer v. Magnavox) b/c encompassed w/in entire fairness test 
	Weinberger v. UOP, Inc
2.  MA - have to pass this test otherwise merger will be considered illegal
a.  merging out minority in order to securitize personal debt is not proper business purpose
	Coggins v. New England Patriots Football Club, Inc. - MA, freezing out minority in cash out merger to securitize personal loan fails proper business purpose test & is therefore illegal merger, remedy is appraisal of value of shares had merger never occurred, sports franchise corp. voting shareholder buys out other voting shareholders w/bank loan & organizes subsidiary to merge current co. into it (voting shares in old to get voting shares in new, but minority non-voting to be cashed out) to securitize this personal debt, class action on behalf of opposing, nonvoting shareholders
	under state law, nonvoting shareholders have right to vote in merger
d.  remedy
1.  injunction
a.  if can’t remedy damages w/monetary relief 
b.  covers situation where price is fair but dealing is bad
2.  rescission
a.  rare
1.  can’t undue merger b/c innocent 3rd party reliers
b.  can get appraisal at today’s value had merger not happened
	Coggins v. New England Patriots Football Club, Inc.
3.  appraisal
a.  if price is not fair
	Weinberger v. UOP, Inc.
	remedy should be flexible
4.	de facto non-merger
a.  no such doctrine in DE
1.  under equal dignity doctrine, if corp. can achieve purpose under one statute that may violate another statute, going to permit it
2.  courts going to give corp. much deference
	Rauch v. RCA, Corp. - RCA to be merged into subsidiary of GE in cash-out merger (common shares given $66.50/share, preferred $40/share),  claims that as preferred shareholder should be given $100/share + dividends under corp charter b/c this is really redemption & not merger, court says not
	appraisal right here
ii.  takeovers
1.	intro
a.  2 ways to takeover in hostile situation
1.  proxy contest to appoint majority of directors
a.  disadvantages
1.  have to share benefits of improvemt w/other shareholders
2.  if lose, lose costs of contest
2.  buying controlling interest of shares
a.  advantages
1.  get more of benefits as majority shareholder
2.  if lose, can still win
a.  can make large profits by selling on mrkt since price will be high
b.  greenmail - hostile bidder can make profit by being bought out by corp itself
b.  disadvantages
1.  costs are high - investmt banks, attorneys, etc.
2.  have to buy stock - have to raise adequate capital to buy stock
3.  power defenses under law & lawyer creativity to incumbent mgt that may not be able to be defeated by bidder
	see less hostile takeovers in 1990’s vs. 1980’s b/c availability of such defenses
b.  tender offer
a.  description
1.  only a tender of stock from shareholder to bidder & not purchase until all conditions are satisfied
2.  bidder returns stock to shareholders if conditions are not satisfied
b.  methods
1.  any & all - bidder accepts tender of all shares provided conditions are met
2.  2-tier offer 
a.  explicit or implicit - when vague what bidder will do after stock is acquired)
b.  1st tier - promising to take certain % of stock
1.  if receive more tenders than promising to take, will return shares pro rata
c.  2nd tier - generally freeze-out merger eliminating remainder of shareholders
d.  front-loaded 2-tier offer - 1st tier offer is $ higher than 2nd tier
e.  back-loaded 2-tier offer - 2nd tier offer is $ higher than 1st tier
c.  economics
1.  bid usually substantial premium over mrkt stock price at time of initial bid
2.  after offer, mrkt stock price will go up
a.  if mrkt thinks bidder is serious & able, mrkt price will go up to bid price
b.  mrkt will pass bid price if thinks other bidders will bid
1.  puts pressure on original bidder to increase offer or w/draw
3.  bidder’s stock price generally goes down but not drastically
	target stock increases more than bidder stock decrease - so net increase
4.  bid success or failure effect on mrkt stock price
a.  if bid is successful, mrkt price will stay at bid price
b.  if bid is unsuccessful but white knight rescues, mrkt price will stay at bid price
c.  if all bids fail, mrkt price will return to price before any bids
d.  mgt participation
1.  potential positions
a.  neutral
b.  auctioneer - to get best price for shareholder so can defend 
1.  good b/c centralizes power
c.  can refuse
2.  concerns
a.  potential conflict of interest btwn mgt & shareholders - mgt interest in remaining in office
c.  defenses
1.  poison pills
a.  definition - corp binding itself to certain action if certain condition arises to make itself look less attractive as a target
1.  referred to as rights of shareholders
2.  example
a.  upon occurrence of certain event, corp. binds itself to pay out large dividend to current shareholders excluding bidder
b.  features
1.  vesting - when certain % of co. stock is acquired by bidder (usually 20%)
a.  corp. can redeem or rescind pill for nominal sum before it vests but not after
b.  rationale for redemption only prior to vesting - bidder will have enough control w/20% of stock (directly & indirectly) to force mgt to redeem or rescind pill
c.  3 different interests
1.  bidder
2.  target mgt
3.  target shareholders - will generally bring shareholder derivatives at this point
2.  exercising - usually only upon passing another threshold
a.  unlikely for bidder to have gotten this far b/c high probability that bidder will lose
c.  antidote
1.  no legal one
2.  courts - will illegalize pill if it looks like mgt is only trying to entrench themselves in office in violation of fiduciary duties to shareholders
3.  bidder - can try to bring mrkt place pressure but costly - trying to get shareholders to pressure mgt
4.  target mgt 
a.  can conduct asset sale to get around pill after it vests but only if poorly drafted b/c most pills cover this loophole
b.  settle class action suit by shareholders
1.  losts of other problems & risky
c.  can separate stock ownership & pill rights
2.  states also have anti-hostile takeover laws
d.  hostile takeover jurisprudence in DE
1.  common thread per Miller - court picks winners or who they think will win given their decision
2.  DE court has only regulated hostile takeovers & not necessarily outlawed them
a.  court has given power to say no to incumbent mgt
2.	rule
a.  business judgmt rule applies
1.  presumes good faith & honest belief of best interest of corp.
b.  when co. is not for sale
1.  when there is potential conflict of interest btwn mgt (entrenching themselves in office) & shareholders
a.  burden on mgt to show by preponderance of evidence that 
b.  there are reasonable grounds for believing danger to corp. policy b/c of another’s stock ownership
1.  have to show good faith
2.  have to show reasonable investigation of threats
	don’t make negative personal sentiments public b/c makes it look like entrenchmt - Revlon
	sounds similar to business judgmt rule except this shift of burden on interested director
	Cheff v. Mathes - 1964, DE, Maremont (known reputation as liquidator) tries to buy out Holland after buying substantial # of shares in Holland, M suggests merger w/H at $14.4/share when mrkt price is $11/share, Holland purchases its own stock driving up price, court holds that this corp. strategy is legal b/c trying to protect proper business practice
2.  mgt can adopt defensive strategies to maintain proper business practice
a.  rationale - corp. has power & duty of care to oppose take-over threat perceived harmful to corp.
b.  measure taken by mgt is reasonable in relation to the threat perceived
1.  have to identify threat
2.  defensive strategy has to be reasonable
	Unocal Corp. v. Mesa Petroleum Co. - Mesa initiated a 2-tier front-loaded tender offer for 37% of Unocal’s outstanding stock ($54/share in front & $54 security exchange at back), Unocal self-tender defensive strategy of $72/share ($6.1-6.5 billion in debt) excluding Mesa for remaining shares if Mesa gets 37%, Mesa seeking injunction against Unocal’s self-tender
c.  when it becomes inevitable that corp. is going to be sold, that there will be transfer of control, mgt duty to shareholders shifts from being protector of corp bastion to auctioneer to maximize value for shareholders
1.  mgt can consider interests of other constituencies only after equity holders maximization
	Revlon, Inc. v. MacAndrews & Forbes Holding, Inc. - Pantry Pride (Perelman) makes repeated hostile bid for Revlon (Bergerac), Revlon self-defense doesn’t work (self-tender financed w/notes - can’t dispose of certain assets, ties up operations, ties up cash flow on interest paymts) & so attempts to defend itself via merger w/Forstmann (F restrictions - waiver of covenants on notes, option for F to buy certain assets if deal falls through, no shop provision, cancellation fee to F if deal falls through, waiver of pill; F2 - agrees to support debts, lock-up option, remainder same), chancery grants temporary injunction against merger, DE supreme court upholds
2.  triggering of Revlon duty - when we know that there is a sale
a.  triggered when mgt decides to sell
1.  to pass 
a.  don’t exclude other bidders
b.  don’t favor one bidder over another
c.  make sure investmt bank opines about offer
d.  have appearance of serious negotiation
b.  triggered when mgt wants to sell to only 1 bidder (first & favorite)
1.  to pass
a.  have to prove provisions are reasonably related to bring first bidder forward
b.  can’t exclude all other bidders
c.  can use termination fee - can’t be egregiously high
d.  can use lock up
2.  rationale
a.  court understands that first bidder needs incentive to come forward b/c they don’t want to become a stalking horse
3.  difficulties
a.  difficult to know if duty is triggered
b.  difficult to pass
c.  uncertain when don’t want to sell but to merge w/another co.
1.  to pass
a.  can just say no if documented long-term corp. plan to show plans of remaining in control
	Paramount Communications, Inc. v. Time, Inc. - 1989, DE, Time (Nicholas/Munro) & Warner (Ross) merge in stock swap, Time adopts defensive strategies (share swap agreemt w/Warner, confidence letters from banks -paying them not to fund acquisitions of Time, onerous no-shop clause), Paramount (Davis) offers substantial premium ($175/share to $200/share) over Warner deal (mrkt valued at $125/share) that is open to negotiation, Time didn’t violate duty of auctioneer by accepting lower offer instead of the highest offer b/c Time wasn’t for sale, uncertain how much bite corp. culture maintenance argumt has
	counterargumts
1.  there is change of control b/c majority shareholders of Time will be Warner shareholders
	Time mgt paid premium to remain in control  arguably Time mgt violated fiduciary duty to shareholders for paying more than they had to Warner but for their interest in entrenching themselves in office
b.  sometimes this strategy doesn’t work b/c looks more like sale
	Paramount Communications, Inc. v. QVC Network, Inc. - 1994, DE, Paramount (Davis) wants to merge w/Viacom (Redstone) for cash & securities, Paramount adopts defensive strategies (agrees to release only Viacom from pill, no shop provision, gives Viacom option to receive difference in mrkt price & $69/share, termination fee $100m to Viacom), in bidding war QVC (Diller) offers $90/share w/Viacom $85/share, Paramount accepts Viacom’s offer, court holds this a breach of auctioneer duty imposed by Revlon 
	eventually Viacom won in mrkt b/c outbid QVC but lots of people speculate that Viacom paid too much
2.  rationale
a.  although majority control of corp. may have changed (held now by another corp. shareholders), there is no real change of control b/c shareholder control is so defuse
b.  otherwise would subject all mergers to Revlon duty which will lead to less mergers which will be bad for society as whole b/c less consolidations of assets creating efficiency
3.  difficulties
a.  uncertain if & when duty triggered in this situation
1.  lots of different options
2.  potential argumt that merger effectuates sale of co.
b.  uncertain when will pass
3.  breach duty of auctioneer if accept lower offer instead of the highest offered
	Paramount Communications, Inc. v. QVC Network, Inc.
d.  examples
1.  self-tender its own shares, excluding bidder
	SEC ruled later on that can’t exclude bidder from self-tender
2.  merging w/someone else to avoid take-over
	things to consider
a.  injunctions
1.  temporary - not final adjudication on merits
2.  permanent - effectively final adjudication on merits

* second semeseter material