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CORP FALL 2012 ZACKS

FALL 2012 CORPORATION OUTLINE


PROFESSOR ZACKS
1) The Practice of Business Law (3-43)
a. Practicing Corporate Law
i. A Different Paradigm from Litigators
1. Corp lawyers deal w prospective matter than retrospective matter
2. Goal: variegated than vindication (arms-length v adversarial)
3. Lawyer client is in charge of the biz proposal; litigator in charge of litigation
ii. The Typical Roles of the Corporate Lawyer
1. Counselor advice clients
2. Conciliator resolve conflict btwn client and another, often regarding a potential transaction
3. Facilitator lawyer as negotiator, applicable regulations, drafter
4. Guardian protect client and public against some contemplated actions by persons acting on the
clients behalf; confidentiality
iii. Professional Conduct of Corp Lawyers
1. Obligation to report up the ladder if fraud, securities violation etc
2. Can reveal to people outside the biz
a. if after reporting up the ladder no action is taken and if lawyer reasonably believes that the
violation is reasonably certain to result in substantial injury to the organization
b. Reveal information to the extend the lawyer reasonably believes necessary to (1) prevent death/
bodily harm (2) prevent client from committing a crime or fraud that will injure organization (3)if
client using lawyer and his work to cover a crime that will substantially hurt the finances of
somebody else
iv. What do Corp lawyers need to know?
1. Law of biz entities: Corp law of the state as well as Delaware
2. Agency law
3. Contracts
4. Tax
5. Securities Regulation
6. Secondary areas of knowledge: Employment and labor law; Secured transaction under the UCC;
biz, economics and accounting
v. Fed Securities Regulation (FSR)
1. 2002 Congress passed Sarbanes-Oxley Act in response to Enron and Worldcom corp govt scandal
implemented up the ladder reporting s.307
a. Go to CFO or chief legal counsel
b. If they dont take any remedial measures go to the board of directors
b. Business and Businesses
i. Biz/firm: engages in sustained profit-seeking efforts
ii. Profit-seeking: intent is to undertake activities that generate more wealth than they use(manufacturer,
trader, investor, worker)
iii. Why Biz Vary in Size
1. Horizontal dimension: biz is national in scope, with multiple biz locations: theoretical optimum size
2. Vertical dimension: everything under one umbrella, one company does the producing, manufacturing
and trading: transaction cost of obtaining and selling goods
a. Levi Strauss knew how to sell to Wal-Mart; he was able to vertically integrate particular
functions
iv. The development of big biz in America

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1. Chandler, Managerial Revolution: Transportation, communication, distribution and production


revolution; transformation in the size and activities of biz enterprises once this hierarchy of
managers were in place, the desire of the managers to assure the success of their enterprise as a
profit making institution created strong pressures for its continuing growth
a. Created middle managers who supervised managers below and reported to managers above
supervised the factory floor and reported to the owners
i. Middle managers: more power and knowledge; the owners have reduced power
ii. Corp law: when biz are held by a large number of widely scattered owners, publicly held corp,
power over the biz resides entirely with the managers; but traditionally owners (SH) had
power. Now managers had more power
b. 3 Categories of Capitalism
i. Family: family owned biz decisions are made by the family members
ii. Financial: a lender provides capital to do biz and puts its members on the BOD (how $$$ in
biz is spent)
iii. Managerial: managers make the decision of how to run the company who to hire, fire etc
iv.
v. Form following Function: From Partnership to Corp
1. Corporate form: ability to amass large amounts of capital, limited liability and the centralization of
control, the ability to commit capital, once amassed for extended periods of time
2. Corp means that it was entity under the law and incorp required governance rules that legally
separated biz decision making from contributions of financial capital
3. As a separate legal entity, separate from managers and investors, allows biz organizers to partition
the assets used in the biz. Partitioning has 2 aspects
a. Individual participants in the biz are not held personal responsible for the debts or liabilities of the
biz (limited liability)
b. Participants and 3rdP are assured that the pool of assets used in the biz will be available to meet
the needs of the biz first before the assets can be distributed to SH eg: Singer owner in
partnership dies, heirs will want it distributed to them, the solution was to form a corporation,
change the ownership and trust from partnership and issue stocks so the corp would remain and
it would not be affected by owners death
vi. Which State Law? The Rise of Delaware
1. Internal Affairs Doctrine: Biz internal governance matters will be regulated by the law of the state of
incorp, regardless of where the corp does biz.
2. NJ was the incorp state however, Delaware also passed similar laws but they had an edge:
Delaware Tax Rates 60% of NJ
3. NJ lost its competitive edge over Delaware (DE) because of the anti-trust laws passed by governor
(president) Wilson
4. Globalization has had an impact on the corp law
2) Agency (89-119)
a. Background and Context
i. The Economic Concept of Agency and the Problem of Agency Costs
1. Agency Relationship: one in which A and P agree that the A will use some degree of judgment to
perform a service for the Ps benefit
2. Legal defn: no agency relationship, unless the parties agree
3. P needs to know whether A is capable of performing well and whether A is motivated to perform
well
4. Adverse selection: P choosing A (and A choosing P) who are less than optimal
a. Signaling: help convince others that they will perform well references, 3rdP evidence (degree),
reputation

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b. Moral Hazard (MH): occurs after agency agreement is made the risk that a party with
discretion to act will choose an action that decreases the expected value of the transaction to the
other party in way y that the pother party cannot effectively prohibit
i. As POV: Main MH Ratcheting P increasing the tasks that A has to do without increasing
recompense
ii. Ps POV: Shirking: A chooses to perform less well than the parties anticipated using
suboptimal skill
iii. Ps POV: Private benefits: A will try to get these from P and will bear only part, or none of
the costs can be nonmonetary as well
c. As tend to be more risk averse: this is because even if P and A share the gain, the A never
receives the entire gain. And if there is a loss, A does not share in it, but P might not be able to
pay the agreed remuneration
d. These costs to P can be ameliorated (but never eliminated)
i. Incentive compensation/profit sharing: parties can agree that A s compensation will depend
in whole or in part on the degree to which the A acts in the Ps best interest
ii. Monitor: simply watching the A work, contractual limitations on the As discretion such as
budget or other operational limitations
e. What As can do?
i. Bonding: expend resources to assure P that they will not shirk or behave opportunistically
obtaining an insurance policy or agreeing to a financial penalty clause in the agency agreement
ii. Note: P can also take bonding actions to assure agents that they will not ratchet
ii. Where do Agency Question Arise?
1. Eees with supervisory powers are both A (of the managers to whom they report) and P (to the Eees
who report to them)
2. General Partnership: each partner is both an owner (P) and an A
3. Corp and BOD: to the extent that directors are also managers they are people given discretion to
act in anothers best interest
a. Because all corp power is vested in the BOD (under corp law), the BOD is not subject to the corp
control
b. Thus it does not meet the legal defn of agent and is not generally held to be subject to the rights
and obligations of agents under CL
c. Individual directors not generally considered to be legal As bc BODs power is collective s.t
no individual director has the power to act alone and therefore is not an agent
4. Legal Agent (Restatement 3rd of Agency, s.1.01) someone who has agreed to act on someones
behalf and subject to that persons control
b. The Current Setting
i. Definition of the Agency Relationship
1. Restatement Third 1.01: agency is the fiduciary reln that arises when one person, a principle (P),
manifests assent to another (an agent) that the agent shall act on the Ps behalf and subject to the Ps
control and the A manifests assent or otherwise consents so to act
2. The defn does not require that parties intend to form an agency reln
3. Courts will find an A relationship exists even though the parties specifically disclaim any intention to
create such a relationship as long as the parties meet the defn
4. A is a fiduciary P; A has higher duties than the implied duties of good faith and fair dealing
ordinarily found in contractual settings Eee has to act within the interests of the P profit
maximizing. Any time we sent A benefiting from a particular act Conflict of interest transaction
specifically relating to duty of loyalty
a. Eg: Eees of a biz entity are A

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ii.

iii.

b. Directors of a corp are not agents party bc they cannot act alone but can only act as a board and
party because the directors govern the corp and thus are not subject to the corps control
c. Gen partners in gen or limited partnership are agents even thought, like corp directors, they must
act as a body and are not subject to the partnerships control
Creation of the Agency Relationship
1. Basile v H & R Block
a. Basile had gone to H & R Block for tax preparation purposes and elected to receive a refund
anticipation loan. These loans were offered by H & R Block, along with other options of
receiving your refund, sent to Mellon Bank for approval and if approved, a refund check was sent
in a few days.
b. The Court found that there was no showing Basile intended Block to act on their behalf in
securing loans. Block actually offered three options, only one of which involved loans. Block
simply facilitated the loan process by presenting Basile to Mellon Bank as viable candidates.
c. Standard: 1) the manifestation by P that A will act for him 2) The A acceptance of the
undertaking 3) understanding of the parties that the P is to be in control of the undertaking.
d. Critical fact: action must be a matter of consequence or trust such as the ability to actually bind
the P or alter the Ps legal reln (affect the legal reln between customer and bank). Because there
was no power to change the reln between the customer and bank, court said not an agent.
e. Not the law in agency reln other jurisdictions comes out the other way
f. One way to think about A law control if no control, then can be said to be A
Relation of the Principle to the 3rdP
1. A principle can become liable to a 3rd P for the actions of the agent
a. Actual authority
i. P bound to 3rdp by anything the agent does that is in accordance with the Ps manifestation to
the agent
ii. Ps manifestation: determined by As reasonable interpretation in light of all the circumstances
iii. Manifestation: express or implied
iv. Agent has actual authority to do collateral acts that are incidental that usu accompany or are
usually done in the biz, or that are reasonable necessary to accomplish the acts that the P has
expressly authorized
b. Apparent Authority
i. Stems from a 3rdp belief, based on Ps manifestation, that the A (or non agent) is authorized to
act for the P
ii. P is bound by As actions within the scope of the As apparent authority
iii. A has apparent authority to do collateral acts that are incidental to accomplishing the acts
authorized by express authority
iv. Where manifestation that P A = what P 3rdp. The As actual authority and apparent
authority are coextensive
v. What happens when manifestation to A and 3rd P are different?
1. Udall v TD Escrow
a. Apparent authority may exist in agents who act beyond the scope of their actual
authority
b. Appropriate analysis: will focus on whether Udall believed, based on TDs
manifestations, that ABC had authority to act for TD to sell the property on TDs behalf
and whether that belief was objectively reasonable
c. A P may make a manifestation by placing an agent in charge of a transaction or situation
d. Buyer had reason to believe based on Banks manifestation, that auction company had
authority act for the Bank and sell the home
e. Buyers belief was considered to be objectively reasonable

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f. Court said that a grossly inadequate purchase price coupled with unfair circumstances
may have changed things here
g. Said that only 35% of the intended opening bid was not grossly inadequate.
2. CSX Transp Inc v Recovery Express Inc
a. Apparent Authority was not found to hold company liable for man who used their web
domain and purported to be president
b. Court compared the email address to a biz card
c. Fact that he had company email address did not imply he was authorized to engage in
such deals
d. This case lacked P communicating to 3rdp that A was authorized to act on their behalf.
e. Note: a job title may carry a great deal of implied actual authority even if the P entity is
vague about the As actual authority
f. Note A title can also have much implied authority even if company tells A exactly
what he has authority to do, a 3rdp may believe he has authority to engage in other
actions bc of his official title.
c. Ps Liability to 3rdp for actions actually/apparently Authorized
i. A P is liable in K if the A acted either with actual or apparent authority
ii. If undisclosed P (knows acting on behalf of P, but does not know identity of P) P is liable to
3rdp
iii. Undisclosed P (does not know that A is acting on behalf of any P) then P only liable to 3rdp
for an As actually authorized actions.
1. Rationale: P initiated the As actions and has a right to control them and in fairness must be
bound under the K the agent made.
2. So they can hold the A (whom they thought were acting on their own) or P (whom they
knew nothing about) liable
3. Note: in this setting, A cannot be acting with apparent authority because the P has
manifested nothing to the 3rdp
d. Estoppel
i. A P who has neither authorized or apparently authorized an As action is nevertheless liable to
3rdp who have changed their position in reliance upon their belief that the action was
authorized if the P caused (intentionally or carelessly) the belief or, if the P knowing of the
belief, did nothing to notify the 3rdp of the facts.
ii. Intentionally or negligently making someone else believe that you have authority and they rely
on it then P will be estopped from saying that an A did not have authority
iii. Estoppel only comes into play where the As action was not actually authorized
iv. App authority covers many settings in which estoppel might otherwise apply
v. In these situations plaintiff can prevail against the P by showing that the P manifested to the
plaintiff that the A had the authority to act
e. Ratification
i. If A took action purportedly on behalf of or for the benefit of B (regardless of whether A was
Bs agent) but such action did not bind B, B may nonetheless ratify the action.
ii. If B ratifies the action, B is treated as though A originally had actual authority to take the
action.
iii. B ratifies by manifesting assent, which is a manifestation of Bs election to treat the action as
authorized
iv. The manifestation can be express, but need not be communicated to A or any 3rdp to be
effective
v. Ratification can also be manifested through conduct that is only explicable on the ground that
the partner intends to ratify the As action

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f. Restitution
i. The P is liable to make restitution to 3rdp where the P is unjustly enriched by the As actions
that are not within the As actual or app authority
g. Ps Liab for As Torts
i. Holds a P liable for an As torts
ii. P liable where P authorized the A to engage in conduct that is tortious, even though the P
may not have intended the conduct to be tortious
iii. P also liable for torts committed by an A acting with app authority where ability to commit the
tort is sufficiently related to the A relationship misrep, defamation or conversion
iv. Torts that case PI to persons or to property? A rarely has actual authority to do these actions.
1. Such injuries are usually too remote from the As app authority to render P liable
2. Some instances, P may still be liable for the As torts that result in PI
v. Employment scenario: P not liable for As (employee) action if it is not within the scope of
employment when it occurs within an independent course of conduct not intended by the Eee
to serve any purpose of the Eer unless
1. The P intended the conduct or the consequences
2. The P was negligent or reckless
3. The conduct violated a non-delegable duty of the P
4. The A (Eee/servant) purported to act or to speak on behalf of P and there was reliance by
the 3rdp upon the app authority of A or A was aided in accomplishing the tort by the
existence of the Agency relln.
5. Generally P is not liable for the tort of A that causes PI to 3rdp outside scope of
employment (eg: Battery)
vi. Next case: theory of vicarious liability : Fisher v Townsend (Eee v Independent Kor)
F: R a weigh-master for Townsends (chicken processor) picked up F to take him to
work. R regularly picked up the workers. R crashed & F was seriously injured.
R: IF P is the employer of an agent who is an employee acting w/in the scope of
employment, the fault of the A will be imputed to P under Respondeat Superior (220)
R: The actions take by the parties, NOT the terms used in the K, are dispositive in
determining whether there was an A relationship
o Determining if Employee (servant) is an A or an IC
Factors to consider:
The extent of Ps contractual control over the details of the
work
Is the employee engaged in a distinct occupation of the
business
The kind of occupation
o Reference to locality: Is the work done under the
direction of the employer or by a specialist w/o
supervision?
The skill require for the particular occupation
Who supplies the instrumentalities, tools, & place of work for
the person doing the work? Employer or Workman?
The length of time the person is employed
The method of payment Is it by time or by job?
Is the work part of the regular business of the employer?
o Did the parties think they were creating an A
relationship (P & A)?
Whether the P is or is not in business?

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iv.

v.

H: Townsend is liable to F for the actions of R b/c R was an A of Townsend (P). T


supplied R with daily instructions on how to do the work, what group would do the
work, supplied the tools, R had to keep a 2-way radio in the car to communicate w/T,
etc.

h. Liab of the 3rdp to the P


i. Can enforce K against 3rdp
ii. Exception: where the A has falsely represented that he/she is not acting for the specific P and
the A or P knows that the 3rdp would not have dealt with the P
iii. Where A knows that 3rdp wont deal with P, the As failure to disclose the P may be sufficient
to make the K voidable by the 3rdp
iv. Note: the validity of the transaction is only affected if the P or A knows that the 3rdp will not
deal with the P.
Relation of the Agent to the 3rdP
1. Agents Liability on K
a. Disclosed P A is not liable to 3rd p w whom the K was made
b. Undisclosed P A is ordinarily liable to 3rd p
c. Unidentified P A is liable to 3rdp (knows acting for P, but does not know identity of P)
d. P is an entity, rather than individual: what information about the P that the 3rdp must have to
constitute the Ps identity
e. If 3rdp does not know whether the entity is a limited liabl one, then the P is unidentified and the A
is ordinarily liable on the K
2. Other Sources of As Liab to 3rdp
a. Every A who purports to K on behalf of a P impliedly warrants that he/she is authorized to do so
if A not authorized, the A may be liable on the K and if the A has affirmatively misrepresented
his/her authority, the agent may be liable to the 3rdp in tort as well
b. Simply acting as an A does not by itself confer any immunity from tort liabl = so an A acting on
behalf of a P maybe liable in tort to a 3rdp
Relation of the P to the Agent
1. Duties of the A
a. A Fiduciary Duty (FD) to the P
b. P does not owe such duties to A
c. A FD
i. act loyally for the Ps benefit, A may not gain any material benefit from the A reln (receiving
tip or other gratuity from a 3rdp).
ii. A may not compete with, nor act adversely to, the P
iii. A must use t he Ps property only for A purposes and
iv. Cannot communicate confidential information to others
d. As non FD duties
i. A has a duty to act only win the scope of actual authority
ii. Comply with all reasonable instructions from the P
iii. Comply with any Ktual obligations between the A and P
iv. A must use reasonable care and act reasonably so as not to damage the Ps enterprise
v. Must render information to the P that the A believes the P would want to know
2. Duties of the P
a. P has fewer duties toward the A
b. P is not a fiduciary and so is generally free to act in his or her own best interest rather than in the
As best interest
c. P must deal fairly and in good faith with the A and must honor any K duties between the two of
them

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vi.

d. P must indemnify the A for out of pocket costs in performing agency duties and whenever else
indemnification would be fair
Termination of the Agency R
1. Termination of Actual and Apparent Authority
a. App authority is rooted in the 3rdps belief, so app authority ends when it is no longer reasonable
for the 3rdp to believe that the A has actual authority
b. Note: simply bc an As actual authority has ended does not mean that the As app authority has
ended
c. Terminating Actual authority
i. Agree to end the agency reln
ii. Unilaterally end the rel A renounce and P revoke the agency
iii. Renunciation and revocation is effective only when the other party has notice of it
iv. While renunciation is always possible and effective, revocation is not effective if the power
given to the A has been made irrevocable in certain ways
v. Agency powers couples with interest is considered irrevocable
vi. For biz entities purposes: an A that can be made irrevocable is proxy an agency reln in which
the A has actual authority to vote the Ps shares of stock either as directed by the P, a limited
proxy, or as the A thinks best in the Ps interest, a general proxy
vii. Death or incapacity may terminate the agency
1. An As death, wout more terminates actual authority
2. A P dies A actual authority terminated when A receives notices
3. P loses capacity to act the A is likewise prohibited from performing the act

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3) Corporations
a. Creation: The Incorporation Process (123-157)
i. Promoter Liability What happens when you act for a corporation to be formed?
1. Defn: persons organizing the corp
2. Corp promoters: those who participate in bringing about the organization of an incorp company, and
in getting it in condition for transacting the biz for which it was organized
3. Controversy is when a party attempts to hold the promoter of soon to be corp personally liable rather
than the corp
4. Rule: A promoter is not personally liable on a K made prior to incorporation which is made in the
name and solely on the credit of the future corporation
5. Unless the K clearly provides otherwise, the promoter remains liable on pre-incorp K until there is a
novation agreement between the promoter, the Corp and the other King party that the corp will
replace the promoter under the K
6. Where a K is made prior to incorp not in the name and solely on the credit of the future corp, a corp
does not assume a K made on its behalf by the mere act of incorp promoters are released from
liability only where the K provides that performance is to be the obligation of the corp, the corp is
ultimately formed and the corp then formally adopts the K. Also the K should provide that
performance thereunder is solely the responsibility of the corp
7. When acting on behalf of a non-ratified, unformed corp = A (promoter_ is acting on behalf of an
undisclosed P) is liable (unformed corp = undisclosed P_
8. Moneywatch Companies v Wilbers
a. Promoter entered lease agreement under his name, then parties agreed to change the name on the
lease to the corps
b. No discussion about whether promoter would no longer be prersonally liable.
c. Court said that a novation to the K releasing promoter from liability must explicitly do and
consideration is required
d. A novation occurs where a previous valid obligation is extinguished by a new valid K,
accomplished by substitution of parties or of the undertaking, with the consent of all the parties
and based on valid consideration
e. In order to effect a valid novation
i. All parties to the original K must clearly and definitely intent the second agreement to be a
novation and
ii. Intend to completely disregard the original K obligation
iii. A novation, in addition requires consideration
iv. A novation can never be presumed
f. In this case, there was no discharge of promoter from his original obligation and no consideration
to implement a novation was given
g. Therefore, promoter was personally liable changing the name on the lease was not sufficient to
cancel promoter liability
ii. Choice of Jurisdiction
1. Why the Corps Jurisdiction Matters The Internal Affairs Doctrine
a. Corp actions that could not be done by an individual will be governed by the law of the state of
incorp
b. Internal affairs doctrine will not be applies in the unusual case where some other state has a more
sig reln to the occurrence and the parties4
c. Internal affairs doctrine: internal issues within corp will be foverned by the corp law and case law
of the state where the corp is incorp eg: voting on the BOD, bylaws etc
d. This is transactional law so have to plan ahead
2. The Special Role of Delaware

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iii.

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a. Substantive rule is identical in many stated


b. The vast majority of provisions in every statute can be varies in the articles or the bylaws
c. Delaware (DE), most popular choice gen corp act is both advantageous to management and
quite flexible, so that planners can vary almost any provision
d. DE corp law is familiar to most corp lawyers in the US
e. A large body of case law interpreting the statute provides a measure of predictability and hence
comfort for corp
f. DE has a specialized court court of Chancery that handles corp matters
Incorporation Mechanics
1. Reserving the Name
a. Name must be reserved 90-180 days, w payment of a small fee (DGCL 102(e)
b. Reserving allows biz to start immediately as soon as incorp is done
c. Name must be distinguishable from every other corp name on file with the Secretary of State
(SOS)
d. Narrow and broad: in some states, any minor difference is accepted; other states minor ways as
punctuation, capitalization or use of a definite article or a plural in the name is not sufficient to
distinguish it
e. A corp name must contain some evidence that the entity is a corp and must not contain words
falsely suggesting that the new corp will engage in certain biz DGCL 102(a)(1)
2. The Incorporation Documents
a. Certificate of Incorp (DE)/Articles of Incorp (MBCA): the document that creates and governs the
incorp
b. SOS promulgates the std form that may or must be used to incorp - 102(a) states the information
required to incorp
c. Articles: must contain
i. The corps name
ii. Name and address of each person who is incorp the new entity lawyer/member of his staff
acts as incorporator
iii. Name a person and address, or other corp, who will act as corps A for service of process and
where A maybe served
iv. Max number of shares the corp may issue (the actual number issued may be fewer than the
max states)
v. If shares are to have different management/economic rights, a statement as to how the shares
will differ from one another
vi. Purpose for which the corp is being formed 102(a)(3)
vii. MBCA: requires the number of directors, or a process for determining the number of directors
(NOT REQUIRED BY DE) MBCA 8.03(a)
viii. Can contain optional provisions s.a
1. Ability to name the initial directors in the Articles DE 102(a)(6), MBCA 2.02(b)(1) by
doing this the incorporator will be automatically relieves of any authority over and also
relieved of any liab for, the new corp once it is created
2. DE 102(b) list of optional provisions
3. Filing
a. Action by which state accepts the Articles
b. Through filing corp comes into existence DE 106
c. DE 101, 103(c) anyone may form a corp by delivering the AI to the SOS
d. The certificate must be executed by an incorpor whose signature is acknowledged either by the
sign alone or by being notarized (DE 103(a)(1))
e. SOS certificate + fees stamps filed on it and becomes effective at that moment

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iv.

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f. MBCA: similar process the only difference is that the corp comes into existence as of the close
of biz on the day the Articles are filed
4. Organizing the New Corporation
a. Lawyer must ensure propert organization
b. Organizational meeting: designed to complete this task
c. Min actions for organizations
i. Electing directors (if not named in articles)
ii. Adopting bylaws
iii. Appointing officers
d. Actual meeting is unnecessary if the incorpors (or initial directors) act by unanimous consent
acting by consent DE 108
e. Stock issuance does not have to occur in the org meeting
f. However, case law in most Jurisdictions provides that a corp cannot engage in biz until it has
received valid consideration in exchange for shares
Defective incorporation
1. Background and Content
a. Sometimes promoters enter into obligations before the corp is actually formed
b. Issue: where the intention of the parties is definitely to K solely with promoters corp, yet the
corp does not exist when K is made, may the 3rdp nonetheless hold the promoter personally
liable? this issue and is resolution are known as the problem of defective incorporation (DI)
c. Several equitable doctrines were developed to relieve promoters from personal liability
2. The current setting
a. The following doctrines are terms that are used by most courts in most CL jurisdictions to
describe circumstances in which a biz organization that has failed to become a de jure corp (a
corp by law) will nonetheless be treated as a corp, thereby shielding SHs form liability
b. De Facto Corp
i. DI that subject a corp to attack only by the state, but not by provate individuals
ii. Elements
1. There is a relevant incorp statute
2. The parties made a good faith, colorable attempt to comply with the statute
3. Some use or exercise of Corp privileges (acting like a corp
4. Note: if applicable, they are treated a corp for all purposes, except in an action by the state
5. However, steps taken toward formation of a corp are sufficient to treat the enterprise as a
corp wrt 3rdp
6. So even if it is not technically a corp based on the requirements, since they have done so
much in good faith, it will be considered a corp
iii. Hill v County Concrete Co
F: H & N tried to incorporate under the name C & M builders.
Their attorney told them the name was okay but it was not
(already in use) H & N bought letterhead, opened a bank
account, and painted work trucks. Later, they had to change their
name to H & N Construction. H & N properly incorporate this
CORP. CCC gets an order under name C & M & b/c he know H
personally he did the deal. H & N paid on C & M checks & sent
letters on C & M letterhead. Later H & N default.
R: De Facto Incorporation (SEE above)
A: H & N did not act in GF (thus fail E2) after they were advised
by their attorney that the name C & M was taken. From that
point on they acted in BF by continuing to use the name C & M
instead of disclosing their proper name H & N. Did not give

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iv.

CCC the chance to do their due diligence and research the proper
corporation
C: CCC wins and H & N have to pay all the costs

Harris v Looney
1. All persons purporting to act on behalf of a corp knowing there is no corporation are jointly
and severally liable for all liabilities created while so acting. you actually acted and you
knew there was no corp, then you will be held liable
2. In order to find liability, there must be a finding that the person to be charged acted as or on
behalf of the corp and knew there was no corporation
3. Individuals not liable if they did not know that the corp did not exist in this case, only Joe
knew that corp was defective, the others didnt
4. 3 buyers purchased a business under a defective corporation. Only 1 buyer was held liable
b/c he was the only one who had signed the contract and acted on behalf of corporation
while knowing there was no corporation.
5. i.e. The other buyers who were not present were not found liable b/c they did not act.
c. Corporation by Estoppel
i. Has been applied in those cases where the 3rdp who has ked with the supposed corp is
prevented from collaterally acting the validity of the incorp
1. People in the corporation thought it was a corporation de jure (validly formed) and Ked
with 3rdp with this belief and the belief that they will have limited liability
2. But if it is not a de jure and it is defective incorporation the 3rd party will not be allowed
to sue people personally and impose unexpected liabilities on them
ii. Estoppel: the principle that parties who deal with each other upon a mutual assumption of the
existence of a certain fact are prevented from disputing that fact is
iii. The associates have reason to believe that they were validly incorp and therefore protected
against unlimited liability
iv. The 3rdp Ked for corp liability and to permit him to hold the associates individually would be
to impose upon them an unexpected liability and to confer upon him a more extensive right
that was contracted or
v. In some jurisdiction, estoppel allowed only if elements of de facto are there, but majority of
Jurisdiction allows for estoppel even when de facto elements are not there
vi. So when there is no de jure corporation, and the principles of de facto and estoppel cannot be
used to protect against liability, should it follow that all the associates should incur individual
and unlimited responsibility because transactions have been entered into on behalf of the
company? No for two reasons the associates are relieved from liability as partners
1. It is emphasized that they have not agreed among themselves to be partners = entered the
association upon the belief that liability was to be limited and they have not conferred upon
the board of managers authority to bind them individually as partners
2. The associates have held themselves out as a corp and not as partnership and the party who
has Ked with them has assumed that they were incorp and Ked for limited liability only
vii. However, if associates cannot claim the benefits of innocence, when they have fraudulently
represented that they were incorporated, knowing full well that they had not complied with
statutory provisions, reason for shielding them form liability disappears
viii. Another reason for not shielding: is if creditor did not K with them as a corp, but understood
that they were a partnership
ix. Justice would be accomplished if all the associates were held at least to he full extent of the
liab which they contemplated that is the liab that would have been their if incorp had been
perfect

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x.

13

American Vending Services v Morse


Morse entered into a K with Durbano and Garn, acting as
officers of AVSI to purchase a carwash
D has not field the articles of incorp before the K was executed
Morse filed suit against D & G for enforcement of the
promissory notes
They alleged the corp did not legally exist when the parties
entered into the K trial court held that AVSI was a corp by
estoppel
Did the trial crt err in holding that AVSI was a corp by estoppel?
Yes
Court: found that there is a dispute in the jurisdictions on the
characteristics of a corp by estoppel
But given the ease of incorp, the court was hesitant to carve
exceptions to the stat grounds of holding individuals who assume
to act as a corp before the corp exists as jointly and severally
liable
D & G had actual knowledge AVSI did not exist and thus neither
of them can invoke the doctrine of corp by estoppel
Crt reversed trial crt judgment
Rationale behind CE: not fair if both parties are aware that one
party is a corp trying to get a benefit that they did not bargain
for
Formulation of the doctrine in this case:
o Formulation 1: if the TP believes that it is contracting with
a corp, it is estopped from suing the individuals acting on
behalf of the uninformed corp
o Formulation 2: if the TP believes it is contracting with a
corp, and the individuals believe a corp has been formed,
the TP will be estopped from suing the individuals acting
on behalf of the unformed corp D& G signed the K
knowing that the corp did not exist idea is that if you
know that a corp has not been formed, you had notice thus
cannot get the benefit = the only way under Formulation 2
that an incorporator can get out by using estoppel is
when they also believe that a corp has been formed need
to know both, depends on jurisdiction
What if only D and not G had known that corp had been formed?
Protection is individually can only sue people who knew stuff
knowledge of the person who is seeking the protection of the
corporate shield the only parties that are protected are those
who did not know the status of a corp the believes have to be
reasonable
v. Lawyers Professional Responsibility to Multiple Clients and Entity Clients
Subjective belief of people that you are representing:

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Just because the agreement reads equally does not mean that the effects of it will be equal on the
shareholders
Corporate context is messy because of multiple parties
Make sure you get waivers
Relationship can exist you have a duty to inform them when their interest is adverse the other issue that
may come up those sort of conversations might not be privileged
Types of Waivers when people think there was a relationship/K
o There must be a provision stating that you are not their lawyer, the lawyer represents the corp and
have been given opportunity to get representation from another lawyer
Under the Utah Rule: can rep multiple parties even if differences exist - even if permitted under rules, you
have to check if long term it is a good thing
Engagement letter eliminate scope of responsibility what you are actually responsible for limits what
they can hold you to later on
1. Detter v Schreiber
D & S formed a corp and in connection with, S executed two promissory notes totaling $19,000
S retained the services of Young, an atty, to draft the SH agreement
S failed to pay the notes
D sued for the enforcement of the promissory notes S was rep by Young and D moved to have
Young removed for conflict
Trial court found Young had a conflict of interest and sustained Ds motion
Trial court err? No
The court found that preparation of the SH agreement would require Young to work with both D
and S and to ascertain their financial personal interests
Thus it could be reasonably inferred Young had knowledge of the two promissory notes which
are subject to the counterclaim
Affirmed trial courts judgment
b. The Corporation and its Finances: Capital Formation (159-74, 179-213)
i. Financing: Getting $$ into Biz
1. When biz being formed, its owners have two sources of $$: owners can contribute the $$ themselves
or they can borrow it.
2. After biz starts: third sources extra cash generated by the biz itself
3. If need addl $$ and dont want ownership interests diluted borrow $$
4. Corp get money in three ways
a. Sell ownership interests (sometimes called equity) person giving the $$ gets certain rights in
exchange
b. They can borrow
c. Use $$ generated by the biz
5. Corp Securities
a. Security: a set of rights that , over the years, has proven useful to corp and those who supply $$
b. Common Stock
i. Ownership interest in the biz rather than a loan ot the biz
ii. Stock: collective ownership interest in the corp rather than the corps assets
iii. DE 151(f): all shares are identical in the absence of an explicit differentiation in the AI. If no
differentiation in AI, then each share has
1. One vote on every submitted to SH
2. The right to its proportionate amount of any dividends
3. And right to its proportionate amount of the corps assets if any upon dissolution
iv. Shares that have all 3 Common stock

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v. Usu. Common stock synonym for stock


c. Preferred Stock
i. Used when suppliers of $$ to a corp does not want to be rewarded proportionately to their
investment.
ii. Occurs particular investor or group of investors is supplying so much $$ that the success or
failure of the biz depends upon their investment
iii. Investor and corp managers agree they should receive different reward economically
either a greater than proportionate return, a priority in receiving a return or both
iv. Investor may also be able to bargain for heightened management power
v. PS: stock that has priority or preference over other stock (CS) in payment of dividends or the
distribution of assets on dissolution or both
vi. Different investors will negotiate for different preferences such that the corp issues more than
one kind of PS this means there is two classes of stock (CS and PS) and has two series of PS
vii. Series subset of a class of shares
viii. Eg: if PS $1/share/year, but the corps BOD does not declare dividend in first year. In year 2
they declare dividend. Does PS get $1 before the CS or $2 for the two years? That depends on
whether the PS dividends are cumulative
ix. If cumulative PS will get $2 dividends before CS gets any dividend
x. If noncumulative gets only $1 even though it received no dividends the year before
xi. Cumulative perverse effect on corp economic downturn companies unable to pay, unpaid
dividends will accrue quicker
xii. Suppose: PS paid dividends, $$ left over, does CS get it all or does the PS receive a portion as
well?
1. If PS participating receives dividends along with the CS even though it has already
received preferential dividend
a. Pari pasu equal dividends per share with the CS or fraction of the amount paid to each
share of CS
2. If Non participating no addl dividend
xiii. PS given preference on dissolution similar to those granted for dividends PS gets fixed
amount at dissolution before the CS gets any $$
xiv. Because dissolution is only once PS cannot be cumulative as to assets at dissolution
xv. PS may/may not participate in dissolution after payment of its preference
xvi. PS = CS unless otherwise states, PS is treated identically to every other share of CS, has one
vote per share and is entitled to equal dividends as declared by the board, PS is noncumulative
and participating unless otherwise stated.
d. Other Relative Rights
i. Voting Rights
1. Frequent trade off for granting certain SH economic preferences is that they do not receive
the right to vote
1. St right to vote is contingent upon the corps failure to pay dividends on the PS for a
particular period of time, often 1 yr
2. In this case, PS gains enough votes to control the management of the corp either because
more shares of PS are outstanding that share of CS or because the PS is entitled to multiple
votes per share.
3. Remember stock can have different voting rights and still not be PS DE 151(a)
ii. Right to have the corp repurchase the shares or convert shares into different securities
1. St SH bargain for the right to require the corp to repurchase their shares useful in the
absence of a public market for the corp shares thus repurchase by corp might be the only
realistic method of ending the investment redemption

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2. Convertible variation of redeemable stock when stock is convertible, the holder has the
option of exchanging the shares for a fixed amount of another security of the corp (eg:
conversion available from more senior shares to junior shares --? PS to CS or from debt to
PS or CS) but statutes permit any sort of conversion agreed to by corp and SH
a. Benefits to corp: may prefer a conversion to a redemption because it will not have to
return money to its investors it just changes right among SH
b. SH: might also prefer conversion: because it provides a ready made power to get a
different security but would prefer stock to be both convertible and redeemable
c. SH of a class or series into which another class or series is convertible maybe unhappy
because they perceive the convertibility ratio to be unfavorable to them
d. Sometimes conversion maybe at the option of corp rather than SH DE 151(e)
e. However, corp may negotiate for the power to require SH to return the Shares to the corp
in return for a predetermined price this protects the corp from having stock outstanding
in perpetuity that has provisions such as heightened voting power or large dividends that
may become particularly onerous over time- stock with this kind of provision Callable
DE 151(b)
3. Kaiser Aluminum Corp v Matheson
The company wanted to recapitalize their stocks
Preferred Redeemable Increased Dividend Equity Securities (PRIDES)
said they cannot do it because then it will go against the no-dilution clause
in the certificate 3(d)(i)
When K is ambiguous: crt normally relies on extrinsic evidence of the
parties intent not possible here bc 1) such an investigation will only
produce thots and intents of at most the issuer and the underwriter - this K
is not the consequence of the relationship of particular borrowers and
lenders and do not depend upon particularized intentions of the parties to
an indenture, evidence of the course of negotiations would not be helpful
and 2) reluctant to risk dis-uniformity by adverting to evidence of the
course of negotiation in a setting in which the same language can be found
in many provisions
Accepted principles that ambiguities in a K should be construed against
the drafter while debtor corps are not the actual drafters of K, they are in
a much better position to clarify the meaning of K terms in advance of
disputes than are investors generally - contra proferentem principle should
be imposed
Moreover, when faced with an ambiguous provision in a doc such as the
certificate, the court must construe the document to adhere to the
reasonable expectation of the inventors who purchased the security and
thereby subjected themselves to the terms of the K
Interlocutory Court of Chancery granting prelim injunction is affirmed and
the matter is remanded to the court of chancery for further proceedings
Inquiry confined to the language of PS contract because intent of such a
diverse group of holders is not likely to be definitive and underwriters
intention likely different from that of the security purchasers
e. Debt

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i.

ii.

iii.

iv.

v.

17

Debt different from Stock


1. Loan temporary
2. Investment in CS permanent
3. A lender is entitled to periodic interest payments, determined at the time the loan is made
4. A holder of CS: entitled to dividends only when and if declared by the BOD
5. Dissolution of corp loan is entitled to be paid in full, but the CS remaining assets
6. Lender no right to participate in the corps management, CS has full voting rights
Debt similar to stock
1. Stock redeemable and callable makes investment temporary like debt
2. Both debt/stock: right to periodic dividends, determined at the time the investment is made
similar to right to receive interst
3. Dissolution: PS may have fixed preferences to some of the assets just as a loan does
4. May or may not have Voting rights debt and stock
Importance of Characterization of Equity/Debt?
1. Corp receives tax benefit for issuing debt (not for equity)
a. Corp can deduct interest payments from their income, dividends payments are not
deductible
b. SH themselves that are corp (Corp A owns stock in Corp B_ can, subject to restrictions
exclude 70% of the dividends paid to them from their own income
c. In contrast: a corp that lends money to another corp must include all the interest it
receives in its own income
d. Thus corp seeking addl investors may find that the most suitable investors are
corporations that desire PS instead of debt
2. Bankruptcy or voluntary dissolution: debt holders have highest priority over equity holders
so investors who treatment is characterized as debt more senior, thus more secure,
claim on the corps assets than an investor who investment is characterized as stock
Short term debt
1. Used to fill the gap between when they spend money and when they receive the revenue
associated with that expense so will use short term debt
2. Corporations are statutorily allowed the power to borrow money - DE 122(13)
3. Usually loans for weeks or months
Long Term Debt
1. Loan for years increased bank risk, and therefore increased interest rate
2. As debt increases, it might be too hard for one bank to provide so several banks, possibly
located in different countries may get together in a syndicate to make the loan
3. Or loan maybe divided into very small pieces ($1000) and sold to the public
bonds/debentures
4. Bonds: typically secured by the corps assets
5. Debentures: typically unsecured
6. Debt may be subordinate to other debts in the corp, interest rates may vary or float with a
min or max rate (often called a collar), so that changing conditions will not render the loan
unfair. The debt may also be convertible.
7. Borrowing corp: affirmative covenants: agrees to do or refrain from doing certain things
that would make the loan more risky
8. Negative covenants: prohibit the corp from increasing its debt beyond an agreed upon level
or prohibit the corp from paying more dividends than it currently does
9. Event of default: if covenants are broken and entire loan may be called to be paid
10.
Sinking fund set aside money each calendar quarter or month to ensure they can pay
the loan

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11.Defeased: debt is said to be defeased, when borrower wants to terminate the loan (if
economically sensible) but cant because it is not callable they can put the money aside in
a trust and interest and payments will be made from that trust .
f. More exotic Securities
i. Holders not SH, so not entitled to dividends or assets upon dissolution
ii. Right: an option granted to an existing security holder usu short term and often used when
the corp believes its current security holders are a likely source of new capital - transferable
iii. Warrant: long term option to purchase securities sold to the general public rather than only to
existing security holders transferable
iv. Option: thee meanings
1. The power but not the obligation to do something right and warrants are both options
2. An option can connote a power granted by the corp to a particular person (Eee) to purchase
securities --? Usually granted for services rendered, not transferable
3. May connote a standardized right sold by someone (the option writer) other than the corp to
purchase securities of the corp from the writer ( a call option) or sell securities of the corp
to the writer (a put option). form of speculation and can be used by sophisticated traders
to modify their financial risks .- strictly agreements between other parties
v.
6. Planning the Corp Capital Structure
a. When selecting a structure: goal maximization choosing the structure that has the best change
of yielding the most value over time
b. The Legal Dangers of XSive Debt 3 of them
i. Deductibility of interest interest is deductible, whereas dividends are not so IRS has two
kinds of inquiry to determine whether the debt is genuine debt or not
1. Obligation has traditional indicia of debt: an unconditional obligation to pay a sum certain,
a fixed maturity date, and interest payable regardless of the debtors income - where debt is
owed to equity holders greater scrutiny that debt owed to outsiders (equity holders might
not have written agreement, therefore might decide not debt, but dividends)
2. Economic realities test: objective inquiry to ask whether an unrelated 3rdp would have been
willing to make a loan of similar size on similar terms to the corp if not, the service/court
may conclude that the debt is really a contribution to equity
ii. Equitable subordination in bankruptcy: in bankruptcy debt holders are paid before equity
holders - if a judge believes that the equity holders intention in taking debt was to raise up a
portion of his/her investment in the bankruptcy priority system, the judge may reduce priority
(subordinate) some or all of that debt in this case, non-equity holders debt will be paid off
first, before equity holders
iii. Piercing the corp veil: if the corp incurs a liability that it cannot satisfy, especially if that
liability is incurred near the corps formation, a court may disregard the corp entity and hold its
owners personally liable - if entity had a significant part of its capital in the form of debt held
by the equity holders, the possibility of piercing is heightened
c. Other Factors that Make Equity Attractive
i. If corp generates income but does not pay dividends, the value of corp increases and the
owners are richer even though they have no money in their hands
ii. An equity holders total return from her/her investment is measured by the dividends and the
increase in the value of the corp
iii. Tax advantages equity holder will only pay tax on what is realized gain (not if it is just
sitting there, only dividends will be taxed) and lower tax (bc of inflation (a dollar in the future
is worth less than a $ today) and capital gain lower tax rate)

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iv.

19

Salaries to Eees who are SH of company for their living expenses are deductible from
corps income just as interest payments are deductible
v. Equity management power, debt does not
d. Choosing a Capital Structure for the Startup Corp
i. The investors relative claims on the bizs income (and assets on dissolution)
ii. The investors relative management power and
iii. The dangers that concern capital structures with excessive debt
e. Background and Context: a note on financing by going public and by venture capital
i. Close or closely held corp: numbers of owners is not large
ii. But large corp? underwent a fundamental change in their capital structure at some point in
their existence these corp obtained significant financing by selling securities (usu equity, but
also debt) to the public
iii. When a corp sells securities to the general public for the first time go public and sale is
called initial public offering IPO
iv. Reason to go public Raise $$ than can be raised conveniently by small group of investors,
securities sold to public will be actively traded among individuals (Secondary trading market
private transactions between sellers)
1. Benefit of secondary market to corp? buyers of securities from corp will pay more for
securities that can be easily disposed of liquidity makes initial buyers more confident in
their investment because they can more readily end their investment and so they are willing
to pay more.
v. Process of going public: select lead underwriter bank, investment bank puts together a
syndicate of other such investment banks to share the risks and rewards of the offering also
advises the corp of the kind of security (debt/equity) that must be offered and underwriting
syndicate purchases the securities at a discount (in effect their fees_, from the corp and
immediately resells them to the public at the announced price.
vi. Many companies that end up going public, do so as the culmination of a process of
involvement with venture capital firms
vii. Venture capital: (VC) description of money supplied to nonpublic corp by entities
unconnected with the corp they will provide the money and provide a step by step of the
process of going public, will watch each stage, key entrepreneurs in the biz will be required to
invest essentially all their wealth in the biz.
viii. Near the end when just about to go public, VC will replace the key executives to ensure
success of the company. The people who are kicked out given stock that makes them very
wealthy
ix. VC only invests in DE companies, those that are not just convert
x. VC tends to receive PS for their investment gives them priority over firms assets, elect
half the board, veto power over extraordinary actions, gets increased voting power in the event
of corp failure to meets its operational and financial milestones. In such case, VC will take
over and restructure the enterprise, by replacing the founders, renegotiating terms of their
investment or dissolving the corp
xi. VC and biz entrepreneurs, want corp to succeed, but interests are different
Telcom-SNI Investors v Sorrento Networks
Reincorporated in Delaware and several provisions were added
Why reincorporated in Delaware? You know the law in Delaware; if you think you are gonna go public, then
incorporate in Delaware venture capitalist funds will require them to incorporate in Delaware with other
articles and decisions
Issue:

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Initial Series A stocks and they have specific rights they wanted to redeem and then approve
Q: is the corp allowed to issue more series A stock without their approval? Article says you need approval
any other stock means any stock but A, or it can mean all stock
Whole case boils down to whether any other means all stock or anything other than Series A
You are allowed to issue stock if it is the same priority, not over
If you own 8.8 million shares, there are only 10 million authorize 0 so they never gonna lose 50% interest
Managers and venture capitalists have different motivations particularly when co is at stake
7. The Mechanics of Issuing Stock
a. Statutory Authorization
i. DE 102(a)(4): AI must contain a statement of the number of shares the corp is authorized to
issue
ii. Number of shares: arbitrary
iii. If corp want to issue more shares than AI, it must amend it time consuming and cumbersome
iv. A corp that purports to issue more shares than it has authorized has acted illegally and the
newly issued shares, called over-issue are void
v. The series and class of stock must also be set out in the AI
vi. But because time consuming and cumbersome, just need to list the max number of nonCS,
terms of those shares can be decided later as corp is prepared to sell them to an investor
vii. Once terms of new stock decided BOD adopts a resolution setting out the terms and files
that resolution with SOS
viii. The resolution becomes part of AI and thus a public record
ix. A provision allowing this procedure is said to be one that authorizes blank stock or blank
check stock DE 102(a)(4), 151(g))
b. Issuance of Stock
i. Process of putting statutorily authorized shares in the hands of investors issuance
ii. Issuance board must approve (authorize) the issuance and the corp must receive appropriate
consideration
iii. When this happens: shares are said to have been validly issued and fully paid and therefore
nonassessable DE 152
iv. Board Authorization
1. Appropriate number of shares as permitted by AI + corp acting through its BOD has
approved a particular transaction in which statutorily authorized shared will be exchanged
for consideration DE 161
2. BOD failure to observe the statutory requirements can throw significant doubt on corps
and BODs power
3. Kalageorgi v Victor Kamkin
Controversy about stock issue
Stock was issued but never signed or approved by Board
The board did not sign the consent nobody signed the agreements
So later on SH comes
Looking at the timeline ratification needed Jan 1- stocks given, but no board actions
Then March 3/1 election
June/1 new board elected arguing whether or not the directors can ratify the stock at the time and
cure the defects in the process
How do we know ratification was effective?
By statute until successors are duly elected you are stuck with the so called hold over directors

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A technical defect in the authorization of a corps stock can be cured by a later, ratifying vote of a
majority of the corps directors thereby resolving a dispute over who constitutes the lawful BOD and
officers of the corp
4. Subscription Agreements (SA)
a. K to purchase shares
b. If the corp has been formed and is already doing biz, a SA is imply an ordinary K and
thus does not present any legal issues particularly germane to biz entities law
c. Before a new corp has been formed, investors may K among themselves and with the
new corps promoters to purchase shares after incorp.
d. Preincorp SA pose a basic agency problem of seeking ot bind a nonexistent entity
e. DE 165 preincorp SA is enforceable for 6 months unless another period is expressly
agreed to this is to increase both certainty of such agreement and to broaden their reach
v. Consideration
1. The Problem of Ensuring Equal Payment by Contemporaneous purchasers (Par
Value)
a. CL solution: par value judicial presumption that SH had agreed that they would pay an
equal amount per share when purchasing at the same time.
b. This presumed agreement could be enforced by SH who purchased for more
consideration than others who purchased at the same time.
c. Could also be enforced by corp creditors if the corp were insolvent and it was discovered
that some SH had paid less than other contemporaneous purchasers.
d. Statutes required corp to state the par value of their shares explicitly in AI
e. Effectiveness of par value undercut bc
i. Shares cannot be used for less than par value, they can be used for more (DE 153(a))
ii. Corp going through hard times found out that they could not raise more money
because no rational investor would pay par value and the shares could not legally be
issued for less = these developments created a strong incentive for corp to set very
low par value (as low as $0.01 per share) and to issue shares for consideration
substantially greater than par value
iii. Ensured that corp can raise money unlikely that value of share will fall below par
value
f. But this eviscerated the protection that SH were expecting: all they knew was that all SH
are paying at least the par value
g. Even though CL requires it, now par value is rarely utilized to ensure compliance
h. So SH get relief through case law: provides relief either by making the other SH pay
more per share or allowing the aggrieved SH to recover the xs they paid upon a showing
of disparate share price.
2. The Problem of Ensuring that the Corp Receives the Consideration
a. Danger: future considerations will not be received
b. Harms: SH who have already paid for their shares and creditors of corp
c. So rule: promissory notes and K for future services were invalid considerations for
shares even though, as an economic matter, such considerations may well have been of
sufficient value.
d. This was deemed too harsh today any kind of property is valid consideration DE 152
e. Further precautions corps may take
i. Shares issued for future consideration may be placed in escrow (held) until all the
consideration is received prevents transfer to a bona fide purchaser for value
without notice that the shares are not fully paid for stock certificates are negotiable

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vi.

vii.

22

instruments such a purchaser would own the shares free from the obligation to
repay, but transferor would still be liable
ii. Issue shares that are explicitly partially paid for = remainder of consideration paid on
the corp demands or as provided in the agreement between corp and investor DE
156
3. The Problem of Later Issuance at an Inadequate Price
a. Once corp has commenced doing biz: ensuring that the shares are issued at a price at
least equal to the value of the currently outstanding shares
b. New shares issues at too low a price: dilute the value of the existing shares
c. Leaves new investors liable to lawsuit by existing SH to challenge the consideration at
which the new shares were issued
d. Corp stock is publicly traded: market price is presumably the price at which new stock
should be issued.
e. Privately held corp: there is no reliable objective reference to determine the value of
currently outstanding shares
f. CL: directors were liable to lawsuits by existing SH claiming that a subsequent stock
issuance was too low a price to answer this statute provides that the BODs judgment
that the consideration for newly issues shares is adequate is conclusive DE 152
directors judgment conclusive in the absence of actual fraud (MI 1314)
4. The problem of Noncash Consideration
a. When other than cash, consideration may be overvalued by the board
b. Danger heightened: when the shares are to be issued to investors connected in some way
to the corps management management has concrete incentive to overvalue the
consideration called watered stock
c. Important problem: because of intellectual property intangible assets = property is
unique which makes valuation comparisons to similar property difficult or impossible.
d. Also value of such property is a function of the success of the biz plan: if the plan fails,
the property is worthless
e. Solution: BOSs decision is conclusive at least in the absence of fraud
The Meaning of Outstanding
1. Outstanding: they have been statutorily authorized, validly issued, and remain in the hands
of someone or some entity other than the corp itself.
2. SH: need not be the original SH shares are still outstanding the hands of a transferee as
long as the transferee is not the issuing corp
3. Important: bc only outstanding shares can vote and only outstanding shares get dividends
DE 160(c)
Preemptive Rights: The economic Component
1. Even if validly issued, a subsequent issuance of shares can harm current SH. How?
2. Eg: Before new investment: two shares: each is worth $100 (50% of $200 company value).
After new investment: three shares, each is worth &90 (33.33% of $270 company value)
3. Two types of dilution: economic and control
a. The price at which the new shares are issued, although legally unassailable by current
SH, may not in reality be the highest price available so value of the currently
outstanding shares will be diluted by the issuance of other shares
b. Current Sh will have to share all future increases in value and future dividends with the
new SH and would not have had to do so if the corp had taken on debt rather than sold
equity

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4. Protection of current SH from this impairment preemptive rights rights of each


current SH to maintain his/her proportionate interest by purchasing the same %age of to be
issued shares on the same terms and conditions as proposed by BOD
5. PR never absolute and were traditionally subject to several categorical of exceptions
6. Under both Modal and DE PR does not exist unless granted by AI DE 102(b)(3)
represents a decision by the drafters of those statutes that SHs economic and management
rights are better protected by imposing duties on the BOD than by granting SH PR
7. Three settings that issuance of new shares does not trigger PR
a. Were consideration for the new shares is something other than cash (noncash is probably
something unique (like intellectual property) and therefore an existing SHs cash, even
though nominally equivalent in value, is not a genuine substitute for the proposed
consideration and so PR should not apply
b. Newly issued shares are issued pursuant to the corps initial plan of financing initial
plan anticipates several investors, delay in issuing shares to some of these investors is
frequent denying PR to existing SH when the shares are to be issued pursuant to the
original financing plan simply prevents opportunistic behavior among the initial
participants
c. Where corp has, or is to have, more than one class or series of shares if the proposed
shares to be issued are significantly different in management or economic rights on the
ground that the existing SHs rights are not being substantially affected by the newly
issued share
ii.

Federal Securities Regulation


1. Definition of a Security
a. For profit corp stock securities
b. Shares issued by not for profit corp not securities because does not look like stock no
dividends, cannot borrow against, cannot be sold for profit, and no voting power proportional to
the number of shares held
c. Debt home mortgage excluded from security
i. Other debt corp debentures sold to the public securities
d. Test: determine whether a particular instrument resembles a category that is included or excluded
e. Factors to consider
i. Whether motivation of buyer/seller are akin to those who finance biz
ii. Whether the instrument could be amenable to common trading
iii. Whether the investors would reasonably expect the fed securities law to apply
iv. Whether the investments risk is significantly reduced (thereby diminishing the need for the
securities laws to provide protection) by another regulatory scheme such as fed bank
regulation
f. Investment K (then securities) defined as (Howey test)
i. an investment of money,
ii. in a common enterprise which means that the investors financial success is bound up with that
of others
iii. in which the investor has an expectation of profit (rather than some other return such as place
to live)
iv. to come solely from the efforts of others which means primarily from the efforts of others.
g. Howey test is applied to determine whether partnership interest and LLC interests are securities
2. Registration (33 Act and rules)
a. Registration Requirements and Exemptions

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i.

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Illegal to use a means of interstate commerce (telephone, mails, internet) to offer a security
unless a registration statement has been filed with the SEC
ii. Illegal to sell a security unless the registration statement has been received by the SEC and
declared effective
iii. Statute excludes govt and charitable securities from the registration requirements
iv. Excludes securities that are issued only to resident of the state in which the issuing corp is
incorp and doing biz intrastate exemption (allows about 20% of biz to be done out of state)
a single share issued or transferred to out of state renders the exemption unavailable
restriction is for about 9 months from the last share that was issued by corp
v. Private placement exemption: exempts securities sold by the corp in transactions not involving
any public offering - public offering is one in which the offerees need the protection of the SA
which is designed to provide corp information to investors. If all offerees can fend for
themselves, there is no public offering and the transaction is exempt from registration
vi. Can offerees fend for themselves? Depends on their investment sophistication and access to
corp info of the kind that would be contained in a registration statement
vii. Exempted from registration is issued securities are for less than $5 mill or because of the
limited nature of the offering
1. Allows corp to raise $1 million - $5 million
2. Prohibition on fraud
3. No general advertising and that the purchasers be either rich people (accredited investors)
of whom there is no limit and not more than 35 non-accredited investors.
b. The Process of Registration Going Public
i. Go through registration purpose is to offer stock to anyone in US and allow that person to
sell their stock unrestricted on stock market
ii. Process of registration begins when corp negotiates with an investment banker to serve as the
lead underwriter for the offering syndicate of banks to buy securities from the issuer
they resell it to the market outside
iii. From negotiations with underwriter until the time the registration statement is filed with SEC
company cannot offer securities
c. Subscription Agreement (SA)
i. Point of the big long paragraph: the people understand that the company is not registered with SEC due
to exemption counsel should make the investors put in paperwork that says that the investors have this
much money SEC is there to protect the investors who cannot protect themselves if something
happens then you have to suck it up and face the loss if you are wealthy

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d. Board Power to Govern the Corporation: How Corp Take Action (325-369)
i. The BOD
1. The Role of BOD
a. Statutory provision: DE 141(a): the biz and affairs of every corp organized under this chapter
shall be managed by or under the direction of a BOD
b. MI 1501: Biz and affairs shall be managed by board
c. Means that SH who are the corps owners do not possess the ultimate management power
d. De 141(a) and 351 allows a corp structure without a BOD, however it anticipates that the
person/persons exercising traditional board power will be treated analogously to the board
e. In corp, every act must have its genesis in the BOD, but appoint of BOD is by SH
f. Grimes v Donald discusses limitations on the very broad grant of power of the board to
delegate
i.

F: Grimes a SH of DSC is suing the CORP b/c he is upset about the COPR K w/CEO Donald.
The K stated that Donald could unilaterally determine in GF that the board had unreasonably
interfered w/his management of the CORP & terminate his employ = Donald gets a 6M
severance. Grimes is seeking a judicial declaration that the K is invalid b/c it results in an
abdication of board authority & responsibility
ii. H: The K between Donald & DSC doesnt formally preclude the board from exercising its
duties & fulfilling its fiduciary roles b/c the board could fire Donald & pay the fine. Though
the fee was 6M over 6 years, the CORP was worth 2B = the fee would not so greatly preclude
the directors from freely exercising their proper business judgment
iii. Abdicate standard: give up all power and have no control over the corp if board retains
some control that is probably not abdication or deletion
iv. There has to be abdication in order to find improper delegation
v. Note: corp statutes expressly allows board to appoint committees of directors where these
committees simply investigate or recommend action to the full board, their existence presents
no real issue of corp law
vi. DE 141(e): permits the full board to rely on such committees in the ordinary course
vii. To the extent that the committee is delegated power to act for the full board, however, the
issues raised in Grimes come to the fore
viii. Exceptions to delegating to committee
1. Statute prohibits a committee from changing the corps bylaws
2. Prohibits committee from approving fundamental actions (such as mergers, dissolution, or
sale of all the corps assets) that also require SH approval
3. Model Statute: prohibits a board committee from declaring dividends except pursuant to a
formula approved by the full board
4. Prohibits a committee from filing board vacancies DE 141
2. Number, Selection, Election, Term and Removal of Directors
a. Number and Selection of Initial Directors
i. A Board must consist of one or more individuals DE 141(b)
ii. One corp can own shares in another and may be able to elect directors to the board, but cannot
be director
iii. Number: must be stated in AI or bylaws they usu set min and max and lets board determine
the exact number
iv. Initial directors: named in the AI - DE 102(a)(6)
v. If the initial directors are not named in the articles, the incorporator must name the initial
directors as part of the organizational meeting DE 108(a)
vi. First method more preferable immediately certain who the directors are and this means that
the initial directors are vested with all corp power at the time of incorp

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vii.

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When chosen in org meeting: there is always a time lag during which the incorpor has corp
power DE 107
viii. If incorpor is the sole director, no harm is done but that is not always the case
b. Election and Term of Directors
i. After the initial: one director must be elected at every annual SH meeting
ii. Default rule: all directors are elected annually by all SH DE 211(b). Can be varied
1. Create a classified board the power to elect at least one director is vested in, or denied to,
at least one class or series of stock corp planners use this when the SHs anticipate strong
disagreements in future; approach also useful when the planners desire to give one set of
SH power disproportionate to their capital contribution DE 141(b)
a. By creating a classified board, the different factions of SH can receive securities that are
identical in all respects except that one faction has the power to select more directors
than another faction
2. Divide the directors into 2 or 3 classes with each class holding staggered terms of 2 or 3
years. The nearly universal approach is to divide the board into thirds so that each director
has a three year term DE 141 (d). (Most DE corp public has staggered terms)
iii. Expiration of a directors term does not oust the director from office but directors remains
in office until he is reelected, another person is elected to fill slot, the board is reduced in
number at the end of the directors term or the slot becomes vacant. DE 141(b)
iv. Annual meeting requirement for election of board not always done Dors who continue in
office after the expiration of their term because no election has been held are called holdover
Dors DE 211(b)
v. Vacancy: occurs through resignation, death or removal of an incumbent statute does not
require filling of vacancy, but most corp statute provide methods of selecting replacement
1. DE default rule: vacancies can only be filled by the remaining board members 223(a)(1)
2. Board can fill the vacancy if it chooses to do so because it is usually able to act more
quickly than the SH
c. Removal of Directors
i. Amotion: SH power to remove directors during their term
ii. Default rule: directors may be removed with or without cause DE 141(k)
iii. But if Dor elected to classified board can only be removed by the same set of SH that
elected them 141(k)(2)
iv. MI 1414 removing D/or without cause is allowed, as long as you have the requisite vote you
can vote them out under MI s.1511
v. Also if corp permits cumulative voting, under which a minority SH has the power to elect at
least some Dor, the quantum of votes required to amote must be greater than the quantum
required to elect Dor DE 141(k)(2)
vi. Note: Board itself has not power to remove a Dor or to limit the right of a Dor to obtain corp
info
vii. Staggered board: can only remove Dors for cause so even if you own 51%, you are still
stuck with the old BOD, until their term is done if there is no cause
viii. If corp has cumulative voting: Dors on a staggered or classified board may be removed only
for cause 141(k)(1) incumbent Dors of public corp protect themselves against unwanted
takeovers proxy wars: seeking to remove the incumbent Dor if target has a staggered
board, and has not waived default, the raider can amove the target Dors for cause
ix. Then question is what is cause?
1. For cause removal Superwire case doesnt matter if the action is taken at a meeting of
SH or by written consent

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a. Specific charges for his removal


b. Adequate notice and
c. A full opportunity to meet the accusation.
d. What happens if a corp fails to hold an annual meeting DE 211(c) next case discusses problem
in electing Dors and deals with the power of SH to act by consent in lieu of holding annual
meeting
i. Hoschett v TSI Intl Software
F: owns 1200 shares of a small closely held CORP TSI. TSI went over 1 year w/o holding an
annual meeting. sued to force TSI to hold annual meetings for the election of directors. TSI
argues that they did not have to hold an annual meeting b/c they had written consent
representing a majority of the voting power of the CORP that had elected 5 directors.
R: Absent unanimous consent a CORP must convene an annual SH meeting to elect directors
H: They did not have unanimous written consent BUT the 5 elected directors can serve until
next annual meeting. CRT ordered the CORP to hold an annual meeting using its equitable
powers
Note: unless directors are elected by written consent in lieu of an annual meeting annual
meeting has to be held for Dor election
SH can act by written consent to elect D;or
But if the consent is not unanimous then such action by written consent can be in lieu of
annual meeting only if all the directorships to which directors could be elected at an annual
meeting are vacant, and the written consent is for filling it.
NOTE In DE the current R is non-unanimous SH election of directors by consent is
ALLOWED in lieu of an annual meeting ONLY when approved by the current board 211(b)
because that is the only setting where it is likely that Dor whose terms are expiring will resign
before the written consent is begun

3. The Mechanics of Board Action (BA)


a. Individual members of the board has no power and next to no rights they have right to info
about the corp but cannot act on behalf of the corp unless there is an agency reln created between
the corp as P and the Dor as A (DE 220(d))
b. CL rules not in statute: board has no power to remove a Dor, default term of office is 1 year, nonunanimous board action without a meeting is invalid; board meetings may be called in any
manner approved in advance by the board; each Dor has one vote on all matters, Dors may not
vote by proxy, each must vote in person
c. Boards take action in two ways
i. If they are unanimous in their intention they can act without a meeting effected by having
each D/or execute a consent DE 141(f), 232(c)
ii. Act in a meeting four elements must be met for a board action taken at a meeting to be valid
if any of these elements are absent, then Boards action is subject to attack as being ultra
vires
1. Call: meeting must be properly called
a. Decision to hold meeting at a particular time and place for a particular reason
b. Regular meetings: periodic meetings will be provided for in the bylaws separate call
not necessary automatically called
c. Special meetings not periodically scheduled necessary from time to time in addn to
regular meetings

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2.

3.

4.

5.

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d. In the absence of a provision in AI as to who can call a meeting, the call is a board action
that must be made, like every other action, by unanimous consent or at a meeting
Notice: must give each D/or proper notice
a. D/ors presumed to be knowledgeable about the corp biz so notice requirements are
minimal
b. DE gives the board great discretion in establishing procedure for notification so long
as each member is given due notice
c. Model Default rule: D/ors must be given 2 day notice of the location and time of the
meeting, but no need for notice of purpose
Quorum: of D/ors must be present
a. Simply the minimum amount of voting power that must be present at a meeting for
actions to be valid
b. Each D/or has one vote: the quorum is defined by the number of D/ors present
c. Idea behind quorum: prevent a collective body, such as the board or the SH, from taking
action when so few members are present that the action may be thought to be
unrepresentative of the whole bodys intent
d. DE Default rule: a quorum is a majority of the total number of directors - number may
be raised but may not be lowered below 1/3 of the total number of directors DE 141(b)
e. Note: the number that constitutes a quorum is measured by the number of authorized
director positions, not the number of D/ors currently in office
f. Eg: 5 BOD, default quorum is a majority which is 3: if there are two vacancies, all
three remaining D/ors must be present to transact biz the presence of 2/3 even though
they are the majority of Dors in office, is not sufficient for a quorum
g. Physically present DE 141(i)- not necessary can be present through conference call
or internet as long as it is oral and not written
Sufficient vote : action must be approved by sufficient vote
a. If board acting by consent unanimous
b. Meeting an action is approved if it receives the assent of majority of Dors present at
the meeting DE 141(b)
c. Breaking a quorum: if the Dors favoring the proposal are insufficient to constitute a
quorum of the board, may the opposing Dors thwart the proposals approval by leaving
the meeting
d. DE Dors cannot break a quorum quorum must be present when taking a vote
e. What if number of Dors has fallen below quorum: should the wait for next annual SH
meeting to elect new ones? remaining Dors, even though fewer than a quorum, can fill
board vacancies thus such Dors can add members to bring the number of Dors over the
number required for quorum - remaining Dors can fill all vacancies at once and corp can
continue to fn DE 223(a)(1)
f. Model says you can break the quorum if you leaving will only leave less than half the
original directors
Alderstein v Wertheimer
a. (P, Chairman & CEO, sued directors for not giving him notice of a meeting that resulted
in removing him from his corporate position. P was deliberately kept unaware.
b. Held: while the meeting was a board meeting, the actions taken are invalid. While not in
direct conflict with the bylaws, Ds actions did not satisfy the minimum standard of
fairness in how BoD must conduct its business.
c. Counterargument could be that A stayed therefore issue of notice is not a problem

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6. If it appears that a meeting of the Dors was attended by a quorum it will be presumed in the
absence of the contrary, that due notice of the meeting was given to all the dors and that all
necessary formalities have been complied with
ii.

Officers
1. Officers and Agents
a. H.D Irrigating v Kimble Properties
F: H-D sued KP to recover damages for misrepresentation & breach of the duty to
disclose. H-D agreed w/ Hobble Diamond & KP to purchase land from Hobble &
irrigation equipment from KP. Kimball was the president of both Hobble & KP.
Kimball said the irrigation equipment worked but it did not.
R: A principal is liable for wrongs committed by an agent while the agent acts w/in the
scope of his employment. A director or officer is individually liable for his false
representations
H: KP is liable to b/c Kimball was acting w/in the course & scope of his employment
when he made his false representation to . Further, Kimball is personally liable for his
fraudulent misrepresentation that the irrigation was working when he knew it was not.
(NOTE Hobble was not liable to b/c Kimball was not acting w/in the course &
scope of his employment at the time he made the false representations about the
irrigation. Hobble only had to do with the land)
Fact patter implicating Enterprise Liability Same H by the CRT but Kimball &
KP have no assets. Instead, all the assets are held by Hobble. IF Kimball as the
common parent cause the damage to then we might be able to take from Hobble.
b. A P is ordinarily bound the As tortious actions that cause PI if
i. The agent is an Eee a term of art meaning that the P has the right to control the physical
performance of the agents task and
ii. The A was acting within the scope of employment meaning the act giving rise to liability was
close in time, space and manner to those the A was employed to perform and undertaken at
least in part for the Ps benefit.
c. Once corp BOD has authorized an act, the person who actually effect the act for the corp is the
corps agent
d. All corp Eees Agents
e. But there may be other Agents who are not Eees- s.a outside accountants and lawyers
f. Corp may make use of people to perform services for it but who are not agents they are nonagent independent Kors eg: people who supply component parts
g. Corp D/ors not agents this is so because the board must act collectively rather than
individually and also because the board is not under the control of the corp (an A must be subject
to the Ps control)
h. Officer: person who holds an office, which, in turn, is apposition to which particular kinds of
duties or powers are attached
i. By contrast, an A, who is not an officer would have powers and duties defined in a more explicit
and ad hoc manner: by board resolution or by grant from another A
j. Statutes: corp has whatever officers it bylaws and board determines and those officers have
whatever powers are specifically granted to them DE 142(a)
k. Defn of O/er narrower than Defn of A:
i. Oers are explicitly held to DS comparable to those of Corp Dors. A are held to a less explicit
and less stringent standard
ii. Oers may be statutorily entitled to indemnity and the corp may be able to purchase insurance
for officer malfeasance. A are sometimes entitled to indemnity, but such protection is
amorphous

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iii.
iv.

Oers sometimes expressly exposed to liability under certain statutes whereas ordinary are not
Statute often provide that service of process on a corp may be effected by service on any (or
certain named) officers; A insufficient to bring about PJ over the corp
v. Oers are usually required to be named in the corps annual report filed with the SOS which
means that the names and titles held are a matter of public record
vi. An Oer may have power to bind the corp (called the power of position) that comprise both
actual authority and apparent authority
l. Corp cannot decide to have only A and not officers DE statute requires at least two officers
142(a), 103(a)(2), 158 secretary and a chairperson of the BOD, vice chair person, prez or vice
prez
m. MI 1531: requires more than one
n. DE 142(a), (d): also says default rule: any number of officers maybe held by the same person
and that the corps failure to elect officers shall have no effect on the corp
o. Officers are appointed by the BOD 142(a)
p. The BOD is an executive Principal, however P does not owe duties to itself
q. Officers needed because corp cannot act without them
r. Andrews v Southwest Wyoming Rehab Center: does being an officer give one a heightened
expectation or right to remain in office or can an officer be dismissed at will, just like an A by
the P?

iii.

1. F: was hired by SWR & later promoted to vice president. He held that position until his
boss Kathy terminated him. alleges that Kathy fired him b/c he tried to inform the SWC
board that Kathy was mishandling CORP assets & causing employee moral problems.
Thus, SWC breach its duty of GF & FD
2. R: The board may remove officers at any time with OR without cause
3. H: The board had a right to remove when they felt like it. Summary judgment n favor of
SWC
ii. MI 1535: Oer can be removed by board w/wout case
iii. Just because Oer has been fired, the Oer can still sue to enforce the Ktual severance claims
but not to get job back.
2. Power of Officers
a. Snukal v Flightways Mfg (addresses the problem of how a 3rdp may be certain that a corp is
bound by a humans actions where the human purports to be acting for the corp = app authority)
Statutes create presumptions about who has authority
F: Snukal leased a Malibu apartment he owned to Flightways for 2 years. Kirk Lyle,
the Pres, Sec, & CFO of Flightways was to live there. Kirk executed the agreement
alone designating his title as president. Flightways did not pay. Snukal sued
Flightways. The company claims that they did not know Kirk signed the lease on the
companys behalf & that Kirk was not authorized to have done so. Thus, they claim
that Kirk should be personal liability & Flightways should not be liable.
R: A person can hold more than one office at a time
Way to sign to prevent personal liability
o Acme Inc.,
o By: Ryan Hads
o President
H: B/c Kirk was both Flightways President & CFO, & b/c did not know Kirk
lacked actual authority the lease agreement is not invalidated by Kirks actual lack of
authority & Flightway is liable to .
i. If you are prez sign on behalf of corp, then corp is bound.
Federal Securities Regulation

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1. Actual limits on boards power


a. Statute legislation
b. Concept of fiduciary duty (FD) based on Common Law

31

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e. Restrictions on the Boards Power (377-392, 371-376)


i. Legislation that Restricts Boards Power
1. Different legislations such as OSHA and other environmental requirements restrict the board power
ii. Ultra Vires
1. Purpose clauses DE 102(a)(3), MBCA 3.01(a)
2. When specific purpose clause was required, the doctrine of ultra vires arose and had some potency
the intention of the UV doctrine was to create an avenue to enforce the specific purpose clauses by
granting relief when a corp took actions that were not related to its purposes which were beyond its
powers
3. Main reason why this doctrine demised is because of the demise of the limited purpose clause
once corp could be incorp for any lawful biz, nearly nothing could be UV in the precise sense
4. About the only act that is beyond the power of corp waste an exchange of corp assets for
consideration so disproportionately small as to lie beyond the range at which any reasonable person
might be willing to trade most often the claim is associated with a transfer of corp assets that
serves no corp purpose or for which no consideration is received at all in effect a gift
5. However, if there is any substantial consideration received by corp, and if there is a good faith
judgment that in the circumstances the transaction is worthwhile, there should be no finding of waste
6. UV today corp actions that are permissible but that have not been properly authorized by the
board
7. Harbor Finance Partners v Huizenga (deals with the distinction between actions that the corp
cannot take (pure UV) and those that it could take were they to have been properly approved)
The directors of a corporation called Republic solicited a proxy statement to shareholders in order to get
approval to acquire a corporation called AutoNation. The shareholders approved.
The directors just also just happened to own a substantial amount of stock in AutoNation and made a lot of
money from the acquisition.
Shareholders brought a derivative lawsuit against the directors for breach of fiduciary duty.
The directors argued that since the acquisition had been approved by shareholders, it could not have been
unfair.
The shareholders argued that the proxy solicitation was materially misleading, and so the vote shouldn't
immunize the directors.
The Trial Court found for the directors and dismissed the claim.
The Trial Court found that the vote on the acquisition was informed and un-coerced and the disinterested
shares voted overwhelming for the acquisition.
The Court noted that under the current law, the shareholders could still potentially prevail by showing that
the acquisition was such a bad deal that it constituted corporate waste.
o Corporate waste can be defined as "an exchange of corporate assets for consideration so small as to
lie beyond the range at which a reasonable person might be willing to trade.
However, the Court looked at the facts and found that the acquisition was not such a bad deal that it rose to
the level of corporate waste.
The Court reasoned that the law should be reexamined to decide if there was even a need for the corporate
waste "safety valve."
o In the Court's opinion, the fact that there was a fully informed, un-coerced vote of disinterested
shareholders would seem to be strong evidence that there was a "fair exchange" so how could it
possibly rise to the level of corporate waste?
8. Something is a waste of corp received no benefit and if it is waste then it UV eg: charitable
donations now statutes specifically empower charitable donations DE 122(9), MBCA 3.02(13)
iii. Ultimate Beneficiaries
1. Corp must be operated for the benefit of some group

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iv.

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2. Therefore BOD and other corp managers shold be prevented from taking actoins that deviate from
that end
3. Potentially, identifying the ultimate beneficiaries is a powerful constraint on board actions.
4. Shareholder primacy rule: theory that SH interests should be assigned first priority
5. BOD as nexus of Contracts/Ktual theory: each constituency or SH group bargains with the firm
over a set of rights that will protect the firm-specific assets that it makes available for production
the duty of managers is to serve the interest of SH alone
6. D/ors primacy model: the corp is a vehicle by which the BOD hires various factors of production
hence the BOD is not a mere agent of the SH, as standard Krian theory claims, but rather a sui
generis body, serving as the nexus for the various K making up the corp. The boards powers flow
from that set of K in its totality and not just from SH
Federal Securities Regulation
1. Foreign Corrupt Practice s Act constrains American corp that do biz in other countries no public
company may pay anything of value ot any foreign official or foreign political parties for the
purpose of influencing a decision, inducing an action or inducing an official to use his/her influence
to obtain or retain biz

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f. Cashing Out: Distributing Money to Shareholders (215-233)


i. How to get $$ out of the biz
ii. SH gain whenever value of biz increases and vice versa
iii. Two ways to convert corp increase into SH money
1. Corp can distribute the increased value or part of it to SH dividends
2. A SH can sell some or all of shares for more than they paid them for
iv. Making a Profit Part 1: Dividends
1. Board Discretion
a. Corp board may authorize the corp to pay dividends subject to certain restrictions DE 170(a),
MBCA 6.40
b. This means that under the statutes, corp cannot pay dividends unless BOD approves it - when
BOD authorizes dividends they are said to have been declared
c. Even if there is increase why wouldnt BOD declare a dividend?
i. BOD judgment that the corp needs to retain the increased wealth to expand the biz or to ensure
that the corp can meet future obligations
1. New biz almost always need to retain all the wealth they can so dividends in such corp are
rare
ii. Corp SH may not need dividends to meet their ordinary living expenses SH will be taxed on
dividends but not on the increased but undistributed value of the corp so BOD might decide
that SH are better served by retaining the increase in the corp rather than distribution
iii. Usually conservative in paying dividends to ensure that they can continue to pay in the future
because telling public and Wall Street that biz is doing good if dividends are increased and
vice versa
iv. Strategy controlling SH might have employed their factions so dont need dividends to live
and they will refuse to pay dividends to punish non-controlling SH = the only way the latter
group can get $$ is to sell their shares this might be a way to get rid of the unwanted SH
d. Can SH ever compel the BOD to declare dividends? Case law shows a near uniform refusal to
compel dividends in the publicly held corp setting. In the closely held corp, courts also generally
refuse to compel dividends
e. The only setting where courts may compel dividends is if there is SH oppression
2. Statutory Restrictions
a. Boards declaration required, but not sufficient
b. Corp statute: restricts ability of corp to pay a dividend even when its board wishes to declare one
c. Public policy: SH are not the only ones who are interested in getting $$ from corp
d. These statutes are not waiveable and Dors are personally liable for knowing breach of these
provisions DE 174, MBCA 8.33 Dors for knowing or negligent violations
e. Insolvency test approach: MBCA: may not pay dividend if afterwards the corp would not able to
pay debts as they become due or the corps assets would be less than total liabilities + the
dividends to PS MBCA 6.04 less permissive than DE rules
f. DE and other par value states: legal capital test every corp, even those that issue only no par
value stock, must have some amount of capital when the corp issues shares, the DE law requires
the board to designate how much of the consideration is to be capital
i. For no par value stock the board need only designate some portion of the consideration as
capital
ii. Par value shares: the minimum amount that can be designated as capital is the par value
iii. If board does not designate: the statute provides that the capital shall be the aggregate par
value and the entire consideration for no par value shares DE 154
iv. Surplus = Corp net assets total liabilities capital
v. Dividends can ordinarily be paid only out of a corps surplus = DE 170(a)(1)

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Another avenue for paying dividends in DE: if a corp has no surplus it may nonetheless pay
dividends up to the amount of its net profits for the current and preceding fiscal year DE
170(a)(2) basically means if they had a surplus this year or the year before they are allowed
to pay dividends only available if no surplus and leaves the definition of net profit to board
GF judgment
3. The Mechanics of Paying Dividends
a. Once declared, SH become creditors as to that dividend
b. In the event that shares are transferred between the declaration and the actual payment: default
rule: SH on the date of BODs declaration are entitled to the dividend even if they transfer their
shares before the payment date the record date is simply a way to fix the list of SH entitled to a
dividend
c. But under corp statute, board has power to set a different record date this is to give notice to
future and current SH that an important event will soon occur (MBCA 6.40(b), DE 213(c))
4. Stock Splits
a. Simply division of outstand shares into more shares - corp receives nothing in a stock split (SS),
SH do not change their relative ownership interests a stock split simply means that those
ownership interests are represented by more shares
b. Nothing is created and no assets are transferred.
c. EG: 10 million of Stock A sold for $40/share = total value $400 million. SS occurs, total value
still remains $400 million; but amount of stock increase to 20 million at a price of $20/share. The
proportion of stock to investors remain the same as well, they just split their already existing
shares
d. Reason why BOD want to SS?
i. Permit transfer of smaller %ages of each SHs ownership private companies
ii. Public companies: stocks are more popular when they trade between $10 and $100 if a corp
has successfully increased its value, the price of its stock may approach or exceed the
$100/share level at that point BOD may effect a split to reduce the price per share
e. Most SS effected through a stock dividend of authorized but unissued shares to the existing SH
DE 173/ MBCA 6.23
f. If the corp does not have enough authorized, but unissued shares, the board can, without SH
approval , increased the number of authorized unissued shares, but only to facilitate a stock
dividend MBCA 10.05(4)
g. NOTE: THIS IS NOT ALLOWED IN DE if DE corp is issuing new shares, it must designate at
least the aggregate par value of the newly issued shares as capital, which means the corps surplus
is reduced by that amount because the corp has already received the capital associated with
treasury shares, no capital adjustment is needed when the corp declares a stock dividend using
treasury stock DE 173 since they already have accounted for the par value of all stock as
capital, they will have to deduct that from capital when it gets issued
h. Nomenclature: 2- for-1 split after the split each SH will own two shares for each share owned
before the split
i. 3-for-2 split: each SH will own 3 shares after the split for every 2 shares owned before
j. Mason v Mason (misunderstanding of stock split can lead to serious problems)
i. Divorcing couple agrees to split wifes stock 1/3 to husband and 2/3 for wife.
ii. However, when agreement was entered into wife knew about stock split - 2 for 1 split
iii. Wife transferred 16,066 shares to husband, but instead of getting 1/3, because of the split, he
only received 1/5 so sued to enforce the benefits of the stock split
iv. Husband could not claim the SS for himself from the corp because he had not been an on the
record SH at the time the SS was announced

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v.

36

Court: because the entitlement to the SS vested before the parties signed the stipulation and
before the divorce was final, the 16,066 shares awarded to husband in the stipulation carried
with them the entitlement to the SS once it occurred so addn shares of 8033 was awarded to
the husband
5. Reverse Stock Splits
a. BOD may decide that it is in the best interest of the corp for fewer but correspondingly more
valuable shares to be outstanding
b. This may happen when a public companys stock trades below $10/share
c. To reduce the number of shares outstanding, the corp may effect a reverse stock split it is not a
split at all, but an amalgamation
d. A 1-for-2 reverse split means that each SH will have one share after the split for each two shares
he owned before each remaining share would be twice as valuable as before
e. Because Shares cannot be taken away from SH wout their consent, a reverse stock split requires
an amendment to the articles of incorp which must be approved by the board and SH MBCA
10.03 and DE 242(a)(3), 242(b)
f. Reiss v Financial Performance Corp effects of SS what happens if 100 shares are used as
collateral and stock split happens and SH defaults, is lender entitled to seize 100 or 200
shares?
i. Warrants to Rebot and Reiss to purchase shares of stock for 10 cents per share, extending for
five years
ii. 3 years later BOD 1 for 5 reverse stock split (RSS)
iii. R&R sought to exercise their warrants within the five, arguing that they were not subject to the
split.
iv. The court found that in the absence of evidence the parties contemplated otherwise, the
warrant holder is limited to the proportional number of shares. Just as P should not suffer from
the possibility dilution of their warrants, Financial should not suffer from the consolidation of
its shares resulting from a reverse stock split
v. Upper court: the plain meaning is going to rule the Financial had the right to protect itself
but didnt - therefore reversed??
g. Antidilution provision: a provision that adjusts an option to purchase stock in the event of an
increase or decrease in outstanding shares.

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g. Fiduciary Duties of Directors (Officers) (393-436)


i. Important because most default rules are waiveable in the AI and internal affairs doctrine which allows
corp planners to select the corp statute of the state they find most beneficial to their legal needs
ii. The one legal constraint on a corps governance is FD of officers and directors
iii. FD is way of describing the legal restrictions on BOD discretion that are imposed as consequence of
having agreed to act on behalf of a corps ultimate beneficiaries
iv. D/ors FD divided into DOL and DOC
v. The Duty of Loyalty (DOL)
1. MI 1541(a) similar to MBCA 8.03 have to act in good faith and in a way that the Dor reasonably
believes is in the best interest of corp
2. MBCA 8.03: codified the DOL, DE has not but adopted similar statement in CL
3. Corp Oer and Dors are not permitted to use their position of trust and confidence to further their
private interests - protect the interests of the corp committed to his charge and refrain from doing
anything that would work injury to the corp or deprive it of profit or advantage which his skill and
ability might properly bring to it
4. The rule that requires an undivided and unselfish loyalty to the corp demands that there be no
conflict between duty and self-interest
5. DOL mandates that the best interest of the corp and its SH takes precedence over any interest
possessed by a D/or, O/er or controlling SH and not shared by the SH generally
6. Bad faith actions/not in best interest actions: stealing, may not take things that belong to the corp,
prohibits using corp assets for noncorp purposes
7. The Corp Oppty Doctrine
a. Corp oppty: is a particular kind of thing a corp may have that a Dor may not take
b. Corp oppty cases: involve instances in which Oers or Dors use for personal advantage info that
comes to them in their corp capacity by diverting a profitable transaction from the corp
c. Northeast Harbor v Harris
F: Harris is the Pres of golf course. Golf course is companys only asset. Harris wants to
develop golf course but board does not. Harris is approached by broker to buy land b/c she is
the pres. Harris buy the land. Board does not act when it finds out. Lawsuit was brought
after a change in composition of the board
Note A duty of loyalty is owed by all agents to the CORP. However, the scope of the
loyalty of the President of the CORP is different than that of a caddy. But, neither can take
from the CORP.
Different Tests Applied by the Various CRTS
The Line of Business Test (DE) Is the opportunity so closely associated with the existing
business activities that it would put the O/D into direct competition w/the CORP?
IF the opportunity is
One that the CORP can financially undertake
In the line of the CORPS regular business & the CORP would benefit from it
One in which the CORP has an interest or reasonable expectancy
By taking the opportunity, the O/D is thrown into competition w/the CORP
A: The clubs business is running a golf course not developing real estate. Further the
CORP did not have the $$ to buy the properties at the time. Thus, under this test, the
opportunity was not in the clubs line of business. However, the club had interest in
developing the property to ensure good biz and with regards to the financial aspect, it
is unfair for insider Dors to know the financial state of the biz and then decide on the
oppty for themselves
The Fairness Test Was it unfair for the director in his role as a fiduciary to the CORP to
take advantage of the opportunity for her own profit while the interest of the CORP call for

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protection? (Is it equitable to the CORP?) provides very little principal content to O/er,
Dors
Minnesota Test Combo test: (1) was the opportunity w/in the CORPS business line & (2)
was it fair? test increases vagueness and uncertainty
**ALI TEST** (Did the O/D find this on his own time or on CORP time?)
General Rule A O/D may not take advantage of a CORP opportunity UNLESS:
O/D first offers the CORP the opportunity & makes full & adequate disclosure
(5.05(a)(1)
The CORP rejects the opportunity (5.05(a)(2)
& Either (5.05(a)(3)
o A) The rejection of the opportunity is fair to the CORP
o B) Disinterest O/D reject the offer in a manner that satisfies the BJR oppty
is rejected in advance, following disclosure, by disinterested Dors or in the
case of a senior executive, who is not a Dor, by a disinterested Superior, in a
manner that satisfies the standards of the BJR or
o C) The rejection is not waste rejection is authorized in advance or ratified,
following disclosure, by disinterested SH and the rejection is not equivalent to
a waste of Corp assets
Corp Oppty Definition
o 1) Any oppty to engage in a biz activity of which a D/or or O/or become
aware either
In connection with the performance of functions as a Dor or Oer or
under circumstances that should reasonable lead the Dor or Oer to
believe that the person offering the oppty expects it to be offered to the
corp or
Through the use of corp info or property, if the resulting oppty is one
that the Dor or Oer should reasonably be expected to believe would be
of interest to the corp or
o Any oppty to engage in a biz activity of which a senior executive (Officer)
become aware and knows is closely related to a biz in which the corp is
engaged or expects to engage
Requirement of ALI full disclose prior to taking advantage of any corp oppty
NOTE The fact that the CORP does not have the $$ to pay for the opportunity is
NOT a defense
A: Harris, the interested director, would have to tell the board about the CORP OPP
& her conflict of interest & then make sure the board rejects it. Then Harris is able to
buy the property b/c they dont want it
H: Remand to the TC for further factual findings
NOTE A O/D cannot compete directly w/her CORP. IF the O/D does then the remedy is a
Constructive Trust
Constructive Trust
CORP gets any profits the O/D makes from competing with CORP
d. DE SC CORP OPPTY DOCTRINE
i. D/O may not take opty for himself if
1. The corp is financially able to exploit the oppty
2. The oppty is within the corps line of biz
3. The corp has interest or expectancy in the oppty
4. By taking the oppty for his own, the corp fiduciary will thereby be placed in a postilion
inimical (hostile) to his duties to the corp
ii. D/O may take a corp oppty (corollary) if

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1.
2.
3.
4.

39

The oppty is presented to the D/O in his individual and not his corp capacity
The oppty is not essential to the corp
The corp holds no interest or expectancy in the oppty
The D/O has not wrongfully employed the resources of the corp in pursuing or exploiting
the oppty
iii. DE 122(17): permits corp to decline corp oppty in advance
iv. MBCA: does not permit corp to decline corp oppty in advance but does provide an optional
safe harbor process for Dors MBCA 8.70
v. MI: 1545(a): formulates it opposite to ALI wont be liable if you had interest in transaction
if you can establish any of the following
1. It was fair to corp when you entered into it or
2. You get clearance ahead of time
3. Ratification afterwards
8. Self-dealing
a. Occurs when a D/O enters into a K with the corp, usually to buy something from, or sell
something to the corp (MBCA includes a close relative of D/O as well)
b. This happens all the time objectively speaking especially in the early days of the corp
c. The rub: whether the corp is exchanging too much for what it is receiving
d. Valuation is a big issue
e. In order to find self dealing D/O has to be on both sides of the transaction Will get benefit as a
pusher of the transaction and in his capacity as D/O
f. Corp oppty: D/O is taking something away from Corp
g. Self-dealing: D/O is doing some transaction with the corp
h. Tomaino v Concord Oil of Newport
F: T became a 25% SH of CO. As part of normal business practice, CO would purchase the
underground gas tanks under the leased property for the gas station. T renewed pre-CO
negotiations to purchase jointly 3 service stations w/CO. T bought the locations. Further he
bought the underground tanks for $1 dollar. T later sold the tanks to CO for $5K which was
below market value.
H: The mark-up on the price of the tanks from 1$ to $5K is not so shocking b/c it was less
than market value for what CO paid for other acquisitions
POINT A conflict of interest that is not a problem now may present a problem down the
road
9. Failure to Monitor
a. Stone v Ritter (explores possibility of violating DOL when they do not act all instances when
the boards failure to consider any action may be seen as violating the requirement that each
member of the board shall act in a manner the Dor reasonably believes to be in the best interest of
the corp
Hamric and Nance were operating a fraudulent 'Ponzi scheme'. They did this with the help of a bank called
AmSouth, who provided Hamric and Nance with accounts and distributed interest payments.
Had bank employees been paying attention they would have easily uncovered Hamric and Nance's scheme.
After the scheme fell apart, AmSouth was forced to pay $50M in fines and penalties for helping the scam.
AmSouth's shareholders instituted a derivative lawsuit against the directors for wasting corporate money.
The shareholders argued that AmSouth's compliance program lacked adequate board and management
oversight, and that reporting to management for the purposes of monitoring and oversight of compliance
activities was materially deficient.
o Basically, since the directors weren't doing their job and investigating what the employees were
doing, the shareholders were out $50M.
The Trial Court found for AmSouth and the directors. The shareholders appealed.

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The Trial Court looked to In re Caremark International Inc. Derivative Litigation (698 A.2d 959 (Del.
Ch. 1996)), and found that when shareholders claim that the directors were ignorant to liabilities, the
shareholder can only win if they show that there was a "sustained or systemic failure of the board to
establish oversight."
The Delaware Supreme Court affirmed.
The Delaware Supreme Court found that the standard for determining whether directors can be liable for
failure to exercise oversight of employees who fail to comply with their duties was a "lack of good faith as
evidenced by a sustained or systematic failure of a director to exercise reasonable oversight." That's the
same standard that was given in Caremark.
o The Court noted that this was a very high standard to meet.
See ATR-Kim Eng Financial Corp. v. Araneta (2006 WL 3783520 (Del. Ch. Dec. 21
2006)) for a case that met this standard.
The Court found that there are two conditions necessary for liability under the standard set by Caremark:
o The directors utterly failed to implement any reporting or information system or controls; or
o Having implemented such a system or controls, consciously failed to monitor or oversee its
operations thus disabling themselves from being informed of risks or problems requiring their
attention.
o In either case, imposition of liability requires a showing that the directors knew that they were not
discharging their fiduciary obligations.
The Court found that there is no duty of good faith that forms a basis, independent of the duties of care and
loyalty, for director liability.
o The Court found that just because there was a bad outcome in this case, that was not evidence of bad
faith on the part of the directors.
Basically, this case said that directors are not responsible for ensuring the legality of every act by the
corporation's personnel, even if the illegal conduct would have been discovered if there hadn't been a failure
of the corporate compliance program
b. Standard
i. Director Liability for not doing their job/duty
ii. MBCA treats oversight as a component of the duty of care, not loyalty. 8.30, 8.31(a), 8.42
iii. Delaware moved this concept to a loyalty issue by adding the good faith element.
iv. Delaware Cases
v. Graham - This method was originally followed.
1. No liability unless directors have reason to suspect the existence of a violation. Only if
there is reason to suspect a violation do directors have the obligation to install a monitoring
system.
2. Entitled to rely on honesty and integrity of employees.
vi. Caremark - Modern View - Courts have recognized the importance that directors keep themselves
informed.
1. Directors have a responsibility to assure that an adequate system exists for receiving corporate
information and reporting, including compliance w/ relevant statutes and regulations. Even if there is
no reason to suspect a lack of compliance, some monitoring system must be in place in order to
satisfy the obligation that directors need to be informed for both legal compliance and decision
making.
vii. Directors are liable
1. If there is a sustained or systematic failure to exercise oversight sufficient to indicate a lack of good
faith
2. This test of liability is high.
3. Level of detail appropriate for monitoring system is a question of business judgment.
4. Necessary Conditions to find Director Oversight Liability:

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a. Directors utterly failed to implement any reporting or information system or controls; or


b. Having implemented such a system, consciously failed to monitor or oversee its operation.
c. In either case, imposition of liability requires a showing that the directors knew they were not
discharging their fiduciary obligations. i.e. Not acting in good faith.
d. High Standard to find liability
e.
5. Trying to Generalize
a. Basic statement of DOL: requires each Dor to act in GF and with the genuine belief that their
actions are in the best interest of the corp
b. The test for whether a DOr has met his or her DOL should turn, entirely on whether a DOR
actually believes that the action will be in the corps best interest
c. One way to demonstrate that a DOR breaches the DOL is a statement by the DOR that they did
not have the requisite belief
d. Two objective indicators
i. Corp oppty
ii. Self Dealing: consequences of SD is different from that of taking a corp oppty
1. Unlike taking a corp oppty, a transaction between a corp and of its DORS is quote possible
a transaction that the DOR could reasonably believes is in the corp best interest so finding
that there was self-dealing does not then definitely establish that the DOR violated their
fiduciary DOL
2. SD has more shades than does corp oppty reason why it is SD is because it raises the
possibility that the DOR believes that the transactions is not in the corp best interest but in
the best interest of the DOR however DOR can reasonably believe that the transaction is
in the best interest of both DOR and corp
3. Note: SD is a subset of COI the presence of a DOR COI is a warning, a red flag that he
proposed transaction may represent one that the DOR does not actually believe is in the
best interest of corp
4. As connection between DOR and benefit becomes more weakened the less likely it is that
the DOR violated the DOL
e. Geller v Allied-Lyons Plc
F: Gellar was the VP of Dunkin Donuts Lipka approached Gellar stating that Allied wanted
to buy Dunkin & would give Gellar a finders fee. Gellar tells the board & the board is not
interested. Later, Kingsbridge tries to buy the Dunkin by buying up shares. Dunkin hires
Goldman Sachs for other buyers. GS cant find anyone. Gellar then reminds the board that
Allied wanted to buy them. Gellar works the deal & Allied buys Dunkin. Gellar does not get
the finders fee & sues
I: Is the finders fee a self-dealing transaction?
R: A K for personal gain which could cause a CORP fiduciary to breach his duty of loyalty
to the CORP is generally held to be unenforceable as against public policy
A: By pledging his assistance to Allied in return for a multi-million $$ finders fee the
placed himself in a position where his K obligation to Allied & his own $$ interest could
have prevented him from acting in Dunkins best interest
C: K violates public policy & is voidable. Set aside finders fee b/c violated his duty of
loyalty to the CORP
What he should have done G should have (1) made a full & adequate disclosure verbally
& in writing & (2) waited for the company to okay the transaction & okay the finders fee
(disinterest SH or board)
NOTE Directors can set their own & the officers compensation BUT it must be
reasonable. IF it is excessive that can be a form of waste = breach of the duty of loyalty

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NOTE: If after deal is done, they provide a finders fee this is fine there is no conflict for
post deal payment
6. Compensation of Dors and Senior Officers
a. At CL: directors could not award themselves compensation for performing their duties as
directors
b. Theory: Dors had to be SH, so compensation was from shares
c. Once requirement of share ownership by DORS fells away, the statutes were amended to permit
BOD to provide compensation to themselves DE 141(h), MBCA 3.02(11)
d. A BODs approval of executive compensation should not raise a COI problem directly because
DOR and Oers are separate people but when there is an overall between the two groups a
conflict is presented
e. Typically, direct conflict is avoided bc the inside DOrs abstain from voting on and often from
participating in the discussion of their own compensation
Duty of Care
1. D/O are under a duty to be informed duty of care distinct from DOL
2. (Burden on to overcome the presumption) Standard: A officer / director owes the CORP a duty
of care. She must do what a prudent person would do w/regard to her own business & act in the best
interest of the CORP (sufficient investigation & acceptable reasons)
3. Duty of Care concerns the directors/officers obligation to take calculated actions. To be informed.
4. MBCA 8.30 - Each director must act in good faith and in a manner the director reasonably believed
to be in the best interest of the corporation, and that the board discharge its duty w/ the care a person
in a like position would reasonably believe appropriate under the circumstances.
5. Traditional Provision (Old MBCA and still used by many states)
a. Directors must discharge their duties in good faith, w/ the care of an ordinarily prudent person in
a like position would exercise under similar circumstances, and in manner reasonably believed to
be in the best interest of the corporation.
b. MBCA dropped the "prudent person" language b/c that might suggest directors need to act w/
caution, when, in fact, directors need to take risks in order to create gains.
6. Delaware - DGCL does not contain a statement of the duty of care, but draws the duty from 141(a)
- all power lies with the board
7. Delaware Case law describes the duty:
a. Duty of care requires a director to take an active and direct role in the context of a sale of a
company from beginning to end. In a merger or sale, the director's duty of care requires a director,
before voting on a proposal plan of merger or sale, to inform himself and his fellow directors of
all material information that is reasonably available to them.
b. Delaware standard is more objective, whereas the MBCA is more subjective and looks more to
what the person actually believed rather than a reasonable person
8. Standards :

viii.

o Most courts have held that the duty of care imposes a "unitary standard" of conduct. i.e. a minimum
to which all directors will be held, even when a particular director is incapable of meeting that
standard.
e.g. Common sense, practical wisdom, and informed judgment are the floor.
o Conversely, directors who have specialized skills germane to the corporation/business, will be held
to a higher standard of care that reflects what a reasonable director with those skills would do.

Tension:

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o Tension exists here b/c unlike normal harms, which can usually be traced back to an act or
negligence, bad business results (harms) may occur for external reasons that are no one's fault. Fair
to say director's violated duty of care?
Investors also want corporation to take risks. If too much liability is sought of
directors, they will be afraid to do anything that could increase the wealth but may
expose them to liability.
9. Crown v Hawkins
o Parties

Hawkins - on board and ran warehouse

Blass - on board; not involved in daily operations; suit against him dismissed

Nungester - defendant; lawyer; on borad, not involved in daily operations

DOA - Dept of Agriculture

The Growers - groups of bean growers that dealt with warehouse

o Overview

Corp is a warehouse that stores and brokers beans between growers and buyers.

Hawkins was committing many illegal acts while he ran the warehouse including Check
Kiting, skimming, and others. Blass may also been involved.

Nungester became aware on check kiting and took action. He also learned of other
discrepancies in accounting. For each discrepancy, he talks to Hawkins and accountants. But
does not investigate further.

Idaho State law make the Growers shareholders, whether or not they actually have shares.
This creates a fiduciary duty

o Issue

Did Nungster violate his duty of care by not fully investigating?

o Standard

A dir shall perform his duties as a director, ... in good faith, in a manner he reasonably
believes to be in the best interests of the Corporation, and with such care as an ordinarily
prudent person in a like position would use under a similar circumstance.

In performing his duties, a director shall be entitled to rely on information, opinions,


reports or statements, including financial statements and other fin data in each case
prepared and presented by:
o 1 or more officers or employees of the corp whom the director reasonably
believes to be reliable and competent in the matter presented,

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o Counsel, public accountants or other persons as to matters which the director


reasonable believes to be within such person's profession or expert
competence.
o Holding

Nungter relied on regulatory experts and accountants so no breach

o notes

In Delaware, duty of care is tied to procedural. Plaintiff must present facts that show director
acted without good faith. SO, without a substantive breach, plaintiff cant get to procedural
hurdles.

MBCA 8.30
o ...with the care that a person in a like position would reasonably believe appropriate under similar
circumstance
ix.

x.
xi.

xii.

Federal Securities Regulation


1. Sarbanes-Oxley Act: must maintain disclosure controls and procedures and internal control over
financial reporting.
Note(c) pg 431 Delware Standard for DOC: stone case takes this standard and makes it a DOL?
Issue generally you cannot find liability unless the person is not following the process
Distinguish between Delaware and MI under stone standard under DGCL it is a DOL of issue
you have to know knowingly set up a standard; this is not how DOC is interpreted in MI purely a
duty of care issue
Fed Securities Reg: essentially trying to make you set up disclosure controls and other control
provisions and internal controls reliability of information being processed -

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h. Standards of Review of Board Actions (437-518)


i. BJR creates a presumption that in making a biz decision, the Dor of a corp acted on an informed basis
(w. due care) in good faith and in the honest belief that the action taken was in the best interest of the
company
ii. Presumption initially attaches to a DOR approved transaction within a boards conferred or apparent
authority in the absence of any evidence of fraud, bad faith or self-dealing in the usual sense of personal
profit or betterment
iii. Presumption in favor of actions taken by loyal and informed board decision will not be overturned
by the courts unless it cannot be attributed to any rational basis purpose
iv. SH: challenging a BOD decision has the burden to rebut the presumption
v. Rebut the presumption: SH P assumes the burden of providing evidence that DOR in reaching their
challenged decision breached any one of the triads of their fiduciary duty
1. Good Faith (GF)
2. Loyalty (DOL)
3. Due care (DOC)
i. If SH P fails to meet this evidentiary burden, the BJR rule attaches to protect corp O/D and the decisions
they make and our courts will not second guess these business judgments
j. If rule is rebutted: the burden shifts to D D.O the proponents of the challenged transaction to prove to the
trier of fact the entire fairness of the transaction to the SH P
k. BJR: procedural device that places the initial burden on the P to show something different than that the
DOR D have breached their FD
l. DE: BJR is a presumption that in making a biz decision, the DOR of a corp acted on an informed basis, in
GF and in the honest belief that the action taken was in the best interests of the company and that the
obligation to act on an informed basis means that the DOR have all material information reasonably
available to them
m. DE SC: Ps burden: Dors decisions will be respected unless the DOR
i. Are interest or lack independence relative to the decision
ii. Do not act in GF
iii. Act in a manner that cannot be attributed to a rational biz purpose or
iv. reach their decision by a grossly negligent (GN) process that includes the failure to consider all material
facts reasonably available
v. DOL
1. Orman v Cullman
a. To rebut presumption of loyalty establish that the board was either interested in the outcome of
the transaction or lacked the independence to consider objectively whether the transaction was in
the best interest of its company and all its SH
b. Interested or lacked independence: P must allege facts as to the interest and lack of independence
of the individual members of the board
c. Must plead facts showing that the a majority of the DOR D have a financial interest in the
transaction or were dominated or controlled by a materially interested DOR
d. If P alleging DOL is unable to plead facts showing interest/lack of independence, then entire
fairness standard is not applied and courts respect business stds of board
e. Establishing Director Interest in Outcome:
i. Interest exists when:
1. Director personally receives a benefit or suffers a detriment,
2. as a result of, or from, the challenged transaction,
3. which is not generally shared w/ the other shareholders , and

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4. that benefit/detriment is of such subjective material significance to that particular director


that it is reasonable to question whether the director objectively considered the advisability
of the challenged transaction to the corporation and its shareholders.
5. When a director stands on both sides of the challenged transaction.
f. Establishing Lack of Director Independence:
i. Inquiry into whether the director's decision resulted from that director being controlled by
another.
ii. Director can be controlled by another party if in fact he is dominated by that other party
through close or family relationship, or through force of will.
iii. Director can be controlled by another if he is beholden to the controlling entity.
iv. Considered beholden to another when the entity has the unilateral power to decide whether the
director continues to receive a benefit, financial or otherwise, upon which the director is so
dependent or is of such subjective material importance to him that the threatened loss might
create a reason to question whether the controlled director is able to consider the transaction
properly.
g.
2. The Entire Fairness Standard
a. Once P has rebutted the BJR, the court will apply the entire fairness std (EFS)
b. HMG courtland Prop v Gray (what does EFS entail?) the party claiming the transaction
as fair has the burden
(WATCH OUT: Fact pattern O/D on one-side of the transaction & CORP on the other side
= conflict of interest)
F: s F & G, partner in NAF entered into a transaction w/ HMG to buy some property. At
the time, both F & G were members of HMGS board. F made full & adequate disclosure of
his buy-side interests but G did not. Rather, G took the lead in facilitating the sale of the
property to NAF on behalf of HMG. HMG did not find out about Gs buy-side interest (selfdealing) for 10 years.
I: Was the transaction between NAF & HMG fair?
R: The transaction is VOIDABLE UNLESS the CRT decides the transaction was fair to the
CORP. That means the interest O/D has the burden to prove that he acted w/ENTIRE
FAIRNESS. The entire fairness standard has 2 components.
Fair Dealing
Factors
When the transaction was timed?
How it was initiated, structured, negotiated, and disclosed to the directors?
How the approvals of the directors & SH were obtained?
Fair Price
Relates to the economic & financial considerations of the proposed merger
Factors
o Assets, market value, earnings, future prospects, & any other elements that
affect the intrinsic or inherent value of the companys stock
A: G, the primary negotiator for HMG had a buy-side interest = self-dealing & the deal is
tainted. B/c of Gs buy-side interest he may not have been motivated to get the best price for
HMG b/c that would harm his self interest. Further the CRT found that based on surveys, G
possibly could have gotten a better price for HMG.
H: Although the K in NOT automatically void b/c it still might be fair to the CORP. Here,
clearly the K was not fair to HMG b/c G was involved in self-dealing
3. The Caremark Standard
a. Caremark - Necessary conditions for director oversight liability

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i.
ii.

vi.

47

the directors utterly failed to implement any reporting or information system or controls; or
having implemented such a system or controls, consciously failed to monitor or oversee its
operations thus disabling themselves from being informed of risks or problems requiring their
attention.
b. In either case, imposition of liability requires a showing that the directors knew that they were not
discharging their fiduciary obligations. Where directors fail to act in the face of a known duty to
act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty
of loyalty by failing to discharge that fiduciary obligation in good faith.
c. ATR-Kim Eng Financial Corp v Araneta
i. Directors were found to have breach their duty of loyalty b/c they did not check to see if the
other director was acting properly. They did nothing to make themselves aware of the bad
actions committed by their co-director.
ii. Araneta owned 90% of a corporation called PMHI. He was also chairman of the board of
directors. Araneta took $35M of PMHI assets for himself and his family members.
iii. Shareholders who owned the other 10%, represented by ATR-Kim sued Araneta and the other
directors, Bonilla and Berenguer for breach of fiduciary duty.
iv. ATR-Kim argued that Bonilla and Berenguer breached their fiduciary duty to the corporation
by standing idly by while Araneta looted it.
v. Bonilla and Berenguer never bothered to check whether PMHI retained its primary assets and
never took any steps to recover them one they realized those assets were gone.
vi. Bonilla and Berenguer argued that they never participated in, nor profited by any of Araneta's
schemes.
vii. The Trial Court found all three liable for breach of fiduciary duty.
viii. The Trial Court found that Ananeta breached his fiduciary duty as a director by impoverishing
PMHI for his own personal enrichment.
ix. The Court found that Bonilla and Berenguer breached their fiduciary duty of loyalty to the
company by acting as "stooges for Araneta, seeking to please him and only him, and having no
regard for their obligations to act loyally towards the corporation and all of its stockholders."
x. The Court noted that Bonilla and Berenguer did not make a good faith error in judgment, they
purposefully neglected their duties to the corporation.
xi. The Court looked to Stone v. Ritter (911 A.2d 362 (Del. 2006)), and found that directors can
be liable for failure to exercise oversight of employees who fail to comply with their duties
was a "lack of good faith as evidenced by a sustained or systematic failure of a director to
exercise reasonable oversight."
xii. While that is a pretty high standard to meet, Bonilla and Berenguer met it in this case.
xiii. "It is no safe harbor to claim that one was a paid stooge for a controlling stockholder."
DOC
1. Duty to be informed
2. MBCA: becoming informed is certainly an important component of DOC
3. The applicable standard of conduct when deciding whether directors have properly exercised their
duty of care is whether they acted w/ "gross negligence," and whether they were adequately
informed at the time they made their decision.
a. Courts only look to see if the process employed by the board was reasonable exercise
independent, GF, and attentive judgment both w respect to the quantum of info
necessary/appropriate w.r.t the decision to be made
4. In re NCS Healthcare Inc SH litigation (Std of review when P asserts that BOD violated DOC)
a. Struggling company enters into exclusivity agreement with a company for merger
b. Minority SH brings suit of DOC

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viii.

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c. Court said that they were not grossly negligent they deliberated and weighed the risks on both
sides before going into it
d. And they gathered facts was materially informed
e. So no DOC violation
f. This was case was overturned on a DOL violation court said that the NCS directors have
violated DOL by agreeing to provision that prevented NCS from abandoning the Genesis
agreement if a superior transaction presented itself
5. Where P can at some point show causation between the Dors lack of care and damage to the corp, a
remedy is compensatory
6. However, where a DOC violation leads to rescission, then no damage link has been shown: award is
simply to punish the DOR
Gross Negligence and Bad Faith
1. GN is the std of review, at least in DE< for a DOC claim
2. Acting in BF is a DOL violation
3. DE extremely different concepts
4. GN alone cannot constitute BF thus a board may act negligently w/o acting in BF
5. Articles may contain exculpatory provision to limit personal liability of Dors for certain conduct
a. BF actions cannot be exculpated (excused)
b. GN acts can be exculpated
c. Basically means care claims can be exculpated, loyalty claims cannot DE 102(b)(7) and 2.02(b)
(4)
6. Spectrum
a. One end: intent to harm company, DOL not exculpatory
b. Middle: intentional dereliction of duty DOL, not exculpatory or conscious disregard for
responsibilities is in the middle (DOL/not exculpatory)
c. At the other end: Duty of care issues lack of intent exculpatory - GN: reckless indifference or
actions that are without the bounds of reason
7. Rebutting the BJR for duty of care issues
a. Gross Negligence?
i. Failure to become informed
ii. Aware of all material facts?
b. Irrational Decision?
c. Conflict of interest?
i. Interested/independent?
d. Knowing dereliction of duties?
i. Knowing failure to monitor?
1. Knowing failure to establish reporting system?
2. Knowing failure to ensure.
8. McPadden v Sidhu
a. Case brought against directors stating that they breached the DOC owed to corp when they put
Dubreville in charge of a deal that he had expressed interest in and they did not monitor his
activities even though they had enough information to warrant monitoring
b. Court said P have not stated a claim for which relief can be given because the D has benefit of a
s.102(b)(7 exculpatory clause in their AI
c. However, Dubreville does not have the exculpatory protection he is an officer he does not
benefit from the protection of a s. 102(b)(7) exculpatory provision so as long as P has alleged
DOL, claim against him will go forward.
Prevailing Despite the Application of the BJR
1. DE SC: frequently suggested that a P who has not overcome the BJR might still succeed if they can
show that the corp actions cannot be attributed to any rational biz purpose

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2. To allege that a corp has suffered a loss as a result of a lawful transaction, within the corp powers,
authorized by a corp Fid acting in a GF pursuit of corp purposes, does not state a claim for relief
against the FID no matter how foolish the investment may appear in retrospect.
3. Brehm v Eisner (possibility of showing boards decision has no rational biz purpose in the
absence of DOL or DOC claims)
a. the Court found that the Business Judgment Rule shielded the Board, which the Court found to
have exercised bad business judgment, since it essentially complied with the Van Gorkom
procedural requirement of informing themselves via an expert before approving the severance
package.
b. Thus the rule seems to protect even terrible business decisions from judicial review. The counter
argument is that shareholders are free to sell their stocks in the open market.
c. Of course, some bad business decisions by the board may well affect the shareholders' ability to
do so.
d. Note, however, that this case was decided under Delaware's rather extreme codification of the
Business Judgment Rule, 102(b)(7), which allows the Corporation to shield its board members
from liability for almost anything short of outright bad faith.
Amelioration of Liability for Violations of FD other approaches to limiting liability
a. Three approaches to limiting liability
i. Boards are permitted to rely on reports made to them by board committees and others inside
the corp at least in the absence of indications that reliance is unwarranted DE 141(e), MBCA
8.30(d)
1. In DE To overcome the presumption that reliance is warranted, a P must show that
a. The DOrs did not in fact rely on the expert
b. Their reliance was not in GF
c. They did not reasonably believe that the experts advice was within the experts
professional competence
d. The expert was not selected with reasonable care by or on behalf of the corp and faulty
selection process can be attributable to the DOR
e. The subject matter: that was material and reasonably available was so obvious that the
boards failure to consider it was GN regardless of experts advice or lack of advice
f. That the decision of the board was so unconscionable to constitute waste or fraud
2. Ability of board to delegate its power either to aboard committee or to others within corp
a. Board allowed to rely on the assumption that their delegates are acting in the corps best
interest DE 141(c), 142(a), MBCA 8.30(c)
3. When some BOD is being sued for breach of FD,t he board frequently constitutes the nonD
DOR as a committee to investigate the allegations and recommend whether pursing those
allegations is in the best interest of corp same for when entering into transactions
b. DOL: Statutory Safe Harbor for COI Transactions
i. De 144(a), MBCA 8.60-8.63 safe harbor statutes nonexclusive which means that parties
and courts need no rely upon them raise three principal issues
1. Which transactions are eligible to be affected by the CoI Safe Harbors
2. Procedural and Substantive prereqs that eligible transactions must meet to be effected by
the CoI safe harbors?
3. What is the CoI Safe Harbors effect on transactions that meet those prereqs?
ii. Current
1. The Transactions Eligible to be Affected
a. Under the model provisions, a director may have a "conflicting interest" in a corporate
transaction under the following circumstances:

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b. The director knows at the time that he or a related person is a party to or has a beneficial
interest in a transaction or is closely linked to the transaction O
c. The transaction is brought before the board of directors for action, and the director
knows of a relationship, beneficial interest in the transaction, or a close link to the
transaction with respect to:
i. another entity of which he is a director, general partner, agent, or employee
ii. a person who controls one or more of the above-listed entities, or is controlled by, or
is under common control with, such entity or entities OR
iii. an individual who is a general partner, principal, or employer of the director
iv. Statutes provide that an interested director transaction is not void or voidable solely
b/c of the Conflict of Interest and creates a Safe Harbor for certain transactions.
v. Under the statute, an interested director could inform the shareholders/directors of his
conflicting interests and give them an opportunity to approve or ratify the transaction.
vi. Nondisclosed transactions may be valid if it is found to be fair and reasonable to the
corporation.
d. Shapiro v Greenfield
F: College park owns a shopping plaza that is not making any $$ & is only 50% leased. The
board wants to redevelop. A possibility arises in the form of creating limited partnership with
another company who would then have interest in the newly redeveloped plaza. Board
calls a special meeting of the SH. All but 2 show up (the minority shares). There is a
unanimous vote to grant the partnership
R: A K is not void or voidable solely b/c of a conflict of interest IF it falls w/in the safe
harbor provisions
CA 310 (NOT used in this case BUT this is what we use for the class)
(a)(2) Full & adequate disclosure of all material facts by the interested party & the
board authorizes, approves, or ratifies the K in GF by a vote sufficient w/o counting
the vote of the interested director.
(a)(3) The K has to fair (reasonable) to the CORP at the time it was approved
NOTE Once the safe harbor is triggered, the party trying to set it aside has the
BURDEN (This is very hard to do b/c now the K or transaction is protected under the
BJR)
NOTE If a K or Transaction does not fall w/in the cleansing provision, then the
BURDEN is on the interested O/D to show the K or transaction meets the entire
fairness standard.
Removing the Raincoat IF can show the board did not act in GF then the rain coat is
removed or if they can show that the board breached one of its other duties.
2. Prerequisites to being Affected by the COI Safe Harbors
a. These statutes typically operate as affirmative defenses.
b. The CoI Safe Harbor statutes provide 3 avenues for affecting covered transactions.
i. The transaction can be approved by certain directors
ii. The transaction can be approved by certain shareholders
iii. The transaction can be found to be "fair" to the corporation
c. These are disjunctive, thus, only 1 need be met
d. Attempted but failed compliance with 1 avenue does not preclude compliance w/ another
avenue.
e. DGCL 144(a)(1), (a)(2) / MBCA 8.63
3. The Effect of Compliance with the CoI Safe Harbor
a. Compliance with DE 144(a) shifts the burden to the P to show that the transaction was
not entirely fair

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b. MBCA: much more explicit - 8.61(b) provides that a complying transaction may not be
enjoyed set aside or give rise to an award of damages or other sanctions ina proceeding
by a SH or by or in the right of the corp, because the DOR or any person with whom or
which he has a personal, economic or other association with has an interest in the
transaction
iii. Background
1. A Note on SH Ratification
a. Methods for protecting a CoI transaction: have the transaction ratified by a fully
informed vote of SH unaffiliated with the conflicted Dors
b. BC SH are the ultimate owners and beneficiaries of the DOrs actions, SH ratification
cuts off all judicial power to redress a finding of breach of FD
c. The D/Dor have the burden of showing that full disclosure was made to the SH, that SH
were not coerced and that approval was given by a majority of shares not controlled by
the board
c. DOC: Limitations Contained in the AI
i. DGCL 102(b)(7) permits a corp. to add a provision to its certificate of incorporation that caps
or eliminates monetary liability of directors for breach of their fiduciary duties.
ii. The MBCA and nearly every state have adopted similar statutes. 2.02(b)(4)
iii. MI: cannot eliminate liability with the amount you get from self-dealing and cannot eliminate
intentional infliction of harm on the corp
iv. Emerald Partners v Berlin
1. An exculpatory provision was the nature of an affirmative defense, and that D seeking
exculpation under such a provision would normally bear the burden of establishing its
elements. Where the factual basis for a claim solely implicates a violation of DOC, this
court has indicated that the protections of such a certificate provision may properly be
invoked and applied
d. Indemnification by the Corp
i. Occurs often. DE 145, MBCA 8.50-8.59
ii. MI: 1561-1565
iii. Current
1. Advancement of Expenses
a. Where does money come from to pay for those expense for legal fees of suit that comes
about due to corp service?
b. Advancement of Expenses concerns who will pay the director or officer's legal expenses
why he fights the lawsuit. Comes into play when the director/officer would be
indemnified should he prevail at trial.
c. Vitally important and is not required under the statute. It is contractually negotiated.
d. Reddy v Electronic Data Systems Corp
2. When must the Corp Indemnify?
a. MBCA 8.52 / DGCL 145(c) require a corporation to indemnify an officer/director who
is exonerated on the merits or otherwise.
b. Courts take these statutes literally. If Officer gets off on Statute of Limitations or hung
jury is entitled to indemnification.
c. Partial indemnification may be required if officer gets exonerated on some, but not all, of
the claims.
3. Procedural and Substantive Prereqs to Indemnification
a. If Indemnification is permissive rather than mandatory, certain constituencies within the
corporation must make certain findings before the indemnification may be paid.

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b. DGCL 145(d) Un-conflicted directors or, if there are none, the shareholders must
make the findings.
c. MBCA 8.55 - Disinterest directors, disinterested shareholders, or special legal counsel
appointed by the corporation may make the finding.
e. Insurance
i. Virtually every corporations statute permits corporations to purchase insurance covering
liability incurred by directors and officers. MBCA 8.57 / DGCL 145(g)
i. Lot of the insurance policy does not cover once the directors leave the corp
ii. Liability after the fact is something they should be concerned about
iii. In general, if dealing with corp/doctors or fiduciary you should be thinking about tail
insurance any sort of malpractice insurance whether or not the policy that they were
covered under when they were there, would cover even after they leave if you were smart
Ement K will ask for this
b. This does not generally apply to 3rd P payments generally SH
c. Can cover expenses that are not indemnifiable if you decide MI statute is complicated the
insurance policy may already cover so be aware of scope
i. Main Exclusions: If you commit a DOL breach, you potentially are most vulnerable if you
are an officer not allowed to be exculpated under 102(b)(7) and insurance probably does
not cover you
ii.
x.

An Exercise in Synthesis
1. In re Walk Disney Co Deriv Litig
n. Identify key players want to make sure we are suing everybody
o. Hiring Ovitz
i. 1) Eisner have to show an intentional dereliction and knew that there was no experience and DOC
violation, bad faith, one way to show COI by rebutted the BJR, is Eisner always under his control
reason ot believe that Eisner cannot act independently - very hard to say friend is controlling him bc
there is no evidence of that how can you destroy independence here
ii. 2) Ovitz DOL working on his K when he was working for them self dealing- he could have fixed
it by delegating it to a 3rd P safe harbor and does it apply here
iii. 3) BOD DOC did they get all the information reasonably available problem with their meetings
because there is a lack of deliberations they delegated it to the compensation company and they met
for less than an hour - russel did not make any recommendations, minutes do not say any
considerations BOD is going to say that system in place who is supposed
iv. 4) Compensation committee
v. 5) The Lawyer no lawyer
vi. 6) Compensation expert fid duty to corp? not typically a regular Eee expert in the field just like you
would hire environmental expert outside 3rd party = duties are going to be outlined by K fid duty?
Nature of the relationship agency relationship ? Can they modify their legal relationship? (HR and
Block case) and did they have agency power if you cannot modify agency relationship, then not
agent. The expert just provided the report asking somebody to provide a report for you is not asking
them to modify legal relationship no change in relationship between the corp
p. Disneys death policy: if you have a heart attack or medical condition, they will get you out before you die
because they dont want the liability assume this is true somebody dies because they did not administer
care on the grounds can you sue the BOD? Medically unsound to have this policy Maybe grossly
negligent as to the cost of the policy. They did their due diligence so their decision was made on all the

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q.
r.

s.
t.

53

information that was available to them it means that they made a deliberate decision they had people
come in and doctor came in and said deaths 5% of the time it does not matter if doc is wrong, it does not
matter for DOC maybe need an outside doc gather info, then Cost benefit analysis then talk about it
importance of deliberation
After policy is adopted you can argue that you are monitoring the situation care mark claim of DOC at
least in Delaware
Criminal act that caused company to enter into it and failure to monitor and there was knowledge - if you
know something was a criminal act and caused company to do it then it is bad corpo does not have fid
duty to the people who come into its park intentionally causing corp to commit a criminal act
How else can it be an intentional bad act? If you knew that it was a bad policy
Eg: Zuckerberg - not timely disclosure, there was disclosure, but not timely knowing failure to monitor
liability? No they delegated authority to CEO the board did not approve this deal, Z just did it thats
the deal can argue that board should have rejected the deal no specific facts to say that they were
Grossly Negligent

HYPO
u. Who are we suing? The Board or Gorker
i. Board: they breached DOC Gross Negligence when they had initial presentation it only lasted 20
minutes did not have enough time to deliberate just rubber stamped what was presented to them,
1. Gathering information: listened to a 20 minute speech length of time, they should have gathered
information regarding the price (that is key here) make a decision as to whether or not it was a
good price they didnt rely on an expert
2. Why is it troubling that Gorker is the one who is doing this? Gorker directed people to calculate
price for buyout BOD was gross negligently in gathering information as to Gorkers involvement
in the deal
3. How can we excuse lack of additional deliberation? IF they had already thought about it a head of
time other facts being presented, rely on Gorker for his expertise and knowledge in area as long as
it is a reasonable belief and in good faith if they had already delegated authority to Gorker to make
the decision and if this was an exigent circumstances (timing)
4. They didnt review the documents
5. The BOD wasnt given notice about what was going to go on in the meeting maybe not all
members showed up
6. First argument: BOD is going to say we are allowed to rely on reports counter argument: not
reasonable and in good faith to rely on a report given by somebody who wont be at company for a
long time, you can also say that what Gorker said is not a report report is supposed to be about
facts and it is supposed to be informative if he is not telling you the essentially provisions of the
deal then it maynot be a report
7. Price: no damages we sold for premium why do we believe that $55 is not enough? They could
have gotten more, but we dont know. The fact that it is premium, does not mean that it is a good
deal if you have a publicly traded company that is objectively worth $50/share, but if you are
buying it you might be willing to pay $55/share control if you own 51% of MCDs then your
shares are worth a lot more general public matter there is some sort of a discount
8. They did not get outside evaluation
9. Negligent as to the interaction with CFO? Why is this GN? The process is defective because they did
not press the CFO does not look like you are gathering all the necessary information
10.
The board should have compared the $55/share deal with the other deals and you want to
know how that calculation was established how did you come up with $55

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11.Fairness opinion
12.
Counter argument for not being GN because we are able to accept better offers they werent
allowed to solicit
13.
Characteristics of board: if they are well informed (Educated) and financially sophisticated
then they pass the deal then can use BJR experts so presumably they can make these decisions
and not be GN - they are up to speed with these kinds of information so no need for information
gathering
14.
Relying on the lawyer: 1) Lawyer provided advice that may or may not protect the lawyer
the fact that he could be sued is not unique to this action DOL claim against the board: no evidence
of financial interest or lack of ______
15.
How do we know that they cannot act in the best interest of corp? they were foreclosing the
possibility of getting better offers from others they agreed to go exclusive and wouldnt solicit
offers so prevented board from determining if there are better offers out there so knowingly
preventing board from finding/determining better offers

a. Do the Restrictions Work? (519-575)


a. Structural Constraints
i. BOD
ii. Internal Actors Below the Board
1. Officers
2. In House Attys and internal Auditors
iii. Reputational Remedies
1. Outside Law firms
2. Independent Accountants
3. Credit Rating Agencies
4. Securities Analysts
iv. Intentionality

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4) SH Power in Public and Private Corp (575a. SH Governance Powers: Paradigms and Public Companies
i. SH power to take action
1. Actions that SH may take as a Group
2. How SH Take Action in a Group
a. Call
b. Notice
i. McKesson Corp v Derdiger
c. Quorum
d. Sufficient Vote
e. The simple Majority Vote Movement
f. The Importance of Being Present
3. How SH take action by Consent in Lieu of a Meeting
ii.
b.
5)

6)

55