Corporations

1) CHARACTERISTICS AND FORMATION OF CORPORATIONS

a) Introduction. Corporation is a form of business ownership that has advantages

and disadvantages over other forms of business ownership. General
b) General Characteristics of a Corporation. A corporation is a legal entity
distinct form its owners. Creation generally requires filing documents with the
state, and requires more formality than other business entities. Corporations have
these characteristics:
i) Limited Liability for Owners, Directors, and Officers. The owners of a
corporation generally are not personally liable for the obligations of the
corporation; neither are the directors or officers. Generally, only the corporation
itself can be held liable for the corporate obligations. The owners risk only the
investment that they make in the business entity that protects his personal
assets form the possibility of being seized to satisfy obligations of the business,
a corporation would be a good business form to consider.
ii) Centralized Management. Generally, the right to manage a corporation is not
spread out among the shareholders, but rather is centralized in a board of
directors, who usually delegate day-to-day management duties to officers.
iii) Free Transferability of Ownership. Generally, ownership of a corporation is freely
transferrable; a shareholder can sell his shares to whomever he wants, at
whatever price he wants in most circumstances.
iv) Continuity of Life. A corporation may exist perpetually and generally is not
affect by changes in ownership (sale of shares).
v) Taxation. Generally, a corporation is taxed as an entity distinct form its owners;
i.e., it must pay income taxes on any profits that it makes, and generally
shareholders do not have to pay income tax on the corporations profits until
the profits are distributed. The corporate tax rate is generally lower than the
personal tax rate. However, this advantage comes at a pricedouble taxation
because when the corporation does make distributions to shareholders, the
distributions are treated as taxable income to the shareholders even though the
corporation has already paid taxes on its profits.

Corps

General
Partnerships
(2 ppl who
agree to do
business for a
profit)
LLCs

Liability of
Owners for
Business
Debts
Shareholders
[SHs] can only
lose their
initial
investment.

Continuity of
Existence

Management

Tax
Consequences of
Owners

Corp continue
perpetually

Double-taxation
((1)Corp revenue
and (Dividend aka)
(2)Distribution
disbursements)

Partners
Personally
liable (house,
cars, cat)

Default Rule:
Dissolves upon
death,
incapacity, or
withdrawal (incl.
bankrupt)
Perpetual

Centralized
management
(may/may not be
SHs. SHs only power
in proportional
(merge, dissolve,
Board of Directors)
Default Rule: Equal
voice in
management,
regardless of
contribution.
Default Rule: Like

Pass-Through

Limited to

Pass-through
taxation. [Partners
receive a tax form
K1,

Lmited Partnership
(LPs). 1 general
partner, at least
limited partner.

initial
partnerships, but
investment
customizable.
Build skyscrapers, one general partner liability for everything, but can attract
investors which are only liable for their initial investment.

c) Bigger Ramifications of Corporate Formation

i) Two Agency Duties:
(1)Duty of Care
(2)Duty of Loyalty
ii) Two Principal Duties
(1)Duty of Reimbursement Indemnification
(2)Duty of Tortious Indemnification (if within scope of agreement) (Frolic vs.
Detour)
2) INCORPORATION, ORGANIZATION, AND PROMOTER ISSUES [Chapter 13 p385]
a) Where to Incorporate and Incorporation Procedure
i) Where to Incorporate? Generally, the choice boils down to local incorporation or
Delaware. For small businesses that do business mainly within one state, local
incorporation is a logical choice. Delaware imposes a number of costs
(franchise taxes) that outweigh any advantage of incorporating in Delaware for
most small businesses.
(1)The internal affairs doctrine. The laws of the state of incorporation governs
the internal affairs of the corporation unless the outcome is repugnant to
the state hosting the litigation. Internal affairs includes the rights and
duties of directors, officers, and shareholder, but not the corporation
obligations to third parties-including its employees and other creditors.
(2)The preeminence of Delaware. Often incorporation of small business in
Delaware is a mistaken calculus of the costs/benefits, or mistaken ambitions.
It is advantageous for large corporation. Advantages include: sophistication
of Delawares Court of Chancery, and its Secretary of State in dealing with
Corporate matters, the breadth and depth of established Delaware law of
corporations, and general flexibility and business-friendliness of Delaware
law.
ii) Incorporation Procedure. A person (incorporator) must file a document known
as the articles of incorporation with the Secretary of State in the state where
the business will be located. Incorporator need do no more than sign and cause
the physical/electronic delivery of the articles to the filing authority.
(1)Incorporation CheckList (p391) [MBCA 2.02(a)]
(a) State Chosen
(b)Incorporator(s) meeting residency requirement, if any
(c) Qualifying name (must include the word corporation, incorporated,
company, limited, or an abbreviation)
(d)Article of Incorporation including
(i) Name and street address of corporations initial registered office
(ii) Name and street address of each incorporator
(iii)
Name and street address of registered agent
(iv)
Number and class of authorized shares, including par value, if
any

(v) Discretionary items, often including the initial directors and provisions
limiting the liability of officers and directors
(e) Requisite filing Fee
(2)Incorporation by postcard
(3)Optional Provisions
(a) Business Purposes. The MBCA presumes that a corporation is formed for
any lawful business unless the articles provide a more restricted business
purpose. [MBCA 3.01(a)]
b) Promoters and Pre-Incorporation Liabilities (p391). The first step in forming
a corporation is the procurement of commitments for capital and other
instrumentalities that will be used by the corporation after formation. This is done
by promoters. Generally, promoters enters into contracts with third parties who are
interested in become SH of the corporation once it is formed. Promoters might
also enter into contracts with others for goods or services to be provided to the
corporation once it is formed. Promoter: a person who acts on behalf of a business
before it is incorporated.
i) Liability of co-promoters.
(1)In general, when a promoter executes a K or commits a tort in connection
with the business prior to its incorporation, that promoter is usually
personally liable for it, and all of his or her co-promoters are liable for it too.
(2)In addition, if co-promoters act on behalf of a business before it is
incorporated, they take on fiduciary duties to one another
(3)Pre-incorporation liabilities can therefore include tort or K liabilities to 3rd
parties, shared among the co-promoters jointly and severally, and fiduciary
liabilities as between the co-promoters.
(4)The promoters liability for pre-incorporation obligations is a matter of
agency law and sometimes substantive contract law
ii) When and how does the corporation become liable? McArthur v. Times Printing
Co.
(1)Holding: A corporation is NOT bound by actions of the promoters before the
corporation existed, unless the corporation ratifies the K. Ratification
occurs (1) The agreement must be one that the corporation could make, (2)
the agreement must the one that the usual agent could make, or (3) the
agreement may be ratified expressly or impliedly (through acquiescence).
c) Promoter Liability as a Result of Defective Incorporation
i) Corporations de jure;
ii) Corporations de facto; Corporations by estoppel Robertson v. Levy
(1)Holding: Corp do not come into existence by accident, only when filing
articles of incorporation and paying the fee. [MBCA 2.03] Corporation by
estoppel and corporation de jure cannot be used. Corporation comes into
existence when articles are filed and fee is paid. Promoter is jointly and
severally liable created while acting on behalf of an unincorporated entity
(MBCA 2.04).
iii) The passive vs. active distinction Timberline Equipment Co v. Davenport
(1)Holding: A de facto corporation cannot exist under the MBCA. However, it
seems appropriate to impose liability only on persons who act as or on behalf
of corporations knowing that no corporation exists. [MBCA 2.04]
d) Promoter Liability to Investors and the Corporation Itself

i) Securities Fraud
(1)
If a promoter has made any misrepresentation and/or non-disclosure to
investors, which are illegal under all kinds of common and statutory laws,
including the federal securities laws.
(2)
Fraud: A misrepresentation of a material fact that induced someone to
detrimentally rely on that fact. (Securities fraud)
ii) Promoter Fraud
(1)
Old Dominion Copper Mining & Smelting Co. v. Lewinsohn, 210 U.S.
206 (1908)
(a) Holding: Corporation cannot sue promoters because, the promoters
were acting on the corporations behalf.
(2)
Old Dominion Copper Mining & Smelting Co. v. Bigelow, 89 N.E. 193
(1909)
(a) Holding: Promoters have a fiduciary duty of care; duty of loyalty, they
are agents of the corporation. But as for separate promoter liability.
(b) Analyze Promoters liability to the Corporation as a liability stemming
from violation of the Promoters duty of care and duty of loyalty.
3) CORPORATE POWER AND PURPOSE (Chapter 14 ; p411)
a) Purpose, Power, and the Doctrine of Ultra Vires A.P. Smith MFG. Co. v.
Barlow
i) Fact: AP Smith gave money to Principle, chancery court ruled that donation was
intra vires; aka Kosher with Board of Directors.
ii) Holding: Doctrine of Ultra vires (ultra unimportant, but not dead). Acts that
were outside the power of the corporation. Legally unenforceable because
undertaken with no legal power. Generally, a corporation is allowed to
undertake any action necessary or convenient to carry out its business or
affairs, including make donations for the public welfare or for charitable,
scientific, or educational purposes. [MBCA 3.02] If a corporation includes a
narrow purpose state in its articles of incorporation, it may not undertake
activities unrelated to achieving the stated business purpose. If it does so, it is
beyond the scope of its state purpose, it is said to be acting ultra vires.[MBCA
3.04] p417
b) The Common Law of Corporate Purpose. Dodge v. Ford Motor Co.
i) Fact: Dodge brothers saw that Ford motor company (in which they were
significant shareholder) of which they had $112M sitting in the corp. as cash on
hand. Dodge brothers wanted a proportion of that money. It is very difficult for
shareholders (as the owners of the corporation) to get the corporation to
distribute proceeds. Henry Ford (owning 60% of the stock) had the idea that
the purpose of the corporation was to help people get back into a corporation,
an eleemosynary institution (giving to alms; charitable).
ii) Holding: A business corporation is organized and carried on primarily for the
profit of the stockholders. The powers of the directors are to be employed for
that end. The discretion of directors is to be exercised in the choice of means in
the end itself, to the reduction of profits, or to the nondistribution of profits
among stockholder in order to devote them to other purposes.

(1)
It is not within the lawful powers of a board of directors to shape
and conduct the affairs of a corporation for the merely incidental benefit of
shareholders and for the primary purpose of benefiting others
(2)
Note: the Directors get to decide what benefits Ford Motor Company,
are experts, and can trump judges (unless theres something clearly amiss)
iii)The fundamental case cited for What is the purpose of the corporation?
c) Corporate Constituency Statutes and Benefit Corporations
i) IN RESPONSE, that shareholder that directors have benefitted third-parties at
the expense of shareholders, i.e. loss of jobs, plant closures, Many states
(excluding Delaware) have passed Constituency Statute (Stakeholder Statutes).
ii) Constituency Statute (Stakeholder Statutes)
(1)
Gives authority to corporate managers to base decisions on what was
best for a corporation on matters in addition to corporate profitability, such
as resisting a take-over, loss of jobs, or effects of plant closures.
(2)
In discharging the duties of the respective positions, the board of
directors, committees of the boardmay, in considering the best interests of
the corporation, consider to the extent they deem appropriate
(a) The effects of any action upon any or all groups affected by such action
including shareholders, employees, suppliers, customers and creditors of
the corporation
(b) The short-term and long-term interests of the corporation, including
benefits that may accrue to the corporation
(c) The resources, intent and conduct (past stated and potential) of any
person seeking to acquire control of the corporation
(d) All other pertinent factors
iii)Public Benefit Corporations (Delaware 362). A for-profit corporation intended
to produce a public benefit and to operate in a responsible and sustainable
manner.
4) INTRODUCTION TO SHARES, SHAREHOLDERS, AND CORPORATE DEBT (Chapter 15;
p431)
a) Shares and Shareholders.
i) Sales of stock by closely held corporations is a simple contractual sale; shares
of stock are issued in exchange for immediately delivered consideration,
including cash, promissory note, tangible or intangible property, or an
agreement to provide services. The only bureaucratic requirement is that a
record of stock sales be kep in the stock transfer record a book kept the
corporate secretary.
ii) Sales of stock by large corporations is a complex and time consuming affair,
triggering obligations by federal securities law. A public offering (IP) usually
involves an investment bank (underwriter), which advising the issuing
corporation as to how to structure the transaction and price the securities and
aids the distribution.
b) Types of Shares
i) The Articles of Incorporation, MUST authorize the issuance of TYPE(S) of
STOCK; but Must include one class of Common Stock
ii) Just because Stock is authorized doesnt mean that it must be issued. (Nonissued stock is referred colloquially as treasury stock.)

c)

d)

e)

f)

(1)
The Issuance of Stock in a Publicly Traded CompanyThis comes with
VERY extensive disclosures through the Securities and Exchange Commission
(SEC).
(2)
State and Federal Securities Law NEVER allow exemption against
securities fraud.
iii)Common Stock: General Voting right; General Rights to any Distribution share
(Majority of corp.)
iv)Preferred Stock: Preference can be with regard to (1) VOTING, (2)
DISTRIBUTIONS, and/or (3) DISSOLUTION
Shareholder Rights: SH enjoyed a right to acquire a proportional number of
shares out of any subsequent offering of the same class. This right is known as the
preemptive right. Under the MBCA, a SH does not have any preemptive rights
unless the articles of incorporation so provide [MBCA 6.30]. Moreover, even if the
articles provide for preemptive rights, the rights do not apply to (1) shares issued
as compensation to directors, officers, agents, or corporate employees; (2) shares
authorized in the articles that are issued within 6 months after incorporation; (3)
shares issued for consideration other than money; (4) shares without general
voting rights but having a distribution preference. [MBCA 6.30(b)(3-4)
Par value
i) Largely unimportant in Model Business Code Act, But sometimes, like Delaware,
Franchise Tax is based on Par-value.
ii) Unrelated to the Value the stock was trading at!
iii)What the minimum capitalization of the corporation was at any given time.
(Gave a false sense of value)
iv)MBCA doesnt contain the idea of par value, or watered stock.
v) MBCA says, Directors may issue stock for any consideration (past services,
future services (incentivize officers and directors).
vi)Checklist for Issuance of Shares
(a) Number and Type of shares authorized in Articles of Incorporation
(b) Preemption rights, if any, observed (Rule: There are no preemptive
rights, unless the Articles provide!!)
(c) Determination by Board that consideration to be paid is adequate, and
verification that it is actually received
(d) Existing shareholder treated fairly
(e) Full disclosure to new investors, including any dilution of investment.
Limited Liability and the Obligation to Pay For Shares; Hanewald v.
Bryans, Inc. (1988)
i) Facts: Harold E. Hanewald, appeals the part of his judgment that refused to
impose personal liability upon Keith, Joan and George Bryan, for the debt of
Bryans Inc..
ii) Holding: Creditors can seek to hold shareholders liable for corporate debt
(DESPITE LIMITED LIABILITED) when shareholders have received their shares
gratuitously.
iii)TODAY, Even though wed get the same result, wed get there but through
MBCA piercing the corporate veil,
Introduction to the Control Rights of Shareholders; Gashwiler v. Willis
i) Facts: The formalities are few, and can be tedious and dry. Nonetheless, it can
be very important to comply with corporate formalities, even when they seem

unnecessary. For example, a role of SH in corporate governance. (Too many

hats.)
ii) Holding: Sale was not valid. The three trustees (members of the board of
directors) were meeting as shareholders not as directors, therefore, the it was
not a signature and not a seal.
(1)Shareholders Have a Right To Vote ON:
(a) Board of Directors, Amendments to Articles of Incorporation, Adopt
Bylaws, Assets, Dissolution
(2)Shareholder DO NOT Have a Right to Vote On: ordinary course of business
(a) Management of the Corporation is vested above all in the board of
directors.
g) Introduction to the Shareholder Right to Sue
i) Replace Board of Directors
ii) Derivative Suit
(1)Shareholder steps into the shoes of the corporation, (AND GAIN STANDING
TO BRING STANDING IN CIVIL ACTION)
(2)Allows shareholder to seek in its right the restitution he could not demand in
his own.
(3)When a Shareholder sue to board of directors,
(4)All residual power is in the hands of the board of directors.
(5)A shareholder may step in into the shoes of director.
h) Corporate Debt
i) The basic distinction
(1)Equity tends to put the risk on an investment more on the investors, but
leaves them with the benefit on the upside.
(2)Debt, by contrast, put the risk on the company, but ordinarily gives investors
none of the upside.
5) PIERCING THE VEIL OF LIMITED LIABILITY (Chapter 16; p459)
a) In some circumstances, even though a corporation has been validly formed, the
courts will hold SH, officers, or directors personally liable for corporate
obligations because the corporation is abusing the legislative privilege of
conducting business in the corporate form. This is frequently called piercing the
corporate veil. This doctrine counterbalances the de facto corporation and
corporation by estoppel doctrines, for here a valid corporate existence is
ignored in equity to serve the ends of justice.
b) Elements Justifying Piercing the Corporate Veil. As a general rule, a
corporation is treated as a legal entity until sufficient reason to the contrary
appears, often including (i) when corporate formalities are ignored; (ii) when the
corporation is inadequately capitalized at the outset; and (iii) to prevent fraud.
i) Alter Ego (Ignoring Corporate Formalities). If a corporation is the alter ego,
agent, or instrumentality of a sole proprietor or of another corporation, its
separate identity may be disregarded. Baatz v. Arrow Bar (p460): Where the
person treats the corporation as an alter ego or a mere instrumentality as a
fraud
(1)Individual Shareholders. If SHs treat the assets of the corporation as their
own, use corporate funds to pay their private debts, fail to keep separate
books, and fail to observe corporate formalities, courts often find that the

corporate entity is a mere alter ego of the SH. However, sloppy

administration alone of the corporation may not be sufficient to warrant
piercing the corporate veil. The operation of the corporation must result in
some basic injustice so that equity would require the individual SH respond
to the damage they have caused.
(2)Parent-Subsidiary Corporations. A subsidiary corporation will not be deemed
to be a separate corporate entity if the formalities of separate corporate
procedures for each corporation are not observed. For example, both
corporations must be held out to the public as separate entities; separate
meeting of directors and officers should be held; identical or substantially
overlapping directors and officers should be avoided; and corporate policies
should be significantly different.
(3)Affiliated Corporations. If one person owns most or all of the stock in several
corporations, a question may arise as to whether one of the corporations,
although not formally related to the other, should be held responsible for the
others liabilities. Dominating stock ownership alone is not enough in such
case, unless the majority SH dominates finances, policies, and practices of
both corporations so that both are business conduit for the principal SH.
ii) Inadequate Capitalization. It is generally accepted that SH will be personally
liable for their corporations obligation IF at incorporation they fail to provide
adequate capitalization. The SH must put at the risk of the business
unencumbered capital reasonably adequate for its prospective liabilities.
Undercapitalization cannot be proved merely by showing that the corporation is
now insolvent. However, if insolvency occurs soon after incorporation, it may
be a primary indicator of undercapitalization.
(1)Walkovsky v. Carlton (p466): An individual can be held liable for the acts of
a corporation through the doctrine of respondeat superior if it can be shown
that the individual used his control of the corporation for person gain. The
operating companies were simply instrumentalities for carrying on the
business for the without imposing upon it financial and other liabilities
incident to the actual ownership and operation of the cab company. The
Main argument for piercing the corporate veil were that Seon corporation
only had capitalization of (1) taxi cab and (2) $10,000 statutory minimum
liability insurance policy. However,even though its an involuntary (tort)
creditor, and there is insufficient undercapitalization, the NY state legislature
has defined proper capitalization for cab companies by state minimum
liability policies.No evidence of Carlton and his associates are doing
business in their individual capacities, shuttling their personal funds in and
out of the corporations without regard to formality and to suit their
immediate convenience. How about capturing the assets of the sibling
assets? Such liability might be possible. HOWEVER, the enterprise does not
become either illicit or fraudulent merely because a single cab corporation
merely because it consists of many such corporations. To impose liability, it
would take a wholesale ignoring of corporate form. Notice how the court is
NOT viewing Carltons taxi fleet! That in and of itself IS NOT A FRAUD. There
is nothing wrong with dividing with up, as long as you observe the
separateness of corporation.

(2)One-Person or Close Corporation. No absolute test for adequate

capitalization has been formed. In any case, the corporation should have
enough capital to pay debts when they become due. The scope of the
contemplated operations of the corporation, and the potential liability
foreseeable from the operations, are factors to consider.
(3)Parent-Subsidiary Corporation. A parent corporations inadequate
capitalization of subsidiary corporation may constitute constructive fraud on
all persons who deal with that subsidiary. One additional test should be
applied in the parent-subsidiary situation: whether the subsidiary may
reasonably expect to achieve independent financial stability from its
operation.
iii) Avoidance of Existing Obligations, Fraud, or Evasion of Statutory Provisions.
The corporate entity will be disregarded anytime to prevent fraud or to prevent
an individual SH from using the corporate entity to avoid his existing personal
obligations.
(1)Avoiding Liability. The mere fact that an individual chooses to adopt the
corporate form to avoid personal liability is not, of itself, a reason to pierce
the corporate veil.
(2)Fraud. The corporate veil will be pierced whenever the avoidance of
personally liability through the formation of a corporation operates as a fraud
on the creditors or other outsiders.
c) Who is Liable?
i) Active-Inactive Tests. Normally only the persons who were active in the
management or operation of the business will be personally liable. In other
words, passive investors who acted in good faith will not be held liable for
corporate obligations.
ii) Theories of Liability.
(1)
Joint and Several. When SH are held liable, they will be held liable for
the entire amount of the claim (even if it exceeds the amount that would
have been considered adequate capitalization). Liability for obligations of
the corporation is extended to the SH as joint and several liability.
(2)
Property Cases. If a corporation has conveyed its assets to a SH in
fraud of creditors, upon piercing the corporate veil, the assets may be
reached on principles of fraudulent conveyance.
d) Types of Liability
i) Tort. A tort victim is often a successful under the theory of piercing the
corporate veil, since she usually has not been involved with the corporation in a
transactional sense, and should not be forced to sue an insolvent corporate
shell for his damages.
ii) Contract. Courts are reluctant to pierce the corporate veil in contract cases,
since the contracting party has an opportunity to investigate the financial
condition of the corporation and, in the absence of misrepresentation or fraud,
has a less equitable claim for relief.
iii)Bankruptcy and Subordination of Claims. When the corporation is insolvent and
some of the SH have claims as creditors, the SH claims may be subordinated to
those of other creditors if equity so requires (b/c of fraud).
e) Who may Pierce?
i) Creditors. Creditors are most likely persons to pierce the corporate veil.

ii) SH. Generally, those who choose to conduct business in the corporate form
may not disregard the corporate entity at their will to serve their own purposes.
Courts virtually never pierce the corporate veil at the request of the SH.
iii)Others. Free v. Complex Computing Co. Glazier develops software, and is
then hired as an independent contractor after he graduates. He is the equitable
owner a person who exercises sufficient control over the corporation,
notwithstanding the fact that the individual is not a shareholder of the
corporation. He controlled C3, because it was his IP that drove the
corporation, even though he wasnt an officer, director, or SH. Stands for the
proposition that ANYONE can Misuse the Corporate entity.
f) Shareholder Liability Under Federal Law; United States v. Bestfoods
(1998)
i) Bestfoods buys OTT in 1965 and runs until 1972 when it sells to Story. Is
Bestfoods (the parent/Shareholder) liable for the corporate debt/pollution of
OTT?
ii) 2 Theories of liability
(1)Piercing the Corporate Veil. A parent corporation that actively participated
in, and exercised control over, the operations of a subsidiary may, without
more, may not be held liable as an operator of a polluting facility owned or
operated by the subsidiary, unless the corporate veil is pierced. Court
refuses to pierce the corporate veil theory, because there is no evidence of
misuse of the corporate form of OTT, and thats the relevant inquiry, here.
(2)Comprehensive Environmental Response, Compensation, and Liability Act. A
corporate parent that actively participated in, and exercised control over, the
operations of a facility itself may be held directly liable in its own right as an
operator of the facility. Based on the fact that under CERCLA, Bestfoods was
an operator of the facility).
(3)In the CERCLA theory liability, The key relationship is between SH/Parent
and the Facility.
(4)In the piercing the corporate veil theory, the key relationship between
the shareholder (Parent) and the corp (Sub)
(5)Interlocking directorsnothing wrong with that.
g) Planners Checklist:
i) Observe corporate formalities
ii) Keep records
iii) Declare any distributions
iv) Maintain separate individual and corporate bank accounts
v) Adequately capitalize/insure against liability
vi) Avoid using corporate funds for personal purposes
vii) Wear the right hat.
6) THE BASICS OF CORPORATE GOVERNANCE (Chapter 17; p491)
a) Traditional Roles.
i) 3 Constituencies of Corporate Governance.
(1)Shareholders Elect Board of Directors
(2)Board of Directors Run the Company/All residual Power to Manage the
Corporation
(3)Officers Whatever is delegated to them (in bylaws or by board of directors)

10

ii) McQuade v. Stoneham

(1)Facts: Shareholders enter into an agreement (amongst themselves) which
takes away some of the authority of the board of directors, by McQuade will
always be an officer, salaries will always be, such and such. Those are
classic directors powers.
(2)Issue: Can a third-party contractual agreement tie the hands of a director or
vary directors powers? NO. SH elect directors and Directors run the
corporation. A K which destroys this check contravenes express charter or
statutory provisions and is, therefore, illegal.
(3)Holding: There is a very strong public policy in favor enforcing contracts (a
cornerstone of our economy). However, there is a countervailing public
policy, that contractual enforcement must bow to corporate governance
structure.
b) Action by Shareholders (Mechanical Rules)
i) Annual Meetings. Corporations must hold annual meetings, the primary
purpose of which is the election of directors [MBCA 7.01].
ii) Special Meetings. The BOD, or those persons authorized to do so by the
articles or bylaws by mall a special meetings during the year to conduct
business that requires SH approval. A special meeting requires at least 10% of
all votes entitled to be cast at the meeting. [MBCA 7.02]
iii) Place. SH meetings can be held anywhere, in accordance with the bylaws. If
no place is stated or fixed, annual meetings are held at the corporations
principle office. [MBCA 7.01(b), 7.02(c)]. A proxy is valid for only 11 months
unless it provides otherwise. [MBCA 7.22(c)]
iv) Notice. Generally, written (or if authorized by SH, electronic) notice of the SH
meetingsspecial or annualmust be sent to the SH entitled to vote at the
meeting. [MBCA 7.05]
(1)Time Within Which Notice Must Be Sent. Under the MBCA, the notice
must be delivered not less than 10 days or more than 60 days before the
meeting. [MBCA 7.05(a)]
(2)Contents of Notice. The notice must state the date, time, and place of the
meeting. For special meetings, the purpose(s) for which the meeting is
called must also be stated in the notice [MBCA 7.05(a)]
(3)Notice to be Waived. Action taken at a meeting can be set aside if notice
was improper. However, a SH will be held to have waived any defects of
notice if the SH (i) waives notice in a signed writing either before or after
the meeting or (ii) attends the meeting and does not object to notice at
the beginning of the meeting 9or, if the defect is that the notice did not
identify a special purpose, when the purpose is first brought up). [MBCA
7.06]
v) Record Date. How do we determine how is a shareholder? Same rule for
Closely held and publicly held company. MBCA uses the idea of the RECORD
DATE, as of which, the shareholders will be locked it, because we just have to
pick a date. MBCA does that, and provides that it cannot be more than 70 days,
MBCA 7.05. and Notice must be given between 10-60 days of the meeting
MBCA 7.07. NO requirements for NOTICE of the ANNUAL meeting.

11

vi) Record and Beneficial Owners, and Street Name. Not super-important
distinction for closely-held companies, but extremely important for publiclytraded company. You used to get share certificates. The Beneficial Owner is
someone who has owner who receives the benefits, and who gets to vote, and
receive distributions. The Record Owner is the owner is the person who is
listed on the owner by the corporations, Cede & Co. or others. Therefore,
NOTICE of meeting, goes to record owner, who forwards to brokerage firms,
which ultimately forwards them to individual BENEFICIAL shareholders.
vii) Notice of shareholder meetings. Notice only requires that notice be
mailed, NO requirement that notice be received by shareholders.
c) Mechanics of Voting
i) Quorum requirements. The Roberts Rules for shareholders meeting. The
minimum number of shares that must be present-not necessarily voting-for an
action to pass is (default rule) is simple majority (half plus one). [MBCA 7.25,
7.27]
(1)Default rule for the Quorum is majority. Articles of Incorporation can change
the quorum requirements, but the quorum requirements can only be
increased.
(2)Voting by Group. The articles may, and the MBCA does, require approval by
certain groups of shares separately under some circumstances. For
example, an amendment to the articles must be approved by a share group
when the share group will be significantly affected if the amendment is
approved.
ii) Proxies. It is possible to vote by proxy. An agreement by someone to vote on
your behalf. They are revocable, unless the proxy has interest. [MBCA 7.22]
iii) Voting Requirements. On any matter (other than BOD), a majority of votes
cast. MBCA 7.25(c).
(1)For the Election of Directors. Directors are elected by a plurality of votes
cast, rather than by a simple majority. [MBCA 7.28]
(2)Voting Senior/Non-Voting Class. Pages 504-505: Doing the numbers: Voting
Groups.
(a) Any amendment that may affect class, you get class-veto get veto power.
(3)Straight Voting. Each Share gets one vote for each opening on the board.
This means that a majority shareholder, or group of shareholders who act
together and constitute a majority, can elect every member of the board.
(Default Rule)
(4)Cumulative Voting. (Must be stated in Art. Of Incor.) A minority interest can
potentially secure at least one seat. You can take you cumulate votes for 3
candidates and cast them for a single candidate. (Must Opt-In)
(5)Other Options: Staggered Boards of Directors. The Default Rule is that Every
Director position is up for election every year. May determine by classes,
every term. (Must Opt In) WHY? Way to dampening shareholder control over
BOD Anti-takeover Device (Preventing quick turnover of corporate control)
(Device to avoid cumulative voting)
iv)Primary actions shareholders take:
(1)Vote for or to remove directors
(2)Sanitize managements self-dealing transactions
(3)Adopt advisory resolutions

12

(4)Approve directors recommendations of

(a) amendments to articles of incorporations
(b)corporate combinations
(c) sale of substantially all the assets
(d)liquidations
d) Action without a Meeting
i) Some of the procedures described above can be tedious, BUT MUST be followed
or can result in liability due to piercing in the corporate liability.
ii) Directors, like SH, may act by written consent. Unlike SH, consent must be
unanimous and, there is no provision permitting electronic transmission of
consent.
Shareholders Meetings
Directors Meetings
Quorum assumed to continue once
Quorum must be present when action
formed
taken
Quorum must be a majority or higher
Quorum may be as low as one-third
Quorum changes only in Articles
Quorum changes in articles or by-laws.
e) Action by the Board of Directors
i) No notice for annual meeting, two day notice for special meeting. NO
MECHANISM for proxy by directors meetings.
ii) Can meet by conference call, physical meeting, etc.
iii) Committee Actions.
(1)BOD can setup a committee.
(2)CANNOT delegate to a committee: (1) authorizing distributions; (2) proposing
shareholder action; (3) filling vacancies on the board; (4) adopting, amending
or repealing boards.
(3)CAN delegate to a committee: (1) Audit committees, (2) Scrutinizing
Directors/Officers compensation;
(4)Directors, like shareholder, may act by unanimous written consent (BUT NO
EMAIL!)
f) Action by Officers. Not all Officers are Directors, Nor all Directors are officers.
Some wear both hats.
i) Officers are the pure agents of the corporation. They have only the powers that
the by-laws, or board of directors gives them. Only one required officers, a
corporate secretary.
ii) Lee v. Jenkins Bros. (1959)
(1)Holding: An officer or CEO an bind the Corp for anything in the ordinary
course of business, but not for contracts of extraordinary natures (i.e.
lifetime employment contracts, lifetime pension contracts.), which needs the
principals approval.
(2)An agents actual authority is based on manifestations by the principal to the
agent. By contrast, an agents apparent authority is based on manifestations
by the principal to a third party.
iii)In re Drive In Development Corp. (1966)
(1)Facts: A Corporate secretary certified that it had taken a particular action,
when in fact, it had taken no action.
(2)Holding: Third parties are entitled to rely on the representations of a
corporate secretary. In other words, a corporation is estopped from denying
statements made by the corporate secretary.

13

7) FIDUCIARY DUTIES IN THE CORPORATE CONTEXT: THE DUTY OF CARE (Chapter 18;
p523)
a) Fiduciary Duty and Introduction to the Duty of Care. Directors and officers
are corporate fiduciaries, meaning they are entrusted with a duty to act in the
corporations best interests. This is traditionally noted as having two main
components (1) the duty of care and (2) the duty of loyalty.
i) What is the standard of care?
(1)Duty, Breach, Injury, actual and proximate cause
ii) Duty of Care. Directors are vested with the duty to manage the corporation to
the best of their ability; they are not insurers of corporate success, but rather
required to discharge their duties
(1)In good faith
(2)With the care that an ordinarily prudent person in a like position
would exercise under similar circumstances; and
(3)In a manner the directors reasonably believe to be in the best interests
of the corporation. [MBCA 8.30(a), (b)] Directors who meet this standard
of conduct will not be liable for corporate decisions that, in hindsight, turn
out be poor or erroneous. At common law, this was known as the business
judgment rule.
iii) Result
(1)Burden on Challenger. The person challenging the directors action has the
burden of proving that the statutory standard was not met. [MBCA 8.30]
(2)Director May Rely on Reports or Other Information. In discharging her
duties, a director is entitled to rely on information, opinions, reports, or
statements (including financial statements), if prepared or presented by any
of the following:
(a) Corporate officers or employees whom the director reasonably believes to
be reliable and competent;
(b)Legal counsel, accountants, or other person as to matters the director
reasonably believes are within such persons professional competence; or
(c) A committee of the board of which the director is not a member, if the
director reasonably believes the committee merits confidence. [MBCA
8.30(e)(f)
(3)Doctrine of Waste. As part of their duty of care, directors have a duty not to
waste corporate assets by overpaying for property or employment services
(e.g., by paying someone an amount substantially above market value for
services or property).
b) The Duty of Care and the Failure to Act; Francis v. United Jersey Bank
(1981)
i) Facts. Ms. Prichard was a director and majority shareholder, but did nothing, in
spite of her sons taking out loans amounting to $12 million. Mrs. Pritchard
failed to meet even the most basic monitoring function.
ii) Holding. A director can be personally liable, even to third parties, if they neglect
to provide the ordinary care of staying current with corporate affairs as one
would normally do in that position, and that neglect is the proximate cause of
the damages. [Nonfeasance]

14

iii) In nonfeasance case, at a minimum, directors are not responsible to

reimburse the company for funds, but they are not required to be accountant,
or audits, but there should be familiar enough with books to view a $12 million
hole that they would see the misconduct and act. May be required to inquire of
corporate counsel
(1)Mrs. Pritchard failed to meet even the most BASIC monitoring function
(a) Not be an accountant, but see the 12 million hole
(b)Not attend every meeting, but go to some meetings
(2)In nonfeasance, there is almost always liability. (if director hasnt done
duty)
(3)In misfeasance, there is rarely liability.
c) The Duty of Care, Decisions That Turn Out Badly, and the Business
Judgment Rule
i) Shlensky v. Wrigley (1968)
(1)Facts. Shlensky, a minority shareholder of the Chicago Cubs, filed a
derivative suit against Wrigley, the majority shareholder, to compel them to
install lights at Wrigley Field in order to hold night games after their refusal
to do so.
(2)Holding. A derivative suit by a SH can only be based on directors conduct
that borders on fraud, illegality, or conflict of interest. [Some
jurisdictions hold this as a threshold inquiry] Then, as to the substance, the
Business Judgement Rule, protects any decisions that a board of directors
makes, and court cannot overturn these.
(3)Policy:
(i) Directors are under no obligation to follow the leader; BOD must be
given room (in the law) to take risk; The BOD is better suited to judge
that risk.
(ii) Business Judgment Rule: The law does not want to make directors
insurers of their decisions (which would chill, business risk-taking)
Judges must avoid post hoc decisions on business risk.
ii) The Business Judgment Rule and Its Possible Limits
(1)ALI 4.01 Principles of Corporate Governance
(a) A director or officer who makes a business judgment in good faith
fulfills the duty under this Section if the director or officer:
(i) Is not interested in the subject of the business judgment;
(ii) Is informed with respect to the subject of the business judgment to
the extent the director or officer reasonably believes to be appropriate
under the circumstances; and
(iii)
Rationally believes that the business judgment is in the best
interests of the corporation.
(b)Acts of corporate fiduciaries that are knowingly wrongful or criminal are
not protected by the Business Judgement Rule (BRJ).
(2)Courts will not second-guess a business judgement, unless:
(a) There is fraud, illegality, or conflict of interest,
(b)Directors followed proper procedure in informing themselves of this
decision.
(c) Can only be overturned if it wasnt, in any sense, rational-based.
(3)
Litwin v. Allen

15

(a) Facts. Bank bought bonds from Trust Company bonds at $100 (Par value
was $102). Good deal for bank. Bonds went down in value. BOD (from
bank) bought the asset at 100 and thought they were gonna increase in
value. Bond market fell. When it came time to sell, Alleghany didnt
wanna buy them. So, the Trust company took a bath on the bonds.
(b)Holding: In approving this transaction, they breached their duty of care
(c) Because the entire arrangement was so improvident, so risky, so unusual
and unnecessary as to be contrary to fundamental conceptions of prudent
banking practice.
(d)This is a breach of the directors Duty of Care BUT, the court applies the
wrong standard. The standard isnt Did the directors take on too much
risk? The standard is where it is irrational.
iii) Lack of Informed Process; Smith v. Van Gorkom (1985)
(1)Facts. Plaintiffs, Alden Smith and John Gosselin, brought a class action suit
against Defendant corporation, Trans Union, and its directors, after the Board
approved a merger proposal submitted by the CEO of Trans Union, fellow
Defendant Jerome Van Gorkom.
(2)Synopsis of Rule of Law. Under the business judgment rule, a business
judgment is presumed to be an informed judgment, but the judgment will not
be shielded under the rule if the decision was unadvised.
(3)Held. The Delaware Supreme Court held the business judgment to be gross
negligence, which is the standard for determining whether the judgment was
informed. The Board has a duty to give an informed decision on an important
decision such as a merger and cannot escape the responsibility by claiming
that the shareholders also approved the merger. The directors are protected
if they relied in good faith on reports submitted by officers, but there was no
report that would qualify as a report under the statute. The directors cannot
rely upon the share price as it contrasted with the market value. And
because the Board did not disclose a lack of valuation information to the
shareholders, the Board breached their fiduciary duty to disclose all germane
facts.
(4)Other Details.
(a) The difference between the per share market price and the price for
control of the market company is the control premium. Shareholder
ought to be getting more for that.
(b)Procedure. Management uniformly against, believed $55/share was
worth more. May have some self-interestedness. VG briefs board. CEO,
as agent, hired a lawyer to represent the company. Nobody read the
documents before signing, no auction. $55/share. DID Directors violate
their duty of care?
(5)Holding: Directors violate their fiduciary duty if they do not follow a
reasonably procedure to reasonably inform themselves.
(a) Directors not informing themselves (form of nonfeasance)
(b) Business judgement rule doesnt apply in cases where the
directors did not reasonably prepare/inform themselves.
(c) A market share is only what a minority stakeholder in the market is worth.
(d)Directors violate their duty of care, and business judgment rule does not
shield them, where the directors did not reasonably prepare and inform

16

themselves. Smith v. Van Gorkem. In these cases it results in personal

liability.
(6)Duty to Disclose. The Directors also have a duty to disclose material
corporate information to other members of the board (e.g., information
material to a decision by the board to approve a financial statement.) [MBCA
8.30(c)]
d) Legislative Response to Officer and Director Liability.
i) Now, (at least in Virginia), you dont have to reasonably prepare, you just have
to make a good faith..
ii) MBCA permits exculpatory clauses, even if directors violate duty of care, and do
not permit personal liability.
e) Oversight, Monitoring, and the Duty of Care
i) What would a reasonable person need
ii) Related Question: When can directors be said to violate their duty of care, by
stopping their mismanagement?
iii) What is their duty to manage the internal company?
(1)The directors must insure that there are reasonable procedures and
reasonable reporting mechanisms that are reasonably designed to uncover
wrongdoing in the company.
8) THE DUTY OF LOYALTY AND CONFLICTS OF INTEREST: SELF-DEALING TRANSACTIONS
AND CORPORATE OPPORTUNITIES [Chapter 19; p563]
a) Introduction to the Duty of Loyalty. A director owes a duty of loyalty to her
corporation and will not be permitted to profit at the expense of the corporation.
The probles in this area involve the directors dealings with the corporation and her
potential conflict of interest; her dealings with third parties and her usurpation of a
corporate opportunity; and her dealings with shareholders, which may raise insider
trading issues. (Self-dealing and Usurpation of Corp. Opportunity)
i) Legal duty of loyalty: triggered when a fiduciary acts under a conflict of
interest
ii) Conflicts usually fall into fall into following categories:
(1)
Fiduciary has direct pecuniary interest in transaction that involves the
corp.
(2)
Fiduciary is related to or closely associated with a person who has a
direct personal stake in a transaction that involves the corporation
(3)
Fiduciary owes duties to both the corp. and to another person involved
in a transaction with the corp.
(4)
Fiduciary has taken something that belongs to the corp. and used it for
the fiduciarys own benefit.
iii)Remedies in examples 1-3 (above) for interested are judged pursuant to
entire fairness or intrinsic fairness standard, and remedied by voiding the
tainted transaction. Remedies in example 4 (above) for illegal usurpation are
judged by standards that vary from state to state, but remedied by imposing a
constructive trust.
iv)Conflicting Interest Transactions. If a director has a personal interest in a
transaction in which her corporation is a party, a conflict of interest arises.
(1)
What Constitutes a Conflicting Interest Transaction? A director
has a conflicting interest with respect to a transaction or proposed

17

transaction if the directors knows that she or a related person (e.g., spouse,
parent):
(a) Is a party to the transaction;
(b)Has a beneficial financial interest in, or is so closely linked to, the
transaction that the interest would reasonably be expected to influence
the directors judgment if she were to vote on the transaction; or
(c) Is the director, general partner, agent, or employee of another entity
with whom the corporation is transacting business and the transaction is
of such importance to the corporation that it would in the normal course
of business be brought before the board (the so0called interlocking
directorate problem). [MBCA 8.60]
(2)Standards for Upholding Conflicting Interest Transaction. A
conflicting interest transaction will not be enjoined or give rise to an award of
damages due to the directors interest in the transaction if:
(a) The transaction was approved by a majority of the directors (but at
least two) without a conflicting interest after all material facts have
been disclosed to the board;
(b)The transaction was approved by a majority of the votes entitled to
be case by shareholders without a conflicting interest in the
transaction after all material facts have been disclosed to the
shareholders (notice of the meeting must describe the conflicting interest
transaction); or
(c) The transaction judged according to circumstances at the time of
commitment, was fair to the corporation.
b) Interested or Self-dealing Transactions
i) Lewis v. S.L. & E., Inc.
(1)
Holding: In a duty of loyalty case, If the fails to prove the transaction
was fair and reasonable, and the business judgment does not apply.
(a) Defendant Director has the Burden to show Fairness and
Reasonableness to the Corporation at the time it was approved
by the board AND the BJR Does Not Apply. (Therefore, Directors would
be personally liable)
(b) BJR only applies in cases where there is no conflict of interest
(self-dealing or usurpation).
ii) Sinclair Oil Corp. v. Levien
(1)
Facts: Parent company, Sinclair, caused Sinven to pay excess dividends
($108M; $38M excess of earnings).
(2)
Holding: The intrinsic fairness test will be applied in a case where a
parent company controls all transactions of a subsidiary, receives a benefit
at the expense of the subsidiarys minority stockholders, which places the
burden on the parent company to prove the transactions were based on
reasonable business objectives.
(a) Even though directors are on both sides of the case, this is not a not a
duty of loyalty cases. Its not really a self-dealing case, where there is not
an exclusive benefit of the directors. No doubt Sinclair benefited, but so
too did the minority shareholders (complainants)., sufficient to invoke the
Self-dealing burden to show fairness and reasonableness.

18

(b) Even where directors are both sides of the transaction, we still have to
ask if there is self dealing. Dividends declared for ALL shareholders,
benefit all shareholders.
(c) Directors have the power to declare dividends for classes of stock.
(d) Therefore, the only way to overturn, is to seek that the stock dividends
paid were violative of the duty of care, which is protected by the Business
Judgment Rule.
(3)
Intrinsic Fairness: a high degree of fairness and a shift in the burden
of proof.
(4)
Fairness: careful scrutiny of whether and the transaction benefits the
corporation and the procedurally fair for the corporation
c) Safe Harbor/Ratification
i) A corporation can ratify (approves) the directors action, after the fact,
then the
(1)Approval after the fact either implicit or explicit; (Full Disclosure to
the Appropriate Parties of the Transaction and Approval, Intrinsic
Fairness)No liability to Directors)
(2)
Defense/Safe Harbor: No Duty of Loyalty analysis
ii) Delaware Approach (Same as in any state)
(1)
K that benefits a director is not per se void (director to be consultant)
(2)
Nor is it per se void if directors participate in a meeting
(3)
Nor it is per se void if counted while in the room
(4)
If:
(a) [Safe Harbor #1] BOD has all Material facts ahead of time, Directors act
in good faith to approve the action, and a majority of disinterested
directors vote to approve (even if not a quorum)
(b)[Safe Harbor #2] Material facts are disclosed to shareholders and a
Majority of shareholders vote to approve in good faith
(c) [Safe Harbor #3] K is fair to the corporation as of the time it is
authorized, approved or ratified, by BOD, a committee, or the
shareholders.
iii) Marciano v. Nakash
(1)Facts: Georges, Maurice, Armand and Paul Marciano, (Appellants) appeal the
decision of the Court of Chancery validating a claim in liquidation of
Gasoline, Ltd. placed in custodial status by reason of deadlock among its
board of directors.
(2)Issue: In the wake of Delaware passing 144, the only way the directors may
escape liability, for breach of duty of loyalty.
(3)Rule: The principle of per se voidablitity for interested transactions does not
invalidate transactions determined to be intrinsically fair.
(4)Holding: Yes. If the statute is not complied with, then we have per se,
violated the duty of loyalty. Section 144 cannot be complied with at all,
because we cant have director approval, shareholder approval, because
there is deadlock.
iv) In re Wheelabrator Technologies, Inc. Shareholder litigation
(1)Facts. The Plaintiffs brought a class-action suit against Defendant
corporation, Wheelabrator Technologies, Inc., and its directors to oppose the
merger of Wheelabrator into a wholly owned subsidiary of Waste

19

Management Corp. Plaintiffs alleged that Defendant directors did not disclose
material information regarding the merger.
(2)Holding: A shareholder ratification does not automatically extinguish a duty
of loyalty claim, but it does make the business judgment rule the applicable
standard that a plaintiff would have to overcome.
(3)What is the meaning of fully informed shareholder ratification?
(4)Was there informed ratification by a shareholder of the corporation?
(a) If NO, then we still have the Common Law burden shifting Marciano case,
to prove intrinsic fairness
(b)If YES, was the transaction with a controlling shareholder?
(i) Then Burden shifts to controlling shareholder to demonstrate intrinsic
fairness
(ii) If no, then protected by Business Judgement Rule, (subject to test for
waste)
Transaction with controlling shareholder?
Informed ratification by disinterested decision maker?

Burden Shifts with respect to fairness

Yes

Yes
No

No

Protected by business judgment rule (subject to test for waste)

Interested party must show fairness

(5)Controlling Shareholders: Transaction between Director/Corporation and a

controlling shareholder. Burden shifts with respect to fairness. (Also in MS)
(6)Even After ratification, Defendant can meet that burden by Ratification, shifts
burden to the burden is on the plaintiff to show unfairness..
(a) Burden of Proof ON Plaintiff to show this is a Duty of Loyalty Case
(b)Burden of Proof Defendant to demonstrate intrinsic fairness
(c) If
shows ratification, then burden shiftsUnderlying
back toTransaction
Plaintiffis void
to show
Were any required SH, board, or supervisor approval gotten?
UNFAIRNESS
Was transaction effective without further approval?
No
(7)Interested Transactions Under Delaware Law:
No

Yes
Did
the fiduciary act under conflict of
Yes
interest?
Only the duty of care applies, subject to the BJR
No
Yes
Was there some approval following full disclosure of the conflict and of material facts?

Board

Intrinsic fairness test, burden shifts to

Yes
Was approval by

20

Shareholders

Only the duty of care applies, subject to BJR.

d) Corporate Opportunities [Usurpation of Corporate Opportunity];

i) Broz v. Cellular Information Systems, Inc.
(1)Facts. Broz was the sole stockholder of RFB Cellular whie also acting as an
outside director for Cellular Information Systems. brought an action
against when purchased a cellular license for RFB Cellular over a bid by
CIS.
(2)Holding: The corporate opportunity doctrine holds that an officer or director
of a corporation can take a corporate opportunity if the opportunity is
presented to them in their individual capacity, the opportunity is
nonessential to the corporation, the corporation has no expectation for the
opportunity, and they have not wrongfully utilized corporate resources to
take advantage of the opportunity.
(a) The opportunity has been present to the corporation in their official
capacity.
ii) Northeast Harbor Gulf Club, Inc. v. Harris
(1)Facts. The Northeast Harbor Golf Club, Inc., (Appellant), brought suit against
Nancy Harris, (Appellee), for breach of fiduciary duty as its president by
purchasing and developing property adjacent to that owned by Appellant.
Appellant appeals from the Superior Court judgment in favor of Appellee.
(2)Rule. A corporate opportunity is one that is closely related to a business in
which the corporation is engaged or one that accrues to the fiduciary as a
result of her position within the corporation. The fiduciary must make a full
disclosure prior to taking advantage of any corporate opportunity. The
corporation must then formally reject the opportunity. A good faith but
defective disclosure may be ratified after the fact only by an affirmative vote
of the disinterested directors or shareholders.
(i) Full disclosure, ahead of time, of all material facts, and
approval, ahead of time, THEN director may take the action.
(ii) Harris was liable for duty of loyalty.
9) FURTHER PROBLEMS IN THE DUTY OF LOYALTY: GOOD FAITH AND DISCLOSURE
(Chapter 20; p605)

a) Is there a separate duty of good faith or disclosure? Or is it enclosed within the

duty of loyalty?
i) It is possible to exculpate the duty of care through an exculpation clause, BUT
no exculpation clause is allowed for the duty of loyalty. So where does Good
faith fit in? Does it contribute to duty of care and/or duty of loyalty.
b) Duty of Good Faith
i) In re The Walt Disney Co. Derivative Litigation
(1)Facts. Michael Ovitz is hot-shot majority owner of premier talent agency, and
hired by Disney. 16 months into his employment, he was terminated without
cause, which triggered a pre-negotiated severance payment of $130 million.
SH of Walt Disney brought a derivative suit, for a breach of fiduciary duty,

21

but was absolved of liability in one sense, because he wasnt a fiduciary. BOD
were not entitled to Business Judgment Rule because they were grossly
negligent (misfeasance) and/or Directors acted in Bad Faith.
(2)Holding. Directors who approved it, ARE subjected to the care and loyalty.
And, court below held no lack of good faith.Delaware Supreme Court:
(3)3 Major ways Directors can evidence Bad Faith
(a) Directors act with actual malicious intent to harm the corporation;
(AKA subjective bad faith)
(b)Directors act with gross negligence; (AKA malfeasance)
(c) Intentional dereliction of duty, a conscious disregard for ones
responsibility.
(i) Directors know they have duties, they simply fail to live up to them.
ii) Stone v. Ritter (Supreme Court of Delaware 2006)
(1)Facts. SH brought a derivative action against directors contending they
breached their oversight duty. Allegedly, the breach caused $50 million in
penalties as a consequence of the employees failure to file specific reports
required by federal banking regulations.
(2)Holding.
(i) When specified facts do not create a reasonable doubt that the
directors of a corporation acted in good faith in exercising their
oversight responsibilities, a derivative suit will be dismissed for failure
to made demand.
(ii)
Synopsis of Rule of Law.
1. A lack of good faith does not, ipso facto, lead to director
liability.
2. Lack of good faith is, ultimately, a component of the duty of
loyalty.
3. (A lack of good faith, at some point, will violate the fiduciary duty of
loyalty).
4. A corporation cannot exculpate a director for breach of a duty of
loyalty.
5. A lack of good faith cannot be exculpated by the corporation.
6. Gross negligence, CAN, for breach of a duty of care.
(b)A conscious disregard for failure to implement ANY monitoring system. Its
also a lack of good faith if, it is only window dressing, and there is nothing
other than board meetings (1) not implementing any monitoring
system, and/or (2) having adopted the monitoring system, not doing
anything
(3)Why is it important for the Delaware supreme court to tell us that the duty of
good faith does not stand alone? EXCULPATION, exculpation, exculpation
c) Disclosure Duty or non-duty of directors to disclose information about stock
sales. Directors failure to Disclosure could be a violation of duty of care and/or duty
of loyalty. Duty of disclosure is not a free-standing duty.
i) Goodwin v. Agassiz (Massachusetts Supreme Judicial Court 1933).
(1)Facts. Officers and directors have an absolute duty to disclose all material
information relevant to the corporation.
(2)Holding. (1) A purchaser of stock on the market does not owe a fiduciary
duty to a seller to disclose the information that the purchaser may know,

22

even when the purchaser is in a position that provides insider information.

(2) Yes, there is a duty of disclosure. But the duty of disclosure is owed from
the agent To the principal. And Shareholders are NOT the corporation. The
directors do not owe a duty of disclosure to shareholders.
ii) Diamond v Oreamuno (NY 1969)
(1)Facts. Directors were shareholders sold their stock in their company that
they were directors, in order to avoid a loss on their stock. The directors
knew information about the company that, once it became public, would lead
to a diminution in the value of the stock ($800,000.00).
(2)Holding. Directors ARE found liable for their duty to disclose. They did not
disclose information. What is the breach of duty: took advantage of an
opportunity
(3)Remedy: Constructive Trusts (an equitable remedy, whereby the
iii) What separates Diamond and Goodwin?
(1)In the first case, No duty to a shareholder-to shareholder. In the second
case, Corporation is the plaintiff (in a derivative suit).
(2)Agent(trustee) benefitting personally, leading to a constructive trust even if
there was no pecuniary harm to the corporation, just a pecuniary harm to the
SH.
(3)WHO is the PLAINTIFF? DID THE OWE A A DUTY?
10) EXCULPATION, INDEMNIFICATION, INSURANCE (Chapter 21; p625)
a) In General. If a person is made a party to a legal proceeding because of his
status as a director, officer, employee, or agent of the corporation ,depending on
the circumstances, the corporation may be required to indemnify the person, may
have the discretion to indemnify the person, or may be prohibited from
indemnifying the person.
b) Mandatory Indemnification. Unless limited by the articles, a corporation must
indemnify a directory or officer who prevailed in defending the proceeding against
the officer or director for reasonable expenses, including attorneys fees incurred in
connection with the proceeding. [MBCA 8.52, 8.56(c)]
c) Discretionary Indemnification. A corporation may indemnify a director for
reasonable expenses incurred in unsuccessfully defending a suit brought
against the director on account of the directors position if:
i) the director acted in good faith; and
ii) believed that her conduct was:
(1)in the best interests of the corporation (when the conduct at issue was
within the directors official capacity);
(2)not opposed to the best interests of the corporation (when the
conduct at issue was not within the directors official capacity); or
(3)Not unlawful (in criminal proceedings). [MBCA 8.51]
iii) Exceptions: A corporation does not have discretion to indemnify a director who
is unsuccessful in ddefending (i) a direct or derivative action when the director
is found liable to the corporation or (ii) an action charging that the director
received an improper benefit [MBA 8.51(d)]
iv) Who Make Determination?: Generally, the determination whetehr to indemnify
is to be made by a disinterested majority of the board, or if there is not a
disinterested quorum, by majority of a disinterested committee or by legal

23

counsel. The SH may also make the determination (the shares of the director
seeking indemnification are not counted). [MBCA 8.55(b)]
v) Officers: Officers generally may be indemnified to the same extent as a director.
[MBCA 8.54]
d) Court-Ordered Indemnification. A court may order indemnification whenever it
is appropriated. [MBCA 8.54]
e) Cases on Point
i) Waltuch v. Conticommodity Services, Inc. (1996)
(1)Holding: A corporation cannot agree to indemnify an officer in a manner that
is inconsistent with the state statute, but the officer is entitled to
indemnification if the charged against him have been dismissed.
ii) Heffernan v. Pacific Dunlap GNB Corp. (1992)
(1)Rule: It is too narrow to view indemnification where the director is only
exercising one of his corporate duties. Despite the fact that Heffernan sold
his own shares to Pacific, a nexus exists between Heffernans status as a
director and Pacifics suit.
(2)Holding: Indemnification is available to him only for duties related to him as
a director. No indemnification for car wrecks, Duh!
f) Exculpation-Raincoat provisions revised
i) Arnold v. Society for Savings Bancorp, Inc.
(1)Facts: Exculpation clauses, within the Articles of Incorporation, can eliminate
the breach of fiduciary duty of care but not for the duty of loyalty. Directors
cannot be exculpated from declaring illegal dividends.
(2)Issue: Whether or not false statements were duty of loyalty or duty of care.
(3)Rule: False statements were a breach of duty of care, and corporation
exculpated them.
ii) WLR Foods, Inc. v. Tyson Foods, Inc. (1995)
(1)Facts. Tyson Foods attempted hostile takeover (merger) with WLR Foods.
(2)Rule: BJR holds that directors cannot be held liable, even if the decision were
inept or incompetent. The statute may protect the utterly inept, but wellmeaning, good-fath director. Directors actions in VA are not to be judged for
their reasonableness and rejected Tysons attempt to inject a
reasonableness standard into the Statute.
11) DERIVATIVE LITIGATION (Chapter 22; p647)
a) Shareholder Suits. SH enjoy a dual personality. They are entitled to enforce
their own claims against the corporation, officers, directors, or majority SH by
direct action. SH are also the guardians of the corporations cause of action,
provided no one else in the corporation will assert them. In this sense, SH may sue
derivatively to enforce the corporate cause of action, as long as they meet the
requirements specified by law and they have made necessary demands on the
corporation or directors to enforce the cause of action. In either capacity, director
or deritivative action, the SH may sue for herself and others similarly situated.
b) Direct Action.
i) Nature of Action. A breach of fiduciary duty owed to a particular shareholder by
an officer or director of a corporation is a proper subject for a SHs direction
action against that officer or that director. However, that is uncommon, so be
careful to distinguish breaches of duty owed to a SH from duties owed to the

24

corporation. If the duty is owed to the corporation rather than to an individual

SH, the cause of action is derivative rather than direct. The basic tests are: (i)
who suffers the most immediate and direct damage? And (ii) to whom did the
s duty run?
ii) Recovery. In a SH direct action, any recovery is for the benefit of the individual
SH, or, if the action was a class action, for the benefit of the class.
c) Derivative Actions.
i) Nature of the Action. The derivative action is often described as a
representative action, since the SH are enforcing the rights of anotheri.e.,
the corporation. Recovery in a derivative action generally goes to the
corporation rather than to the SH bringing the action.
ii) StandingOwnership at Time of Wrong. The commence or maintain a
derivative proceeding, a SH must have been a SH of the corporation at the time
of the act or omission complained of, or must have become a SH through
transfer by operation of law from one who was a SH at that time. Also, the SH
must fairly and adequately represent the interests of the corporation. [MBCA
7.41]
iii) Demand Requirements. The SH must make a written demand on the
corporation to take suitable action A derivative proceeding may not be
commenced until 90 days after the date of the demand, unless: (i) the SH has
earlier been notified that the corporation has rejected the demand; or (ii)
irreparable injury to the corporation would result by waiting for the 90 days to
pass. [MBCA 7.42]
(1)If Demand Futile. Under older law, demand was excused if it would be futile
(e.g., where a SH is seeking damages from the entire board for breach of
duty, they are unlikely to approve the action). However, it has been argued
that this exception does not apply under the MBCA for two reasons: (i) the
MBCA does not provide for the exception; and (ii) even though it may seem
futile to ask the directors to sue themselves, the demand gives the directors
an opportunity to resolve the issue through means other than litigation.
iv) Corporation Named as Defendant. In a derivative action, the corporation is
named as a party defendant. Although the cause of action asserted belongs to
the corporation (so the corporation is the real in interest), the failure of the
corporation to assert its own claim justifies aligning it as a defendant.
v) Dismissal If Not In Corporations Best Interests. If a majority of the directors
(but at least two) who have no person interest in the controvery found in good
faith after reasonable inquiry that the suit is not in the corporations best
interest, but he Sh brings the suit anyway, the suit may be dismissed on the
corporations motioin. [MBCA 7.44] Good business reasons for the directors
refusal might be that there is no likelihood of prevailing or that the damage to
the corporation from litigating would outweigh any possible recovery.
(1)Burden of Proof. To avoid dismissal, in most case the SH bringing the suit has
the burden of proving the cour that the decision was not made in good faith
after reasonable inquiry. However, if a majority of the directors had a
personal interest in the controversy, the corporation will have the burden of
showing that the decision was made in good faith after reasonable inquiry.
[MBCA 7.44(e)]

25

vi) Discontinuance or Settlement Requires Court Approval. A derivative proceeding

may be discontinued or settled only with court approval. [MBCA 7.45]
vii) Court May Order Payment of Expenses. Upon termination of a derivative
action, the court may order the corporation to pay the s reasonable expenses
(including attorneys fees) incurred in the proceeding if it finds that the action
has resulted in a substantial benefit to the corporation. If the court finds that
the action was commenced or maintained without reasonable cause or for an
improper purpose, it may order the to pay reasonable expenses to . [MBCA
7.46]
d) Distinguishing Derivative Suits
i) Eisenberg v Flying Tiger Line, Inc. (2nd Cir. 1971)
(1)Facts: Shareholder didnt post bond. If its derivative suit, bond was required
by state law, case dismissed. If its a direct suit, no bond required, case goes
forward.
(2)Holding: When the injury suffered was personal, rather than an injury of the
corporation, the suit should not be considered derivative for the purposes of
requiring a posting of security for opposing legal expenses.
ii) Grimes v. Donald (Delaware Supreme Court 1996) [Demand is Futile]
(1)Facts: Donald was CEO of DSC corp entered into with DSC corp
(2)Rule: It is possible for the same set of facts to give rise to derivative and
direct claims. Corporation harmed by the failure of oversight Duty of care
and waste. Individual harmed by doing away with the oversight of Donald.
(3)Test: Look to nature of the harm, must be independent of the corporate
injury.
(a) Derivative claims, belong to the corporation: Duties of care, duties of
waste, excessive compensation claims
(b)Direct claim: Abdication claim. (Arguably, waived their ability to supervise
the CEO, but, by proxy, the SHAREHOLDERS, right to supervise Donald.)
iii) Tooley v. Donaldson, Lufkin & Jenrette, Inc. (2004) [MBCA Universal
Demand]
(1) Court should looks to the nature of the wrong and to whom the relief should
go. The stockholders claimed direct injury must be independent of any
alleged injury to the corporation. The stockholder must demonstrate that the
duty breached was owed to the stockholder and that he or she can prevail
without showing an injury to
(a) MBCA have universal approach (Modern)
(2) Make demand & wait 90 days unless earlier rejected or there would be
irreparable damage to not intervene. Can appoint a panel of disinterested
people to decide whether there is a lawsuit or not. No
(3) Traditional Approach: Delaware and NY
(4) Must make demand unless it would be futile to do so.
e) Demand - Excusal
i) Aronson v. Lewis (1984) : Must make demand of the corporation, unless that
demand itself would be futile. MBCA does away with Futility. MBCA requires
universal demand.
(1)Demand will be excused, if Plaintiff can plead facts with particularity leading
to there is a reasonable doubt, as to either (1) directors disinterestedness
and/or (2) business judgement rule will protect directors decision.

26

ii) IN Delaware, SH derivative (futile: can state fact with particularity),

iii) Demand Requirements: The jurisprudence of Aronson and its progeny is
designed to create a balanced environment which will: (1) on the one hand,
deter costly, baseless suits by creating a screening mechanism to eliminate
claims where there is only a suspicion expressed solely in conclusory terms; and
(2) on the other hand, permit a suit by a stockholder who is able to articulate a
particularized facts owing that there is a reasonable doubt either that (a) a
majority of the board is independent for purposes of responding to the demand,
or (b) the underlying transaction is protected by the business judgment rule.
iv) A stockholder who makes a serious demand and receives only a peremptory
refusal has a right to use the tools at hand to obtain the relevant corporate
records, such as reports or minutes, reflecting the corporate action and related
information in order to determine whether or not there is a basis to assert that
demand was wrongfully asserted.
f) Directors Authority To Dismiss Derivative Litigation
i) Auerbach v. Bennett
(1)Facts: Plaintiffs, Elias Auerbach and Stanley Wallenstein, brought a
shareholders derivative suit against Defendants, William Bennett et al., on
behalf of General Telephone & Electronics Corporation (GTEC) after a
corporate audit found that current and former members of the Board of
Directors were involved in the payment of bribes and kickbacks to foreign
officials. A special committee of disinterested members appointed by the
Board refused to support the action.
(2)Rule: A party may challenge the independence of a special committee, but
once a committee is deemed to be independent then their decisions are
protected under the business judgment rule.
ii) Zapata Corp. v. Maldonado
(1)Facts: A derivative suit was initiated by Maldonado (Plaintiff), which charged
officers and directors of Zapata (Defendant) with breaches of fiduciary duty.
Four years later an Independent Investigation Committee of two
disinterested directors made a recommendation to dismiss the action.
(2)Rule: Where the making of a prior demand upon the directors of a
corporation to sue is excused and a stockholder brings forth a derivative suit
on behalf of the corporation, the board of directors or an independent
committee appointed by the board can move to dismiss the derivative suit as
detrimental to the best interests of the corporation, and the court should
apply a two-step test to the motion: (1) Has the corporation proved
independence, good faith, and a reasonable investigation, and (2) Does the
court believe, when applying its own independent business judgment, that
the motion should be granted?

27

iii) MBCA 7.44 Dismissal

(1) Also allows dismissal if appropriate makes decision in good faith that its not
in the best interest of the corporation. Looks like Step one but there is no
step 2. Courts do not get to inject their own business judgment
(Mississippi). Not a per se violation but 3 things you can look at when trying
to determine futility 1) Named as defendants 2) approved of transactions
3) Directors put in place by those that participated in transactions. If not a
majority independent committee, burden shifts to corporation to show good
faith. If majority independent, burden on plaintiff. Corporation can ask the
court to setup a panel to make a decision.

12)

CLOSELY HELD CORPORATIONS (NON-PUBLIC CORPORATION) (Chapter 25; p781)

a) Shareholder Agreements. SH may enter into several types of agreements in an

effort to protect their voting power, proportionate stock ownership, or other special
interests in the corporation. Although most shareholder agreements are
encountered in the close corporation, most of these agreements can be used in
any corporation. Must be in unanimous, must be in writing, but can alter virtually
any provision of the MBCA.
b) SH agreements in Delaware must be examined for undue sterilization.
Court has the independent duty to see if they unduly burden 3rd parties or violate
public policy.
i) Voting Trusts. To ensure that a group of shares will be voted in a particular way
in the future, one or more SH may create a voting trust by (i) entering into a
signed agreement setting forth the trusts terms and (ii) transferring legal
ownership of their shares to the trustee. The trust may contain any lawful
provision no inconsistent with the trust purposes, and the trustee must vote the
shares in accordance with the trust. A copy of the trust agreement and the
names and address of the beneficial owners of the trust must be given ot the
corporation. The trust is not valid for more than 10 years unless it is extended
by agreement of the parties. [MBCA 7.30]
ii) Voting Agreements. Rather than creating a trust, SH may enter into a written
and signed agreement that provides for the manner in which they will vote their
shares. Unless the voting agree provides otherwise, it will be specifically
enforceable. Unlike the voting trust, such an agreement need not be filed with
the corporation and is not subject to any time limit. [MBCA 7.31]
iii) Shareholder Management Agreements. The SH may enter into an agreement
among themselves regarding almost any aspect of the exercise of corporate
powers or management. For example, an agreement may: (i) eliminate the
board of directors or restrict the discretion or powers of the board(Sterilization-

28

Not allowed by Common Law); (ii) govern the authorization or making of

distributions; (iii) establish who shall be directors or officers, as well as their
terms and conditions of office, or the manner of selection or removal; or (iv)
transfer to one or more SH or other persons the authority to exercise the
corporate powers or to manage the business and affairs of the corporation.
[MBCA 7.32(a)]
(1)Statutory Requirements. To be valid, the agreement must either (i) be set
forth in the articles or bylaws, and be approved by all persons who are SH at
the time of the agreement or (ii) be set forth in a written agreement signed
by all persons who are SH at the time of the agreement, and be filed with the
corporation. Unless otherwise provided, the agreement is valid for 10 years.
The agreement is subject to amendment or termination only by all persons
who are SH at the time of the amendment, unless the agreement provides
otherwise. [MBCA 7.32(b)]
(2)Enforceability. Any party to the agreement may enforce it against any other
party. One who purchases without knowledge of the agreement is entitled to
rescind the purchase. [MBCA 7.32(c)]
(3)Termination of Agreements Effectiveness. The agreement ceases to be
effective when shares of the corporation are listed on a national securities
exchange or are regularly traded in a market maintained by a member of a
national or affiliated securities association. [MBCA 7.32(d)]
(4)Agreement Does Not Impose Personal Liability on Shareholders. Even if the
agreement treats the corporation as a partnership or results in failure to
observe corporate formalities, the agreement does not constitute a ground
for imposing personal liability on any SH for the acts or debts of the
corporation. [MBCA 7.32(f)]
Shareholder
Agreements
Agreements amongst SH
that vary one or more
provisions of corporate
law.
MBCA : Must be (1) in
writing, (2) unanimous,
(3) between all
Shareholders (3) may
vary virtually any
default rule of MBCA
other than SH right to
inspect corporate books
and records (4) Expire
after 10 years but are

Voting Trust

Voting Agreements

True trust where SH

conveys legal interests to
a trustee. Only conveys
right to vote.
Must be (1) in writing (2)
detailed (3) can be
specifically enforced thru
injunctive relief

K between Shareholders

29

(1)Under the MBCA they

are specifically
enforceable (2) Must be
in writing (3) No filing of
K w/ corp

renewable. (This can

include doing away
with a board of
directors-talk about
sterilization!!)
Common Law does not
Specifically enforceable
In Delaware, not
allow sterilization, but
everywhere
specifically enforceable.
MBCA does. Sterilization
agreement: takes away
power from directors
c) Direct Management by Shareholders
i) Clark v. Dodge (1936)
(1)Facts. Plaintiff, David Clark, and Defendant, John Dodge, are the lone
shareholders of Defendant corporations. Plaintiff brought this action to be
reinstated as a director of one of the Defendant companies pursuant to an
agreement between the parties.
(2)Rule. An agreement between shareholders, wherein the shareholders
entering the agreement are the only shareholders of the company, is valid
even if the agreement contemplates controlling management decisions.
(3)Held. The Court of Appeals of New York held that the agreement was not
invalid. The McQuade court invalidated a similar agreement because it
affected the rights of others that were not part of the agreement, and
therefore it fell under the public policy argument. In this case, the only
shareholders were Defendant and Plaintiff, and therefore the agreement
between the two did not have any, or at least negligible, consequences on
the public.If there was any invasion of the powers of the directorate under
that agreement, it is so slight as to be negligible; and certainly there is no
damage suffered by or threatened to anybody.
ii) Galler v. Galler (1964)
(1)Facts. Emma Galler (P) filed suit to compel specific performance of a
shareholder agreement that bounds shareholders to vote for specific
individuals and directors and call for mandatory dividends made between her
deceased husband, and his brother, business partner Isadore Galler (D).
(2)Held. A shareholder agreement, particularly in closed corporations, that
controls the voting for board members and the members management
decisions, should nevertheless be enforced as long as the agreement is not
fraudulent or harmful to the public.
(3)Held. The agreement was valid and Plaintiff should be entitled to specific
performance and money that was owed under the agreement. Galler Drug
was a closely held corporation, and therefore subject to different
circumstances than a shareholder of a large corporation. The court cited a
number of prior cases, including Dodge v. Clark, to support the premise that
because this agreement did not harm the public and was fair to the parties of
the agreement, there is no offense to any public policy concerns.
iii) Ramos v. Estrada (1992). Some jurisdictions have provisions for Closely-held
Corporations. California is one such state.

30

(1)Facts. Plaintiffs, Leopoldo Ramos et al., brought this action to enforce

provisions of a shareholder agreement that required Defendants, Angel
Estrada et al., to sell their shares of company stock if they did not vote as
required per the agreement.
(2)Rule: Failure to make the designation as Closely Held is NOT dispositive of
the fact
(3)Held. The agreement was valid despite the fact that the corporation at issue
was not a close corporation. California close corporation laws allow for such a
shareholders voting agreement. The legislative comments concerning the
California statute governing close corporations, Section 706, indicate that
legislators did not intend the law to invalidate pooling agreements in
instances where they were not close corporations.
d) Voting Trusts and Other Control Devices [MBCA 7.30]
i) Lehrman v. Cohen
(1)Facts. Lehrman (P) and Cohen (D), rival factions, have dispute over the
issuance of Class AD stock and its voting power.
(2)Issue. In creating a new class of voting stock, does it dilute and separate the
voting rights, which normally remain vested in the stockholders who made
that class, from other elements in the ownership of said stock?
(3)Holding. Creating a new class of voting stock does not dilute and separate
the voting rights, they remain vested in the stockholders who made that
class, from other elements in the ownership of said stock. NO Voting Trust
was set up. A change in the capital structure was set up.
e) Voting and Arbitration Agreements
i) Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling (Delaware
1947)
ii) Facts. Plaintiff, Edith Ringling, brought an action to enforce a stock pooling
agreement she had with one of the Defendants, Aubrey Haley. Hallmark of a
Voting Trust, is a SH completely gives their right to vote to a third party. Here,
they didnt do that. They merely agreed they would vote in a different fashion
iii) Rule. Shareholders can agree to pool their votes and have a third party
intercede when there is any disagreement as to how to vote.
iv) MBCA (not the law in Delaware; but the law in Many States) specifically
authorizes specific enforcement of Voting Agreements. Specific Enforcement is
authorized, but a judge may, in adjudicating the equities of the case, may
award specific enforcement or other agreements.
v) In Delaware; Rescission of the breach is the remedy. (Its a CL decision)
Specific performance is not authorized.
vi) Held. The court held that it no other shareholders rights were violated and
public policy was not violated, as the result of a pooling agreement.
Shareholders should be allowed to benefit as they see fit from their voting
rights, and this often means banding together to strengthen their position.
However, the court decided not to invalidate the voting and held that the
members that were voted in by Healey and North would remain.
13)

SPECIAL CONSIDERATIONS IN CLOSE CORPORATION CONTEXT, PART II: FIDUCIARY

DUTY AND OPPRESSION (Chapter 26; p817)

31

a) Special problems of close corporations is when a minority shareholder comes into

disfavor, a majority shareholder can seriously oppress that person by (1) denying
him employment with the company and (2) refusing to pay dividends.
b) Unequal Access to Corporate Assets: Repurchase of Shares
i) Donahue v. Rodd Electrotrype of New England, Inc. (Mass. 1975)
(1)Facts. Donahue (P), a minor shareholder in a closely held corporation, seeks
to rescind the corporate purchase of shares of the majority shareholder.
(2)Rule. Controlling stockholders in a close corporation who force the
corporation to buy their stock breach their fiduciary duty to minority
shareholders if they do not offer all stockholders an equal opportunity to sell
a ratable number of shares to the corporation at the equivalent price.
(3)In Massachusetts: SH in a close corporations owe each other the same
duty of loyalty and utmost good faith that is owed by partners to each other.
[Mississippi follows the Massachusetts rule.] Closely held Companies are
nothing more than incorporated partnerships.
(4)Relief:
(a) Rodd gives back the money for the shares; OR
(b)Corporation gives Donahue the equal opportunity that Rodd had to sell
the money.
ii) Revised Uniform Partnership Act [RUPA] (404) and Uniform Limited
Liability Company Act [ULLCA] (409)p827
iii) Nixon v. Blackwell (Delaware 1992)
(1)Facts. Two types of stockholders, Voting and Non-Voting Stock. Employees
would run Corp. Therefore, Employees must have Voting stock. Therefore,
when someone ceases working, they must disgorge themselves of the voting
stock.
(2)Holding: Jurisdictions like Delaware say the Massachusetts force the
agreement into Equal Treatment, but that is not what the law requires.
According the Delaware, the Law doesnt require Equal treatment; the Law
requires Fair treatment. In general, is it fair to the entire group of SH. Is
this fair given the entire context of the transaction? (Much easier context to
pass.)
c) Unequal Access to Corporate Assets: Employment
i) Wilkes v. Springside Nursing Home (1976)
(1) Facts. Plaintiff, Stanley Wilkes, brought this action to recover lost wages due
to his termination by Defendants, Springside Nursing Home, Inc. et al., which
violated either the partnership agreement between the parties or the
fiduciary duty that Defendants owed to Plaintiff.
(a) In close corporations, very often minority SH are employed by the
corporations as their principal livelihood. (Against the backdrop of
Donahue, in which SH of a close corporation is akin to partnership and
owe each other the same due of loyalty and utmost good faith that is
owed by partners to each other.)
(b)Delaware rejected this rule. Its not equality of treatment, its Fair
treatment.
(c) Wilkes is a refinement of Donahue,
(2)Rule: SH in a close corporation owe each other a duty of acting in good faith,
and they are in breach of their duty when they terminate another

32

shareholders salaried position, when the shareholder was competent in that

position, in an attempt to gain leverage against that shareholder.
(a) Donahue is still good law, but recognizing that there must be a legitimate
business purpose.
(b)Presumption of equal SH, BUT if defendant can articular a legitimate
business reason, then we must discuss whether there was a less
burdensome way the corporation could have accomplished his aims.
ii) Ingle v. Glamore Motor Sales, Inc.
(1)Facts. Plaintiff, Phillip Ingle, sued Defendants, Glamore Motor Sales, Inc. et
al., for wrongful termination and a breach of a fiduciary duty owed to Plaintiff
through his status as a minority shareholder.
(2)Rule. Absent an employment contract, an employee is an at-will employee
when his shareholder agreement provides a buyback provision of his shares
if they are terminated for any reason.
(a) (NY)Under minority SH, can only bring this suit if there is a 20% interest.
(NY law)
(b)Minority SH status of a closely held corporation, does not alter the status
of a an-will employee.
(3)Held. Defendants do no owe Plaintiff a duty to keep Plaintiff indefinitely as an
employee as a result of his minority shareholder status.
14)

SPECIAL CONSIDERATIONS IN THE CLOSE CORPORATION CONTEXT: DEADLOCK

AND DISSOLUTION (Chapter 27; p853)

a) Getting to No
i) Hall v. Hall
(1)Facts. The shareholder sought relief from the trial court's decision that
dismissed her action primarily seeking injunctive relief to compel the other
shareholders to attend the shareholders' meetings.
(2)Holding. No person or maxim of equity could compel a shareholder to attend
or participate in shareholders' meetings.
(a) If fail to hold annual meeting to elect BOD, previous BOD carryover as
directors.
(b)No duty in the law for a SH to anything. The law doesnt require the SH to
show up for SH meetings.
b) The Dissolution Solution. Dissolution is the termination of the corporate
existence. To dissolve the corporation, some act must be taken, which may be
voluntary by the corporation or its aggregate members, or may be involuntary
through judicial proceedings.
i) Voluntary Dissolution. Dissolution by corporate action without judicial
proceeding is termed voluntary dissolution and may be accomplished in the
following ways:
(1)Dissolution by Incorporators or Initial Directors. A majority of the
incorporators or initial directors may dissolve the corporation if shares have
not yet been issued or business has not yet been commenced by delivering
articles of dissolution to the state. All corporate debs must be paid before
dissolution, and if shares have been issued, any assets remaining after
winding up must be distributed to the SH. [MBCA 14.01]

33

(2)Dissolution by Corporate Act. The corporation may dissolve voluntarily by an

act of the corporation, involving both board of directors and shareholder
approval. The standard procedure for fundamental corporate change is
followed. [MBCA 14.02]
ii) Administrative Dissolution. The state may bring an action to
administratively dissolve a corporation for any of the following reasons:
(1)Failure to any fees or penalties imposed by law within 60 days after their
due date;
(2)Failure to deliver the annual report to the state within 60 days after it is
due;
(3)Failure to maintain a registered agent in the state for 60 days or more;
(4)Failure to notify the state of a change in registered agent within 60
days; or
(5)Expiration of the period of corporate duration set forth in the articles of
incorporation. [MBCA 14.20]
iii) Judicial Dissolution.
(1)Action by Attorney General. The AG may seek judicial dissolution of a
corporation on the ground that the corporation fraudulently obtained its
articles of incorporation or that the corporation is exceeding or abusing
its authority. [MBCA 14.30(a)(1)]
(2)Action by Shareholders. Shareholder may seek judicial dissolution on any of
the following grounds:
(a) The directors are deadlocked in the management of corporate affairs,
the shareholders are unable to break the deadlock, and irreparable
injury to the corporation is threatened, or corporate affairs cannot be
conducted to the advantage of the shareholders because of the deadlock;
(b)The directors have acted or will act in a manger that is illegal,
oppressive, or fraudulent;
(c) The shareholders are deadlocked in voting power and have failed to
elect one or more directors for a period that includes at least two
consecutive annual meeting dates;
(d)Corporate assets are being wasted or misapplied to noncorporate
purposes; or
(e) The corporation has abandoned its business and failed to dissolve
within a reasonable time. [MBCA 14.30(a)(2),(5)
(3)Election to Purchase in Lieu of Dissolution. If the proceeding to dissolve is by
the SH and the corporation has no shares listed on the national securities
exchange or regularly traded in a market, the corporation (or one or more
SH) may elect to purchase the shares owned by the petitioning SH at their
fair value. The petitioning SH may not dispose of her shares without court
permission until the repurchase is completed. [MBA 14.34]
(4)Action by Creditors. Creditors may seek judicial dissolution if: (i) if the
creditors claim has been reduced to judgment execution of the judgment
has been returned unsatisfied, and the corporation is insolvent, or (ii) the
corporation has admitted in writing that the creditors claim is due and owing
and the corporation is insolvent. [MBCA 14.30(a)(3)] Absolute Priority
Rule
c) Key Cases

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i) In re Kemp & Beatley, Inc.

(1)Facts: Appellants, corporation and majority shareholders, sought review of
appellate court decision affirming the lower court's decisions to grant
petitioners' application for dissolution of appellant corporation unless the
corporation or any shareholder elected to purchase petitioners' shares at fair
value within 45 days.
(2)Holding: The court affirmed, holding there was sufficient evidence supporting
the lower court's conclusion that majority shareholders had altered a longstanding policy to distribute corporate earnings on the basis of stock
ownership, as against petitioners only. Furthermore, the court reasonably
determined this change in policy amounted to an attempt to exclude
petitioners from gaining any return on their investment and no error occurred
in determining that this conduct constituted "oppressive action."
(3)Oppression: Frustration of the reasonable expectations of the SHs.
Oppression should be deemed to arise only when the majority conduct
substantially defeats expectations that, objectively viewed, were both
reasonable under the circumstances and were central to the petitioners
decision to join the venture.
ii) In re Radom & Neidorff, Inc.
(1)Facts. Radom (P) and his sister Neidorff (D), sole shareholders of a music
publishing corporation, deadlocked the election of directors and declaration
of dividends due to dislike and distrust.
(2)Holding. Where corporate dissolution is authorized by statute in the case of
deadlock or other specified circumstances, it is not necessarily mandated.
The court will examine the situation with the shareholders and publics
wellbeing also in mind.
d) SH Agreements (unanimously in agreement) can alter any provision of the MBCA,
EXCEPT the right to inspect the books/records (Cannot be waived). However, Just
what a single SH can show me BOD minutes, annual corporate (w/o notice).
WITH NOTICE, they can get much more, that is NOT public information. They
cannot give trade secrets.

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