Assignment No. 1 – The Corporate Entity

1.  Formation

Del 101-04, 106
NY 401-03

Corp – a legal entity (separate from its s/hs, created under the authority of the legislature)
•	can own property
•	can sue and be sued
•	has duties and rights
•	created by state legislatures – by statute
NY 401, Del 101: anyone can incorporate a corp by following the statute
NY statute is used only for creation of business corps (banking, insurance, schools, not-for-profit, religious – separate statute)
Del statute – corp of any character and any purpose (like not-for-profit)
•	has continuity of existence (as a legal entity, the corp’s existence continues notwithstanding the death or incapacity of its s/hs or a transfer of its shares; therefore, a corp is capable of perpetual duration)
•	investors and managers have no personal obligations and liability (as a legal entity, a corp is responsible for its own debts; s/hs normally are not responsible for corp’s debts; their liability is limited to the amount of their investment)
•	investments are not withdrawful until the business is liquidated (creditors are paid off)
•	interest is freely transferable (ownership interests in a corp are represented by shares, which are freely transferable)

	Corp	General Partnership	LLC	
Creation	state	parties	State	
Entity	yes	? (com. Law has never been able to decide)	Yes	
Continuity	yes	no	No	
Personal Liability	no	yes (each general partner is personally and unlimitedly liable for all debts and obligations of the partnership, i.e. his co, car, house, all other assets)	No	
Tax character	tax payer (corp is treated as an entity for tax purposes, so that it is taxed on its own income; if corp pays a dividend to its s/hs, the s/hs are taxed on the dividend – double taxation).	pass through entity – tax reporter (members pay the tax)	pass through entity – tax reporter (members pay the tax)	

LLP: general partners have the rights and obligations of partners in an ordinary partnership; limited partners do not participate in the management of the partnership’s business and are subject to only limited liability; but limited partner who participates in the business loses his liability status – makes himself in effect a general partner w/2 exceptions: securities industry and theatrical production.

Advantage of forming corp: doesn’t require much thinking; partnership requires a lot of negotiation, drafting – high transaction costs – cut against partnerships
Situations when LLPs are good:
1.	one-man business (don’t need a big agreement; in Del. – can have one-person LLP)
2.	a couple of big co’s who want to have a joint venture – bec. K will be negotiated and drafted anyhow + co’s would want a tax pass through

If you organize a small business – LLC is the way to go:
1.	limited liability
2.	to avoid disadvantages of double taxation
In US, duplicate taxation bet. corp and s/hs – pay tax on dividend – corps pay taxes twice on the same income

Hypo:
Investor X will invest $100, but he wants 10% return of net after taxes - $10,000 each year
How much money corp has to earn to deliver this to him?

RE = DR/(1-ER)(1-IR) = $10,000/(1-ER)(1-IR) = 10,000/(1-34%)(1-31%) = 10,000/(1-0.34)(1-0.31) = $23,675
Required Earnings = Demanded Return/(1-Entity Tax Rate) (1-Individual Tax Rate)
To give him $10,000, corp has to earn $23,675

Suppose there is no tax at all on the entity level (Entity Tax Rate = 0)
RE = 10,000/(1-0)(1-0.31) = 14,500

The coupon = 23,675% on a double taxation basis to give him $10,000 net
If no tax on the entity level – 14.5%
So, LLC is better – no double tax

But: limited liability becomes available over time, grows when people get comfortable with you, so for Joe and Loui who just want to open a hat shop, limited liability has no relevance.
If you want to leave profits in the business, you may be better off w/double taxation

Joe wants to open a hat shop
•	Register the name that you’re using
•	You can’t sue on Ks entered into during the time of doing business under the fictitious name, or w/o being registered
•	No other legal permissions are required (no gov’tal permission is required; if issues of public safety are implicated – then other req’nts)

HOW TO FORM A CORP

1.  Get a name
Del 101
NY 301
Name can’t be General Motors; every state has a mechanism – 
statutory in NY; in Del – non-statutory – practice of Secretary of State – will reserve a name usu. for 30 days while prepare docs for incorporation

2.  Who can form a corp - Incorporator
Del 101 – anybody can form a corp, including corp
NY 401 – natural resident older than 18
	Doesn’t make a difference bec. the only thing incorporators do is sign an original doc (usu. secretaries in the office of a lawyer)

3.  Certificate of Incorporation
doc that gets filed in NY and Del
NY 402, Del 102

4.  Purpose
NY 402(a)(2) – can form corp for any lawful purpose except when investor wants to limit the purposes (only hats, not aluminum)
Del 102(a)(3)

5.  Aggregate number of shares
NY 402(4) – universal requirement that you state the aggregate number of shares: it solves the legal problem of overissue (when corp issued more stock than it was authorized to issue)
NY 402(5) and (6) – there can be more than one kind of stock: unlimited residual subordinated claim to the assets – junior to all other claims
402(a)(5) all s/hs as a class (these rights can be divided up – diff classes of people will have diff claims ag assets)
402(a)(6) authorize some number of hsares as preferred stock – can createa class of preferred stock w/o having to have an amendment to cert of incorp.

6.  402(a)(9) duration of corp if other than perpetual

7.  402(b) eliminates liability of directors or s/hs for negligence

8.  402(c) cert of incorp may set forth any other provision relating to the business of the corp, including what is required or permitted to be set forth in the by-laws: meeting of incorporators, they elect directors – by-laws (internal housekeeping) – when and where mtgs, how often, how many directors, etc.

Any am’nts of cert of incorp require s/h voting.
By-laws can be amended by s/hs, in some states – by directors
If you put smth in cert of incorp – it’s much harder to get it changed

9.  Where to organize a corp
Can do it in any state (don’t have to be a local of that state)
If Joe and Loui – incorporate where you are (doesn’t matter NY or Del)
If for a public client – better to organize in Del

	Advantage of Delaware:
1.	statute is up to date and dealing w/new problems
2.	Del court system: most litigation involving corp law is in equity proceedings rather than in law; s/h derivative suits are equity actions; Del still has separate courts for law and equity; the great bulk of corp suits are in Del equity courts (chancellor) – extremely high level of expertise in these courts – legal predictability (there is huge law on these isssues)
Litigation – not a good thing

10.  File doc’nt w/the office of Secretary of State – comes into existence the moment the office accepts your doc’nt for filing (give you a copy)

Timberlane Equipment v. Davenport		doctrine of de facto corporation
						doctrine of corporation by estoppel

P brought action for equipment rentals ag. D.  D alleged as a defense that the rentals were to a de facto corp, of which D. was an incorporator, director and s/h.  D also alleged P was estopped from denying the corporate character of the organization to whom P rented the equipment.
	People executed Art of Incrop of their Oregon Corp in Jan; Articles were rejected by Secretary of State; they didn’t file revised Articles until June; P leased them equipment between Jan and June; business failed – P is suing the individual Ds because he couldn’t get any money out of corp.

De facto corp is said to exist when there is insufficient compliance to constitute a de jure corp vis-à-vis the state, but the steps taken toward formation are sufficient to treat the enterprise as a corp w/r/t its dealings w/third parties.  In such cases, the corp statuts can be invalidated by the state through quo warranto proceedings, but not by creditors or other persons who have had dealings with/the enterprise.

P: de facto corp doctrine no longer exists in Oregon – paperwork is inadequate, corp is not formed de jure
D: there is de facto corp – so ind’ls are not personally liable
The Model Act – is intended to abolish de facto corp doctrine
Oregon court holds: the doctrine of de facto corp no longer exists in Oregon (read the Model Act that it intended to abolish de facto corp doctrine)

Model Business Corporations Act
1.	almost no influence on NY or Del statutes (except for Cal)
2.	NY adopted the Model Act
3.	a lot of amendments to the Model Act – so different in all states

2 more q’ns:
1.	corp by estoppel; if not – if no corp
2.	who can be sued?

Corp by Estoppel: a party may be estopped from challenging the corp status of an enterprise, even though the enterprise has not achieved de jure or de facto status, on the ground of estoppel.
1.	true estoppel – reliance by one party on the other’s representation: an association, or its owners, having claimed corp status in an earlier transaction w/P, later denies that status in a suit brought by P (at least if P relied on the initial claim) – courts will estop corp from asserting that corp didn’t exist if P seeks restitution for the benefit conferred
2.	technical procedural context: D in a suit brought by a would-be corp may seek to raise the defense that P is not really a corp, and so cannot sue in a corporate name.  The courts tend to regard such defenses as nonmeritorious, and hold that D is estopped from raising the defense.
3.	here (the exact opposite of ordinary estoppel): P who has dealt with a business as a corp seeks to impose personal liability on would-be s/hs who in turn raise estoppel as a defense.  Should P, having dealt with a business as if it were a corp, be prevented/estopped from treating it as anything else

Court doesn’t apply estoppel doctrine here (P didn’t know that there was no corp)
Assuming that there is liability here, who is liable?
	Court:
•	if D is only an investor – he is not liable
•	but if investment + management – liable (D not only has an investment in the enterprise, but also exercise control or actively participate in policy and operational decisions)
NY rule: completely different – agency rule of implied warranty of authority: if I’m an agent and have actual or apparent authority – I bind you; if I don’t have authority – you have a lawsuit on breach of implied warranty of authority (if I represented that I had authority an you relied on it – I’m liable)

Quo Warranto

A trad’l method for testing corp status is through a quo warranto proceeding brought by the state; prerogative writ
Such a proceeding can be maintained even against a de facto corp, bec. the de facto theory is a defense only against a challenge raised by private actors – not against a chalellnge by the state itself.  (NY 109).

Ultra Vires - beyond the purposes and powers of the corp
Del 124
NY 203
S/h may sue corp on 2 theories
1.	this activity was beyond the purposes of corp under cert of inc
2.	this activity was beyond the purposes of corp under the statute -
Del 102(a)(3), NY 402(a)(2) (for any lawful purpose)
Del 122 Specific powers
1.	to have perpetual succession (existence)
2.	to sue and be sued
3.	 to have a corp seal
4.	to acquire, hold, and dispose of personal and real property
5.	to appoint officers
6.	to adopt, amend and repeal bylaws
7.	to dissolve itself
8.	to conduct business inside and outside the state
9.	to establish pension and other incentive and compensation plans
10.	to acquire, hold, vote, and dispose of securities in other corps
11.	to make Ks of guarantee and suretyship: corp now can become a partner and a guarantor
12.	be an incorporator, promoter, or manager of other coprs
13.	to participate w/others in any corp, partnership, or other association of any kind that it would have power to conduct by itself, whether or not such participation involves sharing or delegating control w/others
14.	to make donations

Corp powers can be implied as well as explicit – so the problem of corp powers bec less and less significant.

McDermott v. Lewis		conflict of laws
the internal affairs doctrine (in Del)

In conflicts, the rights and liabilities of a corp are determined by the local law of the state which has the most significant relationship to the occurrence and the parties; such affairs are generally left to courts of the state of incorporation.

Q’ns:	who is amenable to suit
	where it can be sued
	what law applies

McDermott Delaware (Delaware corp) is a public co - parent
McDermott Int’l Panama (Panamian corp) is a 92%-owned subsidiary of McDermott Delaware; primarily does business outside the US
Reorganization: swap places – McDermott Panama becomes parent; McDermott Del becomes subsidiary: McDermott Panama buys a majority share of McDermott Del – McDermott Panama now owns 92%, McDermott Del owns 8%.
P – s/h of McDermott Del – sues McDermott Del to enjoin or rescind Reorganization.
If the stock belongs to McDermott Del – the Board of McDermott Del votes; but its 92% is owned by McDermott Panama – so McD Panama chooses the Board of McD Del – gets to decide how the shares are voted – you couldn’t do it in the US: if McD Panama was incorporated either in Del or Louisiana, its stock could not be voted by a majority-owned subsidiary; in US – shares owned by a subsidiary would be voted in election; Panamian law allowed these laws to be voted (the 10% voting interest given to McD Del would be voted by McD Panama).
	To what law do we look to determine the validity of this arrangement – the law of place of incorporation – the internal affairs doctrine
So S.Ct. of Del – against P – trial court should apply the law of Panama to the internal affairs of McD Panama (no nexus bet McD Panama and the state of Del; issues do not involve the internal affairs of McD Del).

Problem: a number of states (NY) attempt by statute to apply domestic law to foreign corps
NY 1319, 1320
Cal purports to apply its domestic law very broadly to corps doing business in Cal – to pseudo-foreign corps (its charter is granted by state other than where it does business)

2.  The entity idea

•	Since a corp is a legal entity distinct form its s/hs, the rights and obligations of a corp are normally separate from those of s/hs.  All claims and j’nts ag corp may be satisfied only by corp assets.  S/h normally has no liability for corp debts or other obligations.  S/h liability is limited to the loss of her investment, and s/hs may not be held personally liable (if such s/h is another corp, that corp will not be held liable), unless sufficient reasons to defeat this general policy.
•	Piercing the corporate veil: under certain cir’ces, s/hs become liable to corp creditors– if corp entity is used to evade obligations, taxes or other statutory restrictions, courts will prevent the abuse by disregarding the corp entity and looking directly to s/hs
•	Applies usu to: corps w/only a small number of s/hs – 
close corps
parent/sub relationship where parent should be held liable for the actions of sub
•	Veil is usually pierced when:
1.	Fraud – use of corp form to evade creditors, or the corp is specifically formed for the evasion of statute or other duty
2.	Undercapitalization – corp formed so as to avoid liability likely to be incurred in operation: whether corp was organized w/sufficient resources (by way of capital, liability insurance) t meet obligations that reasonably could be expected to arise in its business
3.	Commingling of assets - commingling of personal and corp funds: s/hs deal w/assets of corp as if those assets were their own, e.g. by using corp funds to pay private debts, or for other private purposes (+aggregate shifting of assets, either bet a corp and its subs or a corp and other corps)
4.	Disregard of corp formalities – failure to observe corp statutory requirements (stock issued, corp records maintained, directors/officers elected, regular mtgs of directors and s/hs held)
but: statutory close corps – permit less formal mgmt of these corps’ affairs
5.	Domination and control by s/h – when an individual or another corp that owns most or all of corp’s stock so completely dominates corp’s policy and business practices that corp can be said to have no separate mind, will, or existence of its own (e.g. when parent copr directly determines the business policy of a sub, rather than allowing that policy to be determined by the sub’s board)
6.	Alter ego/Instrumentality/Unity of interest – no separate entity has been maintained; corp is only the alter ego or instrumentality of its s/hs; or there is a unity of interest bet corp and its s/hs (alter ego – a corp used by an individual in conducting personal business)
7.	Requirement of fraud, wrong, dishonesty, or injustice – some courts says that corp veil will be pierced only if it was used to commit fraud or wrong, and injustice would be done to P if the veil is not pierced

United Paperworks v. Penntech	In the absence of fraud, control and alter ego by itself will not result in disregarding corporate entity

•	P created TP to acquire Kennebec.  Kennebec entered into agreement w/Union to extend K.  Kennebec shut down the mill, fired e’ees.  Kennebec is out of business.  Union wants to arbitrate pursuant to arbitration clause in collective bargaining agreement – wants compensation to e’ees.
•	Is Kennebec available to arbitrate w/Union?  Yes, but it doesn’t have any money.  Union wnts to arbitrate w/Penntech, bec Penntech has money.  Union claims: Penntech should be required to arbitrate w/Union.  But neither Penntech, nor TP is a party to col barg agr’nt, just Kennebec.
•	Issue: Whether Penntech can be ordered to arbitrate provisions of the collective bargaining agreement which it was not a party to
•	Union claims: Kennebec should be disregarded; disregard corp entity of TP – get to Penntech.
•	Litigation in fed court – collective barg agr’nts – exclusive j’n of fed courts
•	What law should be applied?  Internal affairs doctrine is n/a – applies only to matters relating to internal business of corp – law of the place of incorporation – not internal here; fed court will look to the law of the state – which state? – Kennebec is incorporated in Maine, K was to be performed in Maine (both TP and Penntech – Delaware corps); Court here refers only to Maine law
Conflict rule: the issue of disregard of corp entity – law of the state of incorporation
•	Court applies Instrumentality Rule – Sub will be deemed alter ego of parent, and mere instrumentality if elements of 3-part test are satisfied:
1.Control – complete domination, not mere majority or complete stock control, over finances and policy/business practice w/r/t transaction attacked, sot that corp entity as to this transaction had at the time no separate mind, will or existence of its own – court found here; and
2. Fraud or wrong – control must be used to commit fraud, wrong or violation of statutory/legal duty (and mirep’n) – not found here; and
3. Proximate cause – control and breach of duty must proximately cause injury or loss complained of
•	Court finds: TP is alter ego for Penntech.  But Court doesn’t decide whether TP’s entity should be disregarded.  Court applies 2-part test:
1.	Control over subsidiaries - yes
2.	Fraud, some wrongful conduct - no
•	Held: In the absence of fraud, control and alter ego by itself will not result in disregarding corporate entity

Riddle v. Leuschner		disregard of corp formalities
undercapitalization (if corp is undercapitalized, the corp entity will be disregarded – importance of undercapitalization)

•	Yosemite and Kadota – 2 corps owned by Leuschners: owned all the stock and controlled the co’s.  Creditor sues them – seeks to hold ind’l officers and directors of two co’s individually liable as alter egos of corps.  Ds - all family members (Leuschner, Sr – no shares, Mrs Leuschner – one share, Leuschner, Jr – a lot of shares) – owned in various amounts the majority of the stock of each co; were commingling the assets of corps – paid personal bills and bills of corps together; made loans to and from the co’s.
•	When you have co of this size – 3 family members as s/hs – corp formalities are disregarded – common practice.
•	Court places great emphasis on the absence of formalities: once things become bad, formalities become important – all the procedures ought to be carefully done.
•	Trial court found: assets of Yosemite were intermingled w/assets of Kadota to evade payment of obligations; they are not separate entities, but a single entity operating as Kadota; each corp was the alter ego of the Leuschners (the two corps used the same offices, furniture/files, retained the same atty/bookkeeper)
•	App. Court – Rule: 2 req’nts for disregard of corp entity
1.	that there be such unity of interest and ownership that he separate personalities of the corp and the ind’l no longer exist, and 
2.	that, if the acts are treated as those of the corp alone, and inequitable result will follow
•	Held: both conditions are met, and cos were alter egos of 2 of Ds – Mother (owned one share) and son (owned majority of stock).  Held, one share is enough in light of facts.  Both mother and son could be held personally liable for liabilities of co as principals or partners.  Father that did not own any stock was not held liable – he’s treated as a managing agent/e’ee, rather than s/h or owner.
•	Slain’s morale of the story: if business is striving not to fail, all formalites should be in place (if you skip formalities, smb will play on it)

Sea-Land Services v. Pepper Source	reverse pierce corp veil to reach D’s other corps
injustice – has to be unjust enrichment - some wrong beyond creditor’s inability to collect

•	P/Sea-Land could not recover its j’nt against PS, so it brought this action ag Marchese and 5 business entities he owns.
•	Sea-Land wants to disregard the corp entity of PS, pierce PS’s corp veil and reach Marchese, determine that he is personally liable for j’nt owned to Sea-Land, and then reverse pierce all Marchese’s other corps bec all corps are his alter ego, so that they also be on the hook for Sea-Land’s j’nt.
•	Here, really asset commingling, corp undercapitalized
•	Court uses 2-part test – 2 req’nts for corp veil-piercing:
1.	there must be such unity of interest and ownership that the separate personalies of the corp and the ind’l [or other copr] no longer exist; and
2.	cir’ces must be such that adherence to the fiction of separate corp existence would sanction a fraud or promote injustice
injustice – non-payment of obligations/unsatisfied j’nt is not enough – has to be unjust enrichment – has to be some wrong beyond creditor’s inability to collect
In the end, both req’nts were satisfied – ag. Marchese

Walkovszky v. Carlton		taxicab case: tort
reject Enterprise Liability theory
undercapitalization
the fact that assets of co and insurance were not enough to cover P’s recovery does not alone justify piercing the corp veil – more than undercapitalization is required (need some sort of fraud).  For personal liability, ind’l s/hs should in reality be carrying the business for personal, not corp ends.

•	P/Walkovszky – injured by taxicab in autoaccident, which belongs to Seon (corp), D/Carlton – s/h of 10 corps, each of which owns 2 taxis and one of who’s co’s (Seon) owns the taxi that hit P.
•	P wins, but can’t get his j’nt: Seon (and all other co’s ) has no assets and only the minimum automobile liability insurance required by law - $10,000 on each 2 cabs.  This structure is common in industry and is designed to limit the liaiblities to cab owners that can arise from accidents (Carlton wants to limit his liability exposure; if he had just 1 corp, he’d be forced to buy higher liability insurance, bec other wise P could get his entire business)
•	P sues to (1) disregard the entity of one of the corps owned by D (Seon) and hold D personally liable, and (2) have 10 cab co’s treated as a single entity/unitary business, disregarding their separate corp existence, so that all of coprs should be liable for any one corp, for all assets and obligations, thereby enabling their collective assets to be reached - Enterprise Entity Theory; P’s theory – Leg’re didn’t want D to escape liability
•	Capital – investment of s/h in the business; here P argues that corp is undercapitalized – it has to cover possible foreseeable losses – cost of injures; but the issue of capitalization is irrelevant in this case; to adequately protect P, D needs to have insurance policy w/high enough limits so that the business can pay for any costs
•	Tort: Walkovzsky didn’t choose to deal w/this co (could ask beforehand, so what can we do for people in his sit’n: (1) arrangement for how much insurance a corp should have, and (2) there should not be limited liability w/r/t tort claims, but people will be reluctant to invest in a business unless other investors are at least in as good shape as you are financially – high transaction costs
•	Concept of Enterprise Liability – here 20 cabs – it’s one business; but what if 10 caps in Manhattan and 10 in Canada – is it 1 or 2 businesses?
•	NOTE: NY courts are very reluctant to pierce the corp veil – most reluctant in the US
•	Held: There was no alter ego – the fact that assets of co and insurance were not enough to cover P’s recovery does not alone justify piercing the corp veil – more than undercapitalization is required (need some sort of fraud).  For personal liability, ind’l s/hs should in reality be carrying the business for personal, not corp ends.
•	Here, no evidence that D was running co’s really in his ind’l capacity, and no evidence of fraud.  It is not fraud to take out minimum insurance; in any case, leg’re should remedy the inadequate insurance coverage, not the courts.
•	In order for P to show that D conducted business in his ind’l capacity and thus be able to disregard the corp entity and hold D personally liable, P must show that D used corp funds in fraud of creditors
Here, P alleged that none of the corps had a separate existence of their own.  However, 
it is one thing to assert that a corp is a fragment of a larger corporate combine which actually conducts the business – then only a larger corp entity would be held financially liable (when pierce the corp veil)
It is quite another to claim the the corp is a “dummy” for its ind’l s/hs who are in reality carrying on the business in their personal capacities for purely personal rather than corp ends – then the s/h would be personally liable (when pierce the corp veil)

	3.  The s/h as a creditor

In re Mader’s Store	Capital Contribution Theory – to order subordination, 3 factors must be present
				here – it was a loan, not contributed capital
•	If you put in money as a loan – you’ll be a creditor, when business fails (but people don’t think much about failure of business)
•	Difference:
If you put in money as stock – payment is dividend
	If you put in money as a loan – payment is interest
Usu s/hs put into the business as much money as they think is necessary for success – part they put in as stock investment and part as a loan – but the US it’s essentially tax driven
If close corp – hard to get your money out w/o paying income tax
If you put in money as a loan – there are no tax consequences – you can get your money out of the deal w/o paying taxes – drives people to put in money as a loan – 		thin-capitalization
Here:
•	State insolvency proceeding (fed courts – exclusive bankruptcy j’n, but not here)
•	Bulk-sale: Maders store sold all its assets to another co; same s/hs
•	Maders/corp is a debtor; Creditor/Gant brings the suit; court appoints the receiver to administer Maders’ assets
•	Gelatt aadvanced money to Maders
•	Receiver wants to treat Gelatt’s money to corp as contribution to capital and thus, as subordinate debt – then Gelatt’s claims will be subordinated to claims of other creditors – absolute priority rule
•	Issue: whether the trial court was justified in subordinating Gelatt’s claim to the claims of other general creditors
•	Trial court used a 3-factor test (from the Braddy case)- when subordination is justified:
1.	that at the time the advances were made the corp was in a very precarious financial position and urgently in need of funds as a result of sustained heavy operating losses
2.	that the needed funds could not then be obtained from banks or other commercial lending institutions
3.	the notes given by the corp were demand notes carrying a moderate rate of interest
•	Trial court held that Gelatt made contributions to capital, rather than loans, and thus subordinated Gelatt’s claims to the claims of other general creditors
•	S.Ct. applies Capital Contribution Theory – to order subordination, 3 factors must be present (s/h’s contribution will be deemed capital if these 3 factors are present):
1.	the claimant must be in a position to control the affairs of the co, at least w/r/t this transaction – yes
2.	advance was not intended to be repaid in the ordinary course of the corp’s business, but rather was expected to remain outstanding a permanent part of the corp’s financial structure – no
3.	paid-in stated capital must have been unreasonably small in view of the nature and size of the business of the corp – no
Unreasonably small when? – for the purposes of characterizing the loans, you look to capital adequacy at the time the business is organized (2 things may happen to the business – they are losing or they are hugely expanding)
•	Held:  This was a loan, not contributed capital.  The money was expected to be repaid, and the amount was not small, so reverse, Gelatt’s claim should not have been subordinated.
•	Social policy: not to discourage the extension of credit to ailing cops by s/hs

•	Subordination – usual remedy for situations when co is undercapitalized and is capitalized by s/hs – their claims are subordinated to claims of other creditors
•	Also, subordination of s/h claims is a common remedy when co’s managers have mismanaged – equitable remedy; usu in a parent-subsidiary sit’n, when parent has mismanaged

Subordination of debt (from Calligar, excerpt)

•	Most subordination is not a remedy – it’s contractual – whatever parties have agreed on
•	In the cir’ces specified in the subordination agr’nt, the senior debt must be paid in full before the payment may be made on the subordinated debt and retained by the subordinating creditor
•	2 kinds of subordination:
1.	Inchoate – does not become operative until a voluntary or involuntary distribution of assets of the debtor is made to its creditors; the specific event which triggers the subordination, such as bankruptcy or insolvency, is specified in the agreement (until that triggering even occurs – the interest and principal can be paid)
2.	Complete – no payment of principle or interest on the subordinated debt may be made until the senior debt is fully satisfied; the subordination is immediately effective (not used in public co sit’ns?)
•	One of consequences of subordination: implied assignment of distributions from holders of junior debt to holders of senior debt – in the event of liquidation, holders of senior debt get double dividends
•	NOTE: the inchoate type of subordinated debt may be reduced at any time, while the complete subordinated debt may only be paid out after the senior debt is satisfied.  Thus, the complete subordinated debt gives more security to the senior debtor.
•	The Deep Rock doctrine: under the doctrine of Equitable Subordination, when a corp is in bankruptcy the claim of controlling s/h may be subordinated to other claims, including the claims of preferred s/hs, on various equitable grounds
The Deep Rock case: serious mismanagement by the parent co – so, as a remedy, court subordinated claims of parent co as a creditor of the subsidiary to claims of other creditors and of preferred s/hs
•	Do we want subordination or capital contribution? – Subordination
If capital contribution, all creditors share equally in the assets
If subordination, holders of senior debt alone get subordinated lenders’ share – they get double dividends

Distribution of Assets upon Insolvency	Liquidation Problem (xerox)

•	Creditors are to be paid before s/hs regain capital
•	Among creditors, subordination of debt is usu contractual.  Creditors ranked:
(1)	secured creditors – collateralized debt, and creditors used collateral to satisfy the obligation (if not fully paid, become general creditors
(2)	preferred creditors – wages and taxes
(3)	general creditors; general creditors are not entitled to priority except by K among themselves (i.e. senior and subordinated debt).  Remaining assets after satisfying (1) and (2) are divided by total claims remaining.
•	S/hs: preferred are paid before common.

See Liquidation Problem:
•	1st mortgage has higher priority than 2nd
•	Non-recourse obligation – you can only go after property that was secured
Recourse obligation – you can go after anything, if land is out
•	Preferred claims – that have priority
•	Gov’nt – number 1 preferred creditor
•	then 2 classes of preferred creditors:
1.	costo of administering the bankruptcy estate
2.	wages
•	general creditors

Subrogation – the substitution of one party for another whose debts the party pays, entitling the paying party to rights, remedies, or securities that would otherwise go to the debtor

Assignment No. 2 – Governance of the Corporation

	1.  The directors’ role

Del 141
NY 701 Board of Directors
702 Number of Directors
703 Election and Term of Directors
704 Classification of Directors
706 Removal of Directors
707 Quorum of Directors
708 Action by the Board
(+ see xerox)

Annual mtg of s/hs – absolute req’nt for corps – mandatory
In fact, corps are governed by Board of Directors
Del141, NY 701
Could you require all directors to be s/hs? - yes
Normal term – 1 year
Classification of the board – 3 year (elect 1/3)
Every state permits Board to operate through Committees (Del 141(c))
Executive Committee – most popular
In a public co, there are usually inside and outside directors
	Executive Committee – usu. inside directors

Number of directors
NY
702(a) The board shall consist of one or more members
702(b) Number of directors may be increased or decreased
•	by am’nt of the by-laws, or
•	by action of s/hs, or
•	by action of the board under by-law adopted by the s/hs, but any such action pursuant to provision in by-laws requires vote of majority of the entire board.  entire board is a total number of directors which corp would have if there were no vacancies

Del
141(b) The board shall consist of one or more members
the number may be fixed by the by-laws or cert of inc
directors need not be s/hs unless required by cert of inc or by-laws

Qualifications of directors
NY 701  Must be 18 years old
Del 141(b)  Only those req’nts specified in cert of inc or by-laws

Election of directors
•	Elected by s/hs – typically common s/hs, and usu annually by a majority of present voting shares in the presence of a quorum
NY 703 Election of directors: at each annual mtg of s/hs; directors shall be elected until the next annual mtg, except as authorized by 704 (Classification of directors)

•	Director holds office until his successor is elected

•	2 election structures:
1.	classified board – different classes of stock elect different (specified) number of directors
NY 704 Classification of directors
Del 141(2)(d) Classification of directors

2.	Staggered Boards – elections staggered so only a portion of the board is elected each year (NY 704 and DE 141(d)

Function of Directors

NY 701, Del 141(a) The business of corp shall be managed by the board of directors
NY 798 Action of the board means action at a mtg of the board
	Exceptions:
NY 708(b) w/o mtg if all members of the board or the committee consent in writing to the adoption of a resolution authorizing this action, o
NY 708(c), Del 141(h)(i) by means of a conference telephone or similar communications equipment

Removal of directors
NY 706, Del 141(k)

Continental Securities v. Belmont		derivative suits
						fiduciary duties of directors

•	2 types of derivative suits:
(1) demand excused: you don’t have to make demand on Board of Directors
(2) demand required: you do have to make demand on Board of Directors
•	Derivative suits – claims can be brought against anybody, most usu – ag. Board of Directors, mgmt of corp
•	S/h brings action for the benefit of corp; corp itself is a necessary party – D (corp can’t be P): here, P sues Belmont and also corp
•	FRCP 23(1) – deals w/derivative suits – P must allege that he was a s/h at the time of events of which he’s complaining or that he inherited it

•	P/s/h brought a derivative suit ag Belmont to cancel shares of stock issued allegedly w/o c’n.  P’s claim: Belmont got a lot of shares he’s not entitled to.  D moved to dismiss for failure of the complaint to allege that P had requested that the s/hs bring the action
•	Held: in this case, where P alleges fraud and a substantial, application to the body of s/hs was not necessary
•	Problem w/P’s claim – he didn’t make a demand on s/hs through Board of Directors.  When is demand required? – Slain doesn’t know
•	Court: directors are trustees - fiduciaries: directors have a fiduciary duty to act on behalf of corp; Board of Directors are agents of corp
•	Tthe law deprives fiduciary the right to prefer his own interests over those of corp

•	Board of Directors get authority from state statutes
•	S/hs have no authority to instruct the directors w/r/t ordinary business of corp (except as provided by statute or art of inc)
Power of s/hs is generally limited to:
•	approving certain extraordinary transactions – e.g. merger, issuance of new shares, etc.
•	certain other permissive authority granted by statute
•	power to ratify certain actions of the Board which would otherwise be voidable
•	S/hs can elect the directors; but once elected – directors have independent authority
s/hs can make recommendations to the board, and they can vote – if you don’t like them, vote them out

Francis v. United Jersey Bank		Summary of duties of director
Reinsurance industry

•	D/Mrs. Pritchard is an elderly woman and director of co that is now bankrupt.  Her sons, also directors and officers of co have misappropriated a lot of $ by taking “loans” from the co.  D and her 2 sons are the sole s/hs.
•	Ps – trustees of Pritchard & Baird.
•	Pritchard & Baird – reinsurance broker
Reinsurance industry: ins.co’s share the risk of the thing that they are insuring; you reinsure – sell the risk that you have to another ins. co through the reinsurance broker.  It’s not an instantaneous transaction: broker receives $ months before he has to turn it in to the reinsurance co; broker makes money on the float (money in between) – a lot of cash that belongs to other people.  Here, the sons took the float and loaned it to themselves, then couldn’t meet their bills – bankruptcy
•	Ps/trustees claim: Mrs. Pritchard was negligent in not noticing and trying to prevent the misappropriation of funds held by the corp in an implied trust – she didn’t do anything - lack of conduct – nonfeasance
•	she didn’t read financial statements (they were not audited)
•	she didn’t have any experience in reinsurance business
•	she was in bad shape (was sick, was drinking)
•	she had a warning from her husband (before he died) not to trust her sons
•	she never consulted w/anybody else about her responsibilities (atty): if she did, her sons would have been deterred
•	Could Mrs. Pritchard have done any of the things court said she should?  No
•	Summary of the duties of director (p.p. 564-567 of textbook):
•	director should acquire t least a rudimentary understanding of the business of corp
•	bound to exercise ordinary care – lack of knowledge is not a defense
•	continuing obligation to keep informed about the activities of corp
•	may no shut their eyes to corp misconduct and then claim they didn’t see
•	doesn’t have to be detailed inspection of day-to-day activities, but a general monitoring of corp affairs and policies
•	advised to attend board mtgs regularly
•	not required to audit corp books, but should be familiar w/fin status of corp by a regular review of fin st’nts – so, duty to inquire into matters revealed by those st’nts
•	upon discovery of illegal course of action – duty to object and, if copr doesn’t correct the conduct, to resign + sometimes duty to seek advice of counsel (outside advice)
•	directors owe fiduciary duty to creditors (when corp is insolvent and sometimes when solvent)
•	There is a different standard of care w/r/t corp engaged in industrial business and money mgmt business (higher standard of care)
•	Court: it doesn’t matter that D can’t do the job – don’t undertake it if you can’t do it
•	Problem of proximate causation: whether D’s negligence was the proximate cause of Ps’ losses (can she argue that she was minority s/h, her sons would have outvoted her in any dispute? – no; here – 2 directors converting trust funds to themselves – they couldn’t continue in the face of serious accusations, they would have been deterred)
•	Law being applied here – NJ law; but Pritchard & Baird is incorporated in NY, so notwithstanding internal affairs doctrine that law of the state of incorporation should be applied; but court: more nexus w/NJ; NJ statute is derived from NYBCL (this may be a case of false conflict); non of the parties is arguing for application of any other law
•	Held: Mrs. Pritchard had a duty to deter the misappropriation; she breached that duty, and her negligence was a proximate cause of the misappropriations.

Joy v. North	Delaware model: NY model (business judgment rule + court’s own independent j’nt
usu. we don’t hold mgmts liable bec. they make bad j’nts
conflict of interest (demand-excused suit)

•	P/Joy brought s/h derivative suit on behalf of corp and its wholly-owned banking subsidiary; P commenced this action after making an unsuccessful demand on directors of corp
•	Double derivative suit: I’m a s/h of s/h of corp that I’m suing
•	No law in Connecticut – court is inventing Connecticut law (predicting what Con S.Ct. would do)
•	Board of Directors authorized the establishment of Special Litigation Committee to determine whether continued prosecution of this derivative action would be in the best interest of the corp; Report recommending that the suit be discontinued as to 23 Ds, 20 of whom were outside directors, and that settlement be considered w/r/t 7 inside Ds (possibility of their negligence)
•	Dist. ct: sum. j’nt for 23 outside Ds and sealing of the Committee Report – court issues protective order (Ds didn’t want the public and P in particular to see the factual findings of the Committee).
•	Dist. ct: court must defer to the Committee’s recommendation under the business judgment rule – this is a decision to be made by Board of Directors or its Committee; the court should check the process, and if the process is ok (Committee was independent and their procedures were reasonable) – defer to Directors’ j’nt – business judgment rule (usu protects the Board that made a bad business decision)
•	2d Cir: reverse – for P – deny sum j’nt + no sealing of Committee Report
•	Here, conflict of interest (directors themselves have profited form transaction underlying litigation + Committee members are appointed by Ds to litigation) – thus, this is a demand-excused derivative suit (no demand need be made, and s/hs can proceed directly w/derivative suit)
•	when no conflict of interest – demand-required derivative suit (P is stuck w/whatever the Board decides, unless bad faith is proven)
•	when conflict of interest – demand-excused derivative suit
•	Incentive for P to name all directors as Ds – here, all directors are Ds, Committee is composed of 2 new directors; by-law permits Board to decide on the number of directors and fill in vacancies – so they increased the number of directors and appointed 2 directors (not Ds in this action) to form a Committee
•	Banks, insurance co’s, investment co’s – standard is closer to trustee, but if this were ordinary industrial co – mgmt wouldn’t be liable, bec. we don’t hold mgmts liable bec. they make bad j’nts
•	Trustees are absolutely liable to the trust and its beneficiaries for any losses; why don’t we have that rule for Board of Directors? – Business is inherently risk-taking; you can’t manage business w/o taking chances – you can’t create disincentive to risk-taking – so, need legal rule that Board is not responsible for loss from bad business j’nt
•	2 models
1.	NY (trial court applied): if Committee acted independently and reasonably – court should follow its recommendation
2.	Delaware (2d Cir. applied) – NY model + court’s own independent j’nt
Test: trial court has to find both
(a)	that Committee was independent, acted in good faith and made a reasonable investigation; and
(b)	that in the court’s independent business j’nt as to the corp’s best interest, the action should be dismissed
This applies to cases involving allegations of direct economic injury to corp diminishing the value of the s/hs’ investment as a consequence of fraud, mismanagement or self-dealing
•	As to (b): Likelihood of recovery: what is the potential gain to corp from having the suit go forward (whether to dismiss the suit) – benefits v. costs to corp – court should balance the probabilities as to likely future benefit to corp
1.	out of pocket cost (litigation is very expensive)
2.	another cost: either by statute or by K, corp is responsible for indemnifying its directors, e’ees who have to participate in litigation bec of their duty (unless they are found liable)
3.	corp can say that litigation is extremely distracting; officers are being deposed; we are losing mgmt effort in this process – big cost
4.	dependence of corp on good public opinion in the community (here – bank); but Court says: the more outrageous the conduct – the stronger the arg’nt of bad public opinion (contradiction)
Held: the probability of a substantial net return to corp is high, so reject recommendation of the Committee – reverse the grant of sum j’nt ag P
•	Dissent: Connecticut would adopt business j’nt rule in this case; courts should not second-guess the merits of business decisions honestly and prudently made; judges are incompetent to determine the settlement value of lawsuits
•	Slain agrees w/majority and disagrees w/dissent: doesn’t see the problem – meritorious lawsuits ought to go forward; no terrible burden on trial court in finding out what the lawsuit is worth – court has to do this
•	How do s/h derivative suits (and class actions) get started?  P’s counsel has econ. interest in the suit – attys’ fees; most derivative suits (and class actions) are settled (less cost to D if settle); settlement is subject to judicial approval (which dissent says courts are incompetent to do – bad arg’nt of dissent)

Kamin v. American Express		Directors can exercise their honest business j’nt, as long as good faith (unless fraud, oppression, arbitrary action, or breach of trust)– no court inerference

•	S/h derivative action
•	Ps – 2 minority s/hs – ask for a declaration that a certain dividend is a waste of corp assets; American Express made bad purchase of stock; P says that they could have saved $8 million in taxes, but directors wanted to declare dividend (distribute the shares); P says – breach of fiduciary duty by directors, bec. corp is better off w/$8 million
•	There is no claim of fraud, self-dealing, bad faith, or oppressive conduct
•	Courts will not interfere w/directors’ discretion unless the above
•	Held: no cause of action when complaint alleges merely that some course of action other than that pursued by the Board of Directors would have been more advantageous; more than imprudence or mistaken j’nt bust be shown
•	Here, disagreement bet. 2 minority s/hs and a unanimour BoD as to the best way to handle a loss already incurred on an investment; directors special mtg for that purpose; but even if they didn’t – same result
•	But assume American Express was in bad shape, and directors made the same decision to distribute the dividend; same result? – No

Efficient Market Hypothesis

Weak form – true: markets do not have memories; there is no reason why price prevailed that prevailed at one point will prevail at another point
Semi-strong form (most important) – arguable: price of a publicly traded security at any time accurately impounds all available info relating to its value; whatever the price is at any given moment is the right price
•	If this hypothesis is right, can we have overpriced securities (assuming all info is public)? – No
•	Can there be any bargains? – No
•	But in the real world, there are both bargains and overpriced securities
•	Does mgmt of American Express accept Efficient Market Hypothesis? – Yes: the loss was widely known, has already occurred, so saving on taxes shouldn’t lead to diminution of value
Strong form – untrue: if you have inside info, it won’t help

	2.  S/h role and meetings

Del 212(a),(b), 211, 212(a), 213(a), 222, 216, 228
NY 602, 604(a), 605(a), 608, 609, 612(a), 613, 614

Del 141(k)  Any director of entire board of directors may be removed with or without cause, by the holders of a majority of shares then entitled to vote at an election of directors (except when board is classified… or when cumulative voting…)
NY 706  Any or all of directors may be removed for cause by vote of s/hs…

Matter of Auer v. Dressel (NY)	S/h resolution case – precatory resolution
S/hs cannot require board to take actions re: co’s day-to-day operations.  But s/hs can seek to influence the board through s/h resolutions that recommend particular action
By-laws – critical for this case
NY 803(a), Del 242(b): Board has to adopt resolution setting forth the proposed am’nt before s/hs can vote on it

•	Held: for Ps - s/hs were entitled to vote on a resolution endorsing the administration of the former president of the corp, who had been ousted from office, and demanding his reinstatement.  
•	Ps – class A s/hs – want to compel the president of corp to comply w/positive duty under corp’s by-laws to call a special mtg whenever requested in writing by majority; president fails to call the mtg.  Ps want to put to s/h vote a resolution endorsing former president, requesting his reinstatement, and amending the by-laws re: forum requirements for the board
•	By-laws – critical for this case: if the provision calling for a mtg wasn’t in the by-laws – s/hs would not get the mtg
•	While s/hs cannot require former president’s reinstatement, they can vote to pass this resolution thereby signaling their desire and warning directors that this matter will soon be up for election – precatory resolution.  S/hs may recommend action or inaction by directors in matters committed to their discretion
•	S/hs who are empowered to elect directors have the inherent power to remove them for cause
•	If the charges are not frivolous or inconsequential, mtg may be held to deal w/them
•	NY 803(a) was enacted after this case.  Same result under the statute?  No, because the Board votes first; now s/hs cannot initiate am’nt of cert of inc.  Unless Board recommends such a change, s/hs can’t do it.  NY 803(a) is modeled after Del 242(b)
•	What about amending by-laws?  S/hs have inherent power to amend by-laws in all states
•	Also here: requirement of notice and opp’ty to be heard, but not req’nt for j’nt by impartial people
•	Here, prerogative writ of mandamus proceeding

Cf.
Del 228  Consent of s/hs or member in lieu of mtg
Del 213(b)  Fixing date for determination of s/hs of record – (b) - w/o mtg

Carey v. Penn Enterprises		Del 231(d), NY 610, 611 - Inspectors of elections
Del212(c), NY 609(i), (j) – valid means of s/h grant of authority to act for him as a proxy
DRIP plan
Overvotes
The holders of record have the right to vote the shares, not the beneficial s/hs for whom they hold the shares

•	P sues challenging the validity of corp election in which P’s opposition to split PEI stock proposed by mgmt lost by a narrow margin.  P wants to enjoin implementation of the result of the election.
•	S/hs were supposed to vote upon proposal to amend art of inc authorizing split of common stock.  Adoption of am’nt required the approval of voters representing majority of PEI’s outstanding shares of stock.  Loriot and Cede were s/hs of record, but proxies for the DRIP shares were issued directly to the beneficial holders, rather than to Cede and Loriot.
•	Held: for P – DRIP votes, i.e. the votes of additional shares acquired by PEI s/hs by reinvestment of cash dividends, w/o which there was insufficient support to approve the stock split, were improperly counted.
•	Under DRIP plan, public co applies an investor’s dividend to the purchase of add’l shares (instead of distributing dividends to s/hs)
•	P/Carey wants to make a tender offer to PEI.  PEI wants split to make potential takeover by P tougher – split will drive price of stock down, enable more people to buy on market and make tender offer tougher since there will be more people to negotiate with.  Also, it will be more expensive for P to make a tender offer, because after split the price of $50 stock will not drop to $25, but to $26-27.
•	PEI hires judges to conduction the election – from Corporation Trust Co (CT system).  Both PEI and Carey solicit proxies.
•	Carey says: judges attributed shares to beneficial owners of stock instead of record owners.  Record owner – Loriot – it’s a certificate co organized by manufacturers Hanover Bank.  All shares are in the name of Loriot.  Double: proxies were sent to beneficial owners directly + to Loriot shares held by Loriot
•	Problem – overvotes: more shares are voted by the broker than the broker holds in street name
•	Ct holds for P and invalidates the vote.  Some of the shares outstanding were from a Dividend Reinvestment Plan, under which s/hs that reinvested their dividends received additional shares – but DRIP plan provided that these shares were to be voted by their owner participants.  But here they were voted by the beneficial owners, rather than the holder of record (CEDE and Loriot)
•	Other challenges (conc judge): the validity of s/h votes by telegraphic transmission (no way to tell if these s/hs even have shares)
Del 212(c) valid means by which s/h may grant authority to act for him as a proxy
NY 609 (i), (j) – deal w/this problem
•	Here, court didn’t defer to inspectors’ j’nt
•	Slain: inspectors of election decide these q’ns every day, not like courts (seldom); in effect, inspectors developed common law of s/h voting – better to defer to their j’nt.
•	Del 231(d)  Voting procedures and inspectors of elections + overvotes
NY 610  Selection of inspectors at s/hs’ mtgs
NY 611  Duties of inspectors at s/hs’ mtgs
Inspectors can look at transfer records, proxies, envelopes submitted w/those proxies (to see which one is first)

	3.  S/h voting, and other agreements.  Closely held co’s

Del 218(c), (d), 212(e)
NY 620, 609(a), (f)

McQuade v. Stoneham & McGraw (NY, 1934)	Close corp
Court invalidated agr’nt among the s/hs of a close corp that curtailed the powers of the board
NY 620(b) – such agr’nts are valid

•	P/McQuade/the treasurer sues Ds/Stoneham/President & McGraw/VP.  These 3 people entered into agr’nt to control their co, that they would use their best efforts to keep each other as directors and officers of co.  P was in effect fired and and sues.
•	2-tier K: (1) elect ourselves + some others as directors and (2) as directors, we’ll see that officers of corp are 3 of us + some others
•	Why McQuade was in bad order w/Stoneham – lower court found that he was protecting minority s/hs from Stoneham’s personal takings from the treasury.  McQuade wants specific performance.
•	The effect of this K – to provide for governance of corp by these 3 people – prevents the Board as Board from governing corp – ag. NY statute.  Court – ag. P – you can’t do that: equities are on McQuade’s side – but the equities don’t matter – this K is inconsistent w/corp norms under NY statute.  Also, minority s/hs didn’t object to McQuade’s being removed.
•	Can this arrangement be validated in NY in 1999? – Yes – NY 620(b)

Galler v. Galler		Close corp
Agreement is valid

•	Close corp – K bet 2 brothers: 2 brothers wanted to provide income for the support and the maintenance of their immediate families (although brothers never thought they would disagree).  They agree to pay certain annual dividends and to pay in the event either brother should die, a specified pension to widows.  One brother dies, the other brother refuses to carry out K.
•	One provision – that s/hs must vote for brothers and their wives – 4 directors.  S/h voting agr’nts are generally enforceable.  Also, salary continuation agr’nt – completely commonplace.
•	Here, P/Emma Galler owns less shares than other family, but K provides that that doens’ reduce her voting power or dividend distribution.
•	Duration: under K, K lasts as long as 1 of the parties was living.  Court – not unreasonable (if K created rights for the next generation – invalid – RAP problem)
•	Held, K is valid.  It’s a close corp; no complaining minority interest; no public detriment; no fraud, no clearly prohibitory statutory language is violated.  Also, agr’nt doesn’t jeopardize creditors’ rights, bec surplus of $500,000 after co pays the dividends is maintained.  But Slain:  this co is in bad shape; not true that $500,000 surplus is automatically enough to pay creditors – it depends on assets and liabilities (balance sheet)

4.  Cumulative voting

Del 214
NY 618

Cumulative voting exists only if cert of inc provides for it

Excerpt, Marsh (p. 306)

Cumulative Voting Problem (xerox)

	5.  Federal regulation of proxy solicitations

Security Exchange Act of 1934
§§12(a), (b), (g)
§14(a); Rules 14a-3, 14a-4, 14a-8
§14(c); Rules 14c-2, 14c-3

	Problems - §§12 and 15(d) of 1934 Act

	The Proxy Rules

Lovenheim v. Iroquois Brands		Rule 14a-8(c)(5)
No-Action Letter (NAL)

•	P wants to prevent Ds from excluding his s/h proposal (to study whether feeding geese for pate cause such geese undue stress) on proxy st’nt.  P wants to form a committee to study the methods of feeding (P can’t just propose a resolution – only Board can propose resolutions – Matter of Auer v. Dressel).  Here, P wants to adopt a precatory resolution (commonplace in 14a-8 proposals)
•	SEC issued a no-action letter (NAL) - said it will not take action ag mgmt if mgmt excludes the proposal.  This is informal procedure (not in the rules, but very reliable): if the matter is brought to SEC’s attention, and SEC asks this division of SEC for recommendation, the division will recommend that the action be not taken – doesn’t commit SEC to anything.
•	Mgmt claims tht proposal doesn’t meet req’nts of Rule 14a-8(c)(5): 5% test and “significantly related to issuer’s business”.  P doesn’t meet 5% test.
•	Rule 14a-8(c)(5) provides that an issue or securities “may omit a proposal and any st’nt in support thereof” from its proxy st’nt:
“if the proposal relates to operations which account for less than 5% of issuer’s total assets at the end of its most recent fiscal year, and for less than 5% of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the issuer’s business”
•	P claims that proposal cannot e omitted merely bec not economically significant if proposal has ethical or social significance.
•	Held: meaning of “significantly related to business” - not limited to economic significance – P’s proposal has ethical and social significance (court looks at history of the rule)
•	This is a motion for preliminary injunction (most such cases), but fully litigated – case is usu finished.
•	These resolutions never win.  Then why did mgmt oppose the proposal? – 2 reasons:
1.	Legitimate reason:  There’s a possibility of being dragged into discussions of things you don’t know much about and which have very little to do w/operations of the business 
2.	Less legitimate reason:  Here, co doesn’t generally deal w/public, but what if a supermarket chain – more damaging bec. of public opinion.  So, arg’nt that mgmt should be protected from tenuous fights – to avoid the embarrassment of saying in public unpopular things, taking an unpopular position.  But it’s not a legitimate reason that people won’t like you – big deal
•	If s/hs have a different view than yours, and if you find s/hs’ view completely unacceptable – resign (can’t make moral decisions for people who pay – it’s s/hs’ money)

Assignment No. 3 – Issuing Stock and Paying Dividends

	1.  Legal Capital and Dividends

		A.  Authorized capital stock

Del 102(a)(4), 151(a), (b) (first sentence), (c), (d), (e)
NY 402(a)(4), (5), (6), 501(a), (b)

		B.  Dividends

Del 170
NY 510, 102(a)(13), (9), (12), (8)

Klang v. Smith’s Food & Drug		repurchase program
(S.Ct. of Del, 1997)				impairment of capital
						Del corps don’t’ have to apply GAP
Rule in every state: decision to pay dividends is entirely w/n discretion of the Board (unless irrational)

•	Class action P/holders of common stock of SFD: calls into q’nt the actions of corp board in carrying out a merger and self-tender offer – that corp’s repurchase of shares violated stat prohibition (Del.C. §160 – Del GCL §170) ag impairment of capital.
•	Held: ag. P – no impairment of capital.
•	SFD wanted to repurchase its shares – offer to buy back their own shares to reduce ownership of previous s/hs
•	Under Del law, the same statute governs distribution to s/hs and amount corp can spend to bauy back its stock from s/hs – they both have to come from surplus.
•	SFD hired Houlihan, investment firm – report – transactions would not endanger SFD’s solvency and would not impair SFD’s capital in violation of §160.  SFD’s Board – sufficient surplus for transactions; SFD’s s/hs voted to approve transactions.
•	P – to have transactions voided or rescinded: stock repurchases violated 160 by impairing SFD’s capital.
•	Repurchase impairs capital if the funds used in repurchase exceed the amount of corp’s surplus – excess of net assets over the par value of corp’s issued stock
•	Court: SFD’s board appropriately revalued corp assets to comply w/160 + in the absence of bad faith or fraud of Board, court will not substitute its j’nt for that of Board – defer to Board’s determination of surplus
•	Slain: fin st’nts must be prepared in acc/w GAP – assets of co have to be taken into account at historical cost w/some adjustments
•	Here – there is deficit: liabilities > assets by $100 million; distribution is made not out of surplus, but out of capital – then arg’nt: this transaction is in violation of Del 170 – wrong: Del corps don’t’ have to apply GAP (here, they got their numbers from an investment firm).  Investment firm looked at the earnings of the co, value of stock, value of the assets, subtracted long-term liabilities – got lots of surplus.  Del limitations are not meaningful if they are that easily avoided.
•	Investement firm used market multiple approach – fundamentally flawed.  Accounting numbers represent things that have happened.  Predictions may be wrong.
•	Standard in NY: like in Del – don’t have to apply GAP – Board can make up its own values
•	Not the law in Cal: §500 of Cal statute requires that GAP be applied to determine whether a dividend can be declared.  Slain – in favor of Cal law
•	Rule in every state: decision to pay dividends is entirely w/n discretion of the Board (unless irrational).  Co can reinvest in the business or declare and pay dividends and then s/h can reinvest
•	Historically, US co’s do not pay a lot of dividends bec of tax system – do not go broke bec. of that
close corps which are not publicly traded – more efficient than paying dividends – hire them and pay them salaries – better for tax purposes
public corps – our tax system works ag high dividends to s/hs
•	More efficient for co than declaring dividends – keeping the money and reinvesting it, provided they reinvest it well

Smith v. Atlantic Properties		Close corp; the 80% provision
					Court extends fid duty of majority/controlling s/h to minority s/h; you can’t go beyond what’s reasonable

•	Ps are 3 s/hs in close corp w/D.  Each owns 25% of co.  Cert of inc and by-laws have provision requiring approval of all decisions by the Board by 80% of s/hs – thus, each s/hs has a veto (essentially unanimous vote is required).
•	Division of opinion w/n the Board as to shat to do w/retained earnings.  D refused to authorize dividend payments, wanted reinvestment in repairs and improvements in existing buildings.  As a result of failure to pay dividends, IRS imposed a penalty tax under IRC §531 (purpose: to coerce payment of dividends.  Has no applicability to publicly held co’s, but remains big thing w/r/t close corps) – penalty if “accumulation beyond reasonable needs of the business”
•	Held: D acted unreasonably, but trial court went too far in ordering dividend paid – judicial reluctance to interfere w/board dividend policy.  Ct retains j’n over corp to ensure that board works it out.
•	Idea of fiduciary duty of controlling s/h to the corp and minority s/hs.  D says he’s not a controlling s/h, he only has a veto.  Court extends fid duty of majority/controlling s/h to minority s/h; you can’t go beyond what’s reasonable.

	2.  Issuing Stock

		A.  Subscriptions

Del 165  Pre-incorporation subscription agr’nts irrevocable for 6 months except w/consent of all other subscribers
Del 166  Subscription must be written and signed by subscriber
NY 503  (a)  Pre-incorporation subscription agr’nts irrevocable for 3 months except w/consent of all other subscribers

A would-be s/h enters into a subscription agr’nt, under which he agrees to purchase a corp’s stock when it is issued to him at some future date; usu the corp has not yet been formed – pre-incorporation agr’nts.

		B.  Consideration

Del Const Art IX §3
Del 152, 153
NY 504

Corp cannot give away shares of its own stock.  Stock must be issued for:
1. money
2. labor done
3. property received

Del 153(a)  Par value shares should be sold at least at par

		C.  Types of stock

Del 102(a)(4), 151(c), (d)
NY 402(a)(4), (5), (6), 501 (a), (b)

	Types of Preferreds

Baron v. Allied Artists Pictures		Contingent voting rights, the contingency 
(Del 1975)					being the failure to pay dividends
						Court: if its’ in the best interest of corp, directors can pay dividends, but they don’t have to – business j’nt rule, unless fraud by directors

•	Business of D goes poorly, fails to pay preferred dividends for 6 quarters.  Preferred has contingent voting rights to elect majority of board at each annual election so long as the dividend arrearage specified in cert of inc exists (6 or more quarterly dividends are not paid).  Preferred s/hs are now in control.
•	P/common s/h – board fraudulently perpetuates itself by refusing to pay accumulated dividends on preferred stock – co has sufficient net income to pay the dividend arrearages.
•	Extremely rare cases when court ordered Board to pay dividends.  Here, common s/hs don’t ask the court to order Board to declare dividends – under business j’nt rule, this suit would be a loser.  Common s/hs ask for return of control of eth co to the common s/hs.
•	Court says that P’s position is that there is an implied condition subsequent – right to elect board ceases when tehre’s a surplus out of which preferred dividends can be paid.  For P, this is a mechanical test: if there’s a fund from which dividends can be declared – they have to be declared.
•	Court: if its’ in the best interest of corp, directors can pay dividends, but they don’t have to – business j’nt rule, unless fraud by directors.  “Board does have a fiduciary duty to see that the preferred dividends are brought up to date as soon as possible in keeping w/prudent business mgmt.”
•	To which s/hs does fiduciary duty run? – not to s/hs who put Board in office, but here fid duty runs to common s/hs.  Fid duty can’t run to both common and preferred s/hs– here, no fid duty to preferred, bec of interest of common s/hs in voting.

Rothschild International v. Liggett	Delaware Independent Legal Significance Doctrine
Pref s/hs have K-tual rights

•	Suit arises out of combined tender offer and merger.  P – owner of 650 shares of 7% Cumulative Preferred Stock in Liggett.  Class action – both those who voluntarily tendered their preferred shares in response to the tender offer and those who were subsequently cashed out under the terms of the merger.  P – 7% Preferred s/hs were shorchanged $30 per share under the terms of both the tender offer and the merger – that D didn’t pay them the full K-tual value of their preferred shares.  P seeks the recovery of $30 per share – the preferred stock had a fixed par value of $100 per share: in the event of liquidation of corp, the holders of the 7% Preferred Stock were supposed to receive the par value - $100.
•	P: transaction was really a liquidation w/r/t 7% Preferred s/hs, thereby entitling them to $100 liquidation value.
•	Held: there was no liquidation of corp here – it was a lawful tender offer/merger.  Del recognizes concept of merger as separate and distinct from liquidation or sale of assets – Delaware Independent Legal Significance Doctrine
•	In a corp liquidation the co would distribute all assets to new owner – stock of co will be cancelled.  Here, GM submerges w/Liggett; s/hs are cashed out – exactly what would happen if co was purchased and assets distributed to s/hs in liquidation.  Functionally – liquidation of corp.  But court: this is not liquidation – Del Ind Legal Sign’ce doctrine: it depends on what method of liquidation you choose.  Had you done this same deal in a diff form – P would get $100, but it doesn’t mean that here he should get $100.
•	The preferential rights attached to shares of pref stock are K-tual in nature and are governed by express provisions of corp’s charter – so can’t be presumed, must be clear language – court doesn’t like implied preferences
•	Slain: rights of pref s/hs are much more like rights of creditors than rights of common s/hs, who are beneficiaries of broadly stated fiduciary obligaitons.  Rights of creditors are K-tual – youget what you bargained for.
•	Participating preferred have slightly diff rights – closer to com s/hs sit’n than usual pref s/hs.  Fiduciary duty runs to people who own residual entity – so, probably, it would run to participating preferred.
•	Actual $ paid/market price = rate of return (current interest rate) (see p.119 of notes)
7%/$60 = 11.66% (rate of return)
	Another preferred stock here – Convertible Pref stock – called $5.25 Preferred
	No % of par value – this is probably no par preferred
	Tender offer price - $114 for each share of $5.25 Preferred
	Market price = $5.25/0.1166 = $45.02
	Tender offeror/GM pays $10 over market price for 7% Preferred and $70 over market price for $5.25 Preferred – Why? – bec they want to merge this corp out of existend – back-end merger following tender offer – they want to govern w/o obligations to minority s/hs (they are being cashed out at the same amount as they’d gotten out of sale of tender offer).  They need enough stock to acquire requisite number of voting rights – votes of people who have voting stock.  7% Preferred doesn’t have voting rights; common and $5.25 Preferred have voting rights – GM needs majority of each of these classes, but they don’t need 7% Preferred, bec. they don’t get to vote on the merger.

Assignment No. 4 - Fundamental Changes

1.  Charter amendments

Del 242
NY 801, 803-805

Common characteristic of these transactions: usual rule is that corp is managed by BoD, but here, requirement  for affecting transaction is of s/h action
Require s/h voting:	1. amendment of cert/articles of incorporation
			2. merger/consolidation
			3. sale of all or substantially all assets
			4. liquidation

Dartmouth College case: a cert of inc is a K between the incorporating state and the corp, and therefore is w/n the K Clause (Art 1 of US Const’n), which prohibits states from impairing the obligation of Ks.
Reserved power clauses – provisions reserving to the state the power to alter, amend, or repeal its corp laws as regards corps incorporated after the adoption of such provisions.  
Reserved power statutes:	Del 394
				NY 110

Del 242(b)(1)
1. has to be a Board resolution proposing amendment
2. call for a special mtg of s/hs or next annual mtg
3. At the mtg a vote of s/hs entitled to vote shall be taken for and against the proposed amendment.  If a majority of the outstanding stock entitled to vote, and a majority of the outstanding stock of each class entitled to vote as a class has been voted in favor of the amendment – amendment passes

Del 242(b)(2):	there is a class vote only if there is alteration of this class’ shares
creation of new stock does not trigger class vote

Hypo:
Corp has 5 million shares of preferred stock and 1 million shares of common stock.  Board proposes amendment to create a new class of authorized stock – prior preferred, whose holders would have rights senior to existing preferred.  This preferred has conversion rights.  Amendment proposes to increase dividends to abolish conversion of shares.
Vote
	Yea	Ney	
Preferred	400,000	100,000	
Common	400,000	600,000	
	800,000	700,000	

Did the amendment pass? – 2 computations

1. whether a majority of the outstanding stock of each class entitled to vote as a class has been voted in favor of the amendment - yes
Preferred: 400,000(yes) > 100,000(no) (compare yes/no votes within the class)
Common does not vote because there is no alteration of common shares (in Del)

2.  whether a majority of the outstanding stock entitled to vote has been voted in favor of the amendment - yes
add all the votes: 400,000 + 100,000 + 400,000 + 600,000 = 1.5 million
what is majority of 1.5 million: 1.5 million/2 = 750,000; majority is more than 750,000
add all yes votes (preferred + common): 800,000
all yes votes constitute majority of all votes? – yes; 800,000>750,000

Thus, amendment passes

If NY – probably would be common class voting
NY 804 Class Voting on Amendment
NY 804(a)(3) Subordinate their rights by authorizing shares having preferences which would be in any respect superior to their rights
Then in this hypo amendment would not pass:
1. Common: 400,000(yes) < 600,000 (no) (do not need to do any further computations)

McNulty v. Sloane (NY 1946)	NY statute wiped out preferred accrued but undeclared dividends - upheld

•	Slain is not satisfied w/this case
•	D reorganizes corp, pursuant to new NY legislation allowing for reclassification of shares.  D amends charter to wipe out accrued but not declared dividends on preferred stock.
•	P – holder of prior preferred stock – says NY statute is uncon’l and claims that the accrued dividends are property rights that were taken w/o due process.
•	Held: accrued but undeclared dividends are not property rights that are constitutionally protected and that corp therefore can amend cert of inc to wipe out such dividends.  The preferential right was created by charter – it doesn’t exist separate from the charter.  Also, the right to accumulated dividends accrued but not declared, is not in the nature of debt.  There is no debt until the dividend has been declared.  The contract bet s/hs is a K subject to a condition that it may be changed in the manner authorized by the Leg’re under the reserved powers.
•	NY 801(b)(12) – allows for charter am’nt wiping out undeclared accrued dividends.  But if declared, this is a debt that must be paid.

Bowman v. Armour		Court refuses to allow am’nt of corp charter

•	Ps/holders of 6% cumulative preferred stock which had a redemption provision requiring co to redeem them for cash.  corp amended its charter to redee, the preferred. but instead of cash, the 6% s/hs are to get debentures (debt).  Corp does this for tax reasons – dividend payments get taxed twice.  You can write off debt, but not dividends.
•	Am’nt – turn prior preferred stock into debt.  Debenture interest is payable only of corp has earnings.  This debenture is subordinated to all creditors.  Court – it’s a compulsory redemption.  “A change in preferences, qualifications or relative rights may increase or decrease the right to participate in profits, the right to participate in distribution of assets of corp on dissolution or liquidation, or other indicia of ownership manifest by the ownership of corp stock.  But the change here contemplated is more than that; it is a compulsory redemption or a purchase of the stock rather than a divestiture of certain rights and privileges.”
•	Slain:  Income tax deduction is all that is at stake here (same outcome for Ps w/r/t money).

2.  Merger and sale of assets

Del 251(a)-(e), 259(a), 261 (merger)
NY 901-04, 906 (merger)

Del 271 (cf. 272) (sale of assets)
NY 909 (cf. 911) (sale of assets)

	Notes (textbook 1130-32; 1148)

Farris v. Glen Alden (PA)		De Facto Merger Doctrine

•	Reorganization agr’nt bet List and Glen Alden, whereby Glen Alden acquires all assets of List and in c’n issues stock to List; List then should distribute the stock to its s/hs; Glen Alden is to assume all of List’s liabilities and to change its corp name from Glen Alden to List Alden; List is to be dissolved.
•	In reality, List acquires Glen Alden.  List is incorporated in Delaware – Del 271 – there has to be s/h mtg – approval at List, because sale of all assets
•	Glen Alden – Penn corp – they are selling shares of stock.  What has to be approved? – cert of inc has to be amended to increase the number of authorized shares.  Glen Alden – public co - calls a s/h mtg.
•	P sues – says it’s de facto merger – wants appraisal rights.  The notice of the annual s/h mtg did not conform to req’nts of Penn statute in 3 respects: (1) it did not give notice to s/hs that the true purpose of mtg was to effect a merger or consolidation of Glen Alden and List; (2) it failed to give notice to s/hs of their right of dissent to the plan of merger or consolidation and claim fair value of their shares; and (3) it didn’t contain certain sections of statute as required.  Thus, approval of reorganization agr’nt by s/hs at annual mtg was invalid, and unless the carrying out of the plan were enjoined, P would suffer irreparable loss by being deprived of sub’l property rights.  Ds say: transaction was a purchase of corp assets as to which s/hs had no rights of dissent or appraisal.
•	Court’s test:
“To determine the nature of corp transaction, we must refer not only to all provisions of agr’nt, but also to consequences of transaction and to purposes of corp law said to be applicable”
“Does the combination outlined in the present reorganization agr’nt so fundamentally change the corp character of Glen Alden and the interest of P as s/h, that to refuse him rights and remedies of dissenting s/h would in reality force him to give up his stock in one corp and ag his will accept shares in another?  If so, transaction is a merger w/n Penn statute”
•	Held: transaction here is a merger.  There is serious financial loss to P
•	Slain: market value of Glen Alden’s stock went up, even though the book value went down: Glen is a coal mining co – had huge assets but no business where they could make any money.  List wants to take Glen’s big assets and use them as collateral for loans + Glen has a lot of tax losses that can offset List’s income (net operating loss carryovers – can be used ag List’s future income: business deduction on net loss carryover – loss incurred in prior years bec income deduction for income in future years – List will get benefit of Glen’s past tax carryovers)
•	In Penn, as in Del + slightly diff in NY – radical difference bet statutory merger and sale of assets
Statutory merger provides for appraisal rights
Sale of assets – doesn’t
•	De facto merger may be when
acquisition of substantially all assets in exchange for stock
acquisition of majority stock in exchange for stock
•	Comment:  In acquisition of assets, stock in the acquiring corp is issued to the transferor corp, while in merger, stock in the survivor corp is issued directly to the transferor corp’s s/hs.  However, if the agr’nt requires the transferor corp to immediately liquidate and distribute the stock to its s/hs, this difference is only one in form.

Hariton v. Arco Electronics (Del)	Del Ind’nt Legal Sign’ce Doctrine –
Equal Dignity Rule
No de facto merger doctrine in Del

•	The form and label that mgmt attaches to corp combination determines whether the transaction requires s/h approval and triggers appraisal rights
•	Asset for stock transaction under Del 271: Arco sells all assets to Loral.  Arco calls for s/h mtg to approve sale and voluntary dissolution; then liquidates and gives stock of Loral to Arco’s s/hs.
•	In Del – no appraisal rights for sale of assets
•	P/s/h of Arco sues – it’s a de facto merger, and so should have appraisal rights.
•	Court applies Del Independent Legal Significance Doctrine: says there are 2 ways to do this deal: statutory merger w/appraisal rights and sale of assets w/no appraisal rights.  Corp has choice of the manner in which to do this transaction.  “271 cannot be legally combined w/dissolution proceeding under 275 and a consequent distribution of purchaser’s stock.”  These statutes are independent and of equal dignity.
•	In NY – Slain doesn’t know.  When sale of assets – approval of majority of votes of all outstanding shares is required (NY 909), not approval of all s/hs – to give minority s/hs opp’ty to cash out.  NY provides for appraisal on charter am’nts.

3.  Small mergers and short form mergers (bet parent and sub)

Del 251(f), 253
NY 905

Short form merger – mechanism by which a parent co can close up subsidiary by merging it into itself w/o s/h approval (bec there is no real change in parent’s affairs) – every statute provides for it.
•	NY 905, Del 253 – typical – make ownership of 90% of stock of sub the critical determinanty of whether you could do it
•	Board of parent decides and does it by itself
•	Difference bet NY 905 and Del 253:  In NY 905(b) – notice of impending transaction shall be given before the event to s/hs of subsidiary, should say what’s the purpose is (even though there is nothing these s/hs could do).  In Del – no req’nt of any notice to minority s/hs, except notice that it all happened after the event
•	Rights of appraisal for subsidiary s/hs in short form mergers – yes, in both NY and Del
•	Right to vote: when parent is merged into subsidiary, parent s/hs have right to vote
•	Parent-sub mergers can be effected simply by vote of the parent’s board – w/o vote of parent’s or sub’s s/hs, w/o appraisal rights in parent’s s/hs, and frequently w/o vote of sub’s board
•	Parent has the means of eliminating minority s/h’s interest by issuing cash rather than stock to the minority – cash-out mergers (thus, parent can force the minority to sell at any time, but the minority cannot force the parent to buy)

Small merger - Del 251(f) – approval/vote by s/hs of survivor corp is not required if stat merger won’t increase stock of acquiring co by more than 20% and won’t alter cert of inc and stock of acquiring co
•	No appraisal rights in Del
•	This is intended to conform Del statute to NYSE s/h approval policy: if co has stock listed on the exchange and is about to issue new stock for acquisition, if new stock will increase outstanding stock by more than 20%, there has to be s/h mtg to vote, whether or not required by state law, otherwise the exchange will not list new shares
In NY – no small mergers

	4.  Appraisal and valuation

Del 262(a), (b), (c), (d), (e), (h), (j), (k)
NY 910, 806(b)(6) (cf. 623)

Exclusivity of appraisal
		if s/h has the right of appraisal – is it exclusive?

Bove v. Community Hotel (RI)	In RI, appraisal rights are exclusive remedy

•	Community Hotel (RI) is overwhelmed w/accumulated unpaid preferred dividends – but could not wipe them out bec under RI law need unanimous vote: recapitalization by charter am’nt requires unanimous vote of preferred s/hs.  So, Hotel sets up sub and conducts downstream merger (parent into sub), which only requires 2/3 s/h approval.  Each preferred is to get 5 shares of $1 par value common in surviving corp, and current no par common is to be converted into one share $1 par value of surviving corp.
•	Ps: this merger is de facto charter am’nt (opposite of Farris).  Purpose is to get rid of accumulated dividends, which could be done by charter am’nt.  P says: Rhode Island merger statute was enacted after Community Hotel was organized and 30 years after preferred stock was created – so statute wipes out P’s property rights.  Thus, am’nt statute should apply and require unanimity
•	Court: Reserved Power (under J. Story’s conc opinion in Trustees of Dartmouth College) – corp can do it + under Del Independent Legal Sign’ce Doctrine there can be 2 independent statutes.
•	Court: proposed plan is no unfair and inequitable, particularly bec Ps have appraisal rights.  In RI, appraisal rights are exclusive remedy
•	P’s econ arg’nt/complaint: common stock has no equity at all in this co – they own zero – why are they permitted to participate in distribution in resulting co: holders of zero stock get 8.5%, while those who own 100%, get 91.5%.
1 answer: Court – 1. nobody is proposing liquidation; 2. no reason to believe that in liquidation, assets would match accounting quanifications – it would be a miracle if they would
2 answer: what if P found expert who said that value would equal accounting quantifications; holders of common have vote - you can’t do this deal w/o them, so common s/hs have their votes to sell you – it is the price of their vote that they get 8.5% of the deal.
Book networth – asset quantifications of the assets onco’s own books

Is appraisal exclusive remedy in Del? – statute is silent
In NY – NY 623(k) – appraisal is exclusive remedy except for right of s/h to bring action in court – so exclusive, except when it isn’t

	Note (textbook p.1184)
Whether appraisal right is an exclusive remedy, so that s/hs can’t seek equitable relief such as injunction or rescission.  In the absence of explicit statutory language, availability of appraisal rights normally does not preclude an attack:
(a)	That transaction is illegal under corp law in that it is not authorized by statute
(b)	That transaction is illegal under corp law in that the procedural steps required to authorize the transaction were not properly taken
(c)	That s/h approval of transaction was improperly obtained, as through fraudulent misrepresentation or violation of the Proxy Rules.
General rule:  The mere availability of appraisal rights does not preclude s/hs from seeking injunctive relief or rescission for fraud, including unfair self-dealing by fiduciaries.  (So usu if unfairness – s/hs will be precluded, but if self-interested transactions – s/hs will not be precluded)

Valuation

Piemonte v. New Boston Garden		Del Block Method of valuation

The court separately determines the value of corp’s stock under diff bases of valuation:
1.	market value – as of the day preceding the vote approving the merger (the weight given to market value depends in part on how deep the market was, i.e., whether there was extensive or only limited trading in the corp’s stock)
2.	earnings value – measured by determining corp’s average annual earnings during 5 years before the event that triggers appraisal rights (capitalize the earnings) and then multiplying that average by a selected multiplier
3.	net asset value – assets less liabilities - based on the liquidation value of corp’s assets
and then assigns weight to each valuation.

Dividend value – no separate weight is given, bec it largely reflects the same value as earnings (sometimes taken into account)

S.Ct of MA holds that trial court was w/n its discretion in valuation and assigning the weight

Weinberger v. UOP (S.Ct Del)	Standard of Entire Fairness: Fair Dealing + Fair Price
Burden of proof
Damages + Del 262(b)(1) – market out provision

•	Signal owned 50.5% of UOP w/remainder owned by public.  5 major directors of UOP were also directors/e’ees of Signal.  2 such directors used fin info of UOP to prepare a feasibility study concluding that any amount up to $24 per share would be a fair price for Signal to acquire the remainder of UOP.  Signal offers only $21 per share.  UOP board only gets hurried fairness opinion prepared by investment bankers.  UOP board approves $21 price, but no real negotiation, and non-Signal UOP directors were never shown the feasibility study.  Market price of UOP stock was $14.50 per share.
•	Class action to set aside merger.  Ps – minority UOP s/hs – bring suit for damages based on deal’s unfairness.
•	S.Ct drops the business purpose req’nt, instead adopts the Entire Fairness Test
•	BURDEN OF PROOF: 2 aspects
1.	burden of introducing evidence
2.	burden of persuasion (who has the risk of non-persuading)
•	This transaction requires s/h vote – approval of majority of the minority of disinterested s/hs.  D says: the effect of this approval is to shift to P the burden of persuasion – the burden of showing that this transaction is not entirely fair.
•	S.Ct – no: P has to raise an issue of entire fairness – the burden of introducing evidence to raise an issue is on P; but then the burden of persuasion is on D to show that transaction meets the standard of entire fairness.
•	What is the effect of add’l fact of s/h vote approving transaction?  S.Ct: usu to shift burden in both senses to P: both burden of introducing evidence + burden of persuasion to establish that transaction doesn’t meet the standard of entire fairness, except for cir’ces where it doesn’t apply – where D hasn’t disclosed all evidence.  Thus, D first has to establish complete disclosure of all relevant facts to all disinterested s/hs who voted for transaction in order to get the benefit of shifting of both burdens to P.
1.	Threshold q’n: has there been complete disclosure to P? - no
•	Should this feasibility study initially have been communicated to UOP board? – Yes.  2 directors who wrote it – e’ees of Signal – owed fid duty to Signal – duty of loyalty (to do the best job).  But they also owe fid duty to UOP.  How to balance 2 fid duties – duty to keep info confidential, but also duty to UOP to ensure that UOP s/hs get all info.  S.Ct: the result here could have been entirely diff if UOP had appointed independent negotiating committee of its outside directors to deal w/Signal at arm’s length.
•	S.Ct: Signal has not met standard of complete disclosure (had to disclose feasibility study to UOP); thus, approval of transaction by majority of minority s/h is a non-event.
2.	P has the burden of introducing evidence – yes, burden met
3.	Now D has burden of proving entire fairness: (1) fair dealing and (2) fair price
(1) Fair Dealing
(a)	defects in the process – haste is itself a breach of fairness of process: transaction was done very quickly, but no reason for such emergency; Signal structured this transaction so that UOP board had no time to consider it; Lehman Brothers had to make their fairness opinion over the weekend
(b)	inadequate disclosure
(2) Fair Price – not only Del Block method, all relevant factors have to be considered; P’s expert evidence should have been introduced w/r/t premium paid over market in ten other tender offer-merger combinations and discounted cash flow method
Damages
•	S.Ct.:  If P only asks only for value of his stock – remedy is appraisal; but if P asks for damages other than value of his stock – rescission (to put parties where they would have been had misconduct not occurred).  Thus, S.Ct says that appraisal is exclusive remedy, except when it isn’t – this is present state of Del law + NY law (NY 623(k)).
•	S.Ct:  Appraisal remedy may not be adequate in certain cases – where fraud, misrepresentation, self-dealing, deliberate waste of corp assets, or gross and palpable overreaching – then any form of equitable and monetary relief may be appropriate, including rescissory damages.
•	UOP’s stock is publicly traded on NYSE
Del 262(b)(1) – market out provision: if you own stock which is traded on the exchange, or held by NASD, or held of record by more than 2000 s/hs – appraisal is not available
but market out applies only if P will have marketable security in the end of the deal.  Here, P has not sought appraisal, but rescissory damages; P winds up w/cash – so market out is n/a.

	5.  Dissolution

Del 275, 278, 282
NY 1001, 1006-07, 1103-05

•	Slain: At no level of abuse of minority s/hs will Am court order dissolution if business is doing well
•	Voluntary dissolution is a fundamental change.
•	Del 275 – usu requires Board resolution recommending this course of action + s/h vote: majority of shares outstanding
•	NY 1001 – different: it doesn’t require a Board resolution antecedent to s/h action, only a vote of majority of all outstanding shares: s/hs could initiate proposal for dissolution w/o Board resolution
•	NY 1006  Half-life of corp after dissolution
•	NY 1104(a)  Holders of shares representing 1/2 of votes of all outstanding shares entitled to vote in election of directors may present a petition for dissolution on 3 grounds:
1.	the directors are so divided that votes needed for action cannot be maintained
2.	s/hs are so divided that votes required for election of directors cannot be obtained
3.	there is internal dissension and two or more factions of s/hs are so divided that dissolution would be beneficial to s/hs
No analogue in Del
•	Business failure – trad’l ground on which c/hs can sue for order of dissolution
•	Power to order dissolution – trad’l remedy in equity
•	Is NY statute exclusive thus ousting trad’l equity jurisprudence?
1. if yes, can’t go to court and argue that dissolution should be ordered
2. suppose don’t have 50% of the stock, is there trad’l equity jurisprudence or not? (Slain doesn’t know)

Matter of Kemp & Beatley (NY)	NY 1104(a) (involuntary dissolution statute)
Oppressive conduct by maj ag min s/hs
Yes, order dissolution subject to opp’ty for a buy-out of Ps’ shares

•	Close corp; 2Ps – former e’ees of corp – no longer received any distribution of co’s earnings according to their stockholdings, in the form of either dividends or extra compensation.
•	NY 1104(a) permits dissolution when copr’s controlling faction is found guilty of oppressive action toward complaining s/hs.  Oppressive actions refer to conduct that substantially defeats the reasonable expectations held by minority s/hs in committing their capital to the particular enterprise.  Oppression will arise only when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the cir’ces and were central to the P’s decision to join the venture.  Courts should consider both
	whether liquidation of corp is the only feasible means to protect complaining s/h’s expectation of a fair return on his investment and
whether dissolution is reasonably necessary to protect the rights or interest of any substantial number of s/hs not limited to those complaining
•	When ordering dissolution, court should permit any s/h of corp to elect to purchase complaining s/h’s stock at fair value
•	Acts of minority s/h should not be made in bad faith

	6.  Triangular mergers and share exchanges
see notes (textbook p.p. 1174-76)

Assignment No. 5 – Federal Corporation Law

•	Very narrow provision for private enforcement
•	1934 Act §9 – securities traded on the Exchange; §9(e) – private right of action for violation of §9, but no cases (very narrowly drafted – hard to get private right of action).  §18 – private right of action for false filing, but no cases.
•	SEC is given the broadest authority to litigate w/anyone
§20(b) of 33 Act, §21 of 34 Act
24 of 33 Act, 22 of 34 Act criminalize willful violations
•	Antifraud provisions
•	§17 of 33 Act forbids only sale of securities (not purchase); j’n – interstate commerce, mails, etc.  doesn’t state that there is private right of action if engage in this conduct.  Sue may sue to enjoin D under §20(b) of 33 act, or criminally prosecute D under §24 of 33 Act
•	§10(b) of 1934 Act – all securities are covered
Grant of authority to SEC; doesn’t itself operate to forbid anything; SEC adopted Rules 10b-1 – 10b-4; Rule 10b-5
Rule 10b-5 – language similar to §17(a) of 33 Act, but applicable to purchase or sale of securities
•	J.I. Case v. Borak (S.Ct 1964) – Established an implied private right of action on behalf of s/hs for violation of §14(a) and Rule 14a-9 (for violation of federeral statute which doesn’t provide for private right of action).  S.Ct: private enforcement is a necessary supplement to enforcement by SEC.
•	Slain: holding that there was private right of action under proxy rules – no conflict bet fed and state law, bec there was no state law.  But Rule 10b-5 action is a tort of deceit – there is state law on that – so, conflict bet federal and state law.
•	Mills created R.10b-5, although it’s not a R.10b-5 case – huge increase in R.10b-5 litigation after 1970.

D.  The Implied Actions

1.  Development

Mills v. Electric Auto-Lite Co	Implied right of action for violation of §14(a) and (S.Ct. 1970)				Rule 14a-9 of 34 Act recognized in Borak
Materiality + proxy solicitation = transaction causation

•	Rule r14a-9 prohibits solicitation of proxies by means of materially false or misleading st’nts.
•	Ps – s/hs in Auto-Lite.  Mergenthaler owned more than 50% of Auto-Lite and names all 11 of its directors.  Auto-Lite sends proxies to its s/hs asking for approval of merger and board recommendation, but proxies did not disclose that all board members of Auto-Lite were nominees and under direct control of Mergenthaler.
•	Ps sue both derivatively on behalf of Auto-Lite and as representatives of the class of all its minority s/hs.  Ps didn’t seek temporary restraining order or injunciton – they sued the day before the vote; voting went ahead as scheduled the following day.  Why did Ps wait so long to bring suit – wanted to have a lawsuit (not settlemen).
•	Auto-Lite is a reporting co, otherwise proxy rules would not be applicable to it.
•	Tort: need causation (S.Ct granted Cert on transaction causation issue)
Transaction causation (here) v. Loss causation
Elements of tort of misrepresentation/omission:
1. materiality
2. reliance
3. scienter
1.	Materiality:  S.Ct – Misstatement/omission in proxy st’nt is material if it might have been considered important by reasonable s/h who was in the process of deciding how to vote.
2.	Reliance:  S.Ct – showing of materiality is sufficient showing of causal relationship bet. violation and injury, if proxy solicitation itself was an essential link in the accomplishment of transaction
•	Showing of materiality satisfies the causation req’nt - need nothing more to prove causation than to prove materiality
•	Materiality + proxy solicitation = transaction causation.  P doesn’t have to establish reliance (impossible to show that this defect in disclosure caused sufficient votes)
3.	Scienter – in a R.14a-9 case – probably not an element
•	Here, 2/3 of Auto-Lite shares were required for approval of merger.  S.Ct: Footnote 7: we need not decide in this case whether causation could be shown where the mgmt controls a sufficient number of shares to approve transaction w/o any votes from the minority.
•	Relief:
§29 of 34 Act – merger doesn’t have to be set aside (it’s already gone through) – thus, no injunction; there may be a remedy, so S.Ct remanded the case.  The most convenient remedy – monetary relief.
	Atty’s fees: court allowed here.  So, after this case (1) trivial missing st’nt – material defect – but anything is material, and (2) if you establish as a class that there is a violation – you get att’s fees anyhow, whether or not you get monetary recovery – great for Ps’ atts - attys – real parties in interest here.
Here, D did need votes of outside s/hs to get the deal done.  Suppose they have enough stock (2/3 or simple majority, if Del corp) – what result? – the proxy solicitation itself, rather than the particular defect in the solicitation materials has to be an essential link in the accomplishment of the transaction – so D has to need the votes.  but most courts – doesn’t matter if you need the votes, if there is defect in proxy solicitation.  Thus, materiality holding has done huge harm (but it’s not even a S.Ct holding, but came to be understood as such); very low materiality standard – flood of litigation.

R.10b-5 cases – mostly publicly traded securities, but don’t have to be

		2.  The standing requirement

Blue Chip Stamps v. Manor Drugs		Rule 10b-5
(S.Ct 1975)	P has no standing to maintain private cause of action for damages under Rule 10b-5 because he is not seller or purchaser of securities

•	P/non-s/h: prospectus distributed by Blue Chip in connection w/the offering to retailers who had used the stamp service in the past was materially misleading in its overly pessimistic appraisal of Blue Chip’s status and future prospects; P seeks damages representing the lost opportunity to purchase shares – allege violation of R. 10b-5 (Slain: it’s not unusual that prospectus is pessimistic in tone).
•	Ps sue for profits that they didn’t get + exemplary/punitive damages.  But §28 of 34 Act: the only damages recoverable are actual damages; punitive damages are not affordable
•	S.Ct upholds 2nd part of Birnbaum doctrine – P has no cause of action – neither purchaser nor seller of securities
•	Rehnquist: problems that would arise if Birnbaum was overturned; anyone could say – I should have sold/bought – would vexatious litigation (extortionate) + problems of proof - availability only of oral testimony.  D would want to settle bec of huge costs of discovery.  So, lawsuit which has very little chance of success, has very substantial settlement value.
•	3 classes of potential Ps are barred by Birnbaum rule:
1.	potential purchasers of shares who allege that they decided not to purchase bec of unduly gloomy representation or omission of favorable material fact which made the issuer appear to be a less favorable investment vehicle than it actually was (here)
2.	actual s/hs in the issuer who allege that they decided not to sell their shares bec of an unduly rosy representation or failure to disclose unfavorable material
3.	s/hs, creditors, and others related to an issuer who didn’t sell and suffered loss in the value of their investment due to corp or insider activities in connection w/purchase or sale of securities which violate R.10b-5 (they were defrauded)
•	Slain: if we adopt “loser pays all” rule – chances of extortious litigation will be much less – the problem will disappear
•	Suppose my security was supposed to be converted on certain dae, but mgmt induces me not to convert – what result? – I don’t have standing to bring the suit – neither purchaser nor seller (+for derivative suit – there has to be harm to corp)

Virginia Bankshares v. Sanderson		§14a + Rule 14a-9
(S.Ct 1991)	2 holdings - subjective belief by directors and standing - both wrong
+ see p.176 of notes
•	Slain: S.Ct got all issues wrong
•	Freeze-out merger: parent co had enough stock (85%) to approve transaction w/o any proxies from outside s/hs, but they issued proxy st’nt and solicitation to minority s/hs.  (In case of subsequent litigation, considerable advantage to D is transaction was voted for by majority of minority s/hs – entire burden of proof would shift to D.)
•	D got most proxies, but not from this P.  P – defect in the proxy st’nt: Board recommends the transaction + says that it recommends bec deal gives s/hs higher price - $42 per share – and this is fair price.  P: directors didn’t believe that this was really a high price; there is info that co can sustain higher price than $42 – P gets this info from proxy st’nt.
•	S.Ct holds 2 things:
1.	Mere subjective disbelief by directors is not actionable.  If disbelief about factual basis which is inaccurate – actionable (if misstate the speaker’s reasons and also mislead about the stated subject matter)
•	R. 14a-9 imposes liability only for misstatements of material facts.  Fact is material if there is substantial likelihood that a reas s/h would consider it important in deciding how to vote.  But a st’nt of belief by corp directos about a recommended course of action, or an explanation of their reasons for recommending it is normally material (expertise, knowledge, perceived superiority of directors).  Mere disbelief or undisclosed motivation is insufficient to satisfy the element of fact that must be established under §14(a).
•	Here, proxy st’nt says that Board believes that trans’n is fair; Board doesn’t have that subjective belief, but trans’n is objectively fair – st’nt, although false, is not actionable
2.	Ps/minority s/hs don’t have standing to sue bec their votes were not required to affect the transaction, even if there is material defect in proxy st’nt (this is what S.Ct didn’t decide in Blue Chip Stamps); parent owns or controls majority of stock
Slain: voting is the least important part of proxy process – proxy rules are needed to provide info to s/hs.  This court – awful result: if you don’t need s/h vote, it doesn’t matter how you lie to them.  Court is wrong: statute or rule don’t require that s/h votes affected trans’n.
•	IF SECURITY IS NOT REGISTERED UNDER §12 - PROXY RULES ARE IRRELEVANT.

		3.  Scienter

Ernst & Ernst v. Hochfelder		§10(b) + Rule 10b-5
(S.Ct. 1976)	Need allegation of scienter when private cause of action for damages
	Scienter – conscious intent to defraud
	Scope of Rule cannot exceed scope of statute

•	D/Ernst & Ernst – accounting firm, failed to discover fraud by President of corp/Nay.  Ps - -customers of corp who invested in fraudulent securities scheme (non-existent escrow accounts).
•	Ps: Nay’s escrow scheme violated 10(b) and R.10b-5.  Nay used money of later investors to pay off earlier investors.  But he didn’t do it in connection w/purchase or sale of any security – still violation.  It’s settled that fictitious security is a security for this purpose.
•	Ps: D aided and abetted Nay’s violations by its failure to conduct proper audits of corp – negligent nonfeasance: D failed to discover internal practices of the firm (mail rule) said to prevent any effective audit.  Ps specifically disclaimed existence of fraud or intentional misconduct on the part of D.  (D could have refused to issue clean opinion on financials as required by SEC – corp would soon go out of business.
•	S.Ct – ag. Ps: private cause of action for damages will not lie under 10b and R.10b-5 in the absence of any allegation of scienter – intent to deceive, manipulate, or defraud.  Negligence is not enough.
•	R.10b-5
(1)	intent
(2)	can do inadvertently (it is unlawful “to make any untrue st’nt of material fact or to omit to state a material fact necessary in order to make the st’nts made… not misleading” and “to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person”
(3)	arguable
But S.Ct:  Despite the broad view of the Rule advanced by the Commission in this case, its scope cannot exceed the power granted the Commission by Congress under 10(b).
•	Footnote 7:  S.Ct doesn’t reach the q’n of where there is a cause of action for aiding and abetting in violation of 10b-5.  (To aid and abet, there must exist an underlying securities law violation committed by someone else.)
•	NB  Footnote 12:
What do you mean by scienter?  Cts of App: intent to defraud, reckless disregard for the truth, or knowing use of some practice to defraud.  Here, Ds didn’t intend to defraud.  Another view: scienter means that this was conscious behavior, doesn’t matter if D was intending to defraud.  S.Ct: in this opinion the term scienter refers to a mental state embracing intent to deceive, manipulate, or defraud; S.Ct doesn’t address here the q’nt whether, in come cir’ces, reckless behavior is sufficient for civil liability under 10(b) and R.10b-5.
•	So, what do you mean by scienter: conscious effort to defraud or just D did what he did?
•	S.Ct also doesn’t consider the q’n whether scienter is a necessary element in an action for injunctive relief under 10b and R.10b-5.

Aaron v SEC		P/SEC seeks injunction
(S.Ct 1980)		10(b) of 34 Act + Rule 10b-5 - scienter
			17(a) of 33 Act
				17(a)(1) - scienter
				17(a)(2) – no scienter
				17(a)(3) – no scienter
Injunction should issue when there is some likelihood of a future violation (conc opinion)

•	Issue: Whether SEC is required to establish scienter as an element of a civil enforcement action to enjoin violations of 17(a) of 33 Act, 10(b) of 34 Act and Rule 10b-5.  (Injunctive relief under 20(b) of 33 Act for violation of 17(a) and injunctive relief under 21(d) for violation of 10b + Rule 10b-5.)
•	P/SEC wants to enjoin D/Aaron/corp from violating these sections – seeks preliminary and final injunction (Fn 12 leaves open the q’n whether scienter is required when SEC is suing for violation)
•	Slain: here – obvious case of scienter
•	Held: violation of
10(b) + Rule 10b-5	requires scienter – intent to deceive, manipulate, or defraud regardless of identity of P or nature of relief sought
17(a) of 33 Act
17(a)(1) requires scienter
17(a)(2) no scienter – mere negligence is enough
17(a)(3) no scienter – mere negligence is enough
•	R.10b-5 and 17(a)(2) – identical language; but Rule has to be interpreted w/underlying grant of authority to SEC (Ernst & Ernst); R.10b-5 – w/n 10(b) – scienter.
•	Is there a private right of action under 17(a)?  If there is, then it doesn’t require scienter in 17(a)(2) and 17(a)(3) actions.  S.Ct never resolved it (every Ct of App held that there is no private right of action)
•	Chief Justice Burger’s concurring opinion:  Injunction should issue when there is some likelihood of a future violation.  To make such a showing, it will almost always be necessary for SEC to demonstrate that D’s past sins have been the result of more than negligence, so Ds whose past actions have been in good faith are not likely to be enjoined (after this conc opinion, dist cts started to hold that they would not grant injunctions w/o showing of likelihood of future violations.)
•	17(a) applies only to sellers; so, because 17(a)(2) and (3) do not require scienter, SEC can now enjoin merely negligent sellers, but has to show scienter to enjoin buyers under 10(b) +R.10b-5

		4.  Materiality and duty of disclosure

Basic v. Levinson		10(b) + Rule 10b-5
(S.Ct 1988)			Materiality depends upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the co activity
				Presumption of Reliance allows for Class Certification:
				Fraud-on-the-market theory

•	Basic was involved w/merger discussions w/Combustion Engineering for 3 years, yet made 3 public st’nts denying that it was engaged in merger negotiations.
•	Ps/class – former Basic s/hs who sold their stock after Basic’s 1st public st’nt and before the suspension of trading (the day before public announcement of its approval of Combustion’s tender offer)
•	Dist ct certified the class, but dismissed suit – negotiations are not material until main negotiation/agr’nt was reached – until there was a deal
•	6 Cir reversed on that issue: any st’nt you make that is untrue is by definition material + certified class on fraud-on-the-market theory: reliance need not be shown independently by Ps, bec presumption of reliance – info was public – affected market price (semi-strong form of efficient market hypothesis)
MATERIALITY
•	S.Ct adopts standard of materiality set forth in TSC Industries v. Northway for 10(b) and Rule 10b-5 cases: there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of info made available
S.Ct adopts 2d Cir test of materiality in SEC v. Texas Gulf Sulphur:
Materiality depends upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the co activity
•	depends on the facts – fact-specific inquiry 
•	probability that the activity will occur – indicia of interest at the highest corp levels: board resolutions, instructions to investment bankers, actual negotiations 
•	magnitude of trans’n to the issuer of securities allegedly manipulated – size of 2 corp entities and potential premiums over market value (but merger is obviously of great magnitude to the co)
•	Ds argue for 3 Cir test: preliminary merger discussions do not become material until agreement-in-principle as to the price and structure of the transaction has been reached bet the would-be merger partners – S.Ct rejects
3 rationales (S.Ct rejects each one)
1.	noise – concern that investor not be overwhelmed w/trivial info
2.	this test will preserve confidentiality of negotiations (S.Ct – should be addressed to Congress)
3.	provides bright line for when disclosure must be made (S.Ct – nice, but not what Congress provided for)
Slain: 2nd and 3rd rationales make sense
•	S.Ct also rejects 6 Cir test that info is always material if what you say about it is untrue; S.Ct – you have to make preliminary inquiry whether info is material in R.10b-5 claim – P must show that st’nts were misleading as to material fact, not enough that st’nt is false or incomplete, if misrep’d fact is otherwise insignificant

•	Footnote 17:  To be actionable, a st’nt must also be misleading.  Silence, absent a duty to disclose, is not misleading under Rule 10b-5.  “No comment” st’nts are the functional equivalent of silence.  Thus, Rule 10b-5 does not impose an obligation to speak.  The only time when it imposes duty to speak is when you said smth, and your st’nt is not completely true, or when you intended your st’nt to make people rely on it, then cir’ces changed – you have duty to correct your st’nt.  So you can just say “no comment”.

Presumption of RELIANCE allows for Class Certification
•	Reliance – element of Rule 10b-5 case
•	Suppose ct adopts D’s position – that Ps in a class action have to prove ind’l reliance – to many ind’l issues, Ps wouldn’t sue.  Modern securities markets are not face-to-face transactions (unlike common-law fraud cases).  Presumptions are useful + allocate burden of proof: difficult to have direct proof, fairness, public policy, probability + common sense, judicial economy
•	S.Ct adopts fraud-on-the-market theory:
In the market, the price of the co’s stock is determined by the available material info re: co and its business; misleading st’nts defraud purchasers of stock, even if they do not directly rely on the misst’nts.
Thus, reliance of ind’l Ps on the integrity of the market price may be presumed.  Most publicly available info is reflected in market price – impersonal efficient market.
•	D may rebut presumption as to ind’l Ps (if D can show that misrep’n did not affect the market price, or that ind’l P did not rely on integrity of the market price).  Slain – impossible to do.
•	Slain: J. White’s dissent – better case
Court decided to take on semi-strong form of efficient market hypothesis; you don’t have to prove what is universally known and incontrovertible, but is this hypothesis universally known and incontrovertible? – No.  Can you justify presumption of reliance w/o fraud-on-the-market theory?  Securities law is replete w/derivative reliance: I buy security not bec the price is right, but bec that’s how I was advised by broker or other securities analyst; they are getting info from publicly disclosed info, they rely on it, so I rely on this info – so, my reliance is derivative and unprovable.  It’s a far easier arg’nt to make than that efficient market hypothesis operates in some way to produce reliance.
	Why is reliance an element of R.10b-5 case?  R.10b-5 itself imposes no disclosure obligations; they come from somewhere else.  In a non-disclosure case, reliance will be assumed.  Court continues to insist that reliance is an element of R.10b-5 case, bec reliance is an element in common law of deceit.

		5.  Enforcement of fiduciary duties

Santa Fe v. Green		10(b) and Rule 10b-5
(S.Ct 1977)			Del short-form merger statute 253
				Breach of fiduciary duty by majority s/sh, w/o any deception, misrepresentation, or nondisclosure, does not violate 10(b) and R.10b-5.

•	R.10b-5 case – same as R.14a-9 case: can’t be violation of the Rule w/r/t transaction that is fully and accurately disclosed
•	D/Santa Fe owned 95% of Kirby Lumber stock, and wants to do a short-form merger under Del 253: parent to merge w/subsidiary upon approval by parent’s board and ot make payment in cash for shares of minority s/hs; doesn’t require consent or advance notice to minority s/hs; requires notice w/n 10 days after merger.  Minority s/hs have appraisal rights under Del 262.  Santa Fe offered $150 per share to min s/hs; market value of stock was $125, as valued by Morgan Stanley.
•	Ps/min s/hs of Kirby – to set aside merger or to recover fair market value of their shares (didn’t seek appraisal rights): Kirby’s stock was worth at least $772 per share based on fair market value of Kirby’s physical assets as it says in info st’nt sent to min s/hs.  Thus, Ps allege violation of Rule 10b-5.
•	But D disclose all this info to P.  Cause of action under 10(b) – only if conduct alleged is “manipulative or deceptive”.  Fund’l purpose of the Act is implementing a philosophy of full disclosure, not fairness of trans’ns.  Plus, there is a cause of action under state law – in Del. Court of Chancery for appraisal.  Congress by 10(b) did not seek to regulate transactions which constitute no more than internal corp mismanagement.
•	Held:  Transaction was neither deceptive nor manipulative and so, did not violate 10(b) and Rule 10b-5 (even if inadequacy of price violates Santa Fe’s fid duties.  Breach of fiduciary duty by majority s/sh, w/o any deception, misrepresentation, or nondisclosure, does not violate 10(b) and Rule 10b-5.
•	Note: if corp had deceived min s/hs, then there would have been a R.10b-5 action.
•	Tobin Q Ratio – compares market price of securities w/replacement value of the assets (see p.p. 185-186 of notes)

	E.  Regulation of Tender Offers

13(d)(1), 14(d), (e), (f) of 34 Act

SEC v. Carter Hawley Hale		13(e) and Rule 13e-4 of the Williams Act
(9th Cir 1985)				8-factor Wellman test: when issuer repurchase program during 3rd party tender offer is a tender offer

•	Issue: whether CHH’s repurchase of shares during a 3rd-party tender offer itself constituted a tender offer.
•	SEC/P brought suit for injunctive relief to enjoin the target co/CHH/D from repurchasing its own stock to defeat takeover attempt by Limited w/o complying w/tender offer regulations under 13(e) and Rules 13e-1 and 13e-4.
•	White Squire – find somebody who is prepared to come in and give shares  to give target co blocking position to prevent tender offeror from completing his plans w/r/t transaction
•	SEC: CHH’s repurchase program constituted a tender offer conduction in violation of 13(e).
•	Ct applies 8-factor Wellman test: issuer repurchase program during 3rd party tender offer is a tender offer when
1.	Active and widespread solicitation of public s/hs for the shares of an issuer;
2.	solicitation made for a substantial percentage of issuer’s stock;
3.	offer to purchase made at a premium over the prevailing market price;
Premium is determined not by reference to pre-tender offer price, but rather by reference to market price
4.	terms of the offer are firm rather than negotiable;
5.	offer contingent on the tender of a fixed maximum number to be purchased;
6.	offer open only for a limited period of time;
7.	offeree subjected to pressure to sell his stock;
8.	public announcements of a purchasing program concerning the target co precede or accompany rapid accumulation of a large amount of target co’s securities
•	Not all factors need be present to find a tender offer.  (Here, only 2 factors are satisfied – 2nd and 8th.)
•	Held: under 8-factor Wellman test, CHH’s repurchase program did not constitute a tender offer.

Epstein v. MCA		14(d)(7) and Rule 14d-10: all-holder, best-price rule 
(9th Cir 1995)		requires all bidders to treat all s/hs on equal terms
There is private right of action for violation of 14(d)(7) under 4-factor Cort v. Ash test

•	D/Matsushita made tender offer to acquire MCA.  Ps/class action/former MCA’s s/hs who tendered their shares for $71 tender price.  Ps: Matsushita violated Rule 14d-10 by treating Wasserman and Sheinberg differently from other s/hs in the tender offer.  Ps want the premium/difference (same price as W)
•	Ct: there is private right of action for violation of 14(d)(7).  Court applied Cort v. Ash 4-factor test to decide whether in enacting 14(d)(7), Congress intended to create private cause of action
1.	whether P is one of the class for whose especial benefit the statute was enacted
2.	whether there is any indication of leg intent, explicit or implicit, either to create such a remedy or to deny one
3.	whether it is consistent w/the underlying purposes of the leg scheme to imply such a remedy for P
4.	whether the cause of action is one traditionally relegated to state law
(+ see p. 651 of xerox)
•	In cases after Borak (1964), courts developed implied right of action jurisprudence, so Congress didn’t think it had to decide the private right of action q’n itself when it enacted the Williams Act in 1968.
•	Wasserman transaction: Capital Contribution and Loan Agr’nt – W agreed to exchange his MCA shares for preferred stock in a subsidiary Matsushita would create.  Performance of this Agr’nt was conditioned on the tender offer in several respects:
1.	neither Matsushita nor W was obligated to perform Agr’nt if any of the conditions of the tender offer were not satisfied
2.	the timing of performance was tied to tender offer – immediately after Matsushita accepted tendered payment for payment
3.	amount of cash Matsushita was required to contribute to subsidiary was dependent upon the tender price
4.	redemption value of W’s preferred stock was set as the tender price
Whether W transaciton violated R.14d-10 depends upon
1. whether W received greater c’n than other MCA s/hs during such tender offer, or
2. whether W received a type of c’n not offered to other MCA s/hs in a tender offer
•	D – defense: timing – W transaction closed after tender offer period expired; But Ct: not rigid period of time; the test is
1. whether W transaction was an integral part of Matsushita’s tender offer
2. if yes, Matsushita violated R.14d-10 bec it paid him, pursuant to the tender offer diff and more valuable c’n than it offered to other s/hs

Piper v. Chris Craft		§14(e) (anti-fraud provision in Williams Act)
(S.Ct 1977)	Defeated tender offeror has no implied private cause of action for damages under §14(e)
Purpose of the Williams Act is to protect s/hs of target co, not bidders

•	P/Chris-Craft made unsuccessful tender offer to D/Piper; now seeks damages ag Piper for alleged violation of 14(e) – that their tender offer was frustrated by somebody else’s conduct violating tender offer rules (which was true).  The Piper family opposed Chris-Craft’s tender offer
•	Held: there is no implied private cause of action for damages by bidders under 14(e)
•	Court applies the 4-factor Cort v. Ash test:
1.	Was P one of the class for whose especial benefit the statute was enacted? – No, on the contrary, bidder is a member of the class whose activities 14(d) seeks to regulate, not protect
2.	Is there leg intent to create an implied cause of action? – No.  Plus, lack of purchaser/seller req’nt in 14(e) does not give bidder standing – rather, it could be designed to give remedy to s/hs-offerees that did not tender their shares due to fraudulent misrepresentations: these s/hs do not have standing under Blue Chip Stamps.
3.	Is creating an implied cause of action here consistent w/the underlying purpose of the statute? – No.  The purpose of the Williams Act is to protect s/hs of the target co, not bidders.  Otherwise, if Piper is found liable, then the effect of the lawsuit is to transfer loss to the precise class that the statute is designed to protect (people who used to be s/hsof Piper are now s/hs of Bangor Punta, the co which won the contest).  Plus, Chris-Craft should have sued for injunction, rather than damages paid by ultimate beneficiaries of the Act.
4.	Is the cause of action one properly delegated to state law? – Yes, common-law principles of interference w/prospective commercial advantage.
•	Note: S.Ct expressly reserved its views on (a) whether the target or its s/hs had standing, and (b) whether a tender offeror might obtain injunction relief as distinct from damages.

F.  Trading on Non-Public Information

1. §16(a), (b), (c) of 34 Act

•	§16 – the only section that expressly deals w/Insider Trading
•	§16(a) – 3 classes of people
1.	beneficial owner of more than 10% of any class of equity security registered under §12
2.	director
3.	officer
Note: but if you are w/n reporting class (director, officer), you have to report your ownership of all equity securities whether or not registered under §12
File Form 3 w/the Commission
At the end of any month, you have to report any change in your ownership; you have to report any gift or purchase
•	§16(b) – any equity security (matches 16(a)’s reporting thing):
	If any class of persons required to report w/n 16(a) has profit from purchase and sale w/n less than 6 months, issuer can recapture this profit
1.	Statute operates automatically (the actual use of inside info is irrelevant)
2.	Are these transactions illegal? – No – all it says it says is that profit is to be recaptured by the issuer
3.	You can have a recapturable profit w/n a loss
How to compute profit: take transaction and go 6 months back or forward and match it w/any sale/purchase at higher price (see p. 202 of notes).
•	16(b) cases – small number of Ps; Attys fees – motivation for litigation (lawsuits w/o clients); 16(b) system – effective, self-administering, doesn’t cost any money to taxpayers
•	16(b) aims at short-term trading: to prevent mgmt from profiting on short-term fluctuations; this is not a broad statutory prohibition on insider trading
•	Prohibition on insider trading is not implicit in law

		2.  §20A, §21A; Rule 10b-5, Rule 14e-3

	Sec 16(b)	Rule 10b-5	
Security	Any equity security of an issuer which has securities registered under Sec 12 (any equity security doesn’t have to be registered under Sec 12)
(Sec registered under Sec 12 – listed on the exchanges + all equity securities w/n Sec 12(g) – can be OTC)	Any equity security
(doesn’t have to be registered under Sec 12)
Classic 10b-5 case: sale of stock of closely held co
+ after O’Hagan, insider trading applies to debt	
Persons Liable	3 classes of people who have to report under Sec 16(a)	Anybody – liable by violating the rule	
Illegal transactions?	No, they are not illegal	Yes, illegal – you can be criminally prosecuted under 10b-5	
In a private suit, who can be be a P?	Issuer of security – corp or s/h suing on issuer’s behalf	Purchaser or seller (Blue Chip Stamps)	

SEC v. Texas Gulf Sulphur		Rule 10b-5 Insider Trading
2d Cir 1968				Duty to disclose or abstain
					Who are liable? - all people who have inside info: e’ees and independent contractors (not only directors and officers)

•	Inhibition on insider trading is applicable not only to broker-dealers, but very broadly
•	Held: Anyone in possession of material inside info must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corp confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such inside info remains undisclosed.
No absolute duty to disclose: duty to disclose or abstain - you only have a duty to disclose if you trade info
•	When insiders may trade: must wait until the material info has been “effectively disclosed” in a manner sufficient to ensure its availability to the investing public.  At minimum – wait until it goes over Dow Jones broad tape.
•	If the info was material, its possessors should have kept out of the market until disclosure was accomplished.
•	Test of materiality: whether a reasonable man would attach importance in determining his choice of action in the transaction in question.
•	Whether facts are material w/n Rule 10b-5 when the facts relate to a particular event and are undisclosed by those persons who are knowledgeable thereof depends upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.
•	Here, knowledge of the results of the discovery would have been important to a reasonable investor and might have affected the price of the stock.
•	Slain: conception of securities market as a place of perfect info: person who is trading on securities market has the same info as anybody else – but impossible to operationalize.  This standard of materiality is absurd, bec speculator is interested in anything
•	The core of R 10b-5 is the implementation of the Congressional purpose that all investors should have equal access to the rewards of participation in securities transactions.  All members of the investing public should be subject to identical market risks.  The insiders here were not trading on equal footing w/outside investors – inequities based upon unequal access to knowledge.
Facts
•	(2 actions here: one for misleading press release and the second one for ag the officers for insider trading)
•	TGS acquired drilling rights to a mineral deposit discovered major mineral fund.  Some geologists, some directors bought stock and calls (options) to by TGS stock.  TGS also issued stock options to various e’ees including 5 that knew of drilling.  Land acquisition goes through (they bought all the land), they start redrilling.  Then TGS issued a press release saying that nothing definite was found.  Then TGS announced major mineral strike.  Court holds for SEC.
•	Call – option to buy a security, usu at a price slightly above the current market.  Writer – person who gives this option, usu institutional investor: 3 classes of people + Of these 3 classes, who is hurt by insider trading? Of these 3 classes, who is hurt by insider trading?
1.	people who write options for purchase by insiders – yes, they are hurt, bec they’ll lose much stock
2.	co, like TGS, itself writes options to its e’ees – s/hs are not worse off by the fact that insiders came into the market as a buyer, it could even help s/hs
3.	people who sold co’s stock in the open market and whose stock was bought by insiders
Nobody could explain why in an exchange transaction there is an injury to counterparty from insiders
If OTC: if I’m the seller, who is my buyer – the dealer; but OTC sellers are never sued for these violations
•	Here, SEC injunction proceeding: SEC seeks remedy – disgorgement – for D to turn over the profit
•	Here, the Option Committee didn’t know about the results; people who received options knew about the results.
•	Motivation for press release – to quell the rumors.  VP Fogarty knew that assay was positive; press release is not very optimistic, less optimistic than the state of his knowledge.  If he issued a more factually accurate press release, price of stock would go up a lot.
•	Rule of thumb: when in doubt – make the news bad.  Whose interests were disserved by that? – people who sold their stock + people who didn’t buy, but see Blue Chip Stamps – they don’t have standing
•	Ernst v. Ernst: elements of 10b-5 violation, one of which is scienter – conscious intent to defraud; this press release is not conscious intent to defraud; these people were trying to keep situation from getting out of hand.
•	But Court: yes, violation; so what’s the meaning of scienter – intent to defraud or just that D did what he did
•	Liability of insiders: who are the people who can be held liable? – not limited to directors and officers; all people who have inside info: e’ees and independent contractors

•	From 1934 till 1975, SEC never lost a case in S.Ct on issue that SEC regarded as important; from 1975 – SEC never won a case

•	Congress amended 34 Act by adding Sec 20A and Sec 21A
•	Sec 20A solves the problem that was though to inhibit private suits – provides for private right of action based on contemporaneous trading; 20A itself does not add anything substantive to insider trading – just that insider trading is a violation of statute or rules

Chiarella v. US (S Ct 1980)