Business Association

INTRODUCTION
Business Association is
Law about controlling business
Private ordering of business
Main themes
Planning ex ante (vs. ex post)
o Try to get things done legally
Form v. Substance
o Form matters
Agency problem
o The problem of not being faithfulfiduciary duty
o Fiduciary duty: demands agencies to act on owners interests
o Standard of review v. Standard of conduct
Standard of conduct: what law expect people to do
Standard of review: how the law judge peoples actions (usually more stringent
than conduct)
Eg. SoC might be ordinary care, and the SoR might be negligence.
Rulemaking authority
o State v. Federal
Traditionally: state law
Exceptions: Federal Security Law etc
Federal law has been intruding
State law: may pass laws that help their state while hurt others
Federal law: imposed uniformity detracts from the laboratory of democracy
idea.
Depend on which one is better
o Law v. Contract
Should the rules be in contract or be in law
Corporate law is moving towards enabling rules
Purpose
o Owners v. Society
Ethics
ABA Model Rules of Professional Conduct (State law)
o Most important: Rule 1.13
Identify the client (the BA, not the agents)
Protect the corporation, not the individuals
SEC Standards of Professional Conduct (Federal law)
o The government wants corporate attorneys to act as gatekeepers to protect society as
a whole
o Mandatory reporting up
Specifically to chief legal officer, if no response, to board of directors.
Morality
o Different from legal ethics
SOLE PROPRIETORSHIP
 Sole Proprietorship Partnership Corporation
Definition Business carried on by a An association of two Separate legal entity
single owner, owned by a or more persons to created by law
single individual carry on as co-owners
of a business for profit
Formalities None None Many required
Control Management= ownership Joint ownership and Separation of
management ownership and
management
Liability Unlimited (debts of the Unlimited liability plus Limited to investment
business are debts of owner) (see later pg ) (you only lose what
you have invested)
Taxation Direct (taxed once) Pass-through Double taxation
(corporate and
personal)
Lifespan Coextensive with owner At will of partners, for Indefinite (not tied to
life of partners owners)
Exit None/sell assets Power to exit at any Sell shares
time (not necessarily
the right to exit at any
time)
Problem of Sole Proprietorship:
Limited fundingonly what you have
Unlimited liability
AGENCY
Terminology:
Agency: a consensual relationship in which one person acts on behalf of and subject to the
control of another
Principal: the one for whom action is to be taken in an agency relation
Agent: the person who by mutual assent acts on behalf of another and subject to the others
control.
Elements of agency relation: if the elements exists, there is an agency relationship
 [Restatement of Agency 1]
Formalities: none
o Intention doesnt matter. Even if you intended not to have an agency, if elements
fulfills, theres still an agency relationship
Mutual consent (express or implied manifestation of consent)
o Parties must consent to the elements of the agency relation, not necessarily to the
agency itself.
o Manifestation:
Objective indication of consentwritten or spoken words or other conducts
which, reasonably interpreted, causes belief
Express or implied
Action on behalf of another
o Motive is irrelevant.
No matter its out of payment (employees), or good faith.
Control
o Element of subservience from agent to principalagent must be doing what the
principal want
o Need not to be total or continuous control, but the principal must be in charge.
o Veto power is not enough. There needs to be a de facto control.
Authority
Restatement (Second) of Agency
Five basis of liability
Actual Authority 7
Authority: power of the agent to affect the principal by transaction of the parties
The act of the agent can bind the principal into a contract
o Even if the third party doesnt know that the person he is dealing with is an agent and
thought he was the principal
Scope of the authority: based on principals desire
o Subject to objective standardthe desire can be reasonably inferred.
Creation
Principals manifestation of consent to agent (express or implied)
o Manifestation: reasonably interpreted (objective) causes belief (subjective)
Incidental authority 35
The authority to do incidental acts that are reasonably necessary to accomplish an actually
authorized transaction
Termination
 Both principal and agent have the power to terminate the relationship at will
But not necessarily the right to terminate (might be liable for damages)
Apparent authority 8
Definition
Power to affect legal relations of principal professedly as agent
Creation:
Principals manifestation of consent to third party
o By accidentalmay did not intend to make someone your agent
o By lieslie to someone that another is an gent when he is not
o By uncorrected statement there used to be an actual authority but no longer exists
Agents are always authorized to describe their authority truthfully
Agency by estoppel 8B
No actual agency, but the person is estopped from denying the agency because of his previous
conduct
Elements:
Belief in agency relation by the third party
o Doesnt have to be a justifiable belief (different from apparent authority)
Reliance by the third party
o Change of position based on belief of the agency
Fault of principal: The principal has to cause the belief, or fail to cure the belief
o You cannot cure something if you dont know about it.
Inherent Agency Power 8A
Not authority, apparent authority, or estoppel
Derived solely from the agency relation not about principals desires
Even if the action is expressly forbidden by the principal
There must be an agency relation
Exists for the protection of persons harmed by or dealing with an agent
The concern of fairness.
Method:
Actual authority apparent authority authority by estoppel
If still no, then go to inherent agency power. At most, the answer will be: there may be one
 o The last resort
Ratification 82
Definition: the affirmance by a person of a prior act which did not bind him but which was done or
professedly done on his account, whereby the act, as to some or all persons, is given effect as if originally
authorized by him.
Elements:
Professedly done on principals account
Affirmance
o Either a manifestation of election
o Or conduct justifiable only if there were such an election
Not acquiescence
o If agent keeps doing something and principal fails to stop him from doing thatactual
authority and give rise to apparent authority to the third party
Spectrum of agency (2-3)
General agent v. Special agent
o General agent: be authorized to conduct a series of transaction involving continuity of
service
o Special agent: be authorized to conduct single transaction, or a series of transactions
not involving continuity of service
Master/servant
o Master: employer, type of principal
o Servant: employee, type of agent
o Principal has control over the physical conduct of the agent in the performance of the
service
Not just quantitative, but qualitative
Factors:
What I can control and how to control
Who supplies tools and locations
Part of regular course of business
Duration
Method of payment
Parties beliefs
o Master can be liable for torts of servant within scope of employment
Section 219
What is within the scope of employment: Section 228,229
Section 228: Time and space
 Policy: who should bear the burden of the conduct unauthorized
Employer is much more likely to be able to pay for the compensation
than the employees.
Independent contractor
o Person who contracts with another person to do something for him but is not
controlled by the other nor subject to the others right of control
o No agency relation IC not agent
No vicarious liability
o If agency relation IC is an agent
Then principal will be liable for the authorized conduct
Servant v. Independent Contractor
o The extent of vicarious liability
Servant: Principal is liable for both
Authorized conduct and
Unauthorized conduct within the scope of employment
IC: Principal is liable for the action of the IC when he authorized the conduct
Stranger
o No liability
Principals status
Who is responsible for the contract
Disclosed principal
o Principal is liable
o Agent is not liable
o The third party is liable
Partially-disclosed principal
o Principal is liable
o Agent is liable
Section 321 default rule
The third party is acting on the agents reputation since he does not know the
identification of the principal
o The third party is liable
Unless he manifest the intention not to be bound by the contract anymore
Undisclosed principal
 o Principal is liable
o Agent is liable
o The third party is liable
Morris Oil v. Rainbow Oilfield Trucking (pg.2)
Fact: Rainbow was using Dawns certificate and Dawn reserved complete control over Rainbows
operations. Rainbow went bankrupt and owed Morris $25,000. Dawn when Rainbow ceased its operations,
opened an escrow account to settle claims arising from Rainbows operations.
Rainbow is not Dawns agent
Actual on behalf of another: Rainbow was using Ds certificate
Control
No consent: they said explicitly that Rainbow is not the agent
Apparent authority?
Secret instruction. Therefore the third party did not at that time know about their relationship
Authority by estoppel?
No. The third party did not know about the relationship
Ratification:
Dawn affirmed the relationship by opening an escrow account after learning of the debt.
Conclusion: Dawn was an undisclosed principal, so liable for acts done in normal course of
business. And Dawn ratified the open account after learning of its existence.

Fiduciary Duties of agents

Definition: Agency is a fiduciary relationship marked by upmost good faith and loyalty
Fiduciary duties with respect to matters within the scope of his agency, not everything.
Duties:
Contractual duties 377
o The agent must do what he has promised to do
Duty of Care 339
o Paid agent: standard care + special skill
Standard care depend on locality
o Gratuitous agent: lower standard based on the reliance of principal
Section 323,324
You cannot make somebody worth off because someone is counting on you
Duty of Loyalty
o Act solely for the benefit of the principal 387
Al matters connected to agency
o Accounting for profits 388 agent who makes profit in connection with agency must
give profits to principal
Exception: tips, if customary
: If specific rule: no tips.
Tarnowski v. Resop (pg.19)
Facts: D as an agent represented that he had made thorough business
investigation, but made only a superficial investigation. And D collected secret
commission from sellers.
Conclusion: P as principal is entitled to the commission and damages
Fidelity in the agent is what is aimed at, the law will not permit him to
place himself in a position in which he may be tempted by his own
private interests to disregard those of his principal.
Actual injury to the principal is not necessary
Damages: 407(1) entitled to both the commission and damages
The principal is entitled to recover from the agent what he has
so received, its value, or its proceeds, and also the amount of
damage thereby caused.
No double recovery you cannot get both the thing and the
value
Reading v. Attorney General (pg.20)
Facts: Sergeant in uniform sold goods and the Crown seized them.
Decision: dismissed Readings claim to recover the seized amount
His position and uniform were the sole reasons why he was able to do
what he did.
Windfall instead of the bad guy getting it, the employer should get it.
A fair decision?
He was off-duty at the time, not within the scope of the employment
Who should get the damages?
The government should not receive the damages since smuggle is
illegal and the money would not go to the government anyway.
General Automotive MFG v. Singer (handout)
Facts: D sent jobs elsewhere which P couldnt handle and made commission.
Conclusion: Liable
The standard is a strict one, even though D was not a bad guy.
Although P couldnt do the work, if D told P, maybe P would want to
expand and be able to take the work.
D did not benefit P, but did benefit himself.
What can D do:
Disclose the situation to P, rather than make the decision by himself.
The owner should have the opportunity to decide.
 He could just refuse the customers, send them away.
Contract law consideration: a breach of contract
not to engage in any other business or vocation of a permanent nature
during the term of this employment
o Non-competition 393
o No conflicting interests 394
o Confidentiality 394
Agent cannot use confidential information obtained during agency for benefit of
anyone except principal
Even though the information is not related to the transaction the agent is
authorized to conduct
Even after the termination of agency relation, different from competition or
conflict of interests, you cannot quit and then use the confidential information.
Bancroft-Whitney v. Glen (handout)
Facts: D was Ps employee. D helped MB hire away Ps employees by disclosing
employee salaries and misleading Ps president in considering giving a salary
raise.
Conclusion: D violated his fiduciary duty
D: at will employee and can leave at any time.
But he is not allowed to take out people with him
Cannot coordinate to help them to leave
Cannot do is by using confidential information such as salary
list.
Rule: must not only protect corp.s interest, but also refrain
from doing anything that would injure the corp.
A mere disclosure that he is stealing the employees from the
company does not necessarily solve the problem
MB: also liable as being the principal of D by authorizing him or
ratifying his action
Conflict of interest: D owes fiduciary duty to both companies and must satisfy
both.
PARTNERSHIP
Introduction
Two bodies of law:
UPA: Uniform Partnership Act
o Drafted in early 20th Century, still effective in many states
RUPA: Revised UPA
o Drafted more recently, in effect in majority of states
Formalities: none
Can be created incidentally, based on substance, not on thought
RUPA allows a filing to form a partnership, but you dont have to.
 Partnership is thought as:
o UPAgroup of people acting together, association
o RUPAseparate legal entity
But sometimes overlapping in practice
Control: joint ownership and management
Each partner is an owner and a manager, share loss and profits
o Problem of agreement and trust
Partners can alter their rights by agreement but not necessarily their powers.
Liability: unlimited plus
You plus your partners
You can alter your own liability by agreement, but only between the partners, cannot against
the third party
Taxation: pass-through (one time)
Lifespan:
At the will of the partners
For the life of the partners
UPAeverytime there is a change of partner, there is a new partnership
RUPApartners can disassociate the partnership without effecting the partnership
o Practically: no difference
Exit: power to exit at any time
Not necessarily the right to exit

Formation
Statutory elements (RUPA202) the first thing to consider in analysis
Consensual association
o Consent to elements of the partnership, not consent to the partnership
Carry on as co-owners (RUPA202c)
o Interpretive rules:
Share of interest of property is not enough
Sharing of revenues is insufficient by itself (i.e., salesman receive commission,
but they are not partners)
Sharing profit is a prima facie evidence of partnership
 Exception: sharing profits at the payment of debt, salary or interest
DOES NOT count as a partnership
A business for profit
o The intent to make a profit
Marriage is not a partnership
Case law elementswhen there is no specific partnership agreement, courts use different tests
An agreement to share profitsa strong indication
o Doesnt have to be equal share
An agreement to share losses
A mutual right of control or management
o Doesnt have to be equal, just some. And sometimes you dont want equal control
A community of interest in the venture
o Not always easy to separate from profits/losses

Partnership by Estoppel (RUPA308)

Elements:
Manifestation
o By the purported partner, or with his consent
Reliance on manifestation
o Enter into transaction based on belief that there is a partnership
o Public manifestation (i.e., advertisement), then the direct manifestation is not
necessary
Liability:
For partnership, if the manifestation is authorized by all partners
o Partnership is liable for the imaginary partnership
For purported partner:
o As partner, if partnership is liable
o Otherwise, with consenting purported partners
The partnership itself is not liable
A virtual partnership between the consenting purported partners
Martin v. Peyton (pg.63)
Facts: Peyton and others agreed to loan money to KN&K firm.
 Facts for partnership: veto power; sharing profits; information right (the right to inspect firm
book etc); option to join firm; hold resignation letters from other partners
Facts against partnership: no actual agreement; no intent; no actual power to manage; profit
sharing as to repay debts
CONCLUSION: NO partnership
Elements:
o Association: yes
o Business for profit: court said no
: merely supervising the business? To protect the investment? Just by saying
its a loan doesnt mean its really a loan.
Lupien v. Malsbenden (pg.67)
Facts: Malsbenden loaned money to Cragin without interest and worked on day-to-day basis before
and after C left. M was getting payment directly from profits.
CONCLUSION: Partnership
Statutory elements:
o Association: yes
o Business for profit: yes
o Carrying on as co-owner: M is working on a day-to-day basis
Case elements:
o Financial interest: getting payment by the profits
o Presumably share in loss
o Participate in the control of the business: involve in daily business operation
o Suggestion of community of interest
What advice you can provide to M?
Dont tell him to lie or to hide assets
Tell his what the law is and what he can do and he cannot do
o Such as dont share profits, but be repaid by the interest instead.

Partnership rights in partnership

Partnership property: property that belongs to the partnership rather than to the partners
individually
UPA: tenancy in partnership
o UPA: aggregate
o Partners have full rights to possess partnership property for purpose of partnership
RUPA204, 501: Partners have no interest in the partnership property
 o RUPA: partnership is a separate legal entity
o The property is solely owned by the partnership.
o Partners can still use the property when authorized
Real issue: whether the property is a partnership property or not
o If is: it can be used to pay partnership debts
o If no, cannot.
Interest in the partnership
Partners can only sell their interest (share) in the partnership RUPA503
Assignment of interest does not effect partnership
o The seller remains the partnership, the buyer doesnt become a partner
The seller is merely selling the right to receive money from the partnership
o Other non-assigning partners rights:
UPA: non-assigning partners can dissolve the partnership
RUPA: non-assigning partners can expel the assignor
Purpose: other partners may not trust the new person assigned interest.
Rapoport v. 55 Perry Co.
Facts: P assigned 10% interest to his children and tried to add them as partners. Par.12 of
partnership agreement allows assignment for immediate family without others consent
Issue: whether the partner can introduce new partner without the consent of other existing
partners.
CONCLUSION: NO. P needs consent from other partners
Law: assignments are allowed
Par.12: limiting partners right to assign interest to strangers
o If the children, theyll still have a stake. But it doesnt mean they can be the partners
Other parts of the partnership agreement other than Par.12 talks about admitting partners.

Creditors
Old rule under UPA: dual priorities
o Theoretical dissolution
o Partnership assets pay off partnership debts first and personal assets pay off personal
debts first, and then the cross between them
Unfair to the creditors, serious limit on liability
New rule under RUPA: partnership creditors get paid first
 o Then they can go after partners on equal footing with individual partners creditors
Capital accounts
An account on a partnerships balance sheet representing a partners share of the partnership
capital (or equity) percentage of ownership property
Capital account = contributions + profits
o What you put into the partnerships + what the partnership makes what the
partnership has already given you
Indemnification v. contribution
Indemnification: reimbursement of a loss or expense incurred by another
o Partner has a right to be indemnified by partnership
o Partnership liability
Contribution: the right of a person who pays a debt to recover proportionally from others who
are also liable on the debt
o Partnership has right to ask for contribution from its partners
o Liability of partner

Rights and duties of partners

Rights
Default rule: RUPA
o Only applies when partnership agreement is silent
o Partnership can change the rules, but only among the partners, not against the third
parties
401(b): Equal share in profits (and losses)
o not necessarily to be equal
401(f): Equal rights in management
o right to participation, to engage in discussion
Some partnership has executive committee, the members of the committee
might have the whole power to make management decisions.
403: Right to information
401(i): Right to consent to addition of partners
o Only with consent of all partners
401(h): No right to salary
o Because the partners are sharing profits
o The rule can be changed
Management of partnership
Every partner is an agent of the partnership (RUPA301)
Generally, all rules of agency apply, slightly changed by statute.
Acts for apparently carrying on business in ordinary course are binding
o Ordinary course: everyday course, typical decisions
o Wont include: exceptional/rare decisions; things beyond the scope of partnership;
management beyond the life of partnership
o Exception: when the third party has notice that the partner has no authority
Either actually knows, or was given notice
The partner is not liable even if its within the ordinary course of the
partnership
o RNR Investment Limited Partnership v. People 1st Community Bank (pg.85)
o Facts: Ps general partner (GP) entered into construction loan agreement and
mortgage. P then defaulted. Partnership agreement restricted GPs authority.
o CONCLUSION: for D, P is liable
Bank could rely on GPs apparent authority (didnt have actual) unless it had
actual knowledge or notice
Apparent authority in ordinary course of business: yes
Actual knowledge of the bank? NO
Did bank get notice?
D: Bank was given the partnership agreement and the restrict
on GP was stated in it.
There has to be an actual notice, not constructive notice
o Has to be something told, not something you could
have divined
RUPA provides greater protection for third party than UPA did.
Act not for apparently carrying on business in ordinary course are not binding
o Unless the acts are authorized
Partnership liable for wrongful acts in ordinary course of business RUPA305
Differences in ordinary course of business may be decided by majority
Every partner has equal vote by default
Other differences require unanimous consent
Summers v. Dooley (pg.74)
Facts: P hires a worker but D says no. D refuses to pay, and P pays out of his own pocket.
CONCLUSION: D doesnt have to reimburse
o Its an ordinary course of business and there was no consent by majority
What if theres no majority?
 o Every partner is an agent of a partnership, and every agent can bind partnership into a
contract
o If the partnership is bound, and if the partner has the right to enter into the contract,
the non-consenting partner is liable too.
o What can non- consenting partners do to protect themselves?
Ex antespell it out in the partnership agreement
Dissolve the partnership
Davis v. Loftus (pg.92)
Facts: Some partners were named income partners who made a contribution to the firm, didnt
share in profits/losses, and had no voting rights.
CONCLUSION: not partners not liable
No share of profits, nor management
Arguments that they are partners?
Bonus based on companys profitability community interest
Management: equal control right. A lot of big partnerships have an executive committee and
some of their partners dont have the right to manage.
Obligations of partners
Partners have joint and several liability for obligation of partnership
RUPA404: Partners have fiduciary duties to each other
Under UPA: it was open-ended, not clear on fiduciary duties
Duty of care (very narrow)
o Limited to refraining from engaging in grossly and recklessly conduct, or knowing
violation of law
o Bane v. Ferguson (handout)
o Facts: P has retired from firm. Pension benefits ceased when firm dissolved
o CONCLUSION: no fiduciary duties exists. D is not liable
P ceased to be a partner after retired
Even if there is a duty of care owed to retired partner, it was not breached.
Business judgment rule. A mere fact of an unwise business decision
doesnt mean there is a breach of fiduciary duty
Court takes a loose approach of duty of care as opposed to duty of loyalty.
Duty of loyalty/ no competing interests (404b)
o A strict approach, with no exception
o Limited to accounting for profits, refraining from dealing business for adverse interest
and refraining from competing with the partnership
o Meinhard v. Salmon (pg.105)
o Facts: D and P had joint venture where D was manager and P mainly funded. When
lease was about to end, D entered into a new lease without P and did not tell P about it.
 o CONCLUSION: D is liable, P got value of 1/2 of entire lease
Its the same venture. D got the information because he was a partner of the
joint venture
He is stealing the business from the partnership
What D should do ?
Share the information. P should be given the knowledge for chance to
compete
Now D have to share the value of the new venture because its the only
remedy
o Arguments that D is not liable:
D had given to the enterprise time and labor as well as money, it was always
his own business, he has made the business profitable
The previous lease was 20 years and the partnership is end. The new venture is
a different one.
Good faith and fair dealing

Partnership Dissolution
Ending a partnership
UPA: three stages to end
o Dissolution: the beginning of the end of a partnership
o Winding up: the process of settling partnership affairs after dissolution (partnership
continues)
o Termination: the end of the partnership
RUPA: adds dissociation 601
o Dissociation: the change in the relation of the partner caused by any partner ceasing to
be associated with the partnership
o Default rule: partnership continues
Dissociation is NOT a dissolution
Major exceptions
o In every dissociation:
Either partnership is dissolved and wound up
Or dissociating partners interest is purchased (buy out)
Causes of dissociation (RUPA601)
Each partner always has power to dissociate, but not necessarily the right to dissociate
o At-will partnership: partners have right to dissociate
o Partnership by term: no right
o If you dont have the right, you pay damages and some other possible consequences.
 As per partnership agreement
o Can also specify involuntary dissociations where other partners can kick you out.
By unanimous agreement, if partner has assigned her interest in the partnership
o Partner can always sell his/her interest in partnership and it does not effect partnership
o But disincentivizes other partners can use as excuse to kick that partner out (even if
they have no right)
Judicial decree for misconduct
o If partner is misbehaving (willful and material breaches etc.), court might order
dissociation
o The misconduct has to be adversely and materially effect the benefit of the partnership
business
Certain bankruptcy events
o Automatically because partner can no longer be responsible for taking losses,
contributing, etc.
Death or incapacity
o Physical, mental or emotional incapacity
o The partnership may still continue
Wrongful dissociation 602
In breach of an express provision of partnership agreement
Before expiration of a term
o Regardless of whether in express provision or not
Judicial decree: court will decree its wrongful
Bankruptcy
(Death or incapacity is not wrongful dissociation because although bankrupt might be
someones fault, if you die, its probably not your fault.)
Causes of Dissolution 801
Partnership at will (unless agreement says otherwise)
By agreement (before or ex post)
o Ex post: if one partner has already dissociated, might agree that its best to dissolve
Expiration of a term
Illegality
o If a business becomes illegal, the partnership from a legal perspective is over.
Judicial decree of impracticability
o Either because of economical circs or personal circs.
Judicial decree to protect transferee
 o i.e., one partner sells interest to creditor and other partners wont give creditor its
share creditor can say that partnership needs to be dissolved in order to protect his
rights.
Effect of Dissociation
Dissociated partner is no longer member
o Authority: no longer have actual authority, but may still have apparent authority
RUPA702 provides two-year window for protection of innocents
o Liability: general rule is no future liabilities.
RUPA703(a): Still liable for preexisting liability, joint and severally
RUPA806: while the partnership is winding up, you still have winding
up obligations
RUPA703(b): subsequent two-year window for protection of third parties
Dissolution process:
o Wind up: finish up work-in-progress
o Sell of assets: reduce it all to cash
Two methods:
Liquidation value: value of a business if its assets are sold individually
Sell different things to different persons
Going concern value: value of a business if assets are sold together
Much larger than the liquidation value when the business is
healthy. But if business is doing poorly, then liquidation value is
higher.
Court hates to order dissolution, they think it as wasteful and unfair.
o Pay off creditors (including partners)
Creditors who are not partners> partners as creditors (partners for obligations
other than profits, partnership loans)> partners in respect of capitals
o Distribute net proceeds
Alternative: buy-out
o Dissociation doesnt always lead to dissolution, partnership may continue, but just buy
out dissociated partner
o RUPA701(b): partnership has to buy dissociated partners for the same amount that
partnership wouldve paid them if there had been a dissolution
o Why virtual dissolution
No transaction costs
Quicker resolution of current and future matters
Less destructive
Privacy concerns
Difficult to find buyers, especially if you want to sell it now.
 Winners curse avoided: the winner of an auction is likely to overpay and
regret, especially if partners are bidding
o Whats wrong with virtual dissolution
Hard to figure out the value of the business.
Consequences of wrongful dissolution
o Damages
o Deferred payment701h
o No right to participate in winding up
Creel v. Lilly (pg.117)
Facts: Ps husband died. Partners did inventory while P refused to review. P claimed partners
continue business under new name and used partnership assets and she had right to compel dissolution
and require an actual liquidation.
CONCLUSION: for D. No dissolution
Under UPA: liquidation is required upon a partners death, but no need to liquidate here.
o Partners may avoid the automatic dissolution of the business upon the death of a
partner by providing for its continuation in their partnership agreement.
Under RUPA, the estate of the deceased partner no longer has to consent in order for the
business to be continued, nor does she have the right to compel liquidation.
Legislature intent: disfavor the compelled liquidation of businesses, the trend in partnership
law to allow the continuation of business without disruption
McCormick v. Brevig
Facts: D used partnership assets for himself. District Ct. ordered dissolution, but allowed D to buy
out P.
CONCLUSION: partnership must be dissolved and wound up (liquidation)
Why different result from Creel?
Here was a judicial decree on dissolution, while Creel its a death.
When a partnerships dissolution is court ordered, the partnership assets necessarily must be
reduced to cash
Page v. Page (pg. 134)
Facts: P wants to terminate partnership. D claims that P cannot terminate because its a
partnership by term. P wants a judicial dissolution to make sure he was not doing a wrongful dissolution
CONCLUSION: Its an at-will partnership P can dissolve partnership, but will be liable for damages
if there is bad faith
There is no evidence of a term; evidence offered was mere hope for profit
Fiduciary duties concern: a party may not dissolve a partnership to gain the benefits of the
business for himself, unless he fully compensate his co-partner for his share of the prospective business
opportunity
If D can prove that P is terminating the partnership in bad faith, then he breaches duty of good
faith and fair dealing
o Wrongful expulsion: you can expel a partner for good reason or for no reason, but just
cannot expel him for bad reason
What can P do?
Continue partnership/ offer to buy D out/ settle
Limited Liability
Shortcomings of
Sole proprietorship
o Very limited funding
o Unlimited liability
Partnership
o Too many managers
Trust issues etc.
o Limited funding
o Unlimited liability plus
Limited partnerships: general partners + limited partners
Two classes of partners:
General partners: a partner with management rights and with unlimited liability
o There must be at least one general partner (there has to be someone liable)
Limited partners: a partner without management rights and with limited liability
o As default rule, limited partners have no control over the business
o RULPA302: an agreement can provide some voting rights
o Limited partners can only lose what they invested in the business, cannot lose any
more.
o Can be any number of limited partners, even with zero limited partner.
Advantages
Greater access to funding
o More investors are willing to invest because they wont have to worry about managing
or liability
Efficient management
o Smaller number of general partners who can manage the business, dont have to worry
about huge partnership votes.
Forming a limited partnership
Cannot be formed accidentally
File a certificate of limited partnership
o RULPA201: only minimal information is necessary
Name of the partnership; members; address of building and general partners;
duration. You can also include anything you want.
Purpose: notice of existence
 o No file general partnership with unlimited liability
Written agreement is optional
o There are default rules, but its always good to have one.
Name limitations
o RULPA102: have to indicate that its a limited partnership with that phrase
o Cannot use certain name, such as bank; cannot use name of limited partner because
that suggests that he is a general partner.
Limited Liability: the legal limitation of an investors liability to her investment in the business,
such as business creditors cannot go after personal assets.
Passive investor status
RULPA303(a): if you act as a general partner, then you may be considered one, even if you
call yourself a limited partner
RULPA303(b): certain activities that make you a general partner
o Consulting/advising is not enough to make you a general partnerdictating might
o Some voting power (on fundamentals) will not be enoughbut voting on everyday
might
o Old rule: control creates automatic liability (if you meet threshold, you are completely
liable as general partnereven if its one thing)
o Holzman v. De Escamilla (handout)
o Facts: Limited partners told general partner what to do and signed for funds,
participate in the management of the farm, have control over the bank account, get
the general partner to resign.
o CONCLUSION: D is general partner, therefore is liable
o Gateway Potato Sales v. G.B. Investment Co. (pg.154)
o Facts: P sold company on promises that D was actively involved. Had no contact with D.
o Issue: whether limited partner can be liable as a general partner if he did not interact
with creditor
o CONCLUSION: Ps claim shouldnt be dismissed. Remand to determine extent of control
by D.
Standard: whether creditors have actual knowledge that D was exercising
control like a general partner
Either direct contact or substantially same as test
Substantially same as test: if limited partners actions are substantially
same as the general partner, then limited partner is held liable
regardless of any other factors.
If substantially same as test not met, then direct contact is required.
Statute: actual knowledge
Court interpreted as actual contact
[Velasco: should be actual knowledge]
o New RULPA: more lenient you may be liable only to those you have direct contact
with, and only liable on the part you exercise control on.
History of increasing availability
Originally: specific purposes (that needed great effort)
o States allowed them to have limited liability because people wouldnt go to the effort if
they have liability risks
Expanded for industrialization
o Needed the funds for companies, for economy to grow
Eventually: universal availability
o Anyone can have limited liability options.
Increasing diversity
Originally: LPs and corporations
Eventually: LLCs, LLPs, LLLPs, etc.
Pros and Cons
Good Bad
Encourages more investment Provide less protection for creditorscould be
Helps society indirectly by providing more jobs, bad for business
paying taxes, providing services etc. Encourage business risks
Ordinary people also have investment
opportunities, to prevent the rich people getting
richer and poor people getting poorer
Encourage business innovation for risk-averse
CORPORATION
Introduction
Laws:
Corporate law is state law
Model Business Corporation Act: model provision, not actual law
o Many states adopt with modifications
Corporation
Formalities: many requirements
Corporation doesnt exist if you dont follow these formalities
o Filings
o Separate books
o Regular meetings
Control: Separation of ownership and management
Board of directors do the management
[but shareholder could elect himself as director who could appoint as officer]
o Even though, he is running the business as a director not as a shareholder
Liability: Limited to the investment
The obligations of the business are never the obligations of the owners
 Shareholders are not personally liable and cannot be required to invest more
Taxation: Firm/double taxation
Lifespan: Indefinite (forever or until dissolved)
Exit: Sell shares easy
Free transferability of shares
Separation of ownership and management allows selling of shares to not impact running of
corporation.
Incorporation: establishment of a business as a corporation
Select state of incorporation
o Internal affair doctrine: choice of law principleonly one state should have the
authority to regulate a corporations internal affairs, the state of incorporation.
To prevent corporations from being subjected to inconsistent legal standards.
The importance of stability
Prevent forum shopping
Internal affairs: matters that pertain to the relationship among or between
the corporation and its officers, directors and shareholders.
o Even if all business is conducted outside the state
o Wont apply to actual business operations (environmental, labor, etc.)
File certificate of incorporation/ charter
[Certificate of incorporation: the document establishing and governing the internal affairs of a
corporation (notice of existence)]
o Name of the corporation (must contain certain words, such as inc. corp., depending on
states (Delaware General Corporation Law102(a)(1))
You cannot use other words such as bank
o Powers of corporation (Delaware102(a)(3))
Anything not included in the charterultra vires
Protects shareholders: if corporation is hurt by third parties,
shareholders can argue that the officers and directors do not have the
authority
Most corporation get around by putting permitted to do any lawful
action in charter
o Classes of stock (Delaware102(a)(4))
List the total number of shares of all classes that corporation shall have
authority to issue and specify which rights each class has (capital structure)
If more than one class, you have classified stock: stock issued in different
classes, terms specified in charter
If you want anything different from default rules, you have to specify it.
Common stock: security representing basic ownership interest (default)
Right to vote on limited matters (i.e., elect directors)
Right to residual profits if corporation decides to distribute
Preferred stock: security representing ownership interest that includes some
preferential claims but also some limitations
 Limited right to vote
Preference in form of dividendspaid first before common stock
dividends can be paid
Can specify any rights wanted (Delaware law has maximum flexibility)
o Incorporator/ initial directors (Delaware102(a)(6))
Promoter: person who establishes a new corporation
Possible liability: do business for corporation before corporation was
formed prevent by waiting or specifying that you are doing it on
behalf of to-be-formed corporation
Anyone can establish a corporation, even a corporation can set up a
corporation
Parent corporation and subsidiary
Usually dont want names of initial directors in charter
Delaware107: if no directors listed in the charter, then promoter is the
initial director
o Any other matter not contrary to law
Hold organizational meeting
o Presence: directors. If no directors, then promoter or incorporator
o Adopt bylaws
Bylaws: document more detailed than charter but subordinate to it that
governs the internal affairs of the corporation
Charter as constitution and bylaw as statutes
o Issue shares: directors have to sell shares
Authorized but unissued shares: shares which have been authorized by
corporation charter but have not been issued
Only stock that has been authorized in the certificate of incorporation
can be issued
Outstanding stock: shares which have already been authorized and issued and
not cancelled
Treasury stock: shares which have been authorized and issued but are not
outstanding because they have been repurchased by corporation doesnt
apply anymore
Hold shareholder meeting
o Elect directors
o Delaware211: must have annual meeting
o Delaware216: must have quorum: minimum presence necessary to have valid
meeting
Defaultmajority of outstanding shares
Hold directors meeting
o *Delaware141: business is run by, or under direction of, the board of directors
o Appoint officers:
Delaware142?152?: allows as many officers as you want
 New York requires four (P, VP, S, T)
Office title is meaninglessbut CEO is real boss
Some bylaws dont even specify responsibilities in order to be flexible and not
run into ultra vires problem
Race to the Bottom & Up
Internal affair doctrinewhere you choose to incorporate depends on costs (taxes and fees) and
benefits
The quality of the state law matters
Competition
States competes to get more corporation to incorporate there for taxes and fees
How?
o Service: innovation, consistence, responsiveness to social changes
o Substance: pass favorable laws
Who benefits?
o Corporation v. society
Race to the bottom: laws may be passed that benefit corporations, but not
society.
Costs are externalized.
o Shareholders v. management
States always want to impress decision maker.
Management is the decision makers. States will always benefit the directors at
the expense of shareholders
o Race to the top: competition benefits society eventually
Corporations need to seek out most efficient laws since bad laws make
business fail
Shareholders wont buy shares from business incorporated in states with
management friendly laws
Competition forces efficiency and improvement
Delawarewinner
o Most large corporation incorporate in Delaware, as well as their subsidiaries
Reasons:
State legislature keeps law cutting edge and revisits every year
amend corporate law to keep it fresh to meet the needs of corporations
Secretary of State is extremely responsive to requests for information
Specialized judiciary (Court of Chancery)corporate law experts
o Small states have advantage
Revenue from fees and taxes relatively large
 Harm to the U.S is small because Delaware makes up small percentage of U.S
economy
o Federal intervention
If corporate laws become too lopsided, the Congress can pass laws that can
affect Delaware
Delaware attracts a lot of attention for its success in attracting corporations
Delaware has more to lose since its the winner, all the harm from federal
intervention will fall on it.
Other states can compete and pass even more corporate friendly laws
Purpose of corporations
Traditional views:
Shareholders are owners, directors are their agents (everyone else is third party who does not
matter)
o But shareholders dont have control directors more like trustees
But shareholders can elect directors not like trustees
Purpose of corporation: maximize the profits for shareholders
o The implication that directors have to do what shareholders expect, which is to make
money
Dodge v. Ford pg.253
o Facts: D decided not to pay dividends when company is profitable, but instead invest
back into the company because D wanted to prevent other competition and avoid
double taxation.
D lower the price of the car to capture larger market share
D raised salaries to maintain workforce, such as experienced workforce and
experts
o CONCLUSION: P as shareholder is entitled to the dividends
o Directors have the discretion on how to maximize profits for shareholders,
not whether to make profits or not
Contractarian theorymost common in academics, but not law
Corporation is not a thing solely owned by the shareholders, but a web of contracts
Everyone is an investor who expects a return
Input Rights (Expectations)
Shareholders Cash, property, labor Residual profits and control
(i.e., elect directors)
Lenders Cash Interest, sometimes a
covenant.
Covenant: a contractual
obligation or prohibition; in a
loan contract, a provision
binding the borrower, which
gives the lender an element of
indirect control (eg. If I lend
you money, you have to keep
current CEO)
Trade creditors Property (materials; Payment
plastic/wood)
Employees Labor Wages
Customers Revenue (cash) Products/service
Society Security (national security Taxes; social benefits (jobs)
guarantees corporation to
function);
Infrastructure
 Purpose of corporation: enable people to do things to benefit shareholders
o Shareholders are the only ones who have a proper incentive to run a corporation
They bear risk of loss at the same time benefit of the profits
o Shareholders profits is a proxy for society wealth: everyone benefits if we seek
shareholder profits
o Shareholders dont always have a proper incentive to run a business limited
liability
Insolvency triggers bankruptcy
Insolvency: inability to pay debts when they become due
Bankruptcy: legal process for liquidation/ reorganization of business
that is often triggered by insolvency
Shareholders do not bear all losses. They have little to lose but so much to gain
when equity approaches 0 incentive to engage in risky activities coz a slightly
profitable investment is not going to attract them
o Credit Lyonnais
Expected value= (probability value)
Example: corporation has one asset (judgment for $51M on appeal) and one
liability ($12M)
To corporation:
25%(chance of upholding judgment)$51M = $12.75M
70%(chance itll reduce to $4M)$4M = $2.8M
5%(chance itll reduce to $0)$0 = $0
Expected value()=$15.55M
Rational person would settle for $15.55M
To shareholders:
If settle:
$15.55M expected value- $12M liability = $3.55M
o $3.55M equity will b distributed among shareholders
If dont settle:
25%($51M-$12M)=$9.75M
70%($4M-$12M)=$0
5%$0=$0
= $9.75M
Incentive: shareholders would rather be risky when approaching
insolvency and not settle because they wont pay those liabilities, but
will have gain a lot more by not settling.
To creditors:
If settle:
Creditors get $12M liabilities
 If dont settle:
25%$12M=$3M
70%$4M=$2.8M
5%$0=$0
=$5.8M
Incentive: Creditors are risk averse and would be happy to settle for
12M, even for $5.8M
o NACEPF v. Cheewalla (handout)
o Facts: P, as director, claimed that D favored shareholders agenda instead of fiduciary
duties as directors of their corporation, which was in zone of inolvency.
o CONCLUSION: affirms traditional view.
Reject Credit Lyonnaisreject vicinity in insolvency theory
Nothing changes in the face of insolvency on directors duty
Creditors of a Delaware corporation that is insolvent/zone of insolvency
have no right to assert direct claims for breach of fiduciary duty against
its directors
But for derivative claims, creditors can take the place of shareholders
and hold directors for breach of fiduciary duty
Directors duties are for best interest of company for benefit of
shareholders.
Social Responsibility Theories
Concession theory (Traditional view)
o Shareholders are owners
o Quid pro quo: socially responsible behavior in return for limited liability
Communitarian theory
o Everyone is a stakeholderweb of relationship principle
o Dont believe that shareholder wealth is the proxy for society health
Social responsibility behavior
o Pursue profits
Shareholders wealth is proxy for society wealth
Excel at business
The more profitable the corporation is, the more benefit the society gets
Create more jobs, better services and products
o Social consciousness
Treat employees well; prevent pollution; sell at fair price etc.
o Charity
 Efficiencies:
Avoid double taxation by allowing charities to be given at corporation
level
Giving more money at once rather than giving singularly (more
effective)
Agency problem:
Directors instead of shareholders who want to give
CEO gets benefit/popularity not pursuing interest of shareholders
Give to different charities (opera v. the poor)
Conclusion:
As a society, we conclude that benefits of charity outweigh the benefits
Legislature allows charity
Difference between social consciousness and charity
Both are about diverting resources from profit maximizing use for some
other socially beneficial use
Morally charity is optional on some level while social responsibility is
not optional because you have moral obligation to engage in safe
practices
Pursue interests of society (not realistic): profits as secondary goal,
primary to make society better
A.P. Smith MFG v. Barlow pg.256
Facts: Directors contribute to Princeton. Charter did not authorize donations, but State law did
authorize donation came after Charter.
CONCLUSION: donation is a valid exercise of corporation power
o Common law: manager of the corporation cannot disburse any corporate funds for
philanthropic or other worthy public cause unless it would benefit the corporation
o Courts: apply it very broadly to enable donations with indirect benefit to the
corporations.
o Should not neglect the realities and the long-visioned corporate action in recognizing
and voluntarily discharging its high obligations as a constituent of the modern social
structure.
o Charter: Charter inherently agreed that the state could change the law. The
shareholders consented to it by forming the corporation.
Legislature: Every corporate charter thereafter granted shall be subject to
alteration, suspension and repeal, in the discretion of the legislature.
Limited Liability
Limited liability: the legal limitation of an investors liability to her investment in the business, such
as business creditors cannot go after personal assets.
General rule: Others (shareholders/managers/employees) are not personally liable for corporate
obligationsunless in certificate of incorporation
Why?
o Separate entity status
o Double taxation (price you pay for limited liability)
Good Bad
- Encourage investmentmore people, who are - Permits shareholders to externalize riskwe
otherwise deterred by liability, are willing to want them to take on only risks they can handle
invest. More investmentmore capital - Better to spread out the cost to a lot of people
- Doesnt make sense from agency standpoint - Unfair to allow some people to profit on upside
shareholders dont have control but not worry on downside.
Limits?
Contracts v. torts
o Piercing the veil seems more common in contract cases
o Contractsvoluntary relationship; you knew what you were doing so you should pay
o Tortssurprise element
Eg. If company goes bankrupt, not our fault
o Whether investors should be liable may depend on foreseeability
Public corporations v. small businesses
o Public corporationspassive investor status
Investors dont have control therefore shouldnt be held responsible
o Small businessesmom and pops are doing everything so should be held to unlimited
liability
Small business should be entitled to LL? Otherwise, wouldnt have
undertaken the risk
individuals v. corporations
o Should a parent corporation be held responsible for its subsidiary?
Depends on circs
Control: passive or aggressive
What type of corporation
o What happens if we give corporations LL?
More corporations are willing to take more risks; riskier investments go to
subsidiaries
A lot of upside, not much downsidecompany gets full benefits of profitable
companies and would care if investments kill people
o What happens if we dont give corporation LL?
Investors will just run separate business and there will be no subsidiaries
Limited liability v. no liability
o Really no liabilityyou invest and thats it. There is no liability after
o Liability that limited
Call on shareholders: shareholders put up certain necessary amount (to pay for
liabilities) or lose stock if dont
Pro rata liability: liable, but not joint and severally
Just for your percentage
Could discourage investment nobody wants big percentage then.
Exceptions
Failure to incorporation
General rule: if you didnt incorporate, you are a sole proprietorship or partnership (if multiple
people)
o Tradition rule: unlimited liability
o Modern trend: only people who are actively participated in the management to be
imposed liability
Fair? Would it be too tough to hold people liable for one little form
De facto corporation doctrine: Courts may treat business that was not properly
incorporated as a corporation if promoters made good faith effort to incorporate and treated
business as corporation
Corporation by estoppel: Courts may prevent someone from denying corporation existence
if they acknowledged the corporation entity and would earn windfall by subsequently denying
corporation existence.
Piercing the corporate veil
Holding shareholders personally liable for actions of company
Rare: People rarely try because going to lose (extremely rare for public corporations)
Two-part test:
o Some sorts of failure to respect the corporate form
Failure to maintain formalities (e.g didnt maintain records, didnt incorporate)
Failure to maintain separate identities (eg. Dummy corporation, unity of
interest and ownership)
o Injustice
Inability to pay debts is not enough
Fraud (difficult to prove, but you will win if you can prove)
Undercapitalization (failure to provide adequate capital for business when you
started it)
Syphoning of funds (excessive withdrawal of corporate resources for
shareholder)
Different from undercapitalization because of timingif you put in
enough money, dont syphon, and something happens to go wrong,
could avoid injustice prong
Intentional scheme to evade reasonability
Unjust enrichment
Walkovszky v. Carlton (pg.422)
Facts: P was injured by a cab. D owned 10 corporations with 2 cabs a piece. P claimed that D
used this set-up to avoid liability
o Its not illegallaw permits incorporators to set up companies to avoid personal liability
CONCLUSION: No cause of action
o Formality: Complete respect of corporation form
D did everything to separate the corporations appropriately
o Injustice: no
 Uncompensated victim is not enough
No fraud
No undercapitalization
The mere fact that he cannot pay liability is not enough
Could be undercapitalization if the capital is not enough to
function
Although its foreseeable that a cab will hit someone, we dont
expect people to have money around for liabilities
o D met insurance minimum requirement of state even
though it does not give proper capitalization
o Court doesnt require more if you want more, go to
legislature. Courts job is not to mandate insurance but
to decide whether corporation was adequately
capitalized.
Entity liability: hold entire business enterprise liable for liabilities of constituent corporations
o Same two-part test
o Fletcher v. Atex (pg.416)
Direct liability: Theoretically, anyone (employee/management/parent corporation etc.) can be held
liable for his own actions not really piercing the corporation veil, but same result
Court generally wont go after individuals

Shareholders v. Management
Directors
Job description
Part-time job
Board consists insiders and outsiders
o Insiders: have job in that corporation; usually go along with whatever CEO wants
Dont want to disagree with the boss who can fire you
o Outsiders: tend to be insiders of other corporation
o Most boards consist of outsiders
Trend: increasingly more outsiders
Agency problem
Directors are supposed to act in shareholders interests, not in the interest of their own offices
Directors are not agents
o They are not under control of shareholders.
o They use their best business judgment
o The power of directors is original and undelegated
 Directors are more like trustees
o Trustees holds assets for beneficiarys benefit; beneficiary has no say
Shareholders have some say and can elect directors
Directors are fiduciaries that are kind of like agents, kind of like trustees.
Authority
Statutorily very broad
o Delaware law121(a): managed by or under board of directors, unless said otherwise in
provision or in charter.
o Courts: fundamental preceptsmust separate the control and management
Equitable fiduciary duties
o Directors MUST act in the interest of shareholders
Practically limited by shareholder rights (elect directors)

Shareholder rights
Economic rights:
Distribution rights
o Residual claims (right to profits after everything has been paid off_
o Entitled to dividends (profits)only if and when declared by directors
Selling
o Default rule: Shareholders can sell their shares whenever they want to without
permission and can keep any profits from the sales
Control
Fundamental matters: right to vote on certain matters such as important transactions
Election of directors: theoretically, if directors dont do what shareholders want, could vote
them out more difficult
Information
Directors cannot ask for shareholder action what full disclosureany time, directors are
seeking shareholders to vote, directors have to disclose information.
Litigation
Can sue to enforce other rights
(Limited) Structural Accountability for directors
Market for corporate control (contractarian theory)
o Wall Street rule: shareholders buy shares if they are satisfied with the corporations
management and sell the shares when they are dissatisfied.
When a lot of sellers and few buyersstock price goes down
 Give people chance to buy cheap, become sole or major shareholder and
replace the management directors dont like that.
Higher price: make it hard for people to buy out the company
Corporate Hierarchy
Purely legal view: Directors are in charge
Old view: Ultimately shareholders are in charge they can elect directors also elect themselves to
directorship
Traditional view: Berle-Means Thesis
Actual separation of ownership and management due to dispersal of shareholding.
Result: executive officers in charge (as factual matter, not legal)
New view:
Executive officers run business
Directors monitor officers (just monitor, not telling them what to do)
Shareholders influence directors
Rational Apathy
Shareholders in public corporations
Dispersed
Small investment
Diversified reduce risks by investing in multiple opportunities
Consequences:
Individual vote is meaningless
Coordination problems
Irrational to pay attention
Rational apathy: indifference based on reasoned conclusion that attention is futile
Why should we follow Wall Street Ruleeven if I pay attention, what can I do about it?
Changing circs
Rise of institutional investors
Many people dont buy their own stocks nowthey invest in institutional investors instead.
Institutional investorinstitution that trades large volumes of securities, usually by managing
other peoples money
o Less dispersed: concentrated
o Larger economic interest: mom and pops just investing $100; institutions invest
millions
o More sophisticated: financial experts
 o Their votes can make difference
Still some rational apathy with institutional investors, but not as much
Voting rights
Shareholder access
Metaphors
Agency
Shareholders are principal and directors work for them
Trusts
Directors can do what they want, but within shareholders interest
Representative democracy
Directors have some degree of freedom, but must be accountable to the electorate
(shareholders)
Division of authority
Each has different role
o Shareholders: make investment decision and take the risk
o Directors: manage and protect business
Charlestown Boot & Shoe Co. v. Dunsmore (pg.269)
Facts: Shareholders voted for D directors to close up affairs with another guy, but D contracted new
debt instead. D also did not get insurance for shop, which later burned down
Rule: Directors manage business and have great latitude
CONCLUSION: For D
DE141(a) entrusts the management of the business of the corporation to the directors, but
also places its other officers and agents under their direction.
o No laws say that they have to dissolve, have to follow shareholders suggestions or
have to get insurance
o Losses uncompensablerisk of business
Trust model: directors manage, shareholders dont have a say
Blasius Industries v. Atlas Corp. (pg.274)
Facts: Shareholder Blasius wanted to put a majority on the board. Atlas called emergency meeting
of board and voted to amend bylaws to increase board and appoint two of their people so that even if
Blasius appoints 7 to fill up 15 maximum, Atlas still has majority with 9.
CONCLUSION: Breach of fiduciary duty
Directors: whether the business decision is valid
o 2 part test:
Whether the directors are acting for the primary purpose of thwarting the
exercise of shareholders vote
Even in good faith
 The division of authority
Shareholders have the right to elect directors
Board has burden to demonstrate compelling justification
Mere proof of shareholders bad decision is not enough.
What possibly can directors do delay the vote and take the time to explain to the shareholders.

Corporate Actions/Voting
Director Action
Directors must act as a group (individual directors have no authority)
Meeting (to act together)
o Substantive protection (supplement)
o Notice of meeting
Typical: 10-60 days
Minimum: to give directors time to get to meeting
Maximum: so that people wont forget
Quorum present: usually a majority, but can make more than a majority or less
than it
Many states have minimumDE141(b): 1/3
Majority vote
Majority of votes present: affirmative majority by those present and
eligible to vote (abstention=no)
True majority: affirmative majority of all possible votes, whether
present or not (abstention/absences=no)
Majority vote in cast: affirmative majority of votes cast (abstention
doesnt count)
Ex: 5 at the meeting, but 9 shareholders total
True majority: 5
Majority of votes present: 3 of those 5
Majority of votes cast: only 3 vote and 2 abstain, then majority
of votes cast is 2 out of 3
Virtual meetings
o Most states allow conference calls as long as everyone can hear
o Written consent
Most states allow unanimous consent by writing without a meeting
Why? Impractical to gather every shareholder.
 Downside: no chance for discussion
Committees:
Made by the board of directors, having responsibilities for certain things
Same rules (meeting, quorum, majority vote)
Need not be advisory, but can be given final authority
Informal action
If directors dont follow formalities, it might not count
But courts will often look the other way especially close corporations or if its not a critical
matter.
Problem with binding a future board
General rule: todays board cannot bind a future board of directors
o Board can always change its mind
But logically its inevitable that some decisions will take away some freedom from a future
board
Officers
Statutory law: woefully inadequate
Some states have no rules
Some states specify certain officers
o NY: President; VP; Secretary; Treasurer
Doesnt say what each title is.
Titles are meaningless
o Different corporations may handle it differentlydepend on corporations structure
o Bylaws may not be helpful since it might be too general and vague
Case law:
Borrow from agency law
Decide on a case-by-case basis
Shareholder Action
Limited voting rights
Election of directors
Charter amendments (also need directors approval)
Fundamental transactions (eg. Mergers) varies from state to state
Other matters directors put before them
 o According to board option, even though the law doesnt require them to vote
o Legal requirement (e.g. shareholder proposals)
Requirements (DE211,216)
Meeting
o Wont actually all meetvote through representative or proxies
o Notice required
o Quorum: Defaultmajority. But can change
Voting
o Default: majority vote (Delaware)
Fundamental matters: true majority (DE)51% of all outstanding share
Increasing trend: majority of votes cast
o Charter or bylaws can change quorum and voting requirements
You normally cannot lower the standard
Quorum you have to specifically say that you want to lower the standard, and
the minimum is 1/3
Written consent DE228
o Requirement: unanimous
Only applies to close corporation cannot really get with public held
corporations
MBCA: charter can allow with less than unanimous
Election of Directors
Historically: plurality voteelection in which candidates/options with most affirmative votes win,
without regard to absentees or abstentions
Consequence:
Majority shareholders elect all directors (because they have 51% of votes)
Incumbent directors always win unless challenged
o They will vote for themselves
o They are rarely challenged in public corporations.
Staggered board
Minority representationcharter can specify
Class votingDE102(a)(4)
o Can have different types of stock
Cumulative votingDE214
 o A voting scheme in which each voter has multiple vote which they can distribute
among the candidates freely, include multiple votes per candidate
o Get proportional representation under this scheme
Capped voting: a voting scheme in which shareholders have reduced voting rights as their
holding increase
o Consequence: more difficult to have controlling shareholders and concentrate power
o Unpopular
Management even though dont like shareholders to have too much power,
their own power is capped too
Biggest group of shareholders in large corporation are management
and officers
Difficult to expect someone to take the company over
Voting against directors
In plurality voting almost cannot
Abstain
o Technically doesnt matter
Send a strong signal if a lot of shareholders dont vote.
Majority voting
o Even if shareholders cannot vote no, withholding still has the effect because it prevent
from contributing to affirmative majority prevent re-election
Modified plurality voting
o Directors are still elected by plurality voting, but those who did not reach majority are
subject to removal by remaining boardmembers
Control
True control=majority voting power
If you have true control, youll win every time, no matter what voting structure is.
Can have effective control with <50%
Not all shares vote
Influence (of the minority shareholders as a whole) control
Ringling Bros. v. Ringling (pg.457)
Facts: Cumulative voting (each share gets to vote 7 times); 3 shareholders

Shareholder Shares Director Votes SH Shares Director Votes

R 315 2 R&H 630 5
H 315 2
N 370 3 N 370 2
 R & H enter into voting agreement where they will elect 5 directors they agree on (to create a
majority) or theyll go to an arbitrator. R & H have a falling out; H & N become buddies and vote together.
Voting agreement: valid
General rule: Shareholder can vote however he wants (no matter by what motives), as long
as he doesnt violate his duties to other shareholders
CONCLUSION: Hs vote doesnt count.
Conclusion or revote, which one is more fair?
Revote4-3(R)
Conclusion3-3better for R

Proxy Solicitations
Definitions:
Proxy:
o One who acts as sub for another (i.e., one authorized to vote anothers shares) (agent)
o Grant of authority by which a person is so authorized (authorization)
o Document that gives the authority (instrument)
Proxy solicitation:
o Any attempt to obtain the right to vote shareholders shares (often by management)
o Governed primarily by federal law
Federal law is not like state law
Federal: form does not trump substance
State: form trumps substance
Proxy contest: Competition to obtain the right to vote shareholders shares, often as part of a
corporate takeover
Reasons for
Proxies:
o Quorum requirement
o Rational apathy: shareholders dont attend meeting, so need proxy voting
Federal rules:
o Accountability
Shareholders rarely vote against management so need something to keep
management honest
Inadequacy of state law
Federal rules
 Basic purpose
Get shareholders the info to decide whether or not they should give proxies
o It wont matter if you give all the info if people are rationally apathetic
But if things are really changing with large institutional investments,
maybe they need and appreciate the info
Mandate adequate and accurate disclosure
Disclose what:
Proxy statement
o Specific rules on whats to be included
Eg. Conflicts of the interest, hows the company doing, hows the profits,
stocks
Annual report to shareholders
o Financial statements, management analysis, how companys doing
o Only apply to management (only management can give annual report)
Adequate: SEC lists specific things to be included; requires filing with SEC
Accuracy:
Anti-fraud rule Exchange Act Rule14a-9
o No false or misleading statements or omissions of material fact
No lies.
No half-truth or deceptions
o A much higher standard than the common law standard of fraud
Materially accurate
o Standard of materiality: an omitted act is material if there is a substantial likelihood
that a reasonable shareholder would consider it important in deciding how to vote
Dont have to be completely accurate
Who enforces Rule 14a-9
The law is silent
SEC can enforce as an agency
o Too many companies and too many proxies for SEC to enforce all of them
Private right of action for the private shareholder
Mills v. Electric Auto-Lite Co. (pg.387)
Facts: P, shareholders claimed that merger approval was obtained with false and misleading
representations in proxy statements
3 part test:
 Materiality of falsehood
o If there is a materiality there is a causation
o Opinions are actionable if you can prove that
The speaker did not believe what he said AND
The statement itself was misleading/not true
Have to prove both subjective and objective fact
o How to prove: use circumstantial evidence (Virginia Bankshares v. Sandberg)
Reliance on falsehood
o If material, assume reliance
Materiality invites conclusion that it might have been considered important by
shareholders when deciding to vote
Causation of injury
o Material +essential link
o Could be implied if
Misstatement is material AND
Proxy statement is essential link (the proxy contest has to be necessary)
If it wasnt necessary, then didnt cause your harmno causation
o Essential link is necessary but not sufficient
o Two theories of causation:
Loss causationdeception caused the loss
Transaction causationdeception caused the transaction that caused loss
(reliance)
Reliance and causation are separate elements courts more and more
require loss causation
Hard to prove in proxy solicitations
o Virginia Bankshares v. Sandberg
NO causation
Proxy solicitation was unnecessaryVA had enough votes to pass
transaction, so lie was not an essential link
Ps argument on causation:
Caused the loss of state remedy coz their lie made minority
shareholders harder to sue
Court: The chance to sue is only lose when the minority
shareholders are fully informed about the merger, but here the
approvals are from deceived shareholders
Relief: broad discretion by court
Monetary damages if can prove monetary damages (hard to prove)
 Injunctive relief
o Stop merger ex ante and get truthful disclosure
o Split the company after merger into two extremely difficult
Funding proxy contests and reimbursements
Rosenfeld v. Fairchild Engine & Airplane Corp.
Facts: Corp. treasury reimbursed both sides in a proxy contest for their expenses.
RULE: When directors act in good faith in a contest over policy, they have the right to
make reasonable and proper expenditures from the corp. treasury for purpose of persuading
stockholders and soliciting support but not allowed for personality conflicts, personal
gain/entrenchment, or unreasonable
Management generally allowed to spend corp. funds to solicit proxies (had to when people
werent coming to meetings) general rule applies to proxy contests: management can use
funds to defend its position in proxy contests
Rooted in the notion that its in good faith and for the benefit of the company
o In normal cases, everyone agrees & just need quorum; in proxy contest, disagreement
important to allow management to defend its side against potential insurgents
o Dont want management to spend own money?if we have them spend own money, it
seems like theyre no longer acting on behalf of shareholders, but rather themselves
o Though management will always say its for policy, trust that they act in good faith
Downsides to rule: uses funds to keep themselves in power; end up spending a lot of money
Shareholders have right to reimburse successful challengers for reasonable and bona
fide expenses
Dont have to, but could via vote
o But maybe should have to? shareholder voted and reaped benefitwhy would they
want?
If insurgent wins, corp. could end up paying for both sides
CONCLUSION: Ps case dismissed

Shareholder Access
How much access should shareholders have to proxy mechanism?
Management has complete accessprepare proxy system with corporation funds
Shareholders have to spend their own money up front and convince apathetic shareholders
SEC Rule14a-8shareholder democracy
Shareholders can have proposals included in the management proxy
Pros? Cons?
- Cost-effective & efficient -Giving individual
(seems almost impossible shareholders a status they dont have
that shareholders can run their Potential for abuse (special
own proxy) interest groups doing things that
arent really co.s interest)
Procedure:
Corporation gets to tell SEC that they are planning to exclude a proposal
If SEC agrees, they write no action letter, if doesnt agree, may pursue matter
 Either side could appeal it to the courts
o Shareholders: too expensive to sue
o Corporation: dont really want to mess up with SEC
Criteria
Limit to which shareholders can do this
o Must have lower of $2,000 market value or 1% shares
Proposal has to be 500 words or less (proposal and explanation)
Company can exclude on specific grounds:
o (i)(8) Relating to elections
Although elections should be what shareholders have a right in, management
has to include a lot of info and cannot expect people to vote based on 500
words
o (i)(l) Improper under state law
political/moral issues often permitted
Its ok for shareholders to just request. Doesnt mean itll get in, but at
least wont automatically be kicked out
Some tendency in proposals
Corporate governance proposals: relate to control of corporation
o Get most shareholders supports, higher chance to be included and get an actual win
Some increasing concern:
o Shareholders say on pay
Shareholders are ill-suited to understand how much directors should be paid
Management might be self-interested
They are shareholders agent and shareholders should have a right to
decide how much to pay them
Law: within directors business action
o Nominating directors
DE112: Shareholders can nominate directors as long as permitted by bylaws
Unlike amending Charter, which require both approval from
shareholders and directors; amending bylaws only need approval from
either directors or shareholders
Too much power to shareholders?
CA Inc. v. AFSCME Employees Pension Plan (pg.285)
Facts: Shareholder submitted proposed bylaw for inclusion in the proxywanted mandatory
reimbursement of stockholders when they nominate a candidate for director election
Issues: (1) whether or not its a proper subject for shareholders; (2) if adopted, would it violate
state law
Tension between DE141(a)directors manage except by law/charterand 109(b)bylaws
can include anything thats not inconsistent with law/charter
o Court tries to walk middle linepermit procedural changes, but not substantive
Function of bylaws is not to mandate substantive business decision, but to
define process by which those decisions will be made
Sometimes hard to distinguish substantial and procedural requirements in
the bylaw.
o Here, the proposal has a substantive effect, but really procedural (about elections)
But this can violate state law
o Directors may be forced to violate fiduciary duties if required to pay reimbursements
DE law: a board may expend corporate funds to reimburse proxy expenses
where the controversy is concerned with a question of policy as distinguished
from personnel or management.
If a proxy contest is motivated by personal interest directors fiduciary duty
to compel the reimbursement.
o P argues: if shareholders are taking that decision away from shareholders, its taking
away the duties that directors have in that area (cant have fiduciary duty for
something you cant do)but court says this is just semantics
CONCLUSION: shareholder proposal is not allowed

CLOSE CORPORATIONS
Close corporation: corporation with a small number of shareholders, or with a few that have
controlling interest
Public corporation: corporation with many shareholders and which is required to register with SEC
 Public corporation Close corporation
Many shareholders Few shareholders
Dispersed shareholders Close-by shareholders
Diversified shareholders (small % of Invested shareholders (greater % of
wealth invested in each co.) wealth invested)
Apathetic shareholders Involved shareholders (Shareholder can
actually be the CEO and work for himself)
Public information (media, Personal knowledge (run business/know
disclosures w/ SEC) who is)
Formal (must file with SEC; hire Informal
attorneys/accountants)
Dividends Employment (money comes from
salary/employment)
Why prefer salary than dividends?
- Double taxation on dividends
Easy exist (e.g., Wall Street Rule) Transfer restrictions (obligations that
limit ability to sell)
Minority control possible. Minority has no control (even 49%
shareholder has no control because theres
someone with 51%)
Agency problem Abuse of minority shareholders (freeze
out minorities)
Should courts treat close corporation differently with public corporation
No:
o They are both corporations. Same corporations should apply same law
o Predictability reduce risk and uncertainty
o Difficult to draw lineno clear distinction between the two
 o Corporate law is formal
o You can contract around it if you dont like the rule
Yes:
o They are in fact very different in reality
o Close corporation is more like partnership
Most states have a statute for close corporation
Very few people elect in statutory close corporation law
o They dont know about the law
o They got enough protection from public corporation statute anyway
o So much you can do under general corporate law to protect close corporation
Easier for close corporation to amend the charter
Create different class of stocks
Enclose various procedures and requirements in the bylaws
Control ArrangementsWhat do shareholders do to work around default corporate laws?
Class votingdivide the power as you wish
Eg. Have Class A&B shares, but only Class A can vote
Irrevocable proxy
One shareholder can authorize another to vote his shares; can be to management or another
shareholder
o Problem: generally revocable at willcan take it away for no reason
At common law, solution was that proxies were irrevocable if coupled w/
interest in stock
So in normal situations, should be revocable but in other situations, when
proxy has interest in shares, will be irrevocable:
E.g., borrow money and offer shares as collateralgive lender an
irrevocable proxy for life of the loan b/c lender has interest in stock
As policy matter, we dont want people who dont have an economic
interestwe want voter to have the economic interest of the
shareholder so they wont do harm in how they vote
But in most close corp. cases, proxy interest isnt in stock, but with the
corporationthis wont work under common law traditions
Courts have loosened the standards
Acknowledged that some times, there is an interest, not in the stock,
but in the corporation
Said an interest in the corp. is good enough; employment with corp. is
enough
Some legislatures/courts have passed laws to that effect
DE 212(e)
Voting trust
 Definition: Plan in which shareholders transfer their shares to a trustee for the purpose of
creating a voting block
Trustee is a registered holder
o Trustees own the stock (but in practice, only has control)divorce of ownership and
control
Mistrusted at first(used to amass power), but eventually with limits
Formation: written trust agreement and transfer
o Public disclosurethe trust agreement should be open for inspection
Duration: limited to 10-year time period
Pooling agreement
Definition: A plan that the shareholders agree to vote their shares together
Difference between pooling agreement and voting trust
o Pooling agreement: no attempt to separate ownership and voting power
o Enforcement issue
Modern trend: to grant specific performance
o Perhaps a better idea to award money for pooling agreement and specific performance
for voting trust
Cruel to force people to work together
McQuade v. Stoneham (pg.472)
Facts: Shareholders entered into a voting agreement, agreeing to vote a specific way as directors in
electing officersone of which is to keep McQuade as treasurer. D did not keep their agreement.
General RULE: Shareholders may pool their votes to elect directors, but cannot agree to bind
directors (i.e., shareholders cannot elect officers)
Directors exercise their own independent judgment 141(a)
Arguments against this rule: in a close corp., shareholders and directors are often the same
people (same people, just wearing different hats) or friendsso silly to make a distinction
What could the court have done if it wanted to help McQuade, but be consistent with this rule?
Offer damages for breach of contract: rather than saying agreement is void for other policy
reasons, could owe damages for promising the undeliverable
Interpret agreement as saying they will only vote for directors who do what they want; you
promised to fire anybody who will fire him (keep kicking out directors until he gets hired again)
Clark v. Dodge (pg.476)
Facts: Agreed to have P maintained as director and officer if he does not reveal trade secrets.
CONCLUSION: for Clark; agreement is valid
Clark court is allowing what McQuade court didntsame court, but different decision
o Policy shift?
EXCEPTION TO RULE: If no complaining minority interest, no fraud or apparent injury to
public/creditors, and no prohibitory statutory language, then agreement will be honored.
Galler v. Galler (pg.476)
 Facts: Shareholders (brothers) created a pooling agreement to provide for their widows after
one died (would bind co. and directors, too).
CONCLUSION: for brothers widow, granted the specific performance on the agreement
o No complaining minority interestminority shareholders have the right to have the
directors to exercise at the best of their business interest.
Not an insurance policy, but really was a gift by a dying person
S Corporation
Internal Revenue Code
Subchapter S: certain close corporation can elect to be taxed as a partnership rather than a
corporation
Requirements:
Unanimous consent of the shareholders
o Can be terminated by majority
No more than 100 shareholders
All shareholders must be individuals
o Cannot be a subsidiary
No shareholders can be alien
Can have only one class of stock
Pros/Cons:
Pros: avoid double taxation
Cons: you have no choice but be taxed on income

Fiduciary Duties of Controlling Shareholders (in Close Corporations)

Duty of utmost good faith and loyalty
General rule: Shareholders dont hold fiduciary duties to each other. Shareholders can act selfishly
Different rule in close corporation: shareholders owe one another substantially the same fiduciary
duty in the operation of the enterprise that partners owe to one another.
Reason: Wall Street Rule no longer applies in close corporation
Donahue v. Rodd Electrotype Co. (pg.489)
Facts: Corp. bought majority shareholders shares. When minority shareholder (only other) offered
theirs, the corp. rejected the offer.
CONCLUSION: for minority shareholder
Duty of equal opportunity: when controlling shareholders exercised their power over the
corp. to deny minority equal opportunity in stock purchases, minority is entitled to relief
In a close corp., there is no market to sell shares
Court isnt requiring a corp. to buyout a shareholders shares in any casejust that if corp. is
going to buy from one, it should offer to all
 Preferential distribution of assets
o Selling shares is not really a distribution of assets dividend is distribution
Remedy: 2 alternatives
Undo the transaction
Force company to buy equal number of shares
Wilkes v. Springside Nursing House (pg.498)
Facts: 4 established co., invested/worked equally and received equal share. Later, other 3 (as
directors) cut off Ps salary and didnt re-elect him as a director/officer.
D chose not to have dividends and pay salaries (so only 3 get) but if they chose to pay
dividends, could not deny only P: duty to pay to all
Court is concerned with Donahue standard because it may hamper flexibility in running a business
developed two-part test:
(1) Majority shareholders have burden of proving they had legitimate business purpose for
its action
(2) Weigh legitimate business purpose against practicability of a less harmful alternative
Even if there is a business purpose, minority shareholder could show theres a better
alternative
o Friendly test to majority: allows them to do what they can while keeping minority
interest in mind not about protecting minority interest at all cost
Donahue remedy is not intended to place a strait jacket on legitimate business
activity
CONCLUSION: D breached their fiduciary duties
(1) had no business purpose no need for part (2)
o If he wasnt being productive, then D might have legit business purpose.
Smith v. Atlantic Properties Inc. (pg.505)
Facts: 4 equal investors. Bylaws made all decisions subject to 80% vote. Some shareholders
wanted to pay dividends; one did not. Corp. subject to excess tax.
No self-dealing on Wolfsons part didnt want dividends because he partly wanted them to
reinvest into the co., but hes also in a higher tax bracket than the others and didnt want to
give it to gov.
Selfishness on both sides3 didnt care about Wolfson; wanted money
CONCLUSION: Wolfson is at fault & ordered to repay penalty taxes
D as an actual majority shareholder he essentially had veto power (needed 80%, but other 3
only had 75%)
Looked like tax evasionppl have strong incentive to retain earnings instead of paying
dividends b/c it increases value of co. by turning dividend income to capital gain income, which
is taxed at lower rate
o Two ways to avoid being punished by IRS:
Reinvest
Pay dividend
The only thing IRS doesnt allow is for the corporation to accumulate
the money without using it
Fault on both sides:
Wolfsons fault:
 o Refuse to pay dividends and lead to IRSs penalties
Other three shareholders fault: fail to reinvest
Normally, majority rule works, but their contract doesnt say majority (it says 80%)so seems
unfair that court says majority wins
Possible argument: 3 was at fault and couldve done something that Wolfson couldnt haveseek
to dissolve company (Wolfson couldnt have because dissolution requires 40%)
Merola v. Exergen Corp. (pg.510)
Facts: P (minority) came to work full-time at co., thinking he could become major shareholder and
continuous employment. P bought shares. Later, fired.
CONCLUSION: not a situation where breach of fiduciary duty
Freeze-outs are wrong, but this isnt a freeze-out
Majority had right to terminate Phe was an at-will employee who just happened to be a
minority shareholder (this isnt a close corp. case, but an employment case)
o Not every discharge of an at-will employee of a close corporation who
happens to own stock of the corporation gives rise to a breach of fiduciary
duty claim
Only if shareholder is essentially like a partner will he be owed fiduciary duties
here, P wasnt like a partner
Delaware tends to not give protection to minority shareholders
Delaware is more concerned about big and public-held corporations
Bargain special protection if you want
Rules are like this, no extra protection

Transfer Restrictions and Buy-outs

Transfer restriction:
charter, provision/agreement
that restricts shareholders
ability to sell her shares
Reasons people
want
- To keep it in the
group
- Minimize risk of
hostile takeover
- Try and lock
people in (prevent people
from selling out, esp. too
early)
- To make sure you
know who your partners are
Problems
- Hampers ability to sell
- Keeps price down to the
extent you want to sell
- Could lead to abuse
(with regards to firing; stuck with
majority, despite even illegal
activity)

Buy-out agreement: - Might be a less - Could give too much

agreement that
allows/requires
partner/shareholder to end
her relationship with other
partners/shareholders and
receive cash payment in
return for her interest in the
business
Take-along right:
before a shareholder can sell
her shares to a 3rd party, other
shareholders should be given
the chance to sell their shares
to that shareholder at the
same price
onerous transfer restriction
- Can use as a type
of retirement package (set
up from the start; without
having to negotiate or be
without money)
- So they are not
stuck if someone else is
trying to jump ship
- Protection on
minority shareholders.
Majority shareholders,
before they can sell their
shares to the others, have
to take the count to buy the
whole company.
power to company: sold in many
different ways (at option of co.,
shareholders, specified events)
- Could give too much
power to shareholders (difficult
for other shareholders to buy the
one who wants to leave for no
reason, esp. if 50-50 co.)
Specified events can lead
to uncertainty; might not have
worked out how you wanted;
prices arent what you thought
theyd be
- Cause problems for the
seller
* Difficult for majority
shareholder to sell
 F.B.I Farms v. Moore (pg.531)
Facts: P buys exs shares at a sheriffs sale to satisfy settlement, thinking shares transfer
restrictions dont apply b/c not a voluntary sale (i.e., involuntary = to creditor). Majority tried to cancel
shares & transaction.
Restrictions: required board approval before you could sell; gave a right of first refusal
Right of first refusal: before a shareholder can sell her shares to 3d party, other shareholders
have right to buy shares at the price at which wouldve been sold to 3d party
Law: statutes allow transfer restrictions (as long as not obviously unreasonable) & rights of first
refusal
To control its ownership and management and prevent outsiders from inserting themselves into
the operations of the corporation.
Common law: restraints on alienation were impermissible: interferes w/ ownership & commerce
CONCLUSION: restrictions did not prevent sale; remain applicable to Ps shares; are reasonable
Co. didnt exercise its right of first refusal, even though it was aware of sheriffs sale
A restriction is reasonable if it is designed to serve a legit purpose and is not an
absolute restriction on shareholders alienability
o Reasonability at time of the agreementhere, P argues that difficult relationships
made it reasonable afterwards; but court says no
o Factors of reasonability (pg. 536)
Transfer registration bars only voluntary transfers.
o Voluntary transfer v. involuntary transfer
Sheriff sale: involuntary transfer transaction passes
Voluntary transfer transaction doesnt pass
Sellers has to disclose
Gallagher v. Lambert (pg. 544)
Facts: At-will employee bought stock with buy-back provision (at termination before 1/31, have to
sell back to corp.inducement to stay longer). He was fired and wanted post 1/31 amount ($3M), but co.
gave him pre-1/31 ($89k). P argues that D breached fiduciary duty by taking advantage of himfiring him
so they dont have to pay $3M
CONCLUSION: summary judgment to D P is a loser
Fiduciary duties do not apply to all shareholders, but only if shareholders are essentially
partners (also see Merola case)
o You may be a shareholder, but if youre really an employee with shares and not a
partner, then youre not owed fiduciary duties
Contract claimP got what he bargained for; he knew about the buy-back going in
o But generally, every contract has an implied term of good faith and fair dealing (but
doesnt really mean much in contracts)
o Exception: at-will employment
o But if court wanted, could have another sub-exception [involving shareholder
agreements]dissent says you cannot actively block the purpose of the contract
Jordan v. Duff And Phelps Inc. (pg.547)
Facts: P bought shares with buy-back (after termination for any reason). P resigned for personal
reasons; corp. let him keep working for 6 more weeks to get more money. Corp. didnt lie to him, but didnt
tell him thered be a merger (& in general no duty to disclose).
CONCLUSION: reverse trial courts summary judgment for D chance for P on remand
Material issue of when P quit (Nov/Dec?)in Nov, mightve been a merger; in Dec, they knew
Special facts doctrine: co. buying their own stock have a duty to disclose material facts
Directors cannot take advantage of minority shareholders
Argument: Co. didnt ask for shareholder action, didnt try to buy his shares, didnt fire him;
even if they fired him, buyer agreed to automatically sell, and here it was voluntary; why
should co. have to tell P this secret info when no one else knew?
Court says when P quit, co. shouldve told him about merger talks, & P wouldve stayed longer
o But co. couldve fired him anyway
o Also, merger fell throughso P wouldve resigned then, still had book value from before
On remand, P has to prove that he wouldve stayeddifficult to prove & disprove

Why take-along right and right of first refusal

 Theoretically expands the power of whoever has those rights
o If its a good price, minority shareholders can exercise the take-along right
o If its a bad price, minority can exercise right of first refusal and buy the company
If you only have the right of first refusal, you can only stay if only the take-
along right, can only leave

Corporate Dissolution
Corporation: seen as a separate entity and doesnt necessarily to have an end.
Method of Dissolution
Charter amendment
Charter can provide for unlimited life or until a certain date
Any charter amendment needs approval of BOTH directors and shareholders
Shareholder vote
Some states allow voting for dissolution
o Ex: in New York, used to be a super majority; no just a majority
o Dont need director approval
Judicial Decree
To protect the minority shareholders right to call for dissolution otherwise minority
shareholders cannot necessarily get enough shareholder votes
Judicial reluctant: Courts are reluctant to dissolve a corporation
o Traditional concern: dont want to shut down a profitable business just because
shareholders are squabbling
Not really a valid concern
If a non-event, it doesnt matter
If a major event, can always sell the business as a going concern
Possibility for the minority shareholders to abuse this option
o Alternative form of relief: Mandatory buy-out
Usually the majority who has to buy out minority but court could
theoretically allow minority shareholder to buy out majority
Reasons for judicial dissolution
o Waste of corporate assets
Not that its not being profitable now, but that it can NEVER be profitable
o Deadlock: inability to obtain votes necessary for an action
Among shareholders (two 50% who cannot agree on election of directors)
 Sometimes minority shareholders are also allowed to seek dissolution
under deadlock they can cause deadlocks through veto power
Among directors
o Oppressive conduct
Illegal or wrongful conduct
Explicit violate the minority shareholders rights, unfair play
Clear casehigh standard, prove that the majority actually did wrong
things.
Not acting in good faith or fair dealing
Looser standard, allows for more subtle forms of misconduct
Reasonable expectations being frustrated
Much loser standard
The expectation has to be reasonable, not a mere hope
DisappointmentOppression
Matter of Kemp & Beatley, Inc. (pg.558)
Facts: P wasnt receiving distribution of company earnings; claimed
fraudulent and oppressive conduct by board.
Statute: NY 1104-a: sounds like illegal or wrongful conduct (least
generous standard), but court interprets as reasonable expectations
(most generous)might not make sense since not everything bad that
happens to me is always oppressive
CONCLUSION: reasonable expectations frustrated not unreasonable
for lower ct. to order dissolution
But courts should determine whether there is some other form
of remedy and whether dissolution is not necessary.
o Dissolution is a serious and severe remedy
Not taking a stance against dissolutioncourt has broad
latitude in fashioning an alternative relief, but shouldnt
hesitate to order dissolution
How to determine reasonableness examine the entire history of the
participants relationship.
McCallum v. Rosens Diversified Inc. (pg.568)
Facts: CEO awarded stock in close corp. Later fired. He wanted to sell stock back for $5M but
company only offered $600k (lowball offer).
CONCLUSION: for P
Reasonable expectations were frustratednot that he was fired, but that he was fired & then
given low-ball offer so he wouldnt get economic benefits
Court didnt want to say that any time an employee of this type is fired that remedy will be
offered
Only shareholders who are essentially partners will be given partnership-like fiduciary duties
co. didnt give shares to everyone; gave to P b/c hes important and is a highly valuable
employee Reasonable expectation found in the inception of the relationship
o Not determinative, but factors that court considers
Remedy: mandatory buy-out at fair value
When considering whether to order a buy-out, courts should consider reasonable expectations
of shareholders with respect to each other and corporation
But court is not extending the holdingsimply holding that terminating CEO and then offering
to redeem his stock constituted conduct to invoke the statute
 o Court says impression was that co. fired P and offered to buy the stocks at low price,
but seems unclearP technically made bid first, then co. counter-offered at a much
lower price.
o Court doesnt want to say company must buy him out, but seems to say if co. makes
an offer, it shouldnt be a low offerincentive then is to not make an offer in first
place
If you offer to buy someones shares, you might have to buy everyones shares.
take-along right
Charland v. Country View Golf Club (pg.575)
Facts: P sought dissolution (alleging illegal activity). State law says if shareholder seeks dissolution,
co. has right to buy out shareholder instead: first negotiate a fair value; if they cant agree, then court will
give valuation.
Issues: whether minority discount or marketability/liquidity discount should be applied
Minority discount: reduction in pro rata value of co. due to lack of power held by minority
o Voting power is different between shareholders & can translate into economic issues
so minority shares might be worth less than would otherwise be
o Court says minority discount should not be applied because of serious consequences
If majority shareholder knows there is a minority discount, he might
be incentivized to oppress minority into seeking dissolution then the
more majority oppresses, the lower the price (since nobody would want
minority share)
And doesnt make sense: in dissolution, get pro rata value after co. is sold & if
option, majority shouldnt be better off so both dissolution & mandatory buy-
out should be pro rata
Make sense if selling the shares to the outsiders but doesnt make
sense when selling to the majority shareholders.
Marketability discount: reduction in pro rata value due to lack of market for co.s
ownership interests
o In a close corp., there is no market so you wont get as much as you would for an
equivalent public corp.
Fair? If there were dissolution (sell) at 80% of value, then minority would only
get 49% of 80% (majority 51%); but if buying out, then co. is still functioning at
100% and just being consumed by majorityif discount, then majority would
bank on that theoretical loss from dissolution
o Court says marketability discount should not be applied
Majority is getting to consume business, so getting 100%
Would have same practical effect as the minority discount: reward oppressive
majority for oppression
Brodie v. Jordan (handout)
Facts: Other 2 shareholders freezing out P (no info, no money, etc.).
CONCLUSION: reasonable expectations frustrated but not entitled to buyout of shares
Freeze-out a minority shareholder by majority shareholders in a close corporation breach of
fiduciary duty
Remedy for freeze-out is to restore minority to position she wouldve been in if no
wrongdoing to those benefits which she reasonably expected, but did not receive b/c of
fiduciary breach
Remedy should neither grant the minority a windfall nor excessively penalize the majority
Neither corporation nor shareholders have the obligation to buy the minority shareholders out
when minority shareholders want a way out. no reasonable expectation to buyout.
P would be put in better position than before wrongdoing if buy-out
o Really? isnt she just getting money for an illiquid stock and value of her stock?
o Benefits to a buy-out would be to put an end to all this and a buy-out does not harm
the company (otherwise, the dispute never ends)
o Just because someone in the close corporation wants a way out doesnt necessarily
mean he/she can destroy the whole company and the life of every other shareholders
Different situation if the person is oppressed majority shareholder no longer
has clean hand
 What would P get for her shares if buy-out? Unfair to say full value since she didnt really have
expectations but maybe it should be based on husbands expectations: if he were in wifes
position, clear he had expectations (he worked at co. until he was fired and stopped receiving
money)

Duty of Care & Business Judgment Rule

Fiduciary duty of care:
Exercising standard care (expected of people in that industry) + special skills
Fulfill duties in good faith and with diligence, care and skill that an ordinarily prudent man
would exercise under the same/similar circumstances in like positions.
Francis v. United Jersey Bank (pg.622)
Facts: Director didnt know anything about business. Sons (directors) withdrew loans & co.
failed.
CONCLUSION: D breached fiduciary duty of care
What are directors duty of care:
o A general monitoring of corporate affairs and policies
Have to be well-informed about the business
Doesnt need to cover all day-to-day activities but could raise suspicion to
misconduct
Lack of knowledge is not a defense
Either acquire the knowledge required, or hire an expert. If you dont
want to do either, then dont be the director.
o Duty to object
Sought the advice from the counsel once suspicious to make sure whether its
legal or not. And let the counsel help you to find out possible solution
Vote against the issue
Threat to sue, sought injunction from the court
If still cannot work you should quit.
Duty of care owed to: normally the shareholders
o Here: courts allowed clients/creditors to sue for the breach
Special protection on special industry such as bank. And insurance company
here is kind of like a bank
A trust relationship gives rise to a fiduciary duty to guard the funds with fidelity
and good faith
Causation: should she pay attention to that and threat to sue, the misappropriations would not
happen.
Jurisdiction: Corp. was incorporated in NY; but NJ law was applied
o Velasco thinks this would probably be wrong today; other cases do this sometimes,
but older cases internal affair doctrine
Business judgment rule
A very high level of review for directors If apply business judgment rule, the management almost
always win
General rule: If management carefully makes an informed business decision in good faith and
without a conflict of interest, they will not be held liable for the result as long as the decision was
rational (doesnt say reasonable)
 In Delaware, Business Judgment Rule is a presumption
Kamin v. Amercian Express Co. (pg.638)
Facts: Shareholders wanted co. to sell shares at a loss of profits so they could pay less taxes.
Directors distributed shares instead because loss would affect their earnings and stock prices.
CONCLUSION: summary judgment to D
o Business judgment: the question of whether or not a dividend is to be declared or a
distribution of some kind should be made is exclusively a matter of business
judgment for the board of directors.
o Good faith: Directors may be mistaken, but as long as they are in good faith
o Conflict of interest:
P: the directors are tying their retirement salaries to the financial statement
Court: too speculative, need more proof
Only 4 of the 20 directors have the conflict of interest will not influence the
whole board to make a valid decision.
How reconciled with Francis case, which seems so demanding, and Kamin, which seems so
lenient?
o Francis looked at standard of conduct: states how a person should conduct a given
activity or play a given role
Ordinary care
o Kamin looked at standard of review: states the test by which an actors conduct
should be reviewed to determine whether judicial relief should be granted
Business Judgment Rule, gross negligence.
As long as the decisions are rational, not liable even if later the
decisions turn out to be bad ones.
Very rare situation where directors are acting irrationally
Ex: Waste
Substance v. Process
o Substance: the actual decision
The protection is complete courts do not want to entertain this. Have to prove
that decision was so bad that it was based on waste, irrationality, or no one
could make such decisions.
o Process: decision-making process
Protection is less strong, but still far beyond mere negligence
Justifications for Business Judgment Rule:
DE141(a): Directors manages corporations
o Directors are specifically authorized by law to make the decisions, not shareholders or
courts.
Business is inherently risky: results dont tell us much about the quality of decisions
Assumption of risk by shareholders
o Its shareholders choice, if you dont want risk, dont invest in risky industry or risky
company
o Shareholders can always diversify the investment to lower the risk
 Necessary to protect incentives
o Willingness to be a director no upside except getting salaries but assume all the
downsides when the business turns bad
Spreading costs
Courts are not business experts and dont want to guess what a good business decision is
Ethics
Client comes in to talk to you about duty of carewhat do you tell him?
Two sides here: its true you can get away with anything under BJR, but duty of care seems to
require a lot out of you
You have a duty not to lie to your client, but on the other hand, the way you couch the truth is
important

Duty of Loyalty & Entire Fairness Test

More stringent standard when there is conflict of interests
Its usually difficult to prove entire fairnessshareholders always win
Historical trend of law:
Historically, mightve been true: in 1880, couldnt have a conflictany conflict would make the
transaction voidable
By 1910, if approved by disinterested directors, transaction would be permitted if fair
By 1960, key issue was fairness
Lewis v. S.L.& E., Inc. (pg.718)
Facts: 6 siblings were SLE shareholders; 3 of them were LGT shareholders. When Donald (not
shareholder of LGT) was supposed to sell SLE shares to others, refused and claimed others had wasted
SLEs assets. SLE had been renting property to LGT, but not charging enough.
Business Judgment Rule doesnt apply:
Business Judgment Rule requires an actual business decisionno decision here because SLE
board (3 on LGT board) didnt even consider a new lease (if you just didnt think about it, wont
be protected by BJR)
There was a conflict of interest apply Entire Fairness Test
o ABCDEF = directors for SLE; DEF = directors for LGT
o Profits made by LGT split among 3; profits by SLE split among 6and low rent to LGT
means more profits to DEF
Entire Fairness Rule:
Burden of proof on D to prove that the transaction was fair and reasonable to the corporation
o Prove that LGT couldnt afford to pay more and couldnt rent to anybody else; etc.
o D failed to prove that the rent was fair
CONCLUSION: D didnt satisfy its burden take difference in rent in what actually charged and
should have been charged, add to book value, and then sell shares (already agreed to book value in
shareholder agreement)

Two elements for Entire Fairness Test

 Conflict of interests & Self-dealing (conflict of interest that rises to level of self-
dealing)
o Self-dealing: when a fiduciary stands on both sides of a transaction, or causes the
company to act in such a way that fiduciary receives something from the company to
the exclusion of, and detriment to, the shareholders
Two basic meanings:
Dealing with myself. Negotiating on behalf of both sides of the
transaction
The fiduciary cause the exclusion of, and detriment to the minority
shareholders
o Sinclair Oil Corporation v. Levien (pg. 814)
o Facts: Sinclair was 97% owner of Sinven. Sinvens minority shareholder claimed that
Sinclair breached fiduciary duty.
Parent owes a fiduciary duty to its subsidiary when there are parent-subsidiary
dealings.
o CONCLUSION: no self-dealing apply Business Judgment Rule
o Claims:
(1) excessive dividend claim (more than it has profits)
Sinclair needed more money, but not self-dealing because paid
dividends fairly to allmotives are irrelevant, unless you can show
theyre improper
Dividend policy works just like this, sometimes its better to
reinvest and sometimes its better to cash out.
(2) denied opportunities to expand
Sinven had no particular right to them so no self-dealingreally
Sinclairs and chose to put them in wherever. The opportunity doesnt
belong to Sinven at the first place
(3) breach of contract claim
Late payment
Sinclair contracting with its subsidiary is self-dealing apply
intrinsic fairness test
Late payments clearly breach of contract
Failure to meet the minimum amount
PurchaseSinclair didnt buy as much as promised, but bought
everything Sinven produced
Sinclair cannot ask Sinven to stop producing just because they
dont want to buy anymore.
Gantler v. Stephens (pg. 708)
Facts: Advisors said external offers were good, but directors rejected them because a lot of them
had other relationships with company and thought new company might not keep those related business
(make more with own co. where Im sole shareholder).
Instead, passed recapitalization exchange: an exchange of securities intended to
restructure the companys capital structure, especially with respect to classified stock
Here, exchanged common stock for preferred stock (get more dividends, but no voting rights)
purpose was to gain more control
CONCLUSION: amounts to self-dealing erred in dismissing
Stop the takeover to preserve their jobs and their side businessself dealing
A trial is needed to prove the facts before the court determines whether Ds were acting
reasonably or not.
Courts are going to require more than complete reasonableness, but complete fairness
 Officers have same fiduciary duties as directors
Self-dealing what kinds of conflicts count
Money conflict
Family interest?
o Close family member, immediate family member. Spouse, child, parents
o Friends? Usually dont, unless you can prove that the friend is like his family
Job
o Job is the proxy for money
o But job cannot count as money, you can get another job. So losing job is not enough
Belief?
Entire Fairness Test:
Fair dealing (Process): time of transaction, structure, how approval occurred..
Fair price (Substance)
Where to draw the line
The balance between authority and accountability
o If place threshold too high (dollar amounts), then real conflicts will go unpoliced
because they wont be cognizable but if too low, then might get courts involved too
much

Business Judgment Rule in Delaware

Smith v. Van Gorkom (pg.648)
Facts: Directors wanted to sell co. because they couldnt use federal income tax benefits and could
get more with un-used benefits. D came up with price and presented to board in a 2-hour meeting.
Whether the board was well-informed?
Yes No (court said no)
Maybe simple decision; had recent 2-hour meeting; relied solely on 20-minute
Boston Group study to evaluate co. & recent presentation; had no documents; didnt actually
5-year internal review; sophisticated board; read agreements; didnt figure out where price came
external constraint to make quick decision from or what intrinsic value of co. was
Did co. think price was fair?
Yes No
D thought it was fair; CFO okay-ed it; Other executives didnt seem to agreeCEO
CEO proposed it; significantly above market thought it was bottom of fair (maybe he was just
price; market test; other shareholders trying to appease his boss)
approved it
Market test: an opportunity for the market to present alternatives to a proposed transaction
in the way of competing bids; auction
o Once offer is made & there is time to complete it, can see if better offers are made
o Here, it was virtually meaningless given time limits
Allowed co. to entertain higher bids, but not seek them; didnt actually allow an
auction
 But market always knows these co. are entertaining offers; other potentials
werent for sureand no one would give up one deal without knowing another
is for sure; and they had hired an I-banking firm to go out and find people to
make better offers (based on contingency)
Court had two concerns with approaching price
Co. didnt seek to determine intrinsic value: theoretical value of company, based on analysis
of info; real value, or what price should be
o Just because its a premium over market value doesnt mean its a fair price cant
just look at premium of market price, but premium of intrinsic value
Fair? EMH says market value is best indicator
Court is suggesting that co. is really worth much more (court seems to
implicitly reject EMH) and thinks board knew market consistently undervalued
their stock
o But even if you think intrinsic value is worth more, might still be a better idea to take
whats offered now
Board/shareholders/market all thought their price was okay; I-banker just goes
with payer but worst person to decide is the court because not business
experts!
Co. didnt seek the best pricethey only sought what was fair price, not best price
o Came up with $55 by running numbers and determining the price at which LBO would
make sense
o LBO (leveraged buy-out): purchase of business financed primarily through debt, esp.
junk bondsif successful, end up with co. for free; if not, go bankrupt
Bondsprice based on risk. Low risk bond charges low interest.
Junk bonds/High yield bondhigher risk and higher return
o MBO (management buy-out): LBO by management
Court finds problematic that co. didnt negotiate terms
Why not negotiate under these circumstances?
o Two possible strategies in negotiations: offer what most willing to pay and negotiate up
or give best price and others negotiate down
o Here, D offered what most would be willing to payand got it (cant go back and get
more after other side accepts)
Any negotiations?
Pritzker didnt want market test; wanted lock-up option
Lock-up option: a provision in an acquisition agreement designed either to preclude a
competing bidder from acquiring a company or to provide compensation to the original bidder
in case it loses in a bidding contest (defense mechanism)
So even if Pritzker loses, he would still make a profit (compensation for efforts)but might
deter people from bidding since there are more shares then and buyer would have to buy more
CONCLUSION: directors acted grossly negligent and dont benefit from BJR held to damages

Aftermath
Here, BJR case but directors found liable
o Many people didnt even believe this was negligence, much less gross negligence
o Sophisticated board with no conflict of interests
o High price and unsuccessful auction
Sent shockwaves throughout industry people were afraid to be directors; insurance
companies were afraid (b/c didnt know where line of liability was)
 Result: Many states adopted statutes allowing companies to eliminate liability except in
worst cases
DE 102(b)(7): allows co. to limit directors personal liability for breach of duty of care
Exculpation statute: law that limits, or allows the limitation of, director liability for breach of
fiduciary duty
Doesnt eliminate duty of care, just damages for itso could still have equitable relief

Cede & Co. v. Technicolor Inc. (handout)

Facts: Similar situation to Van Gorkom, where directors quickly accepted a high offer with no
market test (makes it seem worse). Same court, just 8 years later.
CONCLUSION: court upheld Van Gorkom and remanded BUT on appeal, court found for
defendants anyway, strongly suggesting that DE has backed away from Van Gorkom

Conflicts of interest does not automatically invoke entire fairness test

Individual director v. entire board
o Individual directors conflict of interest does not invoke entire fairness test if rest of the
board doesnt have one
o Makes sense? Gets a pretty good business decision but hard to figure out how much
influence person has on rest of the board
Financial issues do not automatically invoke entire fairness test
Need materialitynot just going to be any financial interest, but a material financial interest
Materiality analysis: need material financial interest of more than one person to invoke
entire fairness test
Must be material to BOTH the independence of the individual director and the entire board
Duties in corporate law
Traditionally only talked about twothen called it triad of good faith, loyalty, and duty of care
o Good faith was never put on equal footing with care and loyalty
o Care: decision-making process
o Loyalty: conflicts of interests
o But court doesnt say what good faith is
Redefined relationship between Business Judgment Rule and Entire Fairness Test
Traditionally, thought of fiduciary duty as: (and how many still think of it as)

But this case applied it differently: Business Judgment Rule is a presumption that in making a
business decision, directors of corp. acted on an informed basis (i.e., with due care), in good faith and in
honest belief that action was in nest interest of the company
BJR is a presumption that directors fulfilled fiduciary duties, which plaintiff has to rebut
How to rebut with respect to duty of care? Gross negligence
With respect to duty of loyalty? Conflict that rises to level of self-dealing (though dont have to
prove that they actually did something wrong)
 With respect to good faith? Intentional misconduct
If rebutted, burden goes back to the defendant to prove fairness of transaction

BJR should be like rational review, but here, now it goes to EFT
P doesnt have to prove damages; D does now a heavier burden
Practically, this framework isnt that different from the traditional view
Very hard to prove gross negligence
So really, not that different from traditional model
o Only real difference is that with duty of care, were going to end up with EFT, but only
after rebuttal of BJR (which is difficult to prove)

Disinterested Approval
When there is a conflict of interest:
Use judicial scrutiny and apply EFT, but courts dont like to do that
Courts would rather eliminate the conflict of interest
Cede said:
o Conflicts have to be material (financial conflict)
o Conflict of one director not necessarily conflict of entire boardbut even though
theyre not directly conflicted themselves, may not completely be an arms-length
transaction
Mostly, corporate law has accepted that un-conflicted board members can make the decision
DE 144 specifically allows conflicted decisions to be made by un-conflicted decision makers
DE144: an interested transaction is not void/voidable because a conflict in a transaction if it is:
a: approved by fully informed, disinterested directors;
b: by fully informed shareholders, or
c: if its fair acts determined by the courts
Court interpretation: require entire fairness along with 1 of the three
Policy problem with what disinterested means
o Maybe court is uncomfortable with what disinterested means, so apply fairness on
top
Technical legal reason: statute just says that such transactions arent automatically
voidable if you do thisbut doesnt mean its automatically okay to do this
Clear that this is probably what statute meant despite language because DE adopted this from
other states that interpret this way
Bottom line: statute doesnt preclude fairness after the factonly voidable if its unfair
fully informed disinterested directors and fully informed shareholders
 But courts still read in disinterested shareholders
Reading this way just gets rid of common law
Not automatically void or voidable; still need EFT and courts are not going to approve it anyway
DE tends to say that if you have truly fully informed disinterested director or truly fully informed
disinterested shareholder approval, then BJR applies but if not truly the case, then entire fairness test
might still apply.
Cookies Food Products v. Lakes Warehouse (pg. 738)
Facts: Cookies and D (w/ distributing co.) entered into contracts. Later D became majority
shareholder. Minority shareholders complained that D was self-dealing: entering into contracts with himself,
royalty agreement for recipe, storage facility agreement, consulting agreement.
Rises to self-dealing: in a contract where on both sides; material b/c lots of money involved
Entire fairness looks at fair dealing & fair price (but must be examined as whole) (Kahn, 700)
Fair dealing (process)when the transaction was times, how negotiated, how approvals from the
disinterested directors and shareholders is obtained.
Arguments against fair dealing: didnt disclose profits (court rejected this); dominated the
board and replaced board with his peopleso essentially him making the decision
Arguments for fair dealing: previous directors had given him the contracts and now these
previous directors are the plaintiffs
Fair price (substance)
Arguments against fair price: he was overpaying himself; not paying dividends (but not big deal
since co. isnt required to pay dividends; and co. couldnt until recently)
Arguments for fair price: made co. a great success so he deserves the money, he has brought
the company much more than he got
CONCLUSION: dismissal of Ps claims affirmed
Court based its decision on success of business
Before D became majority shareholder, he had no fiduciary duty to them and his contracts had
been approved by previous disinterested shareholders (DE 144)
Dissent: maybe D did a good job, but that doesnt mean that:
Co. couldnt have made more moneybut majority probably doesnt want to get into that hypo
and co. was floundering before him
Or just because co. is making a lot of money doesnt mean that D isnt overpaying himself
Argument that another person couldve been brought in to do the work for lessbut that
person might not have the same skill; could they do same thing?
Kahn v. Lynch Communication Systems Inc. (pg.820)
Facts: Alcatel owned 43% of Lynch, but had veto power (require 80%). Lynchs independent
committee rejected Alcatels proposal to buy a co. so Alcatel tried to buy out Lynch. Committee rejected
three offers; then took $15.50 because no other possible offers (Alcatel could veto) and Alcatel threatened
to go to shareholders directly with tender offer of lower price.
Worried about tender offer here because they didnt want to be stuck with angry Alcatelit
only needed 7% more to have complete controlcourt doesnt focus on this, but focuses on
threat of tender offer at lower price (legal); unanswered whether all threats are wrong
Even without 144, conflicted directors can create independent committees (made up of
independent directors w/o conflicts) to make final decisions; theoretically, BJR
Alcatel had a fiduciary duty not to unduly influence other directors (almost certain that they
didnt have duty to not veto first transaction, but not issue here)
Court then discusses how an independent committee could sanitize an otherwise conflicted
transaction often by shifting the burden of proof on the issue of fairness (see below)
This was state remedy that VA Bankshares was talking aboutbut court said it cant be a lost
remedy because you either have a fully-informed group (no fraud) or dont have fully-informed
(then committee doesnt sanitize conflicted transaction)
CONCLUSION: committee acted because of Alcatels position, not Business Judgment burden
does not shift to P
Have to look at entire fairness (Alcatel still not safe under 144 w/ independent committee):
not really an arms-length board because Alcatel has control over Lynch (threats, veto over any
other alternative, got rid of troublesome management, record that they try to force people)
Standard of review: entire fairness with burden on defend we go back to default because we
dont have independent director approval
Have to decide whether independent committee is really independentlook for real bargaining
power

Burden and Shifts

 Director interest Shareholder interest
Default Entire fairness test Entire fairness test
Burden on D to prove entire fairness Burden on D to prove entire
fairness
Independent UNCLEAR (different cases say different Entire fairness test
director approval things) Burden on P*
Delaware: Entire Fairness Test with burden
on P
Some states: business judgment rule,
burden on P
Independent Business judgment rule Entire fairness test
shareholder approval Burden on P Burden on P
* But often difficult to prove that you have independent director approvaldirectors will be
appointed by controlling shareholder and that relationship has potential to influence (might not have fully
informed disinterested shareholders, just scared shareholders)
Why shift to Business Judgment Rule when director conflict of interest but still Entire Fairness Test
when shareholder conflict of interest
How great the shift depends on the source of the approvaldepends on how superior the
source of the conflict
If approval is superior source, then go with BJR
o E.g., shareholders approving director conflict; are superior BJR
o But if not a superior source, then stick with fairness and just shift the burden
E.g., directors approving shareholder conflict; directors are not superior to
shareholders stick with EFT
E.g., shareholders approving shareholders; not superior EFT
o But directors approving directors is an unclear area of independent director approval
Ratification
Definition: the affirmance by a person of a prior act which did not bind him but which was done or
professedly done on his account, whereby the act, as to some or all persons, is given effect as if originally
authorized by him
So if the shareholder vote was already legally required (e.g., for a merger agreement),
then that vote will not count as ratification and will not shift the burden of proof
If ratification was not required and was specifically requested, it will shift the burden of
proof
Cleansing effect of the ratifying shareholder vote is to subject the challenged director transaction
to Business Judgment Rule as opposed to extinguishing the claim altogether
Van Gorkom had said shareholder ratification would extinguish claim altogether
Gantler says it does not extinguishjust brings us back to BJR (though not that far from
extinguishing)

Corporate Opportunities
Corporate opportunity doctrine: a fiduciary should not take an opportunity for himself that belongs
to the corporation
Basic issue: is the opportunity a corporate opportunity or just a personal one
Factors:
Financial ability
 o The corporate has to have the financial ability to take the opportunity
No harm
o Irrelevant corporate can find a way to raise money; discourage the director who
wants this opportunity the incentive to find a way to finance for company
Line of business
o If in the same line of business, may be more likely that its a corporate opportunity. The
more closely related, the more likely
o Irrelevant big company can expand the scope of business
Conglomeration: doctrine of internal diversification
Interest or expectancy
o If corporate has interest in opportunity or expectancy arising out of interest
o Very vague and difficult to apply
Resulting conflict
o Fiduciary cannot have a conflict of interest
o Its better for the fiduciary to disclose and quit and then buy
Source of opportunity
o If you use the corporates assets (including time) in acquiring this opportunity or came
as a result of assets/time, then more likely to be a corporate opportunity
o Could be dispositive for corporate opportunity
Party involved
o The more significant/higher position the person is, the more likely we are going to say
its a corporate opportunity
o Reality: Officer>Director>Employee>Shareholder
Extent of involvementofficers are closer to the inside information to the
company and has the most responsibility of running the company
Fairness
o Considering all circumstances
o Not really a test, just what courts think is right.
Hawaiian International Finances v. Pablo (pg.780)
Facts: On behalf of co., D contracts land and gets commission through his realty company.
CONCLUSION: D is liable for commissions received
Company was hurt by thiscould have paid less if commission wasnt paid
o Even though argument that another realtor wouldve just gotten commission anyway,
we just dont want D in the future situation where hed work for himselfonce hes
conflicted, his loyalties arent going to be entirely to the corporation.
If Pablo had disclosed and company had approved, then Pablo couldve kept the commission
Couldve gotten to same result with accounting for profits (agent has to account for profits; give it
back even if principal isnt hurt)
 Northeast Harbor Golf Club v. Harris (pg.784)
Facts: President of golf club heard about properties surrounding the course being sold and
personally purchased. She then told the board, which took no formal action.
Is it a corporate opportunity? Not clear
o Financial abilitytrial court had said co. had no financial ability
o Line of businessclub was only a business of running golf course; but sometimes
thought of expanding
Golf will be interested in buying the land for not building the houses on the
land
o Interest or expectancydidnt seem that interested based on line of business; but
property adjacent would affect value of golf course
o Resulting conflictnot going to be direct competition; but maybe they disagree on how
property should be developed
o Source of opportunityclear case for the first property; source called D (president)
because he thought P would be interested in buying; a little bit vague for the second
property
o Party involvedshe was president, highest person on hierarchy
o Fairnessshe didnt tell them in advance before buying
CONCLUSION: adopted ALI test remand
ALI Principles of Corporate Governance 5.05: NOT law
(a) A director or senior executive may NOT take advantage of a corporate opportunity UNLESS:
(1) The director or senior executive first offers the corporate opportunity to the corporation
and makes disclosure concerning the conflict of interests and the corporate opportunity
(2) The corporate opportunity is rejected by the corporation; and
(3) Either:
o (A) The rejection of the opportunity is fair to the corporation;
o (B) The opportunity is rejected in advance, following such disclosure, by
disinterested directors, in a manner that satisfies the standards of the business
judgment rule; or
o (c) The rejection is authorized in advance or ratified, following such disclosure, by
disinterested shareholders, and the rejection is not equivalent to a waste of
corporate assets
Once P shows the opportunity is a corp. opportunity, it must show
either that D did not offer it to it or
that P did not reject it properly
o If P did not reject opportunity by a vote of disinterested directors after full disclosure,
then D can defend that the taking of the opportunity was fair to corp.
But if D failed to offer the opportunity at all, she may not defend
Fair test? Could be asking a lot to have directors/officers disclose everything they could have non-
corporate opportunities taken away just because they wanted to be safe and disclose
This court thinks you cant do after-the-fact approvalbut not what Principles of Corporate
Governance requires
(a)(3) gives you three different options: approval in advance by directors, shareholders, or its
fair suggests that if you have approval in advance, you dont need fairness; but you dont
need approval if fair in advance
Problem is that after-the-fact approval is dangerousprovides strong incentives for getting
approval in advance
Actually favorable for the director: both sides are going to evaluate at the same time. Why not
disclose earlier to let the company evaluate the opportunity before the circs changes and the
evaluation goes higher.
 Broz v. Cellular Information System Inc. (pg.794)
Facts: D was pres. of RFBC and outside director of CIS, which knew. D talked to CIS directors about
sale of cell-phone area, but all didnt want. 3d co. was negotiating to buy CIS stocks, and became owner.
CONCLUSION: for D
Corp. opportunity for CIS:
line of business suggests: yes
interest or expectancy: no. CIS was selling the license instead of acquiring the licenses
financial ability: No. CIS went bankruptcy
DE does not require disclosurebut disclosure helps (safe harbor that its not a corp. opp.)
Corporate opportunity and entirely fair are enough
o Assuming it was corp. opp., D was fair to CIShe was always upfront about his conflict
of interest; told them of opp. right away
o Argument that he wasnt: he didnt formally go to board to discuss/votecourt sees as
technicality
D did not have a duty to future companies or possible shareholders of CIS
Too speculative; doesnt owe to 3d parties where no fiduciary duties owed
Argument that he should owe a duty? 3d co. was going to acquire in 9 days and had means to
buy
Energy Resources Corp. v. Porter (handout)
Facts: Howard and P were to submit a grant proposal. Howard didnt want P involved, but wanted D
to form own co. to work on this project. When grant was awarded, D resigned; didnt tell P why.
CONCLUSION: D breached fiduciary duty
Corp. opportunity for P: used corp. assets; in companys line of business; co. had financial
ability; co. came to have this expectancy; resulting conflict
D argued that Howard refused to work with P so not a corp. opportunity but in order to
argue refusal to deal, must have unambiguously disclosed the opportunity together
with reasons for refusal
o If you didnt disclose, you are estopped from arguing refusal to deal defense
o Court wont just trust you; doesnt want after-the-fact manufacturing of reasonswants
to give co. chance to test the deal (if D had disclosed, P couldve made a better deal,
reassured, etc.)
Velasco doesnt think this is the case for a refusal to dealultimately it was
Ds opportunity/decision: he was the main guy; colleagues werent even that
important; D couldve worked with whomever he wanted; P wasnt important to
this opportunity

Duty of Good Faith

Good faith located:
Business judgment rule
o A presumption that, in making business decision, the directors of a corporation acted
in good faith, and
144board authorization
o if the Board or committee in good faith authorizes the contract or transaction
102(b)(7)director exculpation
 o provided that such provision shall not eliminate or limit the liability of a director for
acts or omissions not in good faith
Content of good faithbad faith:
HonestDishonesty
o Not trying to mislead
Sincerity (effort)intentional misconduct
o You are doing your best, you are really trying
Decencyoutrageousness
o Not being outrageous
LegalityIntentional violation of law
o Organizational documents and statutes
Different from normal duty of care/loyalty
Care talks about careful decision-making process
o Careless; but people get careless some time, doesnt mean you are bad
Loyalty talks about material financial conflict
o You can be conflicted but that doesnt mean you are evil
Good faith boils down to intentional misconductyou are bad
In re The Walt Disney Co. Derivative Litigation (handout)
Facts: CEO pushes co. to hire friend as president; co. agrees. Pres. doesnt work out and
terminating him triggers $130M payout.
Duty of care claim: no breach
They fell short of best practices, but they had adequate info, enough to make a decision
Standard of conduct says they shouldve done a lot more; but standard of review is lower (may
have been negligent, but have to prove gross negligence)
Duty of good faith claim:
P argues that trial court is using different standard of good faith, which is substantively
incorrectbut court says two different ways of saying same thing (all about intent)
Standard of good faith: the fiduciary intentionally acts with a purpose other than that of
advancing the best interests of the corp., where the fiduciary acts with the intent to violate
applicable positive law, deliberate indifference and inaction in the face of a known duty to act;
a conscious disregard for ones responsibilities
Mere gross negligence without more is not enough to constitute breach of good
faith
o But disregard of duty with intentional all sound like on same continuum of
negligence/recklessness (due care)?
o Dont want to conflate duty of care with duty of good faith; important to split up duty of
care and duty of good faith:
With duty of care, weve eliminated liability for breach of duty of care
(exculpation statute)
But company cant eliminate liability for bad faith
Stone v. Ritter (handout)
 Facts: Caremark claim: Employees violate law, co. gets in trouble, and shareholder wants to sue
directors for not preventing it (shouldve been aware & stopped)
Graham v. Allis-Chalmers (1963): absent cause for suspicion, no duty on directors to install and
operate a corp. system of espionage to ferret out wrongdoing
o Absent grounds to suspect deception, neither board nor senior officers can be charged
with wrongdoing simply for assuming the integrity of employees and the honesty of
their dealings on the companys behalf.
Caremark (1996): you have to put in a system that might catch these wrongdoings (even if no
suspicion, significant chance in a large corp. for wrongdoing; with systems in place, reduce
chance + general monitoring to run business)
o Caremark claim is duty to monitor sounds like care, but this court said its loyalty
o Caremark is about good faith (analogize to conscious disregard of duties)
o Duty of good faith is in duty of loyalty
Result: No more triad of fiduciary duties (good faith is part of loyalty)
Before: Duty of care; duty of loyalty and duty of good faith
Now:
o Duty of care
o Duty of loyalty
Traditional loyalty
Good faith
Consequences:
Leads to liability: Caremark was care; but now in loyalty duty of care was exculpable (clear
from blame), but now turn it into a case that is non-exculpable
Change of burden of proof: P bears a heavy burden in good faith claim by showing D are evil; D
bears a heavy burden in loyalty claim. to protect P
How do we satisfy monitoring?
Set up a system (Caremark said reasonable system)
How do we show intentional disregard?
Ignore red flagsfacts showing that board was aware but ignored the signs (consistent with
Graham); once you know, you have a fiduciary duty to act

Management Compensation
In re The Walt Disney Co. Derivative Litigation (handout)
Facts: Terminating pres. triggers $130M payout because agreed amount for non-fault termination.
Seemed reasonable: co. was trying to lure Ovitz away from agency co.; Ovitz wanted downside
protection but just because you pay market value for something doesnt make it a good deal
Negotiations? Ovitz wanted huge signing bonus, but co. negotiated for money on backend if he
stayed for awhile (sounds like good negotiations) but P argues they were shifting things
around, trying to make it look like negotiating; no reports when deciding, just general ideas
Two duty of care issues:
(1) Care in authorizing in the first place
o They werent careful, but careful enough to avoid liabilitywerent grossly negligent
 o Court said they knew enough; had two sources of info: demands and valuations
o Brehm v. Eisner (earlier case on pleadings): court said nobody made relevant
calculations for how much Ovitz was going to get if he totally failed
o But okay because directors deferred to compensation expert
DE 141(e): protects directors in relying on corp. documents,
employees, experts in good faith
So that directors can focus on making business decisions, not on waste
time in making sure each number is accurate
Limits:
You cannot count on the information that is clearly wrong
Experts clearly unqualified
If the director himself is the expert in that field
(2) Care in terminating the agreement
Prior agreement: Termination for cause means he gets nothing, but a no-fault termination
means he would get everything he wouldve gotten if he were successful
Ex ante, contracts are written so cause for termination is bad misconduct (protects a lot of
misconduct)so board couldnt get a termination for cause here because they contracted only
for truly extreme situations and now bound by it; board was fair
o Generous no-fault provisions exist b/c conflict of interest (Ks made by same people who
have them); saving money; recruiting device; protects risk-taking
Issue of waste
Waste in general
o Waste will almost never be found (here, borderline case, but still dismissed in Brehm)
o Tough standard: cannot be attributed to any rational business decision
Theres no way a reasonably informed board could make this decision; where
directors irrationally squander or give away corporate assets
Was termination payment waste? Court said they had to make payment under contract, so not
waste (if you have to do it, its not waste); also said co. was better off without Ovitz
P argues that contract was designed to incentivize Ovitz to get himself terminated (stronger
argument): court says its fanciful and without proof that Ovitz did thatbut issue is about
what directors did, not what Ovitz did
Did the directors enter into a contract so horribly designed as to constitute waste?
o Brehm (pleadings): there are incentives for Ovitz because he wouldve gotten even
more pay and options (but is it enough?)
o Sheer amount issue: courts do not want to look at dollar amounts; do not weigh,
measure, or quantify directors judgments trying to revert back to substance, but in
the end, courts reserve the right to look at numbers
o Brehm dismissed on pleadings instead of sending it to trial
Why not a loyalty case:
Courts have a hard time dealing with issue of friendship because they dont want to turn
everything into a duty of loyalty issue
Structural Bias
A prejudice that members of a board of directors may have in favor of one another and of
management
Three models:
Implicit conspiracy: pursue the same interests
Relationship:
o Friendship/collegialitynot going to be rigorous as other times; will overlook more
In group bias/psychological phenomenon:
o People always have a bias in favor of their group subconsciously and instantly
o i.e. Racial divisions, national divisions
Result:
Despite admitting that this was a troubling case in Brehm, the court still allowed the amount
under BJR then Disney decided no liability
So its not unfair to conclude that directors can do whatever they want and theyll be protected
by BJR

Compensation
Top executives make an astronomic amount; and growing
On the one hand, it may not really be a lot and just sounds like it to a normal person
On the other hand, maybe structural bias/conflict of interest is a real problem
 Arguments against Arguments for
Gap between executives Superstar mentality: see other areas
and regular employees continue to where superstars deserve it; similar to
grow superstars in corps.but superstars have
actual arms-length negotiations; not the case
with executives because in practice, youre
negotiation with your buddy (directors)
To get above-average talent, you
have to pay above-average salarybut it
cant be that everyone is paid above-average
salary
Solutions
Pay by performance or incentive compensations
You can align the interests of shareholders and management: both want to make stock
interests increase
Good/bad idea?

Good idea Bad idea

Wont be perfect fit, but will May not have expected
counteract disincentives of risk- result
taking incentivize management to Might create wrong
take more risk to get more incentives
compensation Problem of who sets the
standards
Too low or too high?
How do we judge?
Stock options: right to buy stock in the future at a price set at beginning of the contract
Provide incentive: if director/executive has option to buy stocks for the next 5 years, hell try
and raise the price of the stocks to buy
Problems:
o Stock price is going to rise anyway if we allow people to buy next years stock at $30,
even if price goes up to $40, they make money (almost) no matter what
So is it really tied to performance, or is it just natural expectation?
o Difficulty in determining how much we actually have to pay
o Bad incentives: other ways to make prices go up when fails to raise the stock price
legitimately
 Accounting fraud/ Engaging in a lot of risks
o Cheating by the company:
Backdating: Practice of dating a contract earlier than the date of actual
execution; in an options contract, it refers to setting an exercise price from an
earlier day, generally because it was lower
Backdating is a breach of fiduciary duty (lying)Ryan v. Gibbons
Backdating is illegal under Federal Security Law
Spring-loading: Practice of granting stock options before the announcement of
favorable news so that the recipient can benefit from the announcement
Could be legitimate provided its done properly; but problem if
deceptive or unauthorizedIn re Tyson Food
Bullet-dodging: Practice of granting stock options after the announcement of
bad news so that the recipient is not hurt by the announcement
Ex: Normally you give stock options on Nov. 3, but you know there will
be bad news to announceso you have management the hit
Say on pay by the shareholders
o Amount of compensation is clearly a business judgment
Courts dont really want to get into when/how/etc. pay someone
We have a special corporate rule because we trust managements judgment
but when we dont trust management (conflict), we use entire fairness test
Courts want to use business judgment rule, but critics are saying that there are
conflicts here
o This is an issue
Shareholders are angry about it
Starting to push for say on paythrough by-laws, have executives
submit compensation packages to shareholders for a vote
Wouldnt be a binding vote because shareholders do not run the
business
Some states, like DE, has changed the law to enable this (but not
require)
Federal government
Attempt to require greater disclosure: Regulation S-K
o Require one giant compensation figure
o Include compensation discussion and analysis of how
compensation was decided
Have suggested more substantive regulations in light of new
financial troubles
o Require say on pay
o Salary cap
o Limits on bonus (keep companies from being
competitive to draw out best talent)
But how much limit? And should it be same for
all companies?
o Should shareholders have a say on pay?
Agency model of corporation: maybe yes
 Trusty model: maybe no
Authority model: management should decide. Shareholders dont have that
competency of running a business
Democratic system: If shareholders dont like it they can come out.

Fiduciary Duties of Controlling Shareholders (II)

Zahn v. Transamerica Corporation (pg.804)
Special provisions in charter:
Voting rights: A had limited; B had control
Liquidation rights: A = Class B x 2
Redemption rights: company can redeem Class A at $60 per share at any time
o Redeem: force a buy-back of stock by the issuing co. pursuant to contractual right
Conversion rights: shareholder can convert Class A to Class B at any time
o Conversion: exchange of one security for another with the issuing company
Factual applications
If $60 in assets (co. is worth $60):
o If liquidate: A gets $40 (2/3 of total); B gets $20 (1/3 of total)
o If redeem: A gets $60 (redemption price); B gets nothing (everything else)
If $240 in assets:
o If liquidate: A gets $160 (2/3 of total); B gets $80 (1/3)
o If redeem: A gets $60 (redemption price); B gets $180 (everything else)
If co. is worth a lot, then B wants to redeem / if worth less, B wants to liquidate If co. is worth
a lot, A wants to liquidate / if worth less, A wants to redeem
Facts: A was mostly minority shareholders; B was mostly Transamerica (D). D wants minority
shareholders out, and co. is doing well (~$240 hypo). Caused co. to redeem As shares and liquidate.
What would a disinterested impartial board do? Have fiduciary duties to all shareholders, but
doesnt seem like theres one thing to do thatll favor all
o Litigation: Class A sacrificed their voting right to get their liquidation right and they
deserve that right.
o Redemption: Class A shareholders have a conversion right anyway and if they know
that there are $240 in assets, they would convert into Class B.
Ultimate problem: majority shareholders had a duty to disclose to minority shareholders
Problem wasnt the redemption (because if they did opposite of liquidation, would be favoring
minority)problem was lack of disclosure
Should the directors disclosed, Class A shareholders would have the opportunity to convert
their shares in good time.
But when [stockholder] votes as a director he represents all stockholders and
cannot use his office as a director for his personal benefit at the expense of the
stockholders (682)
But state court in Speed v. Transamerica said directors could favor Class B shareholders
 Knew what the terms were when buying A stockthat redemption of Class A stock was a
continuing option; plus, a co. would redeem for $60 when market value is above $60 (duh)
But its not really favoring one class over anotherjust saying that once you have special charter
provisions, you have to give shareholders realistic means to be able to execute them if wanted
Needed disclosure because of the conversion featureits an independent right to trade up;
A would want to convert whenever B shares were worth more
So co. can redeem you, but you also bargained for the conversion featureso the co. has to
treat you fairly with respect to that
Directors owe fiduciary duty to the shareholders to disclose them the information when the
directors asked/caused the shareholders to act or to make choice.
Jones v. H.F. Ahmanson & Co. (pg.833)
Facts: Difficult to sell Assoc. shares. D exchanged Assoc. for United Financial shares (250 for every
1 Assoc.) and then sold UF shares. UF share prices rose tremendously; but Assoc. became even more
unmarketable. Assoc. minority were denied access to UF action. Later given chance, but at distorted value.
RULE: majority shareholder has duty to minority shareholder of fair dealing
Shareholder can do what he wants with his assets; but cannot use corporate assets to harm
other shareholdersstill cant do it here even though harm was not with corp. assets
Majority could have let corp. engage in a stock split: technical splitting ea. share into 2 or more
shares
Just split each share into 250 shares and make them more marketable
Easy to dojust amend the Charter
Why not to split: But majority might have wanted to retain control with a smaller percentage
by leveraging control through another intermediary (have control of UF, which has control of
Assoc.), need less to maintain control
It could have been easy for the majority shareholders not to harm the minority shareholders but
they chose to harm.
Perlman v. Feldmann (pg.853)no longer good law
Facts: P argues that D cant pocket premium money; all shareholders should share in that money
CONCLUSION: for Ptheory is that D shouldnt be able to sell 100% of the control for 51% of the
sharespeople are paying a premium to capitalize on that control
GENERAL RULE NOW: majority shareholders can sell at a premium
Absent looting of corporate assets, conversion of a corporate opportunity, fraud or other acts
of bad faith, a controlling stockholder is free to sell, and a purchaser is free to buy, that
controlling interest at a premium priceZetlin v. Hanson Holdings (720)
Argument: The shareholder is not just selling the shares, but also selling the control
o But its true all the time.
Mere fact that youre selling is not breaching your fiduciary duty
Fiduciary duty requires much more, such as fraud, or if the shareholder is selling to a
known looter.
o Difficult to sue looterwill do things that BJR would protect (but doesnt make sense
because if you cant sue seller, how can you sue the looter?); cant catch them
Suspected looter
o now cant sell to a suspected looter for something he may do and for someone who
might flee and we cant find
o But who to suspect? How much suspicion?
Paying a premium?
The mere fact that a person keeps buying failing companies doesnt necessarily
means he is a looter.

Shareholder Suits
 Shareholder rights Shareholder Protections
Voting Elections
Charter amendments Allow shareholders to kick out directors
Other proxy solicitation access But problem of rational apathy
Etc.
Selling Markets
Products: directors need to make company
profitable
Credit markets
Security markets
Market for corporate control
o If like co., buy more shares if others
like, drive prices up
o If low, sets up for hostile takeover
Information
Sue Courts
As a last resort, can sue

Shareholder Suits (2 kinds)

Direct Actions: Lawsuit initiated by injured person on her own behalfshareholder sues on behalf
of shareholders specific rights
Very few direct actions in Corporate Law
Limited things a shareholder can sue directly on:
o Declared dividendsif the corporation has already declared dividends, and they dont
pay you, you can sue under direct actions
Corporation can always choose not to declare dividends
Denial of voting rights
Securities law violations
Derivative Actions: A lawsuit initiated by one person on behalf of another, especially, in corporate
law, a suit brought on behalf of the corporation by its shareholders
Example: embezzlement, breach of fiduciary duty
Why allow derivative actions:
o Director conflicts
Nobody wants to sue himself or his colleagues
o Police misconduct
Allowing shareholders to sue brings back accountability and allows policing of
directorial behavior
o Enforce indirect shareholder rights
Shareholders are ultimate beneficiaries of the corporation
Why not allow derivative actions:
o Director authority
141a: directors make judgment. And suing is a business judgment
Legit reasons why not to sue even there is a harm:
Cost of litigation
Business relationship worth to settle than to sue
 To avoid potential counterclaims
Hurt your own reputation by bad press
Uncertainty of success
Time and effort consuming
o Shareholder incompetence
Shareholders arent necessarily business experts
Too many shareholders a huge bite on courts if any one of them can sue
Shareholders can actually be crazy
o Litigation costs to litigants, courts and society
o Incentives
Director incentives
Directors have a low chance of liability due to Business Judgment Rule,
but once lose, the liability can be fatal
Directors might like to settle and let the corporation to pay the spends.
Settlement is dangerousmight encourage even more suits.
Shareholder incentives
Dont have much incentives because the expense come out of their
own pocket. They are risking their own money yet the compensation
will go to the corporation and shared by everyone. And the only thing
shareholder can get is the attorney fees.
Attorneys incentives
Profitable: either win the trial or settlement get an award of
attorneys fees + directors strong incentive to settle
Rise of entrepreneurial attorney: attorney acting as a businessperson
with respect to lawsuits, making investment decisions with her time
and taking the risk of profits and loss.
Give rise to strike suits: lawsuit initiated not with the intention of
winning on the merits, but with the intention of obtaining a profitable
settlement.
Test on whether derivative action or direct action:
Who suffered the alleged harm
Who would receive the benefit of any recovery or other remedy
o If both shareholders direct action
o If both director derivative action
Tooley v. Donaldson, Lufkin & Jenrett Inc. (pg.1057)
Facts: D was acquired by CreditSuisse which allowed for certain delays in the merger. The minority
shareholders sued because of the delay (loss of time-value of money).
CONCLUSION: not a derivative action no recovery to the corporation
but also not direct because theres no cause of action at all
Test applied by lower court:
 Special injury test
o A wrong that is separate and distinct from that suffered by other shareholders here,
the delay affected all the shareholders equally, no special injury so has to be derivative
A better test as long as you have the right and its harmed, you should be able to sue on your
own behalf, regardless to the fact that every shareholders are harmed.
Supreme Court applied the test above.

Derivative action and direct action in close corporations

Barth v. Barth (pg.1065)
In a close corporation case, court may use discretion to treat an action raising
derivative claims as a direct action if it finds that to do so will not:
(i) unfairly expose the corp. or defendants to multiplicity of actions;
(ii) materially prejudice interests of creditors; or
(iii) interfere with a fair distribution of the recovery among all interested persons
Facts: P brought a direct action, but seemed derivative because the harm was to the corp.
(misappropriated fundstaking money from corp.) and recovery would go to corp.
CONCLUSION: reversed trial courts dismissal
Some policies might not apply in close corporations
Shareholders in a close corporation stand in a fiduciary relationship to each other, and as such,
must deal fairly, honestly, and openly with the corporation and with their fellow shareholders
No concern to the corporation creditors
No other non-participating disinterested shareholders involved
Court is not saying that if its close corp., itll always be a direct actionjust that if policies suggest
we dont need it to be a derivative action, we will make an exception

Settlement
Clarke v. Greenberg (pg.1144)
Facts: P brought derivative action, settled for a private recovery, and other shareholders sue to
share.
Why would we allow P to settle? P used own money to bring suit and has decision to keep going
(otherwise, then saying you have to keep spending own money to help corp.)
Why not allow to settle? Its really the corporations suitharming other shareholders who
could share in large recovery; could enhance strike suit potential; directors have incentive to
settle and may pay larger amount than what P is entitled, but not as much owed to corp.
CONCLUSION: P is accountable to corp. for amount received
What to do about attorneys fees?
Normal situation: shareholders attorney gets the attorney fee paid.
Here: same
In most cases, its the attorney who has the bad incentive decision, the problem unsolved if
we let the attorneys get the fees
Dismissal of derivative actions: a derivative action shall not be dismissed or compromised
without the approval of the court, and notice of the proposed dismissal or compromise shall be
given to shareholders or members in such manner as the court directs.
 Standard of review: fairness, reasonableness and adequate

Limits on Shareholder Suits

Limitations on standing
Contemporaneous ownership rule
Shareholder has to have had ownership when harm occurred and has to maintain ownership
through to judgment
Reasons:
o Prevent the manufacture of the shareholder. Particularly dont want entrepreneurial
attorneys to manufacture Ps
Rifkin v. Steele Platt (pg.1080)
Facts: both derivative and direct actions. Harm done prior to Ps acquisition
o Direct action: fraud
o Derivative action: the bad thing done that hurt the corporation
CONCLUSION: remand to consider whether purchase price reflected prior wrongdoings to
prevent a windfall.
o The corporation could not maintain the action for wrongs that occurred before the new
shareholders acquisition of the shares
Demand requirement
Shareholder must have had a demand on the directors that they pursue the action complained
of
o Shareholder must ask the board of directors to sue on behalf of corporation
Exceptions:
o Demand futility
When there is conflict of interest (such as suing a director personally, silly to
ask him)
o Irreparable harm result from making the demand
If there is a time-sensitive issuea delay itself by the board would cause harm
Eg. An injunction to stop a merger
Different standards for demand futility
o New York:
When the demand is futile
Majority of the directors are interested in the transaction, or
The directors failed to inform themselves to a degree reasonably
necessary about the transaction, or
The directors failed to exercise their business judgment in approving
the transaction
When the futile demand is excused:
 When a complaint alleges with particularity that a majority of the
board of directors is interested in the challenged transaction. Either
self-interest in the transaction, or loss of independence because
controlled by a self-interested director
Sounds like duty of loyalty
When a complaint alleges with particularity that the board of
directors did not fully inform themselves about the challenged
transaction to the extent reasonably appropriate under the circs
Sounds like duty of care
When a complaint alleges with particularity that the challenged
transaction was so egregious on its face that it could not have been
the product of sound business judgment of the directors
Sounds like waste; duty of good faith
Particularity: insufficient merely to name a majority of the directors as parties.
Marx v. Akers (pg.1086)
Facts: Shareholders bring derivative suit, alleging excessive compensation of
IBM directors. Shareholder argued demand futility.
Derivative b/c corp. is harmed by paying too much salary
CONCLUSION:
demand is futile as to the compensation set for outside directors,
but not futile for the compensation set for the executive officers.
o Delaware:
A reasonable doubt on whether
Directors are disinterested and independent (duty of loyalty), and
The challenged transaction was the product of a valid exercise of
business judgment (duty of care)
Whether the directors exercised due care on both
o Procedural (informed decision) and
o Substantive (terms of transaction)
Very easy to establish a reasonable doubt
Easier than New York reasonable doubt of honesty v.
reasonable belief of dishonesty
If you make a demand, you waive the demand futility exception
If you have a choice of demand futility, you should choose it, because if
there is no demand futility, you will face something resembling the
Business Judgment Rule.
Allow the board to make the decision, give honest directors a
chance to deal with issue honestly
o If agree bring the action
o If reject they should record why not and judge will
determine whether they were right or not
o Dilemma: argue demand or argue demand futility
Demand: Business Judgment Rule, easy to lose
Demand futility: hard to fulfill particularity requirement
 No benefit to discovery
o Universal approach (Model Business Corp. Act)
A demand is required in all cases without exception
The commencement of a derivative proceeding is permitted within 90 days of
the demand
Unless the demand rejected earlier
Or irreparable harm
Independent committee Zapata Corp v. Maldonado -Delaware (pg.1103)
o Facts: Derivative action against 10 officers. Demand was futile because of great conflict
of interest. The co. moves to have case dismissed.
o Issue: Structural biassubconscious abuse
Co. formed an independent investigation committee with brand new directors
(who theoretically wouldnt have conflict) whose decision was binding and final
(board can give final authority to committee via statute) but court
realistically recognizes that these new directors have to vote against their
colleagues who voted them to the board (structural bias concern)
o Two-step test
The court inquires into the independence and good faith of the
committee and the bases supporting its conclusions
The court determines, applying its own business judgment, whether the motion
should be granted
Court has a serious concern on structural bias
But judges are not business experts.
2nd prong really no much impact
Many states such as New York refuse to follow such test
Court has created an intermediate standard of review
o Processwe trust directors BJR
o Material financial conflict of interestwe dont trust directors EFT
o Derivative where we dont quite trust directors but no material financial conflict
intermediate standard of review where directors prove independence
Independence v. Disinterestness
o Being disinterested: not having a material financial stake (traditional duty of loyalty)
o Being independent: able to make decision on substantive merits, rather than on
extraneous influences
Difficulties of pursuing derivative actions
First face contemporaneous ownership rule
Then face demand requirement
o If you demand BJR
Then have to face special litigation committee
Find a breach of standard of review (not just that they were negligent,
but grossly)
 And if it happens to be a duty of care case, exculpation and no
damages
But if duty of loyalty case, corp. gets recovery
o If you argue demand futility need to make particularized allegations w/o benefits of
discovery

Exculpation, Indemnification and Insurance

Exculpation
States have passed exculpation statutes that limit director liability for breaches of duty of care.
DE102(b)(7)
Purpose of the statute: permit shareholders to adopt a provision in the certificate of
incorporation to free directors of personal liability in damages for due care violations, but
not duty of loyalty violations, bad faith claims and certain other conducts.
o Freed up directors to take business risks without worrying about negligence lawsuits
Affirmative defense
Burden of proof: on directors
If P is only seeking damages and case only has duty of care issues, then notwithstanding that
exculpation is an affirmative defense, courts can dismiss on the pleadings
Malpiede v. Townson (pg.684)
Facts: Co. approved offer with no-shop provision; when someone else offered, original offered
higher with no-talk provision. P claims that directors breached their duties under Revlon by entering into a
no-talk agreement; D argues that this case should be dismissed because of exculpation clause.
No-shop: cant go shopping for better offers, but could entertain better offer
No-talk: may not even entertain a competing offer until current offer is dealt with (buyer will
offer more and seller doesnt think hell get more offers; but illegitimately used if agree with
first person to come along)
Court dismissed duty of care claim
Ps are entitled to all reasonable inferences flowing from their pleadings, but if the inferences do
not support a valid legal claim, the complaint should be dismissed without the need for the Ds
to file an answer and without proceeding with discovery
Court said P didnt show sufficient facts for a breach of duty of loyalty (didnt show conflict)
left only duty of care
o Ds will raise the exculpation statute to bar the claim no valid legal claim
If P also alleged breach of duty of loyalty D would have to argue that they didnt breach duty
of loyalty in order to raise the exculpation defense.

Indemnification
DE145:
(a) allows for indemnification in direct actions
o if the directors sue directly
o only if he is acting in good faith in the interest of the corporation
(b) allows in derivative actions
o good faith
o the indemnification has to be approved by the court as fair and reasonable
 (c) requires indemnification if D is successful on the merits or otherwise
o If they win, the corporation MUST indemnify them
(d) requires specific authorization for any indemnification payment under (a) or (b)
o means if you lose, you need specific authorization
(e) allows advancement of expenses
o allows company to advance litigation expenses, so hopefully you will win
o Also provides that the agents have to reimburse corporation if it turns out they were
not entitled
(f) allows additional rights (via charter)
(g) allows liability insurance
o Instead of paying huge amounts for indemnification, just pool money together for
insurance
o Even if indemnification isnt allowed, can still have liability insuranceto offer
incentives for people to become directors
o Difference between indemnification and insurance
Insurance: outside money is paying
Waltuch v. Conticommodity Service (pg. 1121)
Facts: P was vice-president of D. Clients sued both and in the settlement D ended up paying
$35mil. Claims were eventually dismissed against P. P sued for indemnification.
CONCLUSION: P is not entitled to indemnification under charter provisions, but entitled because of
145(c)
Not entitled to indemnification under Charter provisions:
o 145(a) and (b) both say that agent has to be acting in good faithP wasnt even
arguing good faith because didnt have good argument
o (f) says rights are not exclusive and can be expanded under terms of charters
but this cannot be in contradiction to the statute
You cannot allow what the statutes explicitly prohibits
(g) says we can insure even when we cant indemnifyso that means there are
situations where we cant indemnify
Focuses on two words: rights and powers
(a) and (b) say corp. shall have power to indemnify: what you can do,
an authorization clauseanything thats not in here, you cant do
(f) says additional rights, not powers (rights can be expanded, as long
as not inconsistent with power)
Entitled to indemnification under (c):
o (c) requires indemnification if defendant is successful on merits or otherwisehere,
case was dismissed
o Court: P wasnt successful on merits, but was successful otherwise
Escape from judgment, for whatever reason, is vindication and allows
for indemnification under (c)
What rights you can expend under (f)?
Mandatory indemnification wherever it is permissible by statute
 Mandatory advancements, as opposed to permissive
Accelerated procedures for indemnification
Litigation appeal rights
Default indemnification procedures
Reasonable funding mechanisms
Citadel v. Roven (handout)
Facts: Roven demanded indemnification greater than the charter provided when he became a
director. Someone brought a 16(b) lawsuit against him and he demanded advancement for costs. 16(b)
lawsuits (insider trading) were not covered by indemnification agreement
But Roven argues that advancements are unconditional
CONCLUSION: Citadel required to pay advancements to Roven
Advancement provision was unconditional (co. will pay for advancements); was independent
of the indemnifications paragraph
Advancement not conditioned on indemnification makes sense without absurd result (but it
does sound absurd here since co. wouldnt indemnify him on 16(b) claims anyway)
But advancements have to be reasonable

Shareholder Rights to Information

Inspection rights: right of a shareholder to inspect the corporations books and records
State law provides that shareholder can get basic documents (charters, bylaws, minutes, list of
shareholders) and other documents under certain circumstances (studies, reports, etc.)
Delaware220
Reason allowing inspection rights:
As a matter of self-protection, the shareholder was entitled to know how his agents were
conducting the affairs of the corporation of which he or she was a part owner.
Limits on shareholders right to information
Shareholders must have a proper purpose to seek information
o Proper purpose: purpose reasonably related to such persons interest as a shareholder
Intent to sue derivative action
Wage a proxy battle
Investigate a wrongdoing
Determine the value of shares
o Mixed purposes: As long as you have one proper purpose, the secondary purposes are
irrelevant.
Contemporaneous ownership rule: Shareholders at the time of the transaction
o Exceptions:
Continuing wrong
 Foundation in events that transpired earlier
Seinfeld v. Verizon Communications. Inc (handout)
Facts: P wanted to investigate if executives were being overpaid. P provided no evidence
suggesting credible basis; wanted to change law (doesnt make sense to require evidence in order to
gather evidence)
Credible basis RULE: in order to seek inspection, you have to provide some evidence to
suggest a credible basis from which you can infer a wrongdoing, etc. (38)
Court says this is the lowest possible burdenwe just want some evidence
Suggests that general concerns to monitor is not enoughotherwise, wed have to always
allow inspection
Reasons:
o We dont want fishing expedition. We dont want shareholders to hide their real intent
to get the information
o Monitoring is costly
o So many shareholders, one allowed, everyone is going to ask for information
A proper purpose for one type of documents doesnt mean you can inspect all documents you
want
Other rights
List of shareholders
Shareholders often want shareholder list to communicate, particularly to wage proxy contest
Required disclosures
Generally law doesnt require corporations to make disclosures to shareholders
Exception: whenever corporation is requiring any kind of shareholder action, you must give
information
Duty of candor
Cannot lie or mislead
Traditional: complete candor
State courts standard (esp. Delaware): materiality
Eventually, federal securities law takes care of it

FEDERAL SECURITIES LAW

History of securities regulation
State securities regulation
Common law fraud
Blue sky laws
o Merit regulationstates would decide the merit of securities, you have to get the
approval of the states if you want to sell
o Didnt help all that muchlimited jurisdiction; poor enforcement
Stock Market Crash of 1929 gives rise to federal securities regulation
Originally supplemented state regulation then displaced the state regulation
Features:
o Trying to help people to make good decisions
o Mandated disclosure
o Antifraud liability much stronger than common law fraud
o No merit regulation
Federal Securities Laws
Securities Act of 1933
Regulates primary markets (IPO etc.)
Mandate disclosure
o Must register securities and deliver prospectus before selling securities to the public
File detailed registration statement with SEC
SEC reviews it not for accuracy but for adequacy
Deliver prospectus to investors: documents used to offer securities for sale in a
public offering
Unless exemption is available
Antifraud liability
o Company is responsible for false or misleading statements/omissions of material facts
(deception)
No lies, no misleading, no half truth.
Securities Exchange Act of 1934
Regulates secondary markets: market for securities sold by investors among themselves
o Much larger than primary market; after corporation initially sells
Mandate disclosure
o Must file periodic reports on company performance (detailed one annually, updates
every quarter)
o Must file additional reports under certain circs. (eg. Merger)
Antifraud liability
o Manipulation or deception
o Deception on companys part
o Liability of seller
Regulates securities industry generally
 o Securities and Exchange Commission (SEC) oversees enforcement of the federal
securities law
Federal securities law v. State corporate law
State corporate law: form prevails substance
Federal securities law: most courts do opposite
o No need to worry about race to the bottom

Rule 10b-5
Congressionally delegated authority
Content:
Forbids, in connection with purchase or sale of securities:
Devices, schemes and artifices to defraud
Practices which operate as a fraud or deceit
False or misleading statements or omissions of material fact
Enforcement:
By SEC
By private investors through an implied cause of action
Elements:
Interstate commerce (commerce clause)
Almost always satisfied in reality
Material misstatement or omission: material deception
Scienter: intent to deceive (or recklessness is sufficient)
Connection with a purchase or sale of securities
Reliance
Causation
As opposed to just correlation
Damages: can only recover economic loss
Basic Inc. v. Levinson (pg.915)
Facts: Basic was in merger negotiations with Combustion, but denied when shareholders asked.
After a later merger announcement, shareholders sued the company for misleading them.
Standard of materiality: a substantial likelihood that a reasonable shareholder would
consider it [the disclosure or omission of the information] important in deciding how to act.
Merger negotiationspeculative. Cannot tell whether or not there would be a merger
 Probability/magnitude approach expected value calculation
o Look at both the magnitude and probability
[chances it will occur][the impact it will have]
lower court Agreement-in-principle [rejected]
o Merger discussions do not become material until the price and structure of the
transaction has been reached between the would-be merger partners.
o Merger is the most important event in a close corporation, negotiations can become
material at a much earlier stage because of great magnitude
But doesnt mean merger negotiation is always material, court merely means
that the merger negotiation is not always immaterial.
No specific duty to disclose a merger
o Materiality is about the accuracy of the information, not about the timing
o Absent a duty to disclose, corporation can simply keep silent, but cannot be
misleading, cannot lie
o If someone asks you whether there are merger negotiations, follow a consistent
functional equivalence of silence (no commentbut if you say no sometimes, then
people will understand it to mean yes)
Class action & Reliance:
Fraud on market theory: a rebuttable presumption
o Sounds like efficient market hypothesisprices will reflect all publicly available
information (semi-strong EMH)people rely by relying on stock price.
No one believes that EMH is completely true
o Class action management tool: adopting a rebuttable presumption just allows litigation
to proceed; P is supposed to prove reliance (an element), but its too hard for every P in
a class action to show reliance so in a class action, we presume they relied
o But might not be fair (dissent says not fair)getting rid of reliance just because its
difficult to prove and on a theory thats not completely accepted
o How to rebut:
Each of the P did not rely
The market makers didnt believe the lie therefore didnt reflect the price
Theres not an efficient market the market doesnt reflect the information
quickly
Connection with a purchase or sale of securities
Corporation was not trying to buy or sell anything or causing people to buy or sell securities, a
mere merger negotiation
Very expansive approach, almost always a connection
Santa Fe Industries v. Green (pg.928)
Facts: D owned 90% of Kirby lumber. They wanted to eliminate the other 10%. This was allowed in
DE as long as the minority shareholders were paid fair market value. D had the shares valued at $125 and
offered shareholders $150 for them. P believed they were worth $722. Instead of seeking an appraisal
under state law, he sued under 10b-5.
Ps claims: fraudulently acquired low-valued appraisal; improper purpose to freeze out minority
shareholders (breach of fiduciary duty)
Issue: Does Rule10b-5 reach fiduciary duty?
HOLDING: No cause of action for breach of fiduciary duty or any other substantive
complaint under Rule 10b-5 unless there is manipulation or deception
Rule 10b-5 is not about breaches of fiduciary dutyunless theres manipulation/deception
 o Not all fiduciary duties are about manipulation/deception Rule 10b-5 is about
fairness
o This was not a securities issue, for 10b-5 purposes
But P is not without a remedystate law specifically allows for an appraisal
Fundamental purpose of 10b-5: full disclosure; everything else is secondary
Here: the minority shareholders were furnished with all relevant information on which to base
their decision. Their choice was fairly presented, they can either accept the offer, or reject it
and seek an appraisal.
Price: P said shouldve been $772 Morgan Stanley said $125 D offered $150
Liquidation value was $640 going concern value was $254
Which one is fair price?
o Doesnt matter as long as the company disclosed the information

Insider Trading
Definition: use of material, non-public info in trading the shares of a company by a corporate
insider or other person who owes a fiduciary duty with respect to such information
State law:
Liability in face-to-face transaction v. in stock exchange
o Face-to-face transaction: trust based on knowing each others identification the issue
of fraud or reliance
o Stock exchange: your sale is different from my purchase. There is an impartial market
SECs position on insider trading law:
inside information cannot be used to gain profit
Disclose or abstain rule: anyone in possession of material inside information must either
disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate
confidence, or he chooses not to do so, must abstain from trading in or recommending the securities
concerned while such inside information remains undisclosed.
Why inside information is inherently fraudulent
A justifiable expectation of the securities market that all investors trading on impersonal
exchanges have relatively equal access to material information.
Chiarella v. U.S. (pg. 968)
Facts: D worked for a financial printing company. There was a tender offer and Chiarella, by virtue
of his job, identified it and bought shares of target stock though a broker. When the takeover was
announced, his shares rose and he sold. He was charged with violating 10b and 10b-5.
The insider trading has to be deceptive to be actionable under Rule 10b-5.
Insider trading is not necessarily deceptive but insider trading with a breach of fiduciary duty is
deceptive
Silence absent a duty to disclose is not deceptive (Santa Fe), but silence in face of a duty to
disclose is deceptive and actionable.
o When do you have a duty to disclose material information:
When material facts known to one party by virtue of their position but are not
known to persons with whom they deal and which, if known, would affect their
investment judgment
When one party has information that the other party is entitled to know
because of a fiduciary or other similar relation of trust and confidence between
them
Here: Chiarella is an outsider no fiduciary duty owed to the person he brought stock from, no
deceptive conduct
 Dirk v. SEC (pg.991)
Facts: Former insider informed D that co. was engaged in fraud. D investigated and he revealed
information to investors, many of whom sold their stock. Fraud was exposed. After officers were convicted
of fraud, SEC went after D.
D didnt directly profit/trade off this infobut not a saint; SEC went after him mainly because they
wanted to expand Chiarella
Where tippees, regardless of their motivation or occupation, come into possession of material
information that they know is confidential and know or should know came from a corporate
insider, they should disclose or refrain from trading.
Supreme Court: rejected it. No better than Chiarella
o Too broad to say anyone who CEO talked to have a fiduciary duty to disclose
2-part test: a tippee assumes a fiduciary duty to the shareholders of a corporation not
to trade on material nonpublic information ONLY WHEN
The insider has breached his fiduciary duty to the shareholders by disclosing the
information to the tippee
o Insider breaches fiduciary duty when theres a personal benefit to the insider from the
breach
o Fiduciary duty can be breached even without a personal benefit
o A broad interpretation of benefitboth direct and indirect benefit
The tippee knows or should know that there has been a breach of fiduciary duty
Application:
Under this test, insider did not receive any personal/monetary benefit he was motivated by a
desire to expose the fraud
If insider didnt do anything wrong, then D didnt inherit insiders fiduciary duties
Chain of inherit: unbroken chain of fiduciary duty is needed for the fiduciary duty to be inherited

United States v. OHagan (pg.976)

Facts: D was a partner in a law firm, which represented GM while made tender offer to acquire
Pillsbury. D knew that price was going to rise so he began buying Pillsbury stock and sold them for a huge
profit. The SEC brought charges on misappropriation theory.
Tender offer: public offer to buy a min. number of shares directly from shareholders at a fixed
price, usually a substantial premium over market price, and usually part of a takeover attempt
o A great opportunity for insider trading
Classical theory doesnt workOHagan is the insider of GrandMet but not Pillsbury
SEC expanded the ruleMisappropriation theory
A fiduciarys undisclosed, self-serving use of a principals information to purchase or
sell securities, in breach of duty of loyalty and confidentiality, defrauds the principal
of the exclusive use of that information.
Here: D deceived the company because he breached his fiduciary duty of confidentiality to
GrandMet
Chiarella result would be different from this case
o Misappropriation theory, he would not get the insider information if he doesnt work for
the printer. By using the information he got from the printer by trading with the
company, he breached the fiduciary duty to the printer as an agent of the printer,
which required him to keep the information secret.
Loophole: disclosure kills liability
If the fiduciary discloses to the source that he plans to trade on the nonpublic information,
there is no deceptive device and thus no 10b violationalthough may still liable under duty
of loyalty
 Connection with purchase/sale of securities
The misappropriation theory requires deception in connection with the purchase or sale of any
security, not deception of an identifiable purchaser or seller.

Rule 14e-3
Created after Chiarella and Dirks
Nobody can trade on material non-public information regardless of fiduciary duty adopting
disclose/abstain rule
14e v. 10b
Both anti-fraud provision
Differences:
o 10b:
Delegation to SEC is limited on prescribed manipulation and frauddefine the
fraud
Scope: covers all kinds of security exchanges
o 14e:
broader delegation
Reasonable designed to prevent manipulation and fraud, even things
that are not perceptive, just to make sure that there will not be a fraud.
Scope: limited to tender offers.
If a tender offer case, dont have to look at Chiarella and Dirks. They
are still good law

BUSINESS COMBINITION
Acquisition
Acquirertarget
Three main ways to do acquisition
Stock purchaseacquisition in which an acquirer buys the stock of the target from the
shareholders
The target becomes a subsidiary of the acquirer, but most of the time will not b a 100% owned
subsidiary
A+B=A+B
Purchase shares directly from shareholders
Two different companies before or after acquisition
No approval necessary directors dont have a say because each shareholder is deciding for
himself whether to sell or not
Asset purchaseacquisition in which the acquirer buys the assets (and often liabilities) of the
target
A+B=A
 o Technically 2 companies, but only one operating company and another becomes a shell
company, normally formed for a specific purpose
o Theres going to be only one company in the end.
o Need approval from targets shareholders and directors
Director approvalselling assets
Shareholders approvalspecific state law requirement
Eg. Selling substantially all the assets of the co.
Reason why shareholders have a say is ONLY because law says so.
o Approval from acquirer is not necessarily required
Merger: acquisition in which acquirer & target combine into one surviving company
A+B=AB(A, B or C)very flexible in how to structure
One company remains
Constituent corporation: party to a merger (A & B)
Surviving corporation: constituent corporation that survives
Need approval from BOTH companies directors and shareholders
Procedures: each state has a statutory provision authorizing this
DE251
o Prepare merger agreement
Controlling document
Including consideration for the shareholders, such as which one is the surviving
corporation, how the new Charter is going to be
o Approval of directors of each company
o Approval of shareholders of each company
One of the few things shareholders can vote on
DE standard: true majority50% of all the controlling shares entitled to vote
Non approval = no
o File with Secretary of State (certificate of merger or merger agreement)
Certificate of merger: considerably shorter
o Dissenting shareholders have appraisal rights
Appraisal right: the right of a shareholder in a constituent corporation to forego
the contractual consideration in a merger (or similar transaction) and to receive
instead the fair value of the shares; a.k.a., dissenters rights.
If you have a merger between corporations of two different states, apply both merger
standardstake the one thats most demanding and comply with both
Consideration:
 Standard merger
o Consideration is shares in surviving corporation
o Number of shares depends on value of constituent corporation
Figure out what the appropriate ratio is
Legal possibilities
o Any consideration: securities, cash, property
o Can provide different consideration for different people
Cash-out merger: one companys shareholders receive cash instead of shares
in the surviving corporation.
Starts to look like asset purchase
Clear who is acquirer (end up with everything) who is target (end up
with cash)
Merger of equalsa merger that has no real acquirer or target
and each company is equally merger too ideal to be true
Appraisal rights
Most states allow this option
Provide the shareholders who dont want the merger a way out
Other states: Model Business Corp. Sct
o More expansive rights
o Appraisal remedies for mergers, asset purchase or certain charter amendments
Delaware: can get appraisal rights for mergers ONLY, not even all mergers
o Not for public corporations if you receive shares
You can always cash out your shares on the market
if you receive cash in public corporation, you have an appraisal right a
concern that the amount of the cash you get might not be a fair price
o Procedure: 262
Company gives notice of appraisal rights
Shareholder demands appraisal before vote happens
Cannot vote in favor of merger
Petition for appraisal
Court determines fair value of shares
Reasonable financial techniquenot just DE Block Method
No minority or liquidity discount applied in appraisal
Fair value might be less than merger consideration
 Synergy gaining: The value of the combined corporation shares
might be much higher than the value of your own shares in
corp. A or B.
Premium: Acquirer usually pays more to get merger
Appraisal is costly
o Almost bound to happen if you are the only
shareholder.
o Seek appraisals only when you think you are really
being taken advantage of
Hollinger v. Hollinger International Inc. (pg. 1169)
Issue: whether shareholders must be giving opp. to vote on the sale of a subsidiary since the sale
involves substantially all of Internationals assets, as under 271 (board can sell all or substantially all of
its property/assets only with stockholder approval)
Two different defenses:
Sales of a distance subsidiary, not a sale of our assets under 271
o Court rejected this as too formalistic
Parent, in substance, really is the participant because it is the signatory to the
contractthey are signing and guaranteeing performance of subsidiary
Avoid this by not having parent sign (but harder to sell thenparents
usually guarantee quality, so buyer wants those warranties before
entering deal)
Not a sale of substantially all of its assets
o What is substantially all
Quantitative-qualitative test
Quantitativethe subsidiary may or may not be the single most
important asset, but still only 50%
Qualitativeparent will still be profitable without it.
Economic quality whether the transaction leaves the
shareholders with an investment that in economic terms is
qualitatively different than the one that they possess.
Not substantially all
Exclusivity of the Appraisal Remedy
Availability of appraisal rights normally does preclude a shareholder from seeking to recover on
an allegation that the transaction does not provide fair compensation for the shares.
o Exceptions: fraud
o But if youre just displeased, you cant get another remedy

Form and Substance in Business Combination

(Structure transactions to get around limitations in the law for mergers and acquisitions)
Loopholes:
Stock-for-assets
Engage in asset purchase, without paying cash
o In asset purchases, you theoretically pay cash for assets, but could be other value
(such as stock)
 o Sounds like a merger end up with a surviving corp.
Cash-out mergers
Different considerations for different shareholders
Acquiring shareholders gets stock while target shareholders get cashresembles an asset
purchase
Fair to allow this because theres still shareholder approval and appraisal remedy
Short-form mergerswhere a corporation may merge with its subsidiary without shareholder
voting
DE253
o Parents must own at least 90% of subsidiary
o Must be simple merger
o Cant use merger to slip things into the charter
Shareholders have appraisal rights
Triangular mergera merger between one corporation and a subsidiary of another
The subsidiary is often a shell corporation with the purpose to merger with the target
Still have to get B shareholder approval; but now you dont need parent corporations
shareholder approvaljust need subsidiary shareholder approval, who are the directors of
parent corporation.
o A doesnt want shareholders to vote because acquirer is buying the target and has to
pay premium to the target
Harder to get acquirer (A) approval
Acquirers are unhappy these because they pay a lot
Then follow up with a short-form merger between A and B A
o Without triangular merger, still wouldve ended up with A, but needed As shareholder
approval to get there
Considerations:
Structure
One surviving company: merger and asset purchase
Two surviving companies: stock purchase and triangular merger
o May want to avoid having one co. because of limited liability all of liabilities in B
would stay with B but once you merge, then all of Bs liabilities end up with A
Ownership
Acquirer get 100%: Merger, Triangular mergers, and asset purchases
Stock purchase: minority shareholders always exist, you are not able to get 100% of the stocks.
o Which means you cannot do what you want with those assetsif you do something
unfair, minority shareholders can sue
Liability
Join liabilities: merger
 Keeps liabilities separate: stock purchase and triangular merger
Liabilities optional: asset purchase
o Why purchase liabilities? cost less
Assets liability = equity
Approval
Both sides of directors and shareholders: Mergers
Both directors, targets shareholders: triangular merger and asset purchase
None (consenting shareholders): stock purchase
Appraisal rights (expensive and create uncertainties)
Delaware: only mergers get appraisal right
Other states: merger and asset purchase (in some states, also triangular merger)
Consequences
Renegotiation of contracts
o In stock purchase and triangular merger, end up with two different companies so
theoretically might not need renegotiation
o But if you have a merger, you may need to renegotiate all contracts so theyre
compatible with each other
Non-transferrable rights (some assets are non-transferrable)
o If stock purchase, there is no transfer (stays with individual co.)
o If asset purchase, target co. cannot give non-transferrable rightsso then have to
renegotiate; eliminate such rights; restructure so it doesnt cause transfer
o If merger, not considered a transfer for state law purposes
Tax & accounting
o Modern trend: equate all transactionsso increasingly less significant
Ferris v. Glen Alden Corp. (pg.1200) upside down format
Facts: List purchased 38% of Glen Alden. They entered into a reorganization agreement, whereby
Glen Alden was to purchase all of Lists assets and liabilities in exchange for stock, distribute the stock to
their shareholders and then dissolve. The Shareholders approved, but Farris decided to sue for an
injunction.
CONCLUSION: really a mergerhave to comply with requirements and allow appraisal remedy
In the form of an asset purchase, but essentially a merger: stockholders of both companies
become stockholders of surviving co.; but in an asset purchase, stockholders of the target co.
just go away
De facto doctrine: must refer not only to all the provisions of the agreement, but also to the
consequences of the transaction and to the purposes of the provisions of the corporation law
(look to both form and substance)
o When a corporation combines with another so as to lose its essential nature and alter
the original fundamental relationships of the shareholders among themselves and to
the corporation
o But corporate law looks at the procedures and forms of the transaction, not the
substance
o so many situations under which corporation loses their essential nature
o Rejected later
 Equal Dignity Rule (rejected De facto doctrine)
Equal dignity rule: different sections of a law are of equal dignity, and that action taken under one
section will not be judged by the requirements of another section
Hariton v. Arco Electronic Inc. (pg.1196)
Issue: An agreement of sale of assets embodies a plan to dissolve the selling corporation and
distribute the shares so received to the shareholders of the seller, so as to accomplish the
same result as would be accomplished by a merger of the seller into the purchaser. Is the sale
legal?
CONCLUSION: The sale-of-assets statute and the merger statute are independent of each
other.
o Framers of a reorganization plan may resort to either type of corporate mechanics to
achieve the desired end.
Seeing Corporate law as mandatory or enabling
Mandatory De facto doctrine makes sense, you cannot escape liability for a merger by calling
it something else
Enabling Equal dignity rule makes sense
o Equal dignity ruleFollowed by most states now.

Freeze-out Mergers
Should a cash-out merger be allowed?
Not inherently problematicapproval from both directors and shareholders
o Could be doing something that everyone wants and if everyone agrees
Even if there is a problem (some shareholders dont agree)appraisal rights
o If we need a unanimous approval from shareholdersincentivize bad faith of
shareholders; insufficient
Freeze-out merger: action taken by majority shareholders in close corporation to frustrate the
expectation of minority shareholders
Essentially an involuntary cash-out merger
Majority shareholders can freeze out minority shareholders with majority approval
Problem: minority shareholders dont want to sell their shares.
Weinberger v. UOP (pg. 1216)
Facts: Signal acquired a majority interest in UOP for $1/share. They wanted to buy the remaining
shares at the same price for a merger. P sought to enjoin, but most majority shareholders approved.
Rose to level of self-dealing: directors of UOP used confidential UOP info to prepare report for
Signal (UOPs parent, w/common directors); directors were on both sides of the transaction;
and majority shareholders stood to get the company while minority only got cash
Apply Entire Fairness Test unless got approval from fully informed disinterested
shareholders
o Fair dealing+ fair price
Not a 2-part test, but 2 factors to be considered together
o Here, not fair dealing
Information not fully disclosed.
Rushing through the proceedings and just handing down the price
 o Fair price remand on the issue
Any reasonable method to prove value
Coggins v. New England Patriots Football Club. Inc (handout)
Facts: Sullivan acquired all the voting shares of the patriots. The corporation was to pay the bill for
that. To eliminate the minority shareholders, he cashed them out and the shareholders sued.
Legal test: Business purpose + fairness
Business purpose here: NFL wanted a controlling shareholder (but not necessarily sole
shareholder)
o Court: D was a controlling shareholder and didnt have to get rid of the remaining
vestiges of shareholders
o : In order to get the loans to control was to get co. to back him, but it couldnt
guarantee unless he was only shareholder
Fairness: fair dealing + fair price
Remedy:
Shareholders wanted to undo the merger:
o Shareholders were not arguing that the price was not fair, they just want their shares.
Court: we cannot give the shares 10 years ago back to you. Lets try to figure out what theyd
be worth
o Nobody is happy here.
Glassman v. Unocal Exploration Corp. (pg.1232)
RULE: in a short-form merger, appraisal remedy is the exclusive remedy
o Statute: the company can do short-form merger unilaterally without negotiation
between the two companies no dealing, therefore hard to apply Entire Fairness Test
o Appraisal remedy already looks like fair price
Exception: fraud/illegality
o Duty of full disclosure remains
Whenever the company causes the shareholders to act or make choice
(whether to accept the merger or to ask for appraisal), the company has to
disclose information.

Takeovers
Definition: attempt by acquirer to gain control of target
Hostile takeovers: takeover which does not have the support of board of directors of target
company (hostile to management)
Stock purchase in this situation because the directors are unlikely to approve a merger
Shareholders tend to love takeovers, they got premium at a higher price
How: usually done through tender offer
o Gain foothold through open market purchases, slowly, quietly, from low percentage
o Then you do a tender offer to the public get you at least control (51%)
 o Then once you have control, can do a freeze-out merger and kick out remaining
shareholders
Shareholders like being taken over because they usually get targets dont
necessarily like being acquirer
Management is opposite: directors dont like being target because they might
lose their jobs
Reasons why takeovers happen
Undervaluation
Market value might be less than fair value
EMH suggests that this doesnt carry much weight
Synergy
The combination of A & B values more than A+B
Why?
o Economies of scale: cost reduced with the increase of quantity
o Economies of scope: cost reduced by producing similar products
o Assets may be transferrable
o As well as skills
o Financial synergy
Internally raising money. If you can raise money internally, borrow money from
the company which earns a lot of money. Its lot cheaper than borrowing money
from other financial institutions.
Conglobation: internal diversification; expansion into unrelated lines of
business
Agency cost
Agents problem (problem of loyalty)
o InefficienciesHard to get rid of directors
Proxy cost, rational apathy
o Excessive compensation
o Self-aggrandizement
Profits help shareholders shareholders ideally want small investment that
makes lots of profits
Management want a huge company (lots of assets/employees/activities), even
at cost of profitability
May value size more because of power
Takeover can help reduce agency costs to some extent
Controlling shareholder taking over business and running it directly
Wealth transfers: shift in wealth from one group to another, often without net benefit to society
Not creating wealth
 Employees: cut cost by reducing salaries, benefits, eliminating jobs
o Shareholder wealth comes from employee loss
Creditors: business is going to be more risky
o But because of contract, creditors are locked in into a lower rate when economically,
they should be getting something higher
Government: shareholder wealth comes from tax savings
Reasons for defense
Coercive offers: shareholders may not have a fair choice so the directors shall step in to protect the
shareholders
Eg. Two-tier tender offer: tender offer at a premium seeking control, but not ownership, with
illicit/explicit promise of a freeze-out merger
o That means, even shareholders who reject the initial offer will be forced to accept that
offer for fear of an even greater loss
If takeover succeeds at premium price, then theyll freeze out shareholder in
freeze-out merger at market price
Not because he wants, but because hes being coercedafraid of what
everyone else is going to do
Undervaluation: The market value is less than the intrinsic value, the premium is actually a
discount (trading at $50, but really worth $100, so the tender offer of $75 is actually a discount)
But EMH says this is impossible
Opportunity loss: can block this deal because a better on is coming
How do you know?
Some says: alternative is to have a market test
Shareholders are going to be skeptical on it and decide by themselves
Incompatibility: a good reason from corporate perspective
But shareholders wont care. At least they will be brought out, its the acquirer who is bearing
the risk
Other constituencies: deal may be unfair to everyone else besides the shareholders
Other people have their own remedies and dont need directors protection
Entrenchment: efforts by management to protect against ouster really to protect their own jobs
Takeover defenses
Previously considered:
Constituency statutes
Staggered board
o Doesnt actually block, but makes it more expensive to engage in takeovers
can only replace 1/3 at a time
Voting rights
o Split up voting rights by classes of stock give management the voting shares, while
give shareholders the economic interest
 o Or capped voting, prevent an acquirer to ever have control
Additional mechanisms
Greenmail: repurchase by target of its own shares at a premium
o Sounds like blackmail
o Shareholders hate this: instead of getting a premium for their shares, they have to pay
a huge premium
White Knight Defense: the target convinces a friendly third party to make a superior offer
o Management wants to stay independent, but if it cant, it would rather be employed by
a friend than an enemy
o Shareholders like itthey get more.
o Certain advantages management gives to white knight
Termination fees:
Ask white knight to make an offer, but if it doesnt work out, well give
you $100M (well pay you for your troubles)
This also raises acquirers costhave to pay a higher bid, and if they
win, have to pay this fee
Lock-up option:
Asset lock-up: give white knight the right to buy the most important
asset at a discount
Then acquirer doesnt want to buy because even if they win,
they only get co. without the important asset
Incentivizes white knight to come in, but also prevents
acquirers
Stock lock-up: The right to buy 20% new shares at $33, the original
market price.
If you lose, you still have 20% shares at $33. More expensive
for the acquirer coz instead of paying 100% of shares, they now
have to pay 120% shares.
No-shop provision: promise the white knight not to solicit other offers
No-talk provision: cannot entertain any other offers
Even more difficult for acquirer to engage in any type of
negotiation
Poison pillultimate defense
Three ways to get over with poison-pill
o Can negotiate a friendly deal because target
management can remove the poison pill
o Get court to order redemption (argue its a breach of
fiduciary dutiesbut might not work so well)
o Can launch a proxy contestmost effective way;
replace board of directors and have them remove the
poison pill and buy co.
Impossible to go forward the deal hen the poison-pill is in place
Unocal Corp v. Mesa Petroleum (pg. 1253)
Facts: Mesa did a two-tier tender offer (coercive); shareholders will be forced to tender.
Managements response was also a selective repurchase: after Unocal gets 51% of company, we will then
buy the remaining 49% for $72 of high quality bonds. Did this because Mesa came along and offered $54.
So half shares go at $54; rest gets $72 (average = $63, which is what theyre really worth).
Mesa argued that this is a breach of dutymanagement is not treating all shareholders fairly
Unocal argued that this was Mesas fault, that they came up with the horrible deal, and Unocal
was only responding to protect against Mesas coercive offer
 Directors: inherent conflictedask for more than Business Judgment Rule
The inherent danger in the purchase of shares with corporate funds to remove a threat to corporate
policy when a threat to control is involved
2-part test:
Reasonable ground to believe there was a threat
o Directors must show good faith and reasonable investigation
o Examples of the belief: inadequate offer; nature and timing of the offer, questions of
illegality; impact on constituencies; risk of non-consummation; securities being offered
Response/defense must be reasonable in relation to the threat
o Reasonable:
To extent that threat was inadequate offer, this makes sure that offer ends up
being adequate but problematic again because you could just come up with
a number
To the extent that threat was coercive, fighting fire with fire; by itself its illegal,
but once you start it, we can continue it
o Unreasonable:
This should be illegal: directors are not supposed to discriminate against
shareholders
But court has already decided that shareholders can be
discriminated against
Upheld greenmail, so they can uphold this
This deal will prevent any deal from happening
No one will tender at $54 because if they hold out, they can get $72
But $72 is conditional on $54 offer happening so $72 offer wont
happen because $54 will never happen
So this is a two-tier backhanded offereveryone holds out and deal
never happens
Court doesnt see this problem; and just because it could be a problem
doesnt mean it should be viewed as one
CONCLUSION: directors satisfied enhanced scrutiny entitled to BJR

Revlon v. MacAndrews & Forbes Holdings (pg.1291) white knight

Facts: Pantry Pride expressed an interest in acquiring R but R didnt want them to. PP made several
offers but were rejected by R, who began negotiating with other parties, including Fortsmann (white
knight). R kept negotiating with and giving benefits to Fortsmann to the exclusion of PP. Fortsmanns deal
provided better for the note-holders. R entered lock-up option and no-shop provision with Fortsmann.
Defenses:
Not illegal per se to seek a white knight, to use advantages or poison pills because the
directors are protecting shareholders best interest
Once the sale becomes inevitable, you have to get the best price.
The duty of the board of directors changes from preservation of the company (Unocal) to
maximization of the companys value for the benefit of the shareholder.
Here, break-up of company was inevitable and it was easy to tell because D started recruiting a
white knight (either way, will have to sell to takeover co. or white knight)
Once you have a white knight, you can no longer say you have a better option for staying as
you and can no longer say that price is not high enough (now its just about comparing two
prices)
Board tried to consider bondholder interestsconsider constituencies (Unocal)
 This is not the shareholders interests
o Once were selling the company, we only care about the bottom linewe dont care
about anyone else
o You can consider constituencies only if they are related to shareholder interest
Best price?
Means:
o Conduct an auction and whoever offers most money, wins
Not mandatory
o Negotiate (with hostile bidder/white knight/everyone)
Here: at some point, it became clear that they werent trying to get a good price
o Result of lock-up was not to foster bidding, but to destroy it
o Favored white knight very heavily
If youre going to play favorites, you have to have a good justificationgetting
best price

Other Forms of Business Associations

LLCs and LLPs

History of BA has clearly evidenced flexibility over time
LLC*: limited liability company
Like a corporation, but it isntunincorporated
The law is a mixture of corporate law and partnership law
Few basic differences:
o Certificate of formation*: charter for LLC
Its not an LLC, so no certification of incorporation
o Operating agreement*: agreement that sets forth structure and terms
Can be seen as analogy of partnership agreement or charter
o Members*: owners of LLC
Dont call them shareholders or partners
o Managers*: designated managers of LLC
Optional
Dont call them directors; call them managers
 Operating agreement can make LLC as much of a corporation or as least as you like You
have to look at operating agreement to tell anything about the business (completely freedom)
o Can make it member-managed (partnership) or manager-managed (looks like
corporation)
o Can share profits and losses as desired (like partnership)
o Can decide limited liability (if so, corporation; if not, partnership)
o If lives forever (company); if limited life (partnership)
o Transfer or nontransferable
o So make like shares or partnership interests
o Double-taxation or single-taxation
o Even fiduciary duties can be specified (within limits)
De facto LLCs; piercing the LLC veil; etc.
Business increasingly being LLCs (so much flexibility)
Reasons not to have LLC
o Fewer statutory default rules
o Smaller body of case law so some risk
You might think you know how court will interpret, but could be wrong
Hard to get investors if they have to look at operating agreement to
understand whats going on
Some businesses cant be corporations or LLCs
o For example, law firms in some states have to be partnerships
But this lead to changes some states develop PCs* and LLPs*
LLP
Dont confuse with limited partnership
Means that youre responsible for your own actions, but not for partners actions
Unlimited liability for yourself; limited for partners
Depends on state
Some states also create LLLPs
It all comes down to giving people flexibility
Traditional view v. contractarian
o Traditional you had rules you had to follow
o Contractarian corporate law is actually more enabling
o Is there a place for traditional theory in a word of contractarians?
 Maybe its another option to increase options to people
Different levels of rigidity
One option is to have complete freedom
Other option is to have more rigid rules
Are LLCs fair?
Corporation: you get limited liability, but double-taxation partnership vice-versa
Now, in LLC, you can do single-taxation and limited liability you can have your cake and eat it
too is this fair?

Basic Accounting
Balance sheet: snapshot of a business on one day
Assets = Liability + Equity
o Assets=sources of assets
Most liquid asset is cash
o Liabilities: outside sources (that have corresponding assets)
o Equity: inside sources or proprietorship (stake in the business)
Categories:
Paid in capital: funds invested in business in exchange for interest
Returned earnings
Income statement
o Performance over time
o Revenue-expenses=income (Profit/return)
Income: net income before tax
Revenue: cash in
Expenses: cash out
Cash basis accounting v. accrual method of accounting
o Large corporate business use accrual method more

Basic Financing
Introduction to debt
Debtor= borrower; creditorlender
 o Debtor: one who owes a monetary obligation to another
o Creditor: one to whom a monetary obligation is owed
Debt = monetary obligation
o Repayment of principal
o (periodic) payment of interest
short term: principal + interest
long term: probably periodic interest every year and principal in the end
Interest: time value of money
$1 today > $1 tomorrow Why?
o Riskchance that you wont get that $1 tomorrow
o Inflationwidget costs $1 today but $1.05 tomorrow, if I get $1 tomorrow, I will not be
able to buy it
o Opportunity costs
$1 today > $1 tomorrow >> $1 later on
compounding
o If I have $1 and I get 10% after a year = $1.10
o If after 2 years, Ill have $1.21
1st year: $1 to $1.10
2nd year: $1 to $1.10 but $0.10 will become $0.11 (everything 10%)
o Becomes significant amount over time

Risk & Return

Risk: uncertainty; possibility that future returns will deviate from expected returns
Return: profit
Directly related: Risk & return are inversely relatedin order to earn more profit, you must accept
more risk
No risk, no return
Leverage creates more risk
Leverage: use of debt in a business
o Potential for loss: once you borrow money, you have to pay them back. And sometimes
you might not be able to pay it back.
o Potential for profit: you invest by the money you borrow, you might double the
production, earn more than you borrowed
Leverage creates risk for everyone
 o Borrower: takes on risk of losing profits by repaying loan
o Lender: risk on losing money if borrower cannot repay
The more they lend, the more risky they are
Diversification reduces risk
Diversification: reducing risk by investing in multiple opportunities
o If you invest in only one company, your entire fortune is tied to its success
o If you have multiple investments, more likely of a moderate result; things balancing out
Expected return doesnt tell us about risk
o Ex: coin toss
Can bet $10 on one flip for a possible return of $20 (so you get either $20 or
$0)
Or can bet $1 on 10 flips for possible return of $20
Get a more rounded curvegood probability of breaking even
Expected return is the same, but risk is very different (expected return
is just weighted average)
o Risk is measured by variants and averages, the spread of likely outcomes

Valuation & Efficient Market Hypothesis

Valuation
Special goods: rare/unique item
Difficult to value an asset
o Appraisalvery subjective
o Auctiontry and actually sell, but might just get 2 nd best price +$1
Commoditiesproducts that are abundant and fungible
Easy to value by looking at the market
o Look at supply and demand
Corporation
Special good. Each is unique
o Has to be valued subjectively
Stock can be a commodity a market for stock
Features for a strong market
o Liquiditycan be converted in to cash (able to buy/sell quickly)
 o Availability of informationknow what you are buying
o Efficiencyability to buy/sell cheaply; not much transaction costs or hassle
Public corporations: a strong market
Close corporations: no
o No stock buyers; no public disclosure of information; high transaction costs; no
knowledge on how to run the business
Efficient Market Hypothesis (EMH)
Definition: the theory that, in a strong market (e.g., U.S. capital markets), prices quickly reflect all
available information
Market quickly reflect the value
o The stock price doesnt mean how much the corporation worth
o Its everyones best guess as to how much the corporation worth
Reason:
o EMH deposits that there are many different investors who are analyzing company at all
times
Combined efforts provide equilibrium price for stock
If price is too low, people will realize that so more people will want to buy at
that price and more people will want to sell this will raise the price up
Inverse is trueif information suggests price is too high, will drive price
down
Three forms of Market Efficiency
Weak:
Current pries reflects all pre price information so you cannot beat the market by looking at
the trends
o Tells you nothing about what will happen tomorrow
o An all-time high/low is insufficient to know
o You may see the trend, but so does everyone else
Generally accepted as truth (but not universally)
o Proof: prices move randomly all the time
But not entirely randomgenerally looks like an upward trend, but around that
upward trend, prices move randomly
Semi-strong:
Current prices reflect all publicly available information so you cannot beat the market with
fundamental analysis and the information in the market
o Not just past info, but media info (NY Times, Wall Street, etc.)
o Because current price already reflects current info, by the time you get it, its old and
stale
Widely accepted as more-or-less true
o Proof: randomnessnew info to extent its new is actually random/unpredictable
 o Experience demonstrates that very few people can consistently beat the market.
o Problems:
Inconsistencies
Anomalies show that market is not totally efficient
E.g., stock prices tend to be higher on Fri., lower Mon. (should
theoretically disappear if people know)
Big eventslike Stock Market Crash of 1987
If markets are so efficient, shouldnt happen
But EMH doesnt say it reflects accurate price, just guess
Internally contradictory
Demands that there is a lot of analysts in order to have supply &
demand work, but then concludes that it gains you nothing
o It works anyway:
Over time, things vacillateas markets become more efficient, people stop
doing research; then becomes less efficient, and people think they can make
more money by researching
Enough inefficiency to compensate people for efforts: people can make money
by doing, but not really as much by not doing
Real point of EMH is that you cant beat the market
Strong:
Current prices reveal all info, public and private so you cannot beat the market even with
inside information
o Insider trading has already adjusted the price
The trade has already be undertaken. Everyone involved in the trade knows
about it
Not accepted as true (its a theoretical placeholder)
o Proof:
If true, then public announcements would not have an effect on prices but
they do
You could not make money from inside trading but people can and do make
money and then go to jail
o But it doesnt mean there is no truth in it.
If you cannot beat the market, is investing a gambling?
Yesif just one or a few stocks, then EMH says its gambling
Noif you diversify, then it becomes investing
o Eventually, you are eliminating all specific risk and just investing in the market to make
expected return. You can earn the market rate by making the market
Lesson: dont try to beat the market; just diversify
Diversify through mutual funds and index funds
o Index funds try to match the market; buying and holding
o Opposite of mutual funds, which try to buy and sell to maximize profit
If everyone else is wrong, it doesnt matter if youre right (even if youre right, you can still
lose)

Delaware block method

Weighs different techniques to determine value of business in judicial process
Ways of evaluation:
Market value
Asset value
Earnings value
Piedmont v. New Boston Garden Corp. (pg.513)illustration
No longer used in DE