OVERVIEW

What do businesses do and what do lawyers for businesses do

o Why does someone own a business
 Most people own a business to make money
 Friedman: “In a free-enterprise, private-property system, a corporate executive is an
employee of the owners of the business. He has direct responsibility to his employers. That
responsibility is to conduct the business in accordance with their desires, which generally will be to
make as much money as possible while conforming to the basic rules of the society, both those
embodied in law and those embodied in ethical custom…The key point is that, in his capacity as a
corporate executive, the manager is the agent of the individuals who own the corporation and his
primary responsibility is to them…there is one and only one social responsibility of business—to use
its resources and engage in activities designed to increase its profits so long as it stays within the rules
of the game, which is to say, engages in open and free competition without deception or fraud.”
o Views of courts & legislators
 Smith v. Barlow
• Defendant corporation made a donation to Princeton. Shareholders sued arguing
that he was not authorized by the articles of incorporation to be able to make this gift.
• Court said that laws enacted after incorporation that allowed directors to make
charitable gifts without approval from shareholders applied to this corp, and as long
as the gifts contributed to the corporate interests, they were appropriate.
 33-3-102(13) (p. C13)
• A corporation can “make donations for the public welfare or for charitable,
scientific, or educational purposes.”
• Expressly allows charitable donations.
 33-3-104 (p. C14)
• Ultra vires: beyond the scope of authority or power granted to a
corporation (would void an action beyond the scope of authority)
• Of little practical significance today. Corporations are now deemed to have the
power to engage in any lawful business activity.
• Cannot challenge acts of corporation on the grounds that it doesn’t have the
powers to act.
 Enacted to stop litigation that argued a company did something it wasn’t authorized to
do- but it still goes on
 Shareholders can still challenge to enjoin an act or in a proceeding by the corporation
directly or through a receiver
 If brought by a shareholder, the court can award loss (other than profit) suffered by the
corporation
o The Board of Directors is not acting as an agent; it is functionally a principal (this is the common
view although the officers waffle on this)
o See §33-8-101 for Board of Directors
o Provides that Board will manage the company
o In theory these are the ones who manage the company – this is true for large corporations, but not
for small ones- our statute anticipates this and provides a few other options
o Most people say that the Board acts as the principle and not the agent and therefore makes the
decisions
o Certificate of existence and articles of incorporation- a document issued by a state authority granting a
corporation its legal existence and the right to function as a corporation- normally filed with Sec. of State
o Cert of Existence says that the corporation is in good standing in SC- but 33-1-280 is deceptive-
most of the problems a corporation has will not be with the Sec of State, so it will be in good
standing even though it is in trouble with other agencies- Dept of Revenue

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 o § 33-2-102 is the Articles of Incorporation – which lists what you have to do to set up a
corporation
o 33-3-102 provides General Powers of a corporation
 corporation lasts forever unless something happens
 corporation has the same powers as an individual would have to conduct its business
o General building block concepts:
o The law views a business, at least a business in the corporate sense, as a separate entity, a separate
legal person
o A body of law—both statutory law and case law—has developed to control the actions of that
separate entity or person
o Real persons act for the corporation—they are agents
o A business with more than one owner, at least a business with more than one owner that is a
corporation, can distribute and use its funds in ways that are opposed by at least some of the owners
o The owner of a business can make money from the business by:
o Receiving distributions of all or part of the money the business has earned (this is called a
dividend) or
o Selling all or part of her ownership interest in the business for more than she paid for it
o A lawyer for a business is hired:
o To help the business make money or
o To help the owner get money from the business or
o To help the business and the owner protect that money from the claims of others
o How do you know how much a business is worth? See the financial statements
 33-16-200 (p. C98): A corporation is required to furnish its shareholders with financial
statements, etc. See also 33-44-408 and 33-41-520.
o Partnership Records in SC
o 33-41-520 – just have to keep books in accordance with partnership agreement and all partners
must have access to them
o So not much guidance on what they have to have
o LLC statute gives even less guidance on what financial statements they have to keep
o They are prepared according to GAAP – Generally Accepted Accounting Principles
o Matching- costs or expenses should be booked in the same period as the revenues those
expenditures helped generate
o Conservatism- the date should be conservative – they should present the firms financial data in an
accurate way but err on the side of understating its revenues and the value of its assets and on
overestimating its costs and liabilities
o Off –balance sheet financing- this is what Enron did- its liabilities were carried out through
subsidiaries, so the liabilities didn’t appear on the balance sheets
o This only works when the subsidiaries’ debt is nonrecourse debt- meaning the parent company
could never be liable for it- in Enron’s case, the debt was recourse
 Income Statement
• Shows the profit for a corporation over a given period based on data about
revenues and costs
• Formula = Income – Expenses – Depreciated value of assets – Taxes= Net
Income
• We depreciate because the machine is getting less valuable each year since we
are using up part of it. The portion we use up is called depreciation. Accelerated depreciation
might be used for tax purposes.
 Cash flow statement
• Shows how much more cash a business has at the end of the year than the
beginning
• Formula = Profit after tax + depreciation taken out – cost of investment in that
year.

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 • In other words, it’s the income statement over a year without allowing the
business to depreciate the cost of investments. We put depreciation in because it is non-cash
 Balance sheet
• A snapshot of the value of a business at a particular time
• Assets on one side (include things like cash, land, buildings, accounts
receivable, and machinery and equipment)
• Liabilities on the other (include things like accounts payable, wages payable,
and debts)
• Assets = Liabilities + Stockholder Equity or
• Owners’ equity = assets - liabilities
• Thus, profits accrue to equity
 A key component in the valuation of any business is the future profitability, which is not necessarily
reflected in the financial statements (look at cash flow/income statements)
o Problems on 27
o don’t buy the company for 189k because there are significant liabilities
 but we would recommend buying for 80K because that is the amount of equity- but
valuing business is a very complex topic-
 so yes you want to know the assets and liability and equity – but what the buyer would
want to know is the future income stream- what is it going to make in the future
 it also depends on the type of business-
 Lender would be interested in balance sheets, so it can determine whether they would be
able to pay
o Looking at cash flow statements
 Don’t sell for 3,700 because that’s the same amount you are making, and if you keep it,
then you will make this again next year- and probably more
 20,350 – this is equal to the cash flow for five years, but this is still low
 The cash flow statements does help a prospective investor and certainly helps lenders
o The Sarbanes-Oxley Act and Corporate Governance
o Mainly apply to publicly traded major corporations, but some of the general principles should still
apply to the smaller business
o Passed in 2002 in reaction to Enron. Purpose is to try and prevent fraud
o Frauds had to do with the financial statements discussed above
o Public corporation have an auditing committee the oversees the financial accounting including the
SEC filling
o Auditors will use a principle of sampling certain random transactions as well as looking at
suspicious looking ones to make sure they really did happen
o Fraud is motivated by the fact that if the numbers on financial statements look good, then stock
prices will go up
 Managers want to make stockholders happy
 Also, they often receive bonuses when the numbers are good
o Types of Fraud
 Off-balance sheet
• Move liabilities off you balance sheet and onto a subsidiary
 Hiding costs
 Two basic types are
• Representing the company’s financial condition as better than it is
• Or misappropriating the wealth of the company for private gain
o Sarbanes-Oxley clarifies the role of auditors, company management, and boards and audit
committees as well as impose new process and responsibilities on these parties
 Ie- have to say whether their auditing committee has a financial expert
 § 404 says the company must design internal controls and test their effectiveness
 CEO and Chief Financial officer must attest to accuracy of statements under penalty of
criminal liability

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 o Lots of companies have said that this is to much regulation and is costing them way too much
money to prove that they are honest
 To get out from under Sarbanes-Oxley, they are becoming private- cashing out the public
holders and becoming private
• This means that we wont have anything to invest in
o What are the basic business structures?
 What are the primary driving forces behind structure choice?
• Taxes - how profits are taxed
• Liability - the exposure of the owners to liability for the corporation’s actions
 Sole Proprietorship
• A single person
• For taxes and liabilities, the person and the business are treated as the same
person
• Profits are taxed as personal income
• Liability of the company goes straight to the owner
• Note that a sole proprietor doesn’t need to file with the state
• Don’t need an atty to form a sole proprietorship
 C- Corporation
• Owners of corp are protected from personal liability
• The corp pays taxes on income, and the recipients of dividends pay taxes on
them (known as double taxation).
• The incentive for forming a c-corp is that if you can pay out all of your income
as salaries, then the company will not show a profit and it will avoid the double taxation problem.
 S-Corporation – SC 33-18-103
• This entity is taxed like a partnership but has the liability protection of a
corporation.
• Profits are distributed directly to partners, and as such are taxed only as the
income of the partners – no double taxation problem (this is known as flow through taxation and
the tax is paid by the shareholders)
• IRS places a bunch of restrictions on who can be an S-Corp
o Can only have one class of stock
o Must be domestic, and wholly owned by US citizens
o No more than 80% of revenue can come from non-US sources
 Ex – Shrimp boat business in Charleston fishing in
international waters.
o No more than 100 stockholders
o No more than 25% of revenue from passive sources (rent, interests,
royalties).
o Only individuals, estates, and certain trusts can be shareholders.
 Limited Liability Company – (LLC)
• Just like the S-Corp
• Rather than complying with IRS laws, LLCs are governed primarily by state
law.
• Offers protection both from liability and from double taxation (you are taxed as
a partnership- only the individuals are taxed)
• SC – don’t need an atty to form an LLC
• Don’t have to file an annual report with the SOS office.
 General Partnership
• taxes are paid only as money is distributed to partners; taxes are paid at the
individual level; pass through taxation
• partners are EACH jointly and severally liable for actions of the partnership
• So an injured party can go after any partner for the full value of their claim.

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  Limited Liability Partnership -(LLP)
• Has limited and general partners
• General partners have management responsibility/control and unlimited liability
for the business
• You would make a corporation the general partner so the individuals are
protected
• Limited partners are liable only for what their capital contributions to the
business were.
 Family partnerships are common in SC because they are an estate tax avoidance
technique.
 Factors that go into whether you choose one style of business over another
• Who will the investors and owners be? If small group of investors- then an LLC
or partnership would work
o What are the capital requirements and cash flow characteristics of the business likely to be? if you
require venture capital, you will probably need to be a corporation bc venture capitalists wont
invest in LLC because of the personal tax liability
 But this isn’t really the case- people still invest, and its easier to change from an LLC to a
corporation - but not visa versa
• Who will own the business?
• Who will manage it?
• Who will reap any profit?
• Who will bear the risk of loss?
• Who will pay taxes on profits?

SOLE PROPRIETORSHIPS
o The good things about sole proprietorships
 You don’t need a lawyer or any forms to start one. Just start doing business

Problems of Sole Proprietorships:

 Employees and Agency – Creates Contract Liability
• R3 § 1.01 and 1.02 – definition of agency.
o Agency is a fiduciary relationship. Created when:
 The principal manifests consent to act on his behalf to the
agent
 The agent consents to act on the principal’s behalf subject to
his control
• Authority – the extent of the agent’s power to act and bind the principal
• Actual Authority – R3 2.01, 2.02, 3.01 (R3 mixes actual and implied authority
together)
o Authority to do an act can be created by
 Written or spoken words (Express Authority)
 Other conduct (Implied Authority)
o An agent acts with actual authority when, at the time of taking action that has legal
consequences for the principal, the agent reasonably believes, in accordance with the
principal's manifestations to the agent, that the principal wishes the agent so to act.
• Apparent Authority – R3 2.03, 3.03, 7.08
o Apparent authority exists when a third party reasonably believes the
actor has authority to act on behalf of the principal.
o Created by manifestations of the principal to a 3rd party which
reasonably cause the 3rd party to believe that the principal wants the purported agent to act
for him.
o The information can come to the 3rd party directly from the
principal, through authorized statements by the agent, or from other indicia of authority.

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 o No detrimental reliance is needed
o Giving an agent a job that typically carries an authority can create
apparent authority
 Ex – hiring an atty grants the atty the apparent authority to act
in the client’s bests interests to protect the client.
• Legal Consequences of Actual or Apparent Authority
 See problems on p. 46.
 Problem 1: Agee might be legally obligated b/c R3 6.01, 6.02, and 6.03; Propp is bound
by 2.01 Actual Authority; second part depends on whether the P is disclosed or unidentified or
undisclosed – if the first then no; if not then yes – 6.01 and 6.03
 Problem 2: Propp might be obligated to pay even though agent ordered more than
principal allowed under the theory of apparent authority. Agee may or may not have to pay. It
could be considered a tort claim instead of a K claim; prop is liable because there is apparent
authority – Prop knew that Agee had made prior orders from TP and that he has paid it, so TP
would reasonably believe that Agee still has this authority. Propp should have taken action to let
him know
• Is Agee liable to TP – an agent is liable if he makes a misrepresentation to TP –
but authority is split on whether this is a K claim or a tort claim
 Problem 3: Propp would not be liable. Agee might be liable under a misrepresentation
type claim; there is no express authority and there is no apparent authority because the call was
made by the supposed agent and not the principle. Also this is outside the scope of Agee’s
authority so there is no implied authority
• Finally, the Agee will be liable- even though the P is exposed, there is a
misrepresentation- In SC you would have to pursue this as a K claim instead of a tort
claim
• Disclosure of Principal – When the agent is liable for a contract
o R3 6.02 – If the principal is known to the 3rd party, the agent is not
liable for any contracts entered on behalf of principal.
o R3 6.03 – If there is partial disclosure of the principal (3rd party
knows agent is an agent, but doesn’t know who he is an agent for) then the agent is liable for
the contract.
o RSA § 322 – if the agent is purporting to act on his own behalf, but
is in fact acting on behalf of an undisclosed principal, the agent is liable for the contract.
 Master/Servant – Creates Tort Liability
• Must create a master/servant relationship to have tort liability
• R3 7.07(3) – Creation of a employee
o an employee is an agent whose principal controls or has the right to control the manner and
means of the agent's performance of work
o Why should an employer be liable for torts committed by the employee?
• Cost of business- employer is better able to shift the cost
• Employer maybe could have prevented the accident
o All servants are agents but not all agents are servants
o Some independent contractors are agents and some independent contractors are not agents.
The independent contractors will not be servants.
o Attorneys are typically independent contractors who are agents.
o Factors to Consider finding employer/employee relationship
 Extent of control the employer can exercise over details of
the work*
 Whether or not the person employed is in a different kind of
business from the master
 Whether the type of work is generally done with or without
supervision
 The skill needed by the employee

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  Length of time of employment
 Whether work is regular business of employer
 Whether the principal is in business
 *Whether the employer supplies the tools (Imp in SC)
 *Method of payment – per time or per job (Imp in SC)
 *Express manifestation of creation of employer/employee
relationship (imp in SC)
 *Whether the principal has the right to fire the employee
(imp in SC)
• R3 7.07 – Scope of employment
o TO find the employer liable, the worker must be an employee working
in the scope of his employment.
o Conduct is in the Scope of Employment
 It is what he was hired to do
 It occurred for the most part within time and space limits of
employment
 Work is done to serve the employer
 If use of force is part of the job, then intentional torts might
not be unexpected
o Coming and going doctrine – travel to-from work in most cases is not
within scope of employment unless that travel is part of the job
o Frolic v. Detour
 Generally depends on how different what the employee was
doing was from acting in the service of the employer
• R3 7.07 – kind of conduct within scope of employment
o Conduct of the same general nature as that which is authorized
o Determining whether conduct is so similar as to fall within scope of
employment
 Whether or not commonly done by such employees
 Time, place, and purpose of the act
 Previous relations between employer and employee
 Extent to which the business of the employer is apportioned
between different employees
 Whether or not act is outside the enterprise of the master
 Whether or not the employer has reason to expect that such
an act will be done (forseeability)
 Similarity in quality of act done to act authorized
 Whether or not instrumentality of harm was furnished by
employer to employee
 Extent of departure from normal method of accomplishing
an authorized result
 Whether or not act is seriously criminal
o Problems on pg 49
 Is Servantes a servant – yes
• What’s the difference b/w servant and agent
o A person who employs an agent is a – Principle
o A person who hires a servant – employer
o No term for hiring an IC
• How do the agent and employee groups overlap?
o You have employees as a subset of agents – the P must have control to
be an employer – circle would be inside the agent circle
o THe IC circle would overlap – because they could be agents or not

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  Attorneys
o See page 49
 The CEO of GM is a servant as is the pilot
• You would not be liable for the accountant’s tort because they are an IC
 Yes you are liable for the coffee spill – employee = respondant superior
• Still liable even if he tells him not to spill coffee
• Is Servantes also liable – Yes – just because the employer is also liable doesn’t
get you off the hook for your own tort – but he wont be able to collect twice
 Prop is not liable for the tort committed while Servantes was on the way to work- its
outside the scope of employment
 Is Propp liable for the cook hitting the customer with a frying pan
• Employers are liable for some intentional torts – but it depends how closely the
act is related to the employment
 Does he need an atty if he hires an atty
• That would cover a lot of it, but not all
o Other business agency relationships
o Attorney-client
o Note that an attorney is most likely an independent contractor who is also an agent.
o Hayes v. National Service Industries
 Hayes sued for wrongful termination. Her lawyer settled, and Hayes tried to reject the settlement
on the grounds that the lawyer didn’t have the authority to settle.
 Rule on Atty’s Apparent Authority: The court held that simply hiring an attorney to deal with
third parties creates apparent authority to act on behalf of the client UNLESS the client expressly
limits the authority and communicates the limitations to the 3rd party.
 Note: the agent cannot create his own authority – this case gave the lawyer apparent
authority which is designed to protect the third party
o The manifestation of authority comes from the act of hiring an attorney- which people will assume is your
agent and has authority to act on your behalf
 Malpractice protects the attorney
o The agent cannot create his own authority no matter how persuasive he is
o Franchises
o Agency will arise if the franchisor-principal has the requisite degree of control over the franchisee-agent,
notwithstanding the customary boilerplate provision in the franchising agreement that the parties do not
intend agency relationship
o Sometimes courts apply the theory of apparent agency or estoppel to hold franchisors liable. Jurisdictions
differ on the P’s burden of establishing detrimental reliance on an appearance of agency and in probative
significance assigned to a party’s failure to correct misimpressions that others may draw about the nature of
a relationship.
o Miller v. McDonalds
 Facts: Lady bit into a really classy heart shaped sapphire when she chowed down on a big mac
purchased at a McDonald’s franchise owned by 3K Restaurants. McDonalds tried to defend on
the fact that they didn’t own the restaurant. Specifically, the franchise agreement specified that
3K was an independent contractor and responsible for it’s own torts.
 P had two theories as to why vicariously liable: actual agency relationship (because of control
asserted by McDonalds) and apparent authority/agency.
 Court looked at MASTER SERVANT relationship, and looked into the details of control that
McDonalds could exert over 3K in its day to day operation, and decided that this created a right to
control and thus was a question of fact as to whether McDonalds was a master and responsible for
tort? The generally accepted principle is: If the relationship between McDonalds and 3K is such
that McDonalds has the right to control daily operations, that is enough to cause them to be liable.
• Applies right to control test bc employer-employee relationship doesn’t work well here
3k would be the servant – so if the tort occurs within the scope

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 • Must not only set standards, but control day to day operations.(some courts might
say that setting standards would be enough) Simply controlling the lay out and setting
standards wouldn’t be enough (Shell case) but controlling the detailed performance of the
franchise and its employees in how they meet those standards does (Hilton)
o it does here, so there is
• One big thing is that McDonalds controlled the food handling- which is the cause of the
tort in this case
• One difficult problem that franchisors have is that to protect their trademark, they must
exercise control over anyone using it
 Court also looked at RSA 267.
 RSA § 267 – Apparent Servant Doctrine. If a party (1) represents that another party is a
servant and (2) a 3rd party reasonably relies on this representation then the apparent master
can be responsible for torts. In this case, the use of the McDonalds name and uniformity of
operations and appearance and the fact that patrons rely on the McDonald’s name to find “quality”
was enough to create a question of fact as to apparent servant.
 § 267 appears to have disappeared from the Rest. 3d, but Burkhard assumes § 267 is alive and
well in SC. This is apparent agency, which is different from apparent authority; it creates an
agency relationship that does not otherwise exist while apparent authority expands the authority of
an actual agent
 See R3 on apparent authority
• Apparent agency is the wrong term because this is a tort problem it should be Apparent
servant
• P must hold the franchise out as its agent and the TP must rely on that to her detriment
• Texaco case- apparent authority where national ads and logos at site lead customer to
believe the service station was the A of Texaco
• Franchise agreement must require franchisee to act in ways that identify it with the
franchisor – this is the case here so there is apparent authority
• ∆ argues that there was a sign that said it was owned by 3k – but that wasn’t enough
• Centrally imposed uniformity is key
• Π does not have to prove that the other McDonalds she went to were owned by
McDonalds rather than being franchises
 3K is directly liable and McDonald’s is vicariously liable
o Simmons v. Tuomey (SC Case from 2000)
 SC court adopted 429 as the basis for applying liability, but they did it in a strange way. They said
a hospital owed a nondelegable duty to render services. They then applied Restatement of Torts
§ 429 (essentially they’re saying that 429 is really an expression of nondelegable duty) to find a
hospital liable for the torts of a doctor who would otherwise have clearly been an independent
contractor. We don’t know if 429 applies outside the world of hospital/doctor cases in SC?? That
is the only place it has come up so far.
 Rest of Torts 429 - This restatement lowers the RSA § 267 from detrimental reliance on the
part of the third party to a reasonable belief. A plaintiff’s attorney would rather 429 apply.
o Sum of Rest 267 cases
• ∆ win most of the cases- many people think it is stupid to hold the franshisor liable for torts committed by
the franshisee – others
o Notes
• Agency by estoppel is used to hold liable a party who benefits from a relationship in which the parties did
not intend the legal consequences of agency – ie you don’t get the benefit without the risk
o To avoid this, the P should alert the public that there is no agency relationship
o This article on page 67 is important because the author became the reporter of the Rest of Agency
3rd
 see 2.05
• 429 is better for Π because it only requires reasonable reliance and not detrimental reliance as Rest 2nd of
Agency 267 does

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 o This is important in SC because in Simmons v. Tuomey Reg. Med. Center
 The employees working in the ER are not hospital employees but IC
 The SC Crt App and the SC both concluded that the hospital is still liable
• The Sup. Court adopts 429 as the basis for finding liability – however the did so
saying they did not adopt a view totally against delegable duty
o Not sure if 429 applies outside the world of hospitals – but it probably
does. Assuming that it is not this is important because its BOP is lower
than the Restatement of Agency
o Problems page 65
 2) court didn’t care about the agreement and it shouldn’t, because it the acts, not the
boiler plate.
 4) YES you would take advice of counsel
 The indemnification clause is good
 As are the clear warnings – especially the sign requirement which says the place is owned
by someone other than the company
 There is almost always an agency relationship between franshisor and franchisee, but
there is normally question of whether it goes to the employer/employee level
o Growing a sole proprietorship
 The owner can put his own money in, or he can take loans. If the owner puts in his own
money, it will serve as an investment or equity; it is not a debt to be repaid
 Debt v. Equity
• Equity funding does not come with a legal obligation to repay; it is an
investment that the business receives for selling a part ownership in the business
• Debt funding has a legal obligation to pay back, which of course, flows right to
the sole proprietor
• Compared to being a creditor, being an owner has a higher risk, both up and
down; the risk is higher, but so is the potential return.
• Debt is riskier to the business (leveraged is a term used when the company has
debt funding; the lender has leverage against them and can force them to pay); the equity
owner has no right to repayment
• Debt has a fixed cost: the interest rate the business pays to borrow the money is
the cost of those funds. On the other hand, at the time the equity is sold, the cost to the
business of the equity is uncertain.
• So a sole proprietor can’t use equity funding and still be a sole proprietor;
instead he must use debt funding
o Way to structure a loan so it will be perceived as low risk
o Security - Pledge personal or corporate assets against the loan as a form of collateral to secure the
loan
o Promise to pay the money back in a short time = more certain predictions
o Give the creditor some measure of control over the business
 Loan covenants
 Participation in business decisions- like a seat on the board
o Lender may also want profit share instead of interest
o Should you automatically arrange the company as a corporation so you wont be liable for the loan
o Wont work because the bank will require you to personally secure the loan
o See handout with comparison of capital structures. The concept is called leverage. We are using other
people’s money and paying less to them than we can make with their money (preferred shareholders).

PARTNERSHIPS
o Estate of Fenimore – DE Rule for finding a partnership
o Facts: Fenimore died insolvent. His sister loaned him some money for his business. Later, Villabona
loaned him some money for the same business. The estate inherited $20K, and both the sister and

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 Villabona wanted a cut. If both were deemed to be creditors, sister would have priority as she made the
first loan. Villabona argued that the sister was really a partner, and her “loan” was an equity investment”.
o Issue: Equity Investment in a Partnership vs. Loan.,
o DE Rule for the Existence of a Partnership: The court looked at the terms of the sister’s loan. She said
“advanced” rather than “lent.” Further, a condition of the loan was that she would receive profits from the
business. The court said that receiving a share of profits was prima facie evidence of a partnership,
and the fact that she made no decisions wasn’t enough to rebut that evidence. Thus, she was a partner,
and didn’t get her loan back. The court acknowledged that she didn’t intend to be a partner, but the court
didn’t care. You can create a partnership without realizing it.
o Courts have said that not all partners have to share in the decision making and liability – but they do have
to have at least one- and there must be an intent to share profits – not all courts would agree with this.
These concepts are important, but not absolute
o Agreement looks like a partnership
 Intent of parties
 Sharing of profits
 Allocation of expenses- ie sharing liability
o The BOP is less strict when at third party is involved then when the dispute is b/w the 2 partners
 This lowered standard plus the fact above mean that this was a partnership agreement
 She may not have intended to enter into a partnership, but she has- this is common – many people
enter into partnerships just by going into business with another and that there are consequences
o Therefore her claim to her brothers assets come in behind Villabona
Problems page 78
o 2.1 – using lend would have helped, but it probably wouldn’t trump the profit sharing; it doesn’t negate the
other aspects
o 2.3 – taking out the profit sharing (or at least use clearer terms) and clearly writing the document to be a loan
agreement. But there is a risk that a court will say it still meets the requirements of 210
o Note 5 – Martin v. Peyton held that Peyton was not a partner where he had no active control, only reactive – ie
that he cannot initiated a transaction
o Important but may not be controlling
o But beware – veto power may be enough
o What is a partnership
o For this class, we will be looking exclusively at the UPA (don’t worry about RUPA) b/c SC mostly follows
UPA.
o UPA § 6/ 33-41-210 –Partnership Defined
o A partnership is an association of two or more persons to carry on as co-owners of a business for
profit
o “Persons” includes entities
o Rule: that anything not specifically formed as something else under the laws of the state is
automatically a general partnership.
o A corporation can be a partner. Often business entities become partners.
o A joint venture is a limited purpose partnership (Meinhard).
 Entity approach (RUPA – not followed in SC) – the partnership is an entity in itself
• Tax – the partnership reports income on one statement but the individual partners pay
their portion of the taxes.
 Aggregate approach (UPA – the SC approach) – the partnership is an aggregation of
individuals.
 Tax – the NET INCOME of the partnership flows to partners, and is taxed to them on their
individual tax returns. You are taxed on the money, whether or not it is paid out to them or
not.
o To become a limited liability partnership, look at § 33-41-1110. You have to file to be a limited liability
partnership. Also you must demonstrate that you have at least $100,000 of liability insurance or higher if your
partnership renders professional services. § 33-41-1130.
Problems page 83

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o Can’t be both a sole proprietor and a partnership, nor can you start a partnership by yourself. But you can have
a single member LLC.
o Cant be both a corporation and a partnership – you’re one or the other
o SC allows a corporation to be a partner § 33-3-1029
o What is partnership law?
o The rights and privileges of partners are primarily governed by the partnership agreement. The UPA
contains fall-back provisions in the event there is no partnership agreement or the partnership agreement does
not cover the issue. However, there are a number of provisions of the UPA that say they cannot be changed by
K.
o Both RUPA and UPA serve as the default rule when partners fail to agree on a rule in the agreement
o So if you contribute 70% of the capital, you need to put in the agreement that you have the most say and get
70% of the profit, otherwise RUPA and UPA kick in and a majority vote rules decisions and profits are
shared equally
o Somewhat misleading – the statute does allow you to trump it, but there are some that it does not allow you
to side step it – often this is when disputes with third parties are involved
o Modification of the Partnership Agreement:
o Under UPA-SC the lawyer drafting the agreement must look section by section to see if a particular
section can have the rights and obligations modified in the agreement.
Page 85
o You don’t have to have a partnership agreement to operate as a partnership – but they should
o They don’t need a lawyer. But if they do, they probably need separate ones – but that’s an ethic issue
o However often only one lawyer does it – but be sure to think carefully
o Problem with sample agreement on 86 is that it doesn’t tell us what “mutual agreement” is – it doesn’t say what
the vote has to be on decisions – this would get us in trouble; the language is imprecise
o It may mean unanimity, but that’s not totally clear, and you could make it clear with better drafting – so do
so
o Extent of Partner’s Ownership Interests
o Who owns what?
o UPA § 8/ 33-41-230 – Partnership property
o All property brought into the partnership or later acquired on account of the partnership is partnership
property.
o Unless there is some appearance of contrary intent by the partnership, property acquired with p-ship
funds is p-ship property
o You can buy property in the p-ship name, and as such can only be sold in the name of the partnership.
o See § 33-41-230 for what happens if real property is conveyed to a certain partner.
o If property is owned by one before the partnership is formed and the partnership uses it
 Does the property get treated as a capital investment
 SC 33-41-230
• All prop brought into the partnership stock is partnership property
• But not clear what is brought into the partnership – so make it clear in agreement
o What if property is acquired by the partnership with the funds from one partner – what if it is in the individual’s
name
o 33-41-320(4) – says it doesn’t matter, the equitable title passes to the partnership
o UPA § 24/ 33-41-710 (p. A8) – Extent of Property rights of a partner
o Has the right in partnership property
o Has interest in the partnership
o Has the right to participate in management – this can typically be modified by the agreement
o UPA § 25/33-41-720 – Nature of a partner’s right in partnership property
o Partners are co-owners with “tenancy in partnership”
o How tenancy in partnership works:
 The partners each have an equal right to use partnership property for partnership purposes, but no
right to the property for any other purpose without consent of partners.

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  Rights to property can’t be assigned unless all partners assign their rights (Mutual Consent for
Assignment)
 Creditors can’t attach to partnership property unless they are making a claim against the
partnership.
 On death, a partner’s right is vested in the other remaining partners. On death of the last
partner, the property goes to his legal representative
 Next of kin can’t attach to partnership property
o Essentially you have the right to use the property that the partnership owns
 Partners rights in specific property is not assignable unless they are transferring everyone’s rights
in the property – so you cant sell a part of something unless the partnership agrees
o UPA § 26/33-41-730 – Nature of a partner’s interest in the partnership
o Partner’s interest in the p-ship is his share of profits and surplus and his personal property.
o Problems p. 87
o 2. Cooking equipment used in restaurant might be partnership prop depending whether it was loaned or
contributed
o 3. Cash and credit card receipts from operation are partnership property
o 4. New tables and chairs are partnership prop
 Who decides what the p-ship will do?
o Solving General Disagreements - UPA § 18/33-41-510 (8)
o If the partners disagree as to an “ordinary matter,” the disagreement shall be resolved by a majority
vote. No act in contravention of any agreement between the partners may be done rightfully without the
consent of all the partners.
o Also, if an act goes against the p-ship agreement, it must be consented to by all partners.
o Partners as Agents – UPA § 9 / 33-41-310
o (1) – Every partner is an agent of the partnership for the purposes of its business when he is
apparently carrying on the business of the partnership in the usual way-binds the partnership
 In all likelihood, this “usual way” is considered from the perspective of a 3rd party.
o (2) – An act of a partner which is not apparently for the carrying on of the business of the partnership in the
usual way does not bind the partnership unless authorized by the other partners.
o (4) - If a partner is restricted from acting in some way, his actions aren’t binding if the 3rd party has
knowledge of the restriction.
o Partnership agreements are private agreements that are not made public.
 Partner’s Duties to One Another
• Meinhard v. Salmon (NY)
o This is the most important business case ever decided in the US. Cited more
times that any other business case in America. Some people agree with the decision and some people
don’t
o Facts: Meinhard and Salmon were in a partnership where Meinhard paid to
renovate a building, and Salmon managed the building during a 20 year lease. Near the end of the
lease, somebody approached Salmon with an offer to develop some new apartment buildings. Salmon
took the deal and didn’t let Meinhard have a shot at it. “Salmon appropriated to himself in secrecy and
silence.”
o Test for Partner’s Duties to One Another: Partners must treat one another
with a punctilio of honor – the duty of the finest loyalty.
o “Joint adventurers, like copartners, owe to one another, while the enterprise
continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for
those acting at arm’s length are forbidden to those bound by fiduciary ties. A trustee is held to
something stricter than the morals of the marketplace. No honesty alone, but the punctilio of honor the
most sensitive, is then the standard of behavior.”
o Because Salmon’s position within the p-ship gave him exclusive access to
opportunities and information, he had a duty to disclose to Meinhard. Salmon breached that
duty.

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 o Basically, for a breach like this, you’re looking for a partner taking
advantage of the business of the partnership for his own personal gain
• ∆ appeared to the owner to have the lease in his own right, but in fact he held it as a fiduciary
o If he had acted as such, the development plan would have been presented to both Π
and ∆, but he didn’t act as such and acted as if he held it as his own
 He acted in secrecy
• If he had told the Π and they had competed for it, then he might be able to keep it as his own,
but because he didn’t the court is going to give the Π an interest in the venture
o The fact that he had sole power to make decisions means he had an even higher duty
to disclose
 He robbed Π of a chance of renewal
• So there is a graduated scale- if you are in charge, you have a greater duty to look out for your
partners
• Dissent
• Says there wasn’t a general partnership- merely a joint venture for a limited object to the
end of a fixed time – so it was a one shot deal
o The new project is much bigger in size and duration – it wasn’t a mere renewal
o If this had been a general partnership he would agree with the majority, but
since its not, he sees no fid duty other then that which is within the scope of the limited
venture
• He also thinks that these ventures are distinct enough that even if there was a partnership,
the ∆ was still in the right to act alone
• 33-41-530- Duty of Partners to Give Information
o Partners shall render on demand true and full information of all things affecting the partnership
o Case law says that as a fiduciary a partner has a duty to make a disclosure regardless of demand
• UPA § 21/ 33-41-540 – Partner Accountable as a Fiduciary
o Every partner must account to (present information to) the partnership for any
benefit he gets from any transaction connected with the formation, conduct, or liquidation of the
partnership or from any use of the partnership’s property
• UPA § 22 /33-41-550– A partner has a right to a formal accounting of p-ship affairs:
o If he is wrongfully excluded from the business by his co-partners
o If the agreement gives him the right.
o If a benefit was received as described in § 21
o catch all: Whenever the circumstances render it just and reasonable
Problems on 96
o 1.2 – you could say that the opinion would come out differently – the nondisclosure issue wouldn’t arise, but he
still may have taken something that didn’t belong to him; there is an argument that it would have come out
differently; see 530 and 540
o Would SC find these two to be a partnership – yes – see §210 they are both in a lease arrangement to make
money
o Most attys would say that a joint venture is a kind of a partnership – a limited purpose partnership
o If so- §540 says a partner will hold as a trustee any profits derived by him without consent from the others
from any transaction connected with the formation
o §530 – Partners shall render on demand true and full information of all things affecting the partnership to
any partner or the legal representative of any deceased partner or any partner under a legal disability
 This wouldn’t kick in in the Meinhard case because Meinhard never demanded the information
 However, case law shows that there doesn’t have to be a demand and that a partner has a fid duty
to make a disclosure regardless of demand
o These two sections are the only times that the UPA talk about fiduciary duties
o 1.3 – probable would reach the same result – Cardozo talks about managing partner having a higher duty but
they still have a duty as partners
o On page B-17 § 33-44-409

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 o Fid duty as contained in the LLC statute – its very different then what is in the partnership statute – but is
similar to page 98 of the text (RUPA)
o Also look at B-5 LLC
 Operating agreement may not change
• Duty of loyalty – but may id types of activities that do not violate those duties
• Cannot reduce standard of care
• Rules of goof faith and fair dealing
o What if Meinhard case was an a SC LLC – what section would have helped Meinhard the most
o 33-44-409(b1)
o To Salmon?
o 409(e)- just trying to make some money
o Read 56 S.C. L.Rev. 275 (2004)
o Compares fid duties of partnerships to LLC – written by Toal
o Takes position that despite 409 – there are more fid duties owed by partners then by members of LLC
o Would the language in 5 work?
o Problem is that not everyone will be in equal bargaining position, so there is room to challenge it
o Delaware - you can put in an LLC agreement that if anyone wants to steal, lie cheat, its fine, you can say there
is no duty of loyalty – this wouldn’t fly in SC- the kicker is though that neither the Del. SC nor the Leg was
willing to delete their language which we find in SC 409(d) – which talks about K obligation of good faith and
fair dealing
o Burcky thinks this will be used by Del courts to reach the same result as you would if you said there was a
duty of loyalty
o What is a punctilio? A detail about which one is fastidious, a point of honor
 Liability in Partnerships
o Partnership liability as an Entity
o UPA § 13 / 33-41-350 – Liability for Wrongful Act of a Partner: The partnership itself is liable as an
entity and is bound by any wrongful act of a partner acting in the ordinary course of business.
 If partner injures TP in scope of business, then the partnership is liable to the same extent as the
partner
 When partner acting in scope of apparent authority, receives money or property from 3rd person
and misapplies it, or if the partnership receives it and a partner misapplies it – the partnership must
make good the loss
o UPA § 14 / 33-41-360– P-ship is bound by a partner’s breach of trust. Partnership is bound to make
good the loss when 1) one partner acting within the scope of his apparent authority receives money or
property of a 3rd person and misapplies it and 2) when the partnership in the course of its business
receives money or property of a 3rd person and the money or property so received is misapplied by any
partner while it is in the custody of the partnership.
o Joint and Several Liability of the Partners
o Liability of Partners
 RUPA – partners are jointly and severally liable for all obligations of the partnership
 UPA – partners are jointly –NOT severally- liable in contract BUT ARE jointly and severally
liable in tort
 SC – partners ARE jointly and severally liable for K and tort- § 33-41-370(a)
o UPA § 15 / 33-41-370 (modified in SC): Nature of Partner’s Liability
 (A) All partners are jointly and severally liable for claims against the partnership, regardless of
whether they are tort or contract claims. (Except as provided in B below)
• Note that with joint and several, a plaintiff is free to go after a single partner, and force
them to go out and get the rest of the partners.
 (B) A partner is not liable by way of indemnification, contribution, or otherwise, for debts,
obligations and liabilities charged to the partnership arising from negligent, wrongful acts, or
misconduct committed while the partnership is a registered LLP and in the course of the
partnership by another partner or an employee, agent, or representative of the partnership
• Unless that person was under his direct supervision

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 • Or a person rendering personal services on behalf of the LLP, unless the partner was at
fault for appointing or supervising them.
• There is no protection against K claims
o 33-41-510: A partner is entitled to contribution or indemnity from other partners if the personal liability
was reasonably incurred by him in the ordinary and proper conduct of its business or for the preservation of
its business or property
o 33-41-1200(g): addresses the liability of the partner of a limited liability partnership for a partner who
transacted business in a state without a license.
o 15-5-45: Suing Partnerships
 A plaintiff can sue a partnership with or without joining any of the partners.
 Judgments against a partnership bind its real and personal property, and the partners are personally
liable for any judgment.
o 15-35-170: Judgment against a Partnership
 Burkhard says that this has never been used against partners (its purpose is to nail the unions). If
you get a judgment against a partnership, you can go after the personal assets of the partners if
you can manage to join them in the suit; due process says you can’t collect from a party unless
that party is a named party of the lawsuit. You better name all of the partners.
o RSA § 404 – Liability of agent for use of principal’s assets
 Agent who uses for his own purposes the assets of a principal’s business is liable to the principal
for the value of the use.
 Not liable for use of time he contracted to the principal in some other matter, unless he violates a
duty not to act in competition with the principal.
Problems page 100
o 1) looks like an easy answer, but there is nothing in SC act that give a TP the right to sue the business –
aggregate idea comes in and says you have to sue the partners
o §15-5-45 and §15-35-170 – on TWEN allows you to sue the partnership, and also allows the partnership to
sue.
o 1.2 – yes P can sue A –the tortfeasor
o 1.3 – yes, P could also sue E, who is another partner – SC makes us severally liable; § 370(a)
o 2) how can P enforce judgment against the partnership –
o Because all the partners are not named in the case, which equals violation of DP if you aren’t named in the
lawsuit – so this is a problem because the statute says you are jointly and severally liable
o So to collect against the partners they have to be joined – name the partnership, the partners as partners, and
the partners as people
o 5) 510(2) – the partnership must indemnify every partner in respect of payments made and personal liabilities
reasonably incurred by him in the ordinary and proper conduct of its business or the preservation of the business
or property
o So yes, but he must qualify. Not sure how negligence would fall
o §370
o Allows for some partnerships to qualify as a registered Limited liability partnership, which means they are
not liable for the acts of others
 Doesn’t protect from K claims
o D) if you take part in the services you are liable
 If someone else in the limited liability partnership does it, then you are not liable for torts unless
you are at fault for appointing, supervising or cooperating with them.
o This statute is mainly the result of lobbyist for accountants from out of state said they were pulling out of
SC unless they passed this statute
o How do you become a limited liability partnership – A-18
o § 1110 (A) says you must file an application with the Sec. of State – this is unlike a general partnership
which can be created without any paperwork
o Must renew registration every year
 Failure to do so will make you a regular partnership
o Must have at least 100k of insurance

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  Or more if your professional licensing board requires you to
o If you are a registered NC LLP and you come into SC to do business but forget to register in SC
o 1210(C)
 Doesn’t matter, you still are liable for the torts of your partners
o Growing a partnership
o Contributions from Existing owners: Rules on Capital Calls
o If the partners agree, they can decide that the partners will contribute capital to the partnership.
o Normally, there should be something in the p-ship agreement that states what vote is required for a
capital call, criteria for making a capital call, and how things will be handled if a partner can’t or
won’t respond to a capital call.
o Input from outside lenders
o Discussion on leverage. Debt in essence levers up the return on equity. It almost always increases the
investor’s return but it also increases the investment’s risk.
o If the bank forces a partner to sign a guarantee on a loan, the partner might not care because the bank could
come after the partner anyway under joint and several liability. However, it would be easier if the partner
signed the loan agreement.
o Additional Owners
o UPA § 18 / 33-41-510(7)– adding a new partner requires consent of all partners unless the agreement
specifies otherwise.
 If the partnership agreement requires the consent of all existing partners and they want to amend
the partnership agreement to provide that admission can be approved by a majority, the question is
whether amending the agreement is in the ordinary course of business.
 Problem page 104
• Default rule says they all must agree, so they will need to change the agreement to add
this – which is why they come to you
• Answer depends on whether amending is in the ordinary course of the business – if so
then a majority vote will do – if not, it must be unanimous
• Problem 2)
o §390 – partner IS liable for existing partnership obligations that arose before you
joined – except for liability that is to be satisfied only out of partnership property
o Privity of estate says he will only be liable for property obligations from the
time he enters to the time he leaves
 New partners are not liable for preexisting liabilities. Liable for the time period in which he
enters to the time he leaves.
o Earnings from Business Operations
o Must consider if the partnership can earn a higher return than the partners can individually
o They should be distributed unless the partnership has some lucrative use for the funds
o Problem 106
 2 partners want to invest. 1 wants to use profits to pay school loans
• Majority vote rules because paying profits out is in the course of ordinary business (only
need 51%)
o How do owners make money?
o Salary
o The assumption is that partners make money through distributions
o UPA § 18 / 33-41-510 allows salary if the partners put it in the agreement
o Problems:
o 1. Agee and Propp who work at the partnership can receive a salary while Capel does not (he doesn’t work
there)
o 2. Capel can prevent Agee and Propp from increasing their salaries if the salaries are in the partnership
agreement (can’t change without the consent of all partners); if it is not in the partnership agreement, they
could change it by a majority vote because it is an ordinary matter
o 3. Capel can’t compel the partnership to employ him and pay him a salary

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 o 4. The partnership can pay Capel a salary even though he doesn’t do any work for the partnership. They
have discretion. The creditors care and the IRS cares (because this could be income shifting to get from a
high bracket to a low bracket)
o Profits
o Generally, profit distribution is specified in the p-ship agreement
o UPA § 18 / 33-41-510(1) provides default rule: each partner shares in profit and losses equally unless
agreed otherwise; doesn’t matter who put in what; when partnership ends partners would be repaid
contributions before profit divided
o Problems
o 1. Default distribution is equal to all- they should put it in the partnership agreement what % they get.
Don’t get confused about liability to partners- that only comes up when the partnership ends. Aside: you do
not have to make a capital contribution to be a partner
o 3. Majority vote would rule for an ordinary matter regarding profits
o Sale of interest to 3rd party – doesn’t cause dissolution by default
o Remember that the selling partner will have to find someone, get the other partner’s approval, and work out
an agreement about his prior obligations, which the new partner does not inherit by statute
o Also he can only transfer his right to share profits and losses and receive distributions – so not control
o UPA § 26/33-41-730 – a partner’s interest in the partnership is equal to his share of profits and surplus,
and his personal property.
o UPA § 26/33-41-740 – Effect of assignment of partner’s interest in partnership and this is assignable.
(Does not by itself trigger dissolution)
 Doesn’t give the assignee any mgmt or administrative rights in the partnership, only entitles
them to receive in accordance with his contract the profits to which the assigning partner
would otherwise be entitled.
 Selling financial rights doesn’t necessarily end your participation in the partnership unless you
quit.
o UPA § 18(g)/33-41-510(7) :by default, adding a partner requires consent of all partners
 So the sale of transferable interest to a third party does not automatically make that person
a partner unless they’re voted in
o Problems
o 1) §740 says no- when you sell your interest, you only sell rights to distributions and liabilities –this does
not necessarily give a right to make decisions
 This is different than being a partner under 510 which requires a unanimous decision
 If you sell your interest you are really selling your financial rights – this doesn’t mean that you are
no longer a partner. You have to quit to no longer be a partner
o 2) not automatically unless he is voted in;
o 3) Partner’s Share of Profits – these are computed at the partnership level, so the partnership will
determine how much the business made and then allocate on its books what everyone’s share is
 Right to receive distributions – is the actual physical paying out of your % of the profits
o Sale of interest back to the partnership
o Buy-Sell agreements – the partners can agree to buy an individual partner’s interest from him.
 Easier to sell to the partnership then to an outsider = buy-sell agreements allow the partnership to
do this
 Need to include
• Whether the partnership is obligated or has an option to buy
• What events trigger that option
• How is the selling partner’s interest to be valued
• What is the method of funding the payment
 Absent such an agreement, the partnership is still compelled to buy the partnership interest if the
partner withdraws – but how much he gets is up to the agreement and statutes
 Tells you what happens when someone dies or quits
 Normally you provide that you can buy out the dissociated partner’s share

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 o Withdrawal / Dissolution– Compelling the partnership to buy your interest, which leads to dissolution of
the partnership.
o Dissolution of the Partnership
o UPA § 29 / 33-41-910 – Dissolution Defined: a change in the relationship among the partners when any
partner terminates his association with the partnership.
o UPA § 30 / 33-41-920– The partnership is not automatically terminated upon dissolution, but continues
until winding up of affairs is completed
o UPA § 31 / 33-41-930 – Causes of dissolution
o Without violating the agreement
 Term Expiration - If the agreement specified a term and that term expired
 A partner expresses that he wants to dissolve if there is no express term or particular undertaking
specified in the agreement.
 Express will of all the partners who haven’t assigned their interests or suffered them to be
charged with their debts
 By expulsion of a partner in accordance with a power to expel conferred in the agreement
o You can have a dissolution in violation of the agreement if a partner quits in a way that isn’t provided
for in agreement. This is wrongful and you have breached your K obligations.
o If an event occurs that makes it illegal to carry on the business of the p-ship or for the partners to be
associated with the p-ship
o Death of a partner
o Bankruptcy of a partner or the partnership
o If the court says so in accordance with UPA § 32
o UPA § 32 / 33-41-940 – Dissolution by Decree of the Court
• UPA § 38(1) &(2) – How to handle dissolution situations
o 38(1)/ 33-41-1030 – When dissolution not in violation of partnership agreement
 Each partner can have partnership property credited against his liabilities and can have the net
amount owed to him paid in cash. (unless otherwise specified in the partnership agreement)
 If the dissolution was b/c of an expulsion, and the expelled partner is discharged of all of his
liabilities under 33-41-1010, then the expelled partner gets his net amount owed in cash.
o Note that this can all be modified in the agreement
o 38(2)/ 33-41-1040 - Dissolution in Contravention of the Partnership Agreement -When a partner
wrongfully dissolves
o The partners who didn’t cause the dissolution
 get all the rights under paragraph § 38(1) -33-41-1030 (can get cashed out if his liabilities are
paid off) and the right to damages for breach against the dissolving partner
 May continue the pship under the same name if they pay off the dissolving partner less
damages for breach
o The partner who caused the dissolution
 Gets his payout minus damages
 Does not get his share of the value of the good will of the business if the p-ship is continued
o Note that this can all be modified in the agreement
o Dissolution is the beginning of the end and Termination is the end
o RUPA says any partner has the power to dissociate at anytime but there could still be legal issues
o Unless the agreement says otherwise- a partner in a “partnership at will” (one with neither a specified end date
nor a specific undertaking to complete) can quit at any time without it being wrongful
o Problems 112
o 1) yes he can withdraw but it will be wrongful 930(2).
 When will he be paid - §1040 -
• he is liable for damages (but not sure how to compute that)
• if they continue under the same name – you pay him off
• do not consider value of good will in computing the assets – so you’re getting a
discounted amount
o Creel v. Lilly (MD)

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o Facts: Creel started a NASCAR store and eventually entered into a partnership to expand. Creel died, and
the partnership wound up and accounted and paid the estate Creel’s share. The wife was not satisfied with
the accounting, and wanted the pship assets liquidated, presumably b/c they were selling memorabilia that
was worth much more than its book value.
o The court states that the UPA entitles the wife to automatic liquidation unless specified otherwise in
agreement. However, the court looked at the “termination” section of the p-ship agreement and decided
that the partners intended this section to take the place of automatic dissolution under UPA and that the
agreement doesn’t mention forced liquidation.
 Section title “Termination” but really covers dissolution and ‘winding up’
 It says the assets and liabilities be ascertained – but this does not mean by liquidation
 The ∆ followed the winding up method- full inventory, accounting and the deceased share of the
remaining profit was distributed to him – this is all the surviving members need do
 Document need not account for every continuation as long as intent is shown
 Burcky says the court is reaching here because the document isn’t that great
o Court says agreement has a “continuation clause” in the form of a buy-out option by providing that the
deceased partner’s share of the partnership goes to his estate
 If the estate wishes to sell that share, it must first be offered to the partnership
o Rule: If the partnership agreement provides for otherwise other than liquidation upon an event
causing dissolution, such as the death of a partner, then the intent of the partners in the agreement
will prevail.
 The Court’s comment about the UPA rule requiring automatic dissolution of the partnership upon
the death of a partner is wrong because when a person dies there is automatically a dissolution.
 The court said that if the agreement clearly states the intent of the partners, then that intent
controls even though it didn’t provide for every possible contingency, and in this case, the intent
was “clear” that they didn’t intend for liquidation
 b/c of the automatic dissolution absent consent from estate or provision in partnership agreement,
many jurisdictions switched to RUPA
• UPA – aggregate theory – one dies, it ceases to exist
o SC follows this
o But court gets language wrong – agreement can’t prevent dissolution- it should
say “termination”
• RUPA – entity allows continuation, BUT remaining partners must elect to buy out the
dissociating partner
o UPA requires buy-out provisions to be in the agreement, but RUPA does not –
but they must actively choose to buy out
 Under RUPA – the estate cannot compel liquidation
 Of course – the partnership agreement can trump both
o Rule: Liquidation Value of a business: There is also a dispute between Book Value (Cost of the Goods in
the Store) vs. Market Value (that would include Goodwill). Ct says this is ok b/c the Business in its
infancy stages probably doesn’t contain goodwill and Book Value is ok. Should make clear in the
agreement which measure of value you will use.
o The court noted that RUPA doesn’t have a forced liquidation, but Burkhard said that is wrong under
UPA 33-41-1030 (below)
 Court is wrong to say that UPA wouldn’t require termination if the agreement doesn’t provide
otherwise
 §33-41-1030 would require liquidation to pay off the debts and pay out the assets
o Comparing to SC LLC provisions: Our LLC provision 33-44-601 follows the RUPA description in the
Creel case. The withdrawal of a member from an LLC is not an event of dissolution. When a member
leaves an LLC, they have dissociated. It means something slightly different in the context of the LLC than
it does in the partnership context. 33-41-602(b) points out what would be wrongful dissociation. 33-41-
603 explains the effect of an LLC member’s dissociation. Almost all of these provisions can be changed by
an operating agreement.
 Key Points

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 • LLC is deemed like a corporation to be an entity (not aggregate) so if someone leaves,
the entity is still there and the LLC can continue
• Withdrawal of member is NOT a dissolution, they have instead dissociated
o When the LLC statute does use dissolution, it means that the ₪ is going to go
into termination and liquidation
• §601 gives a laundry list of items of causes of dissociation
o 1 is important – it occurs when the company has notice of the members express
will to withdrawal on the date given
o 7 talks about when someone gets in financial trouble
o Death, appointment of guardian, or judicial decision saying he is incompetent
• §602
o There are rightful and wrongful events of dissociation
 Wrongful methods result in consequences
• Withdrawal against agreement provision
• Bankruptcy
o 602(a) has some ambiguity- says you can leave unless the agreement otherwise
provided
 Not sure how this operates
• §603 – withdrawal of member
o What happens depends on whether you are an at-will LLC or a term LLC
 At-will means the other members will simply buy you out
 Term – the members do not buy you out, you take the status of an
assignee – kind of like creditor – you continue to receive your share of
the profits (but they will vote to change these once your gone)
• When the term is over, you get your capital
• all of these default provisions can be changed by provision in an agreement
 if you can’t agree on how much to pay someone who leaves an LLC, the court can decided for you
 §704
 §801
• Events causing dissolution and winding up of corporations
• The ₪ must be wound up on occurrence of stated events
 § 806
• Tells you who gets what when you go out of business
Problems page 123
• 6.a – is he liable for the property lease
o YES - §33-41-1010 – dissolution does not discharge the existing liability of any partner
• 6.b – is he liable for tort claim that arises after he leaves
o Partnership doesn’t end at dissolution – so during windup phase, it is still a partnership, and he
would still be part of the partnership, so if the tort happens during the winding up stage, there is a
strong likelihood that the withdrawing partner is still liable
• 6.c – liable to long time TP supplier for orders made after he leaves
o §1011, 960, 970
o 970 is key – after dissolution a partner can bind the partnership by any act for winding up and by
any transaction that would bind the partnership if dissolution had not taken place . . .
o Yes, he can be liable for K claims if windup is still going on – merely because you leave the
partnership does not get you off the hook for something that happens after you quit
o Also read 980
Page 124
• When one partner leaves, the other partners can continue to operate the partnership if the leaving partner
allows it (?)
• After one partner leaves the other partners cannot continue after windup - §1030 – right to liquidate
• What if withdrawing partner wants the partnership to terminate but the other partners don’t – they still
have to liquidate under 1030

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 o If partner dies and widow wants the partnership to terminate, they have to liquidate under 1030
o But if the withdrawing partner gives consent to the others to continue, then they may and the
withdrawing partner becomes something like a silent partner (?)
• What if it’s a term partnership and one tries to leave before its over
o §1040 says that the others can continue the partnership
Page 125
• Are the debts owed to a partner that he lent to the partnership treated differently than outside creditors
o Yes - §1060(2) gives order –outside creditors collect first
• If the partnership has no assets, outside creditors can collect directly from the partners
o But from inside creditors issues of indemnification come up – we won’t look at this
Page 127
• (1)Yes they need to agree to partnership accounts because the beginning capital account for Capel is 250K,
Propp’s is 150K , Agee 2,000 – so their capital accounts are different
• (2)We also need to know how much money the partnership earned during the time the P was in business
o §510 and 1060 say that each partner gets the remaining capital accounts at termination – but these
accounts will be reduced by what is distributed to them
o C = 250 -150 = 100
o P 150-142= 8
o A 2-0 = 2
o So we owe the partners a total of 110 – so deduct 110 from 200K (the remaining money) = 90K -
we then distribute 1/3 to each partner
• Problem 3
o Says only 20k is left over, so we don’t have enough to cover the remainder of their capital account
o So 20k – 110K = -90k loss
o Statute says the partners share the loss equally absent provision
o So each suffers a 30K loss
 C is owed 70K
 P has to put back in 22k (8-30)
 A has to put back in 28 (2-30)
o So 22 + 28 + 20 (money left over) = 70K
 Liability of Dissociating Partners
o When a partner withdraws under RUPA, the partnership can either
o Purchase his interest and continue the partnership
o Dissolve, liquidate, and terminate
o Under RUPA, dissolution isn’t the end, but it means the scope of the partnership contracts to completing work
in process and taking other such actions necessary to wind up the business
o Winding up the business entails
o Selling its assets
o Paying its debts
o Distributing the net balance, if any, to the partners according to their interests
o When the winding up process is completed, the business terminates
o RUPA rules for distributions to partners according to their interests
o Unless partners agree to the contrary
 They share responsibility not only for the losses from operation of the partnership business but
also for partners’ losses from investments in the partnership
 SEE page 126
o If the Partnership Agreement is Silent, UPA indicates 3 Ways that you can handle Dissolution
o Liquidation - Sell the Partnership- the Accountant comes in and values the partnership and after bills are
paid the partners divide up the remaining value.
 Problems - During the wind-up which can take a long time, the withdrawn partner is still entitled
to his or her own share of the profits, then during liquidation the withdrawing partner or his estate
gets his or her share of the value. One of the problems with the long wind-up is the estate or
withdrawing partner may be subject to creditor’s claims.

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  Ct will conclude that what happened in the post dissolution behavior is that the business has gone
into a wind-up mode. The wind up can take a short time or a long time
o 33-41 -1030 – Application of property upon dissolution not in contravention of agreement: at the end
of the wind-up mode we liquidate the business
o Buy-Out – Business Continuation
 all of the remaining partners get together and buy out the other one’s share.
 one of the remaining partners buys-out the withdrawing partners’ share
• Problem - During the Business Continuation period the value is calculated at the day the
partner dies – so if they settle up 5 years later, the value of the partner’s capital is
what it would have been the day he or she left.
 33-41-1070 - Liability of Persons Continuing Business in Certain Cases (Business
Continuation)
• The liability of the dissolved partnership attaches to the continuing business
• (7) the liability to a 3rd person becoming a partner in a partnership to creditors of the
dissolved partnership can only be satisfied out of the partnership property.
• (8) – creditors to the deceased partner’s interest in the partnership have a priority over
other creditor’s of his estate
• (10) use of the deceased partner’s name does not make his individual property liable for
any debts contracted by him or his partnership
o Death - In the event the dissolution is caused by death or incompetency, and the partnership agreement is
silent as to what to do, the deceased estate can make 3 arguments and the court then decides what to do:
 Business Has Continued –
• 33-41-1080 – Rights of Retiring Partners or estate of deceased partner when
business is continued. (Death of a Partner) –
o Deceased partner is entitled to the value of his interest at the date of dissolution
with interest (Liquidation will be valued then)
o or in lieu of interest the profits attributable to the use of his right in the property
of the dissolved partnership.
 Liquidation
• Partnership will be valued at the time of death.
• Often problems arise with valuation/goodwill
 Estate is a New Partner
• One way to do this is to - Convert this partnership interest to a limited partnership
interest.
• Usually the deceased partner will agree to this prior to death
o UPA § 36 – 33-41-1010: Effect of Dissolution on Existing Liability of a Partner
 A withdrawal doesn’t change the liability of the partner that existed before his withdrawal.
 He can agree with the creditor and the remaining partners to have his obligations assumed
by the partnership – this agreement can be inferred from a course of dealing between the
partnership and the creditor
 If someone assumes the liability, the partner will be discharged from the liability if the creditor
knows of and agrees to the new deal
o Tort Liability: Not clear whether a dissociating partner is liable for torts that accrue after dissolution.
Apparently, he probably will be liable for anything that accrues before winding up.
o Statute is silent regarding liability for Tort Claims that occur after a partner withdraws.
 If this is an event that occurs during the wind-up, presumably, the former partner is on the
hook.
• Ex - A lawyer who leaves a law-firm and then his partners subsequently commit
malpractice, then the lawyer is liable
o Liability for Contract Claims –
 UPA § 33 / 33-41- 950 – Effect of Dissolution on Partner’s Authority to Act.
• Dissolution terminates the partner’s authority to act for the partnership (with the
exception as so far is necessary for the winding up affairs).

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  UPA 34 – 33-41-960 – Liability of Partner for Acts (BOC) of other partners after dissolution
– Contract Liability
• All the partners are still liable for any pre-dissolution contract liability claims caused by
another partner, unless that partner knew at the time he created the liability of the
dissolution.
 UPA § 35 – 33-41- 970 - Power of a Partner to bind the p-ship after dissolution
• After dissolution, a partner can bind the p-ship:
o with any act appropriate to winding up the business
o with any transaction that would bind the p-ship if dissolution hadn’t happened IF
 the other party had extended credit to the p-ship prior to
dissolution and didn’t know or have notice of the dissolution OR
 the other party knew of the partnership and had no notice or
knowledge of dissolution, and the dissolution hadn’t been
advertised in the newspaper in the area where the business took
place
• Liabilities created under (1) are charged against p-ship assets
• Exception (990): the partnership isn’t bound by the act of a partner after dissolution
if
o dissolution was because it would be unlawful to carry on business unless the
act was appropriate for winding up.
o the partner has become bankrupt
o where the partner has no authority to wind up affairs
 Winding up of Business – Post Dissolution
o Winding up = selling assets, paying debts, and distributing the surplus to partners according to their
interests
o UPA § 40 /33-41-1060– Settling of Accounts between Partners: Rules for Distribution
 The assets of the Partnership are the partnership property and the contributions of the partners
 liabilities of the partnership – ranks of creditors
o Settlement of Partnership Accounts
 Partners are responsible for operation losses and individual partner’s losses from investments in
the p-ship.
 Track this with partnership account – track how much each partner put in and how much each
partner took out
 At Dissolution we must determine what the remaining capital accounts of all 3 partners is to
determine what their share of the profits is.
 On dissolution, if a partner is owed money in account, the partnership has to pay it
 If some partners owe to the p-ship, they have to pony up and pay what they owe so that losses
from investment are shared equally
 Option #1 - If there is a surplus after paying off all debts, it’s easy – pay off the p-ship
accounts and then divide the remainder equally.
• Ex: Capel puts in $250 (earlier distributions/withdrawal= $150)), Prop puts in $150
(earlier distributions/withdrawal= $142), and Agee puts in $2. So total owed to
partnership is $110. If the partnership is worth $200 then all of them get paid off and then
they divide the $90,000 equally so they all get $30,000
 Option #2- If there isn’t enough to pay all the accounts after paying debts:
• Determine how “short” the partnership is with respect to the partnership accounts
• Divide the short amount by the number of partners – they divide losses equally
• Subtract this amount from each partner’s account and voila! You have the cash out
amounts
• In Class Ex. Same example as above except profit is only $20,000, so $110 is owed, total
loss is $90,000. Divide this loss equally and it will be shared equally amongst all
partners. Section 510 - So subtract $30,000 from the amount all of these are owed. Capel
now is owed $70,000. Prop now owes $22,000 and Agee now owes $28,000. Take the

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 amounts they both owe and add the $20,000 the business made and this equals $70,000
which equals the amount owed to Capel – Balances.
o Kovacik v. Reed (CA)
o Facts: Kovacik invested $10K in a venture to do kitchen remodeling and told Reed that if he would be the
superintendent, they would split profits 50-50. They didn’t discuss loss. The venture ended up losing
money and Kovacik came to Reed for his share of the loss.
o Minority Rule –CA Rule: Court stated the general rule that members of a partnership are expected to bear
profits and losses equally. However, when one partner contributes money and the other contributes
labor, neither party is liable for losses to the other without an express agreement to the contrary
 (Burkhard says that this is the ONLY case that has come out contrary to the statute – so you
would try to argue this case but it isn’t the law – so in SC don’t allow your clients to get
stuck in this relationship and draft the agreement that ensures your clients don’t get stuck
in).
o Majority Rule - SC rule is that the worker owes the money to the p-ship UNLESS you have trumped the
statute – put in an express agreement; see 33-41-1060(2) and 510(1)
o Law presumes that absent an agreement, partners and joint adventurers intend to share equally in the losses
and profits of a common enterprise – regardless of how much each contributed to the capital employed in
the venture – the losses are to be shared in the same proportion as the profits
 BUT this rule only applies where each party has contributed money, land, tangible property, or
services that are to be paid for before profits are computed – however the court might be
misconstruing these cases- they didn’t base their decision on this basis
 IN cases like this, where one contributes the money against the other’s skill, then neither is liable
to the other for losses
• That way the each looses his capital – one the money, and the other his labor – so the ∆
doesn’t get paid, but he doesn’t have to contribute to the money loss
• Rationale is that the labor rendered is equal to the money spent
o This is not a mainstream case and most of the time it would come out the other way
 Reaches fair result, but Burky doesn’t think it follows the statute
o §1060 - says who gets what when the P ends
 (2) the liabilities shall rank in order of payment – and subection c says those owing to partners in
respect to capital
o Then look at 510
 Each partner will be repaid his contribution and each partner will contribute toward the losses
regardless of what he put in in relation to his share of profits
o Reading these statutes together, the ∆ should have had to pay
o If this same situation happened between members of an LLC, the working partner would not be liable for
his half of the losses because the whole point of an LLC is to eliminate personal liability.
 Expulsion of a Partner
o Bohatch v. Butler & Binion (TX)
o Facts: Partner in a firm reported another partner to the managing partner for overbilling. The firm expelled
her by reducing her partnership distribution to zero and eventually voting to expel her. The girl is a brand
new partner to the firm.
o Rule: Court said that there is no duty that partners have to remain partners, and because the trust and
loyalty that must exist between partners can’t survive Bohatch’s actions, it was ok to expel her. If they
expelled a partner in bad faith (for personal gain), they would have breached their fiduciary duty.
 Partners have a fid duty to one another to deal in honesty, but they have no duty to remain partners
 “at the heart of the partnership concept is the principle that partners may choose with whom they
wish to be associated
 If she stays, how would they get around the tension and how would that effect the client
 Others say this doesn’t make sense, the real reason is that your throwing her out for being stupid/
having bad judgment – which you can do. No need to go into these ideas of trust and client tension
o Focuses on the at-will nature of a partnership and even more importantly there is a fiduciary
relationship and duty to the clients and this duty trumps all of the concern that the girl was not
treated fairly (expelled her even though she did what she did in good faith)

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o Some argued that there should be protection for a whistleblower, or else they would be discrouged from
reporting unethical conduct – even if they were wrong
 Court rejects this argument
 Partners must trust each other, and just like they could expel each other for other disagreements,
they can do so for acusing each other
 Court says that partners cant expel each other for self gain- ironic because that’s always why they
are expelled
 So trust issue trumps here
o SC Rule: UPA does not give an automatic right to fire partners; reasons for expelling a partner have
to be set out in the partnership agreement.
o When you read the dissent you get an entirely different approach than when you read the majority.
o Issue: Can you expel someone b/c her actions are unprofitable to the partnership (question 1.2 p. 137)
o Ct of Appeals - says you can’t throw someone out for self-gain purposes, but this Court disagrees with
them and suggests that anytime you throw someone out it is for self-gain
o When they threw her out, she had a right to be paid her share of the value of the partnership unless it was
trumped by the partnership agreement.
 Freeze-out of a Partner
o Def of a “Freeze Out”: when a majority owner (superior financial position) acts to force a minority owner
to sell their interest
o Page v. Page (CA)
 Facts: 2 brothers each chipped in equal amounts to start a laundry business. It lost money for a
few years and the plaintiff’s corporation made a big loan to the business. Then things started
looking up, and the plaintiff attempted to terminate the partnership. One brother argued that it was
a term partnership and that his brother was obligated to stay until he could pay-off all the notes.
The other brother argues that it is a partnership at will and he can quit whenever he wants.
 Rule: If the partnership agreement does not contain an express term then the partnership can be
terminated at will by either partner at any time. However, a termination that results in one partner
freezing out the other and putting the business to his own use breaches the duty of good faith and
is not permitted.
 Court found that this was a partnership with no term or purpose, so under UPA can be terminated
by either partner at either time; however the termination was in bad faith and so the result is that
the little guy gets to stay on as a partner
 Rule: a partner is not bound to remain in a partnership regardless of whether the business is
profitable or unprofitable. A partner may not, however, by use of adverse pressure “freeze
out” a co-partner for his share of the prospective business opportunity (two opposite
sentences). In this regard his fiduciary duties are at least as great as those of a shareholder
of a corporation.
 Court says that in this case, the P has the power to dissolve the partnership by express notice to the
D. If, however, it is proved that the P acted in bad faith and violated his fiduciary duties by
attempting to appropriate to his own use the new prosperity of the partnership without adequate
compensation to his co-partner, the dissolution would be wrongful and the plaintiff would be
liable pursuant to § 1040.
 Page Case Rule: Whatever remedy the Court is suggesting, the court suggests that whenever
a partner is dissolving he or she can not merely do what is in their bests interests; they have
a fiduciary duty to his or her partner – very different from Bohatch case
 SC Rule – Toal would probably follow the Page rule.
 There is much debate about whether or not a dissolving partner in an at-will partnership has a
fiduciary duty to his or her partner.
 SO – you can dissolve at anytime, but not if the other partner shows you are doing so in order to
take control of the business for yourself. If you do this, then you must adequately compensate the
other partner

i. Summary of the Different ways a person’s partnership interest can end

Page 26 of 182
 1. Freeze out
2. Expulsion
3. Withdrawal followed by purchase of interest or dissolution
4. Sale to third party of transferable interest
5. Partnership converted into or merged into another corporate structure

CORPORATIONS
o What is a corporation and how does a business become one??
o A corporation is a creation of state legislatures where
o It is its own legal entity
o The owners usually aren’t personally liable for the debts of the corporation (the most you can lose
is what you paid for the stocks)
o Most American corporations are very small business, but the economic impact of the few larger
corporations is what drives the U.S. economy.
o Different from a partnership, with a SC or a Corp in any state you MUST file with the Sec of State’s
Office.
o 4 Sources of Corporate Law:
 State Statutes
 Articles of Incorporation
 Case Law
 Federal Statutes
• Federal Securities Statutes
• Federal Tax Statutes
o What are the legal problems in starting a business as a corporation
o Necessary Papers = the articles of incorporation- 33-2-102 is the statute of articles of incorporation and
the CL1
o A corporation doesn’t exist until these are properly executed and filed with the sec of state
o Once this is done, you issue shares to shareholders, who then elect directors, who will then create
bylaws if needed
o The MBCA suggests that a corporation comes into existence as soon as articles are filed, but also
seems to mandate that a corporation adopt bylaws – normally statutes don’t require this
o Bylaws may provide any provision for managing the ₪ that is not inconsistent with the articles of
incorporation
o Bylaws
o Much more inclusive document than articles
o Tells how corporation will be run
o Title and description of officers
o Procedures for calling meetings for directors and shareholders as well as how they will be run
o How the organization will be run legally
o Problem is that people don’t sit down and go through each article
 Instead the atty normally downloads a form from the SC form book and then fills in the
blanks
 So it’s boilerplate –
 As long as everyone is getting along, there is no problem, but if something comes up,
there can be trouble
o Articles will trump the bylaws if there are any inconstancies – but this shouldn’t happen
o Avg atty cost for setting up corporation in SC is 1-2K – which encourages many people to form LLC
which they can do themselves
o Preparing the necessary papers
o SC 33-2-xxx – our incorporation statutes
o Articles of incorporation (must be filed with the sec of state for all corps- the corporation doesn’t
exist until these are filed)

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 SC CL-1 Form
 33-2-102 - SC Articles of incorporation:
• Must have – Mandatory!!!
o Approved Name that satisfies 33-4-101
 Can’t use a name that is grammatically similar to one that is
already on file with the Sec of State.
 Name recognition in SC and most states relies on CL
principles
 There is nothing on the form that says you must use that name
after commencing business
 Mere filing of name does not necessarily give you the right to
use it
o Number of shares and classes of shares that the corp can issue
 If I check box A, these are common shares
 If I check box B, you have to rank each class of stock by
preference
o street address (no PO box) and
o name of agent
 Should it be someone in the company
 Or should it be the lawyer
 The signature line is not in the statute and could be waived if
you were in a rush
o name and address of each incorporator
 All they do is file the documents
 No real risk of getting sued for this
o attorney’s signature (this rule unique to SC)
o Must have a signature
o Must file the CL1 at the same time
 Some things on the form are not included in the statute or the
articles, so for instance number 3 – nature of the business- if
you change it, you won’t get in trouble
 Always say “not yet commenced” when asked for date the
business started because you never start the business before
articles are filed
 Issued shares – zero because you do not issue shares until after
the articles are filed
 Form is important because
• Goes to department of revenue
• It appears on every corporations tax return filed with
dept of revenue in SC, so it is prepared every year
and it is public information that a Π could get for a
law suit
• May have - Discretionary!!!
o names of the initial directors
o provisions not inconsistent with law regarding
 purpose
 management and regulation
 defining, limiting, and regulating powers of corp,
directors, and shareholders
 par value for shares
 imposition of personal liability on shareholders
o anything that is permitted in the bylaws

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 o What are the differences between Articles of Inc & bylaws: How do you decide what goes
into each?
 Articles control – the bylaws should not be inconsistent.
 The bylaws are a much more comprehensive document.
 The lawyer will tell the client that they need to have bylaws and will pull a set of boiler
plate bylaws and stick them in the record book. No one thinks about it for 2 seconds.
That’s wrong but it’s the reality.
o Bylaws
 SC 33-2-106
• You shall adopt bylaws
• The bylaws can contain any provisions for running the business that are not
inconsistent with the law or the articles of incorporation.
 Articles of incorporation always trump bylaws
 Under the default corporate code, directors can change bylaws while the shareholders
must vote on any amendments to the articles.
 Contracting Prior to Incorporation
• Promoter = someone who acts on behalf of the corporation before formation
• Sometimes you need to jump on a contract (e.g. a lease contract for retail space)
before incorporating. Typically this is done through a promoter
• Promoter liability: 33-2-104 (Liability for Pre-incorporation Transactions)
o Every state has a section similar to 104, but the language differs
(the presumption of liability differs – SC’s is reasonably friendly to the promoter).
o Anyone acting on behalf of the corporation before filing articles is
jointly and severally liable.
o Exception: If the person was acting under a good faith belief that the
articles had been filed, no liability under this section (important defense)
o If the promoter enters into a contract, the corporation will not be liable when the articles are first filed
o The corporation wasn’t around when the K was entered into – it must take some action to adopt
the K
o Secret Profit Rule
o Not a real issue in practice
 Promoters aren’t the bad guys, but the book is pointing out that once you agree to do this,
you have to treat the investors fairly = fid duty
o After incorporation, if the promoter sells property to the corporation, he must disclose any profit
that he is making, if he doesn’t, the corporation can seek to recover his “secret profit”
o Arises out of fid duty to corporation
o But there is no fid duty for pre-incorporation actions because the corporation is not yet in
existence
o Determining Profit
 For property acquired before he was acting as promoter, you look at the price the
corporation paid minus the fair market value of the land, so you don’t just look at what
the promoter paid
 For property acquired while acting as promoter, you look at the amount the corporation
paid minus the amount the promoter paid – fair market value is irrelevant
o If he discloses the profit, he gets to keep it
• Promoter liability: RSA
o RSA § 320 – if the principal is disclosed, the promoter isn’t liable
o The promoter does owe a fiduciary duty to the company.
o RSA § 330 - However, if you misrepresent that you have authority to
bind someone that you don’t actually have, then you are personally liable for the loss caused
by the misrepresentation
• Rule: Generally, the corporation has to adopt the actions of the promoter after
incorporation in order to release him from liability and take it upon itself.

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 • Best advice to a forming company is not to do anything until the articles are
filed
o Problems – page 155
o 1.1 - yes –
 Under agency principle he has made a misrepresentation because there is no Bubba’s
Burritos yet – so he cant say he is acting for it
 SC § 33-2-104 says he will be jointly and severally liable when there is no corp yet
• One caveat – if the promoter in good faith believes the articles have been filed,
then he is not liable
• 1.2- same answer
• 1.3 – there is a legal theory L&L can sue Agee on is the legal theory of acting as
an apparent agent; or could argue they were jointly and severally liable under
partnership law – if arguing under 33-2-104 – Agee could argue he was not
“purporting to act as or on behalf of a corporation”- could interpret the language
to say that he silent partner is off the hook; although split, some cases say only
active partners may be liable
o Π would argue under partnership principles that the three had a joint venture to start a corporation
and so they are jointly and severally liable
 Caveat to 104 may come in if they all thought the articles had been filed
 Another defense is that we have no evidence that the other two are acting as or on behalf
of the corporation, so they wouldn’t be liable
• 2 – Corp not liable unless it does something that directly adopts the action pre-
incorporation – usually done by the BOD – ratification by implication is not
enough
 Attorneys get burned here because simply agreeing to form the corporation does make it
liable for your legal fees
• 3 – Yes, Can still enforce the lease against Propp (promoter) individually; even
if the corporation is on the hook, the promoter is still on the hook as well
• Until the corporation is formed, the people that are out there trying to put the
corporation together owe NO fiduciary duty to their clients.
 Issuing Stock
o Shares of stock = the units of ownership in a corporation
• 33-6-103(a) – A corporation can issue as many shares of stock as are
authorized in the articles of incorporation.
• 33-6-102(b)(2)(iv) – a corp can have par value stock in SC – they can
determine their own par value – what are the implications of this?
 Says you may have par value, so you don’t have to
 Accounts are going to want you to have par value
 1220 is a tax statute that says that tax returns is based on a formula that basically results
in the par value, but you don’t have to have it, so make the accountant figure it out
• 12-20-50 - Tax statutes – the license tax of a SC corporation is to be computed
paid on the stated capital and capital surplus (the terms still exist in the tax statutes, however they are
not defined)
o The Accountants will insist that they have par value so they can
determine the proper taxes on the company.
• When a company is formed and they become shareholders it is the company that
is issuing stock. The articles will determine the # of shares and the types of shares that will
become issues.
o This is a big issue when setting it up – how many shares should the corporation say it is authorized
to issue then it initially does
 If you represent the minority share holder, you don’t want many more authorized than are
issued, bc you may lose what control you initially had
o A corporation does not have to issue all of its authorized shares

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• When a corporation sells its own stock, it is an issuance
• A corp doesn’t have to issue all the shares authorized by the articles
• Can have various classes of stock each of which comes with different rights
• Issuance terminology
o The shares that the corporation actually does issue are called issued
shares.
o Outstanding shares consist of issued shares that the corporation has
not reacquired (the corporation can buy stock back from shareholders, and those shares that
have been issued and not reacquired are outstanding)
o Common stock has two characteristics: unlimited voting rights and
common stock gets the residual value of the corp when the corp goes out of business
• In SC, every company must have stock that has the two features of common
stock.
o Preferred stock is treated more favorably in one of the following areas
than the other class of stock: dividend rights (ex. first guarantee on dividends or non-
cumulative right to get a certain amount per year), liquidation rights (typically you would see
a fixed liquidation value), or redemption rights; preferred stock holders usually can’t vote or
have limited voting power
 Stock that gets special treatment – such as being paid out first
 Normally pertains to
• Dividend rights – such as being paid 3 times the amount of common stock –
more commonly it would be a set amount that must be paid out first if the
corporation is liquidated. So you might get less, but you get first dibs incase
there isn’t enough
o Looking at sample on 160
 Here, it gets paid out before any common stock is – but this is
unusual – normally they are paid out at the same time with the
exception of liquidation
 Liquidation is also different because normally there is a fixed
value, but here there is only a fixed minimum, so they get
value equal to common stock
 Most preferred stock have provisions that can force the
corporation to buy it out – here there is a provision that says
they can call a vote to make them do so
• Liquidation rights
• Redemption rights
 Family Business often use preferred stock
• You trust your kids and you want to get them money by having mandatory
payouts and such
o Par value = the minimum issuance price a corp can receive for a share
of stock. Par value is just a minimum issuance price, not a fixed price. Many states don’t
require a par value.
 Also remember that par value doesn’t apply to shareholders, only issuance form the
company
 This is a concern in SC
 Some states require you to state whether common and preferred stock have a par value-
which is set out in the articles
 Def- the minimum price for which a corporation can issue its shares –
• Cant issue for less, but you can for more
• Also, this doesn’t effect how much the holder could later sell that share for on
the stock market
 States that require par value also require two separate funds
• Stated capital

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 o Includes the aggregate par value of all issued shares of par value stock
 Ex – 50 shares at 1K each = 50K stated capital fund
o Cannot be distributed to shareholders – supposed to serve as cushion
for creditors
• Capital Surplus
o When shares are issued in excess of par , the excess goes to the Capital
surplus
o This money can be distributed back out as dividends
• Market Capitalization – total intake form stock sale = Stated Captial + Captial
Surplus
o Stated Capital = par value * number of shares sold
 $ went into this in theory could never be paid out by the
shareholders and the $ that went into capital surplus you had to jump through a
million hoops
 The purpose of this complex system is to protect the
creditors – many states have abolished this entire system.
o Capital Surplus = price per share over par value * number of shares
sold (premium over par value that the shares were sold for)
o Market Capitalization: Total intake from stock sale = stated capital
+ Capital Surplus
o If you sell stocks for less than the par value, each of the shares is worth
less. The shares of people who already own them would decrease in value.
• 33-6-210: Issuance of shares
o Power to issue generally reserved for directors, but can be given to
shareholders through articles.
o Shares can be issued in exchanged for any tangible (like land) or
intangible benefit to the corporation.
 Rule: The board must decide if consideration received for
shares is adequate, but they can’t issue below par value.
 So consideration can be in many forms as long as the board
considers it adequate. Any benefit could be a release from a claim.
o If you issue for a promissory note or a promise of future services, the
shares go into escrow until the note is paid or the services performed. If the note is never
paid, the corporation can reclaim the shares and distributions.
 Exception: if the corporation is subject to the 1934 Exchange
Act, the shares don’t have to go into escrow when issued for future services if the
plan has been approved by the shareholders.
o You may run into setting up the issuance of preferred shares in the
setting up of a small business in SC
Problems 162
o 2) corporation cannot issue stock for less than par value
o 3)corporation can sell it for more than the par value – the excess goes into the capital surplus (today if there is a
par value, most corporation make a tenth of cent so it isn’t much)
o 4) 6,000 because the stated capital is par value times amount of shared sold
o 5) yes she can do it b/c par value only controls issuance price, not sales between shareholders
o She would do this if the company is going down in value
o 6) yes
o 7) no, she doesn’t care what the par value is or whether is one. It has no relation to the actual value of the stock
o 8) Yes, if more stock is sold, your voting power will decrease
o Also the price at which the additional stock is sold may effect the value of the corp and the shares Capel
owns
 Say Capel and Propp both bought 100 shares @ $100 each

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  Later Agee says she will buy 100 shares @ $90 (remember, this must be adequate compensation –
which we assume it is here)
 What impact will the issuance to Agee have on Capel
• It lowers the value per share
o Before 100 a share
o Now its 96 a share, (29000/ 300)- figure these numbers out
 so Capel is hurt (if she pays more, then Agee will be hurt because here
shares will be devalued)
 But if Agee is putting in property rather than cash, then we don’t exactly know what the value is –
so this could be how this situation comes up
 Choosing the state of incorporation
• In SC – the rule is you should always incorporate in SC unless you have a
very good business reason.
• The laws of the state of incorporation become the default rules that govern
the internal affairs of the corporation.
• You can incorporate in any state, even if you have no business there. Usually
you incorporate either in the state you’re doing business or DE
• Almost all the fortune 500 companies are incorporated in Delaware
 commerce clause – instead the business must be intra state
• Reasons to incorporate in DE:
o Delaware corporate law is the most sophisticated corporate law in the
country
o Highly developed; most questions will already be answered by caselaw
o Secretary of State office is efficient
o Protecting Management – the law of DE is geared to protect mgmt
not shareholders. Mgmt controls where the Co will be formed – they have the power to
move it to DE.
 Key Decisions always favor Mgmt.
• Reasons not to incorporate in DE
o Higher legal fees
 If there is a squabble – jurisdiction is in DE and your folks are
not going to be happy going up to DE to resolve a conflict.
o Double Tax - Corporation will be subject to taxes in DE and in the
state of operation
o You will have to file as a foreign corp in SC and be treated as a
foreign company
 Foreign Corporations
• Obtain authorization from state agency
• Appoint a registered agent in the state
• File annual statements
• Pay fees and franchise taxes
• But you only have to do this if you are transacting business in the state
o Most statues list what does not qualify as transacting business, but
don’t define what is – Interstate business will not make you register as
a foreign company because of interstate
o Ethical issue: If a SC corp wants you to incorporate them in DE, it is questionable whether you can
even do this since you are not licensed in DE.
 Why do you want to invest in Co’s as a shareholder?
• Want to make $
• You have no personal liability as a shareholder
o Who is liable to the corporation’s creditors – When will a shareholder be liable?
 See 649 S.E.2d 135- read this case before you take the bar exam, 344 S.E.2d 869
o TP can sue corporation but not the shareholders

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o Exceptions
o Contractual – if the TP makes the shareholder personally guarantee the payment – TP lenders use
this when they loan to corporation with limited assets
o Judicial
 Cases will show below
 Piercing the corporate veil
 Dewitt v. Flemming Fruit Company (SC Case) – lead case
o Facts: Contract claim. Corp was formed with $5000 in capital; $2000 was immediately drawn out by
shareholder. Flemming was the 90% owner of a fruit distribution company, and he had contracted
with Dewitt to ship fruit around. The principle shareholder orally promised Π that he would personally
pay if the corporation did not – but this is not enforceable because of SOF
• The company couldn’t pay, and so Dewitt sued to “pierce the corporate
veil” and hold Flemming personally responsible
• There is no longer any requirement that you have to capitalize your corporation
with any specific amount of money (there used to be a requirement like this).
• Issue: When is it ok to pierce the corporate veil and hold a S/H personally liable
for the actions of the corporation?
• Says separate entity is just a theory and wont be recognized if doing so would
extend the principle of incorporation beyond its legitimate purposes and produce injustices or
inequitable consequences
 But piercing will be done reluctantly and cautiously
 Requires case by case analysis
• Holding: Court said that veil piercing was to be done on a case by case basis,
and that a number of factors are to be considered:
• Rule: Factors to Consider in order to Pierce the Corporate Veil:
o Fraud is NOT a requisite to pierce the veil
o Substantial ownership by a single person combined with additional
factors:
 Inadequate capital on hand
• Burkhard thinks that the most important one is
undercapitalization,
• Arguably, this business was not undercapitalized b/c
all he needed to run the business was a telephone, he had no overhead as a
middle man.
• Elders suggests that inability to pay debts and high
risk business are determinative for undercapitalization.
 Failure to observe corporate formalities
 Siphoning funds by dominant shareholder
 Insolvency
 Non-functioning of other officers or directors
 Absence of corporate records
 Non-payment of dividends
• Burkie says this is scary.
 The fact that the corporation is a façade for the operation
of the dominant shareholder
 Fairness Consideration: Finally, the court will look to see
if it would be fundamentally unfair or lead to injustice for it not to pierce
o Alter Ego
o Court looks at reality and not form of how the corporation operated and the shareholders’
relationship to that operation
o One big thing looked at is the lack of capital in comparison to the undertaking
 The obligation to provide capital begins with incorporation and continues afterwards –
 So how much do you tell him to put into it to assure that it isn’t undercapitalized

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 • You have to look at what its doing- when the company started, all he had to
cover was the phone – so 5k would have been enough
• But you must adapt as things change, so once you had trucks involved, you
needed more
• In this case, they didn’t have shareholder meetings – no formalities,
• Flemming tended to take money out of the corp as soon as it went in
(undercapitalized) – siphoning of funds by dominant S/H
• Also, it would be unfair to allow Flemming to make a bunch of money at
Dewitt’s expense just by hiding behind the corporate veil.
• Fact always mentioned when this case is cited but then they say it wasn’t
important: oral guarantee to pay
o Here it was closely held, there were no formalities such as records, ∆ owned 90% of the stock, and he,
his wife, and atty were the incorporators
o It was personally operated – no other stockholder ever received a salary or dividend or exercised
control
o He withdrew what he wanted – company operated for his good, not the stockholders
o There was little capital for what he tried to do, and it appears that the corporation always operated
on ∆’s capital
 So if the veil is not pierced, then ∆ gets the protections of the corporation without putting
in capital and sharing the risk = unfair
o All this combined with his personal assurance is grounds to pierce the veil
o Two things also going on here
o When Flemming got the check for the fruit, he dispersed money to the farmers – so its kinds of
like an escrow function of an atty, and we don’t want him to escape liability to them
o Oral guarantee – the court says SOL takes this issue out, but its clear that it factors in
• Red Flag of Case: Suggests if you don’t follow corporate formalities, courts will
pierce.
o Penalty Factors
o If you don’t play by the rules, it is less likely that your business will
operate correctly.
Problems page 176
o 1.1 – yes you can have only one shareholder
o 1.2 – mystery of life
o 1.3- capitalization begins with incorporation and continues afterwards (see Elders) – so are these cases
saying when we hit hard times and your capital drops you have to either go out of business or risk
piercing the veil – this worries Burcky – big time
o 1.4-it’s hard to say whether the Π was adversely affected by the failure to comply with corporate
formalities. Some think you should just be penalized if you don’t play by the rules
o 1.5 yes creditor should be happy dividends aren’t paid out – as long as its not be siphoned off
 Sturkie v. Sifly (SC) – Expands Dewitt Piercing TEST!!!!
• Facts: Sturkie was hired as a sales agent by D’s company, and they didn’t pay
him. He went out and got a judgment for lost wages. However, the company closed before paying the
judgment. Defendant had not complied with corporate formalities, and took money out of the
corporation to satisfy loans they had made to the corporation.
• Π brought suit to pierce corporate veil under 33-11-240 for improper distributions to the ∆’s
stockholders
o Fails
o One thing at play here is that the receiver is the Π instead of the injured party- which may
have affected the holding
• Sifly and Water were sole stockholders in Carolina Furniture
o Startup capital of only 5K
o corporation was in trouble so S and W got personal loans which they then loaned to the
company

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 o When the corporation had money, S and W would take from the account to satisfy the loans
o No records or meetings
• corporation lost 265K in 1977, S and W then moved unfinished inventory to a company in NC held by
W and Carolina Furniture ceased to exist
• Ruple won a 39K judgment later that year against Carolina Furniture for wages
o Π is his receiver
• “When a corporation is so controlled as to be the alter ego or mere
instrumentality of its stockholder, the corporate form may be disregarded in the interests of
justice.”
• Piercing the veil is an equitable remedy
• In SC, piercing of the corporate veil is a 2 part test.
o Factors from Dewitt
o An element of injustice or unfairness if the acts of the corp are not
regarded as the acts of the individuals.
 2 PART FAIRNESS TEST:
 D had to be aware of P’s claim against corp
 D acted in a self-serving manner with regard to property of
corp and in disregard of the P’s claim
o In this case, Sturkie lost because he couldn’t prove that the company
was aware of the claim against them when they were draining the corporation. Of
course, the argument that they were aware was that they had a contract they didn’t pay and
they transferred the furniture in a self-serving way, but whatever.
 You would think that would know that they weren’t paying the guy. But because there
was a receiver involved things get skewed
• Plaintiff also made a claim under SC
 This provision comes up all the time.
o Recover distributions made by respondents to themselves under § 33-6-400
 33-6-400: improper distribution to shareholders
• (c) – no distribution can be made if (1) it would make the corporation unable to
pay debts that come due or (2) if total assets would be less than total liabilities and the
company wouldn’t be able to satisfy the rights of people who would be higher in the
chain of preference to the people who received the distribution if the corporation would
be dissolved at the time of the distribution.
• (d) talks about how you can compute these numbers
 § 33-8-330 talks about who is liable for unlawful distributions. Seems like it is a director.
There is a safe harbor; no automatic liability. Only liable if they didn’t perform their duties in
compliance with a code section that talks about how you go about making decisions. Shareholders
who receive the money can also be liable if the shareholder accepted knowing the distribution was
made in violation
 Note that it seems we can skip the “unfairness” question in tort cases. Perhaps it’s a
given.
 Hunting v. Elders (SC) – Torts Piercing the Veil Case.
• Facts: Girl was injured by a drunk driver and sued the bar that got the driver all
sloshed. She won, and when the bar couldn’t pay she wanted to pierce the veil against the bar owner.
She brought suit against Elders as the alter ego of the corporation. Apparently he was missing several
important records, siphoned off money for his personal use, and had family members as officers who
didn’t even know it.
o EE was incorporated original to sell tires and had two shareholders. Elders then bought the other
holder out
o He then opened 2 bars on property he owned
o Held liquor license in his name
o 3 years later he reinstated EE to run the bars
 Capitalized with only 1,000 for each bar

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  Equipment was leased to EE from other business owned by Elders
o Later that year, he transferred several shares to his Wife and Niece
 Wife was VP
 Niece was Sec/Treasurer
• But she didn’t know she had any shares or was an officer
 There was a record of these transfers
o Money was siphoned for elder’s personal use
 Records were not kept for accounting
o Evidence that Elders altered his personal tax forms before trial to hide dividend income from
investment accounts Elders held while running the ₪
o Freeman testified that Elders was running the corporation as a façade and that the bars were
grossly undercapitalized for the purpose of running bars and the risk of liability associated with
alcohol
• In this case, there was a bifurcated trial as to liability and as to piercing.
• Question: when I bring my lawsuit initially, do I have to allege independent
liability of the shareholders (I may not even know who they are) or can I wait and once I get my
judgment against the corporation then bring an action against Elders alleging a piercing claim? This
opinion suggests the second option. From a plaintiff’s perspective, the second option is much better.
It appears, from a SOL perspective, the clock doesn’t start running until I file my piercing claim. It
tolls the statute of limitations against the shareholder, and this is a huge advantage because it gives you
time.
• This was a close corporation (with one shareholder) and it didn’t have to meet
the normal business formalities because it is not a standard corporation (it is a statutory close
corporation). It is adopting an S-Corporation status so the factor considering the non-payment of
dividends is not as important.
• § 33-18-250 says that the failure of a statutory close corporation to observe the
usual corporate formalities is not ground for imposing personal liability on the shareholders. This is an
anti-piercing provision. The court says that this anti-piercing provision doesn’t always work. The
comment to this section says: this section does not prevent a court from piercing the corporate veil of a
statutory close corporation if the circumstances should justify imposing personal liability on the
shareholders where the corporation not a statutory close corporation. It merely prevents the court from
piercing the corporate veil because it is a statutory close corporation.
• The court couldn’t figure out how to apply the Sturkie factors in a close
corporation setting, but decides that in many cases, and especially tort cases, undercapitalization is
the most important one. Because a bar has lots of risks, it should be more capitalized than other
entities, the defendant was undercapitalized and that along with the lack of formalities was enough to
pierce.
• At what point is undercapitalization determined? It begins with incorporation
and continues thereafter.
• The court writes, “The essence of the fairness test is simply that an individual
businessman cannot be allowed to hide from the normal consequences of carefree entrepreneuring by
doing so through a corporate shell.”
• The facts in the opinion don’t say that the defendant was aware of the plaintiff’s
claim against the corporation, as the second prong of the Sturkie test requires.
• The court also clarifies the “awareness” test of the unfairness branch of Sturkie:
“notice of facts which, if pursued with due diligence, would lead to knowledge”
• This is a scary case for small businesses in SC.
First Prong
• Change In LAW
o Statutory Close Corporation
 Allows corporation to act with less formalities
 It may operate without board of directors
 Need not adopt bylaws in certain circumstances
 Need not have annual meeting unless the shareholders request one

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  * purpose of law was to eliminate argument that shareholders can be personally liable for
debts and torts of the business because the corporation did not follow the classical model
of a corporation- ie that of a large corporation
o **- SC statutory change has diminished the importance of several of these factors by allowing
“statutory close corporation status.”
 Failure to observe corporation formalities
 Nonfunctioning of other officers
 Absence of corporation records
o Also federal law allowing S corporations has diminished the importance of lack of dividend
payment
• Statutory close corp – this is something the court has to think about because it’s not a normal corporation –
ie the corporation formality factor doesn’t matter. The Fact that it is an S corporation which means the
dividend factor isn’t important
o Changes the required records and duties of officers
o ∆ says he kept the minimum needed
 Court said he did have bare minimum, but was missing normal business records
• Income statements etc.
• Cash flow sheet
 May have been some fraud in the election of officer records
 Lack or records alone wont be enough, but court recognizes that the trial court coupled
this with the siphoning on funds to make its decisions
o Lack of dividend payments shouldn’t have been considered
• Burcky comments on close corp and S corp
o A statutory close corporation has unique features
 33-18-250 – says failure to observe corporate formalities is not ground for piercing the
veil
• This provides some protection, but it wont save you from piercing if the other
factors are met
• This statute is also in the LLC section and will probably have the same
effect
• Issue of capital
o The bars made plenty of money, but nothing shows money was ever put into their capital accounts
o Also the inherit risk of alcohol increases how much capital it had
o corporation was undercapitalizes according to court
 ∆ defends saying it could always pay its bills, but the risk analysis comes in
o This is an important factor, but burcky suggests that it really isn’t that big
• SO
o Undercapitalization, siphoning of funds, and evidence that it was a façade go against the ∆
o Lack of records and dividend payments don’t matter
o Crt App Agrees that the 8 factor prong of the test is satisfied in favor of piercing
Second Prong
• 1)knowledge of claim 2) subsequent self serving act and disregard of claim
• Knowledge prong
o Constructive knowledge will do
• Here ∆ knew of the claims and still siphoned off money and comingled funds. Also transferred his own
funds to other corporation he held. Also transferred stock to others without consideration and then
dissolved the company – Problem is that all this occurred before the accident occurred. The test says it has
to be subsequent, but the court glosses over it
• This element is also satisfied – so the veil is pierced
• Court says “the essence of the fairness test is simply that an individual businessman cannot be allowed to
hide from the normal consequences of carefree entrepreneuring by doing so through a corporate shell” –
this isnt Sturckie, but not sure if it makes a difference

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Parent-Subsidiary Cases
o Court is going to shift from Sturkie analysis once you get away from close held corps
Notes
o Well recognized basis for piercing is to avoid fraud- ie forming a corporation to avoid an obligation or
liability you have already assumed- such as not to compete in a certain area
o Corporations can also be shareholders
o They are often the only shareholder of another corporation, which is known as a subsidiary
 A subsidiary is a corporation, a majority or all of the outstanding stock of which is owned
by another corporation called the parent corporation
o A parent corporation is not liable for the contracts, torts, and other obligations of its subsidiary corp
unless there is a contractual or judicial exception to the rule
 In re silicone breast implants – (AL)TORTS Peircing the Veil Case – Parent/Sub
• Can you hold the parent liable for the torts of the sub? This different analysis
applies when you start shifting from one individual shareholder to a corporate shareholder.
• Facts: Bristol Meyers Squibb was the sole shareholder and parent corp of MEC,
which made and sold breast implants. We know what happened, and the class action tried to pierce the
veil and get Bristol. The board of MEC consisted of MECs president and two officers from Bristol.
MECs budget had to be approved by Bristol, and Bristol set MECs employment practices. Also,
Bristol had its name and logo on the breast implant packages. Plaintiffs made 2 piercing claims:
corporate control and direct liability.
• Relationship bw corporation
o MEC has a 3 member board
 2 members were Bristol executives
 The president was not employed by Bristol
o One of the Bristol execs on the board couldn’t be outvoted by the other two
 And several MEC presidents didn’t recall having a board let alone being members to
it
o MEC prepared reports for Bristol on the implants. Basically Bristol controlled MEC
 Bristol also had to approve MEC’s budget, which consisted of filling out Bristol
forms
 Bristol controlled employee polices
o Other subsidiaries of Bristol distributed MEC’s implants
o Bristol’s name was also included in the packaging
o No dividends were paid out to Bristol
 They had consolidated federal tax returns but separate state tax forms
o At time of suit MEC had ceased operation and only has a 57 million demand note towards
Bristol and a 2 billion insurance policy
• Π suing on corporate control to pierce and also direct liability
o The risk of abuse of the corporate structure is greatest when there is only one shareholder –
but the court recognizes that shareholders must exert some control over the subsidiary
 Limited liability is rule not exception
o Must look to see if MEC is the alter ego of Bristol
 ∆ here have moved for summary judgment – this is hard to do in alter ego case
because it is so fact specific and jury needs to look at it
o Court goes through totality of circumstances
• “A parent corporation is expected…to exert some control over its subsidiary.
Limited liability is the rule, not the exception. However, when a corporation is so controlled as to be
the alter ego or mere instrumentality of its stockholder, the corporate form may be disregarded in the
interests of justice.”
• Court said that there was no need to show fraud in a parent/sub case, and
there is definitely no need to show injustice in a tort case. Thus, court again looks at totality of
circumstances and a bunch of factors to find corporate control

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 • Issue: What is the test to pierce the corp veil in a torts case for a claim of
corporate control and direct liability?
• TEST to Pierce the Corp Veil for a Corporate Control Action: Parent/Sub
o Common directors between parent and subsidiary
o Common business departments
o Parent and sub file consolidated tax returns
o Parent finances subsidiary
o Parent caused incorporation of sub
o Sub is undercapitalized
o Parent pays salaries and expenses of sub
o All of subs business comes from parent
o Parent treats subs property as its own
o Daily operations of parent and sub are not separate
o Sub doesn’t observe corporate formalities
• The facts meet several of these factors
o Fraud is not require to pierce
 Also most jurisdictions that require fraud in K cases, do not require it in tort cases
• This is becaues a party to a K can ask for further assurances from the parent
o Significant is the fact that Bristol put its name on the packaging – it would be against equity
to allow Bristol to escape liability from those who were induced to believe it vouched for the
product
 This is similar to McDonalds case – that the court gets you because you represented
yourself to the public
 So this would prevent summary judgment in favor of ∆ even if fraud was required
• (Restatement Torts § 324A - Under a theory of direct liability), the fact that
Bristol put its name on the implants was a showing of support for the product subjects Bristol to
liability if it failed to exercise reasonable care.
Notes
o There must be control, not mere contacts for the veil to be pierced
o Piercing is almost exclusive to close held corps
o Public corps won’t be pierced – but they could be reached as a parent of a subsidiary
o Courts pierce more often to get at an individual than at another corporation
o Courts have actually pierced more for K claims than tort claims
o Piercing can also occur in LLC
o Courts will pierce the LLC veil by applying the same test that is applied in the corporate situation
o Hasn’t happened in SC yet, but we will probably follow the other states
 Other Theories of Liability:
o Parent liability under agency concepts (doesn’t usually happen)
o Agency is consensual, so the parent corp would have to consent to have the subsidiary act on its behalf
and the sub would have to consent to act on the Parents behalf
o This isn’t how businesses work in this situation
o Parent liability on a control theory
o If the parent corp exerts direct control or operation of something owned by the sub, then it can be
directly liable
o Personal jurisdiction: sometimes you pierce the veil so that subsidiaries’ contacts with a state are
imputed to the owner
o Enterprise liability
o Concept that although technically separate, two corps that are commonly-owned and in reality
engaged in one enterprise together should be treated as a single legal entity for purposes of
liability
o Business today has developed so that a large-scale business doesn’t have one company but instead
has a holding company that owns smaller corps

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  This is far from the conception of protecting individuals, instead, this allows a single corp
to subdivide and reduce liability by being able to isolate it
 So the individual corps should be treated as a single enterprise that is liable as one
 If a plaintiff’s theory of enterprise liability is successful, he would treat all the companies
as one and the plaintiff would be able to recover from the combined assets of all the companies.
See. P. 190-91. Walkovszky v. Carlton (2 cabs in each corporation)
 See facts – they support the Enterprise theory – you had ∆, which owned a number of
companies that owned 2 cabs and had the bare minimum to keep them running. Idea was
to insulate Carlton. The all operated out of the same garage with central dispatch
 See Kincaid saved in SC Bar Exam folder. Kincaid applied enterprise liability.
 Family had several corporations –
• One purchased land
• One advertised
• One actually built houses on the land
 There are reasons other than liability for having three companies instead of one
• Π sued all three companies for problem with house
• ∆ said you could only sue the company that built the house
• Crt App applied doctrine of Enterprise liability and said it was the business as a
whole, so they could collect from wherever the money was
 See Mid-South Management also in bar folder: went after them under piercing theory
(lost), enterprise theory (the court didn’t buy this one), silicone breasts alter ego parent analysis
(this test is now recognized in SC)
o Reverse piercing
 Occurs when you are suing an insolvent shareholder of a company with no cash, and you
go after his percentage of the assets of the company
 Generally can’t occur because the shareholders’ claim to the corporate assets is
subordinate to any creditors claims, and so the assets can’t be taken out of the corp
o Deep Rock Theory
 If a corporate insider has loaned money to a corporation, his claim will always be
subordinate to claims of outside creditors
o Page 174 – statistical piercing analysis
 In 40% of piercing attempts, court actually pierced
 Always directed to closely held corps (less than 9 shareholders)
 Courts pierce more often to get an individual who is a shareholder in a corp (Dewitt) than
to get to a corp who is shareholder in another corp (Bristol)
 Courts are less likely to pierce in tort claims than contract claims
 Undercapitalization and failure to follow corporate formalities are important, but only
show up in a small number of cases
 Piercing has been used a lot in the environmental cleanup area. The feds love to go after
the parent corporation.
o Who makes decisions for the corporation?
 The general notion is that shareholders elect the board of directors, who in turn choose
executives, oversee corporate policy, and watch over the executives
 Keep this statement in the back of your mind: Generally, if a corporation has more than
four or five shareholders, most shareholders play virtually no role in making decisions regarding the operation
of the business (for most shareholders of corporations with more than four or five shareholders, their only
important decision is when to sell shares).
 In actual practice, the board of directors is the decision-maker for a large, closely-held
corporation (although sometimes it is made by the president and rubber stamped by the board). For a small,
closely-held company, the primary shareholder/owner will make almost all decisions and ignore the corporate
formalities. This is what practically happens.
 Board members are not agents for a corporation but officers are
 Directors and Officers

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 • Powers of Directors
o 33-8-101: Unless stated otherwise in the articles or bylaw, all corporate
powers must be exercised under the supervision of a board of directors
o RSA § 14C – neither the board nor individual directors are agents
for the corp or the shareholders. They are the principal collectively (make the decisions)
so not an agent- otherwise agency principles would make the shareholders liable for the
actions of the company through the directors
o The Directors generally make the big decisions that fall outside of the
general operation of the business: mergers, significant policy changes and shifts in
business direction
o Directors can elect each other to be officers.
• Powers of Officers
o See p. 196-197 for functions the board should and may perform
o 33-8-400: the positions of officers in the company are established in
the bylaws; an individual may hold more than one office at a time
o 33-8-410: the duties of the officers are either set forth in the bylaws or
prescribed by the board of directors or an officer authorized by the board to prescribe
duties to other officers.
o An officer IS an agent of the corporation, and may be able to bind
the corporation
 Note 33-6-250: any stock certificate issued must be signed
by two officers who are designated in the bylaws to have this power
 SO if you’re making a loan to a corporation, make sure the
person who signs it has authority to do so under the law of Agency.
 Also make sure the BODs has approved the loan!
 Ex – The 2 things to think about to determine whether the
actions of the Officer are valid under the law of Agency?
• Does the officer have actual authority?
• Does the officer have apparent authority? (b/c the
reasonable law student would presume that the officer would have the legal
authority to hire)
o Does the officer have implied authority?
o Problems 198
 1) does a VP of a corp have authority to bind the corporation if he offers you a job – yes,
implied and apparent authority
• Second – probably no, it wouldn’t be reasonable to think he had authority to do
so; you as a third party probably don’t have a right to rely on a title
 2) you would want the President to sign the loan not the director or the shareholder,
because he is the one that makes these actions. But also get proof that the board has approved the
loan
• McQuade v. Stoneham - (NY Case)
o Stoneham was a majority shareholder of the New York Giants. This is
a closely held corporation with a limited number of shareholders. McQuade had a minority
stake. As part of the transaction in purchasing his minority shares he entered into an
agreement with Stoneham that the parties would use their best endeavors to have the
same 3 people remain directors and officers AND that contract also fixed the officer’s
salaries – there was no durational aspect in the K. Then a new guy came in and Stoneham
and McGraw didn’t vote and allowed McQuade to be voted out of his position. McQuade
sued for breach of contract for not using best efforts to keep him in his position as Treasurer.
This was an action for specific performance; he wanted his job back.
o McQuade Agreement: “there shall be no change in salaries, no
change in the amount of capital or the # of shares, no change in the amendment of the by-
laws of the corporation or any matters which may in anywise affect , endanger, or interfere

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 with the rights of minority stockholders, excepting upon the unanimous and mutual consent
of the parties.”
 The agreement said nothing was to be done to affect the rights of minority stockholders
without unanimous consent. Also there weren’t supposed to be any change in the number
of shares
• Later, the ∆ added 4 more board members, they were selected by him and he had
complete control over them
• At a meeting in 1928, the ∆ and McGraw refrained from voting, the Π voted for
himself to remain as Treasurer, and the 3 new members voted against him and in
favor of Bondy, who became treasurer
o Thus ∆s didn’t keep their agreement to use their best efforts to keep
him as treasurer
• Lower court refused to reinstate him, but did award damages
 Π was ousted because of a falling out bw him and ∆. He did nothing wrong, but ∆ got
pissed bc Π challenged ∆’s control over the treasury. Court also found Π was protecting
the company and minority stockholders
 ∆ argues the agreement was void because as directors, they had to exercise their best
judgment to act for the company, and any agreement that compels their vote to keep
someone in office is illegal
 RULE – Directors may not by agreements entered into as stockholders abrogate their
independent judgment
 So part X of the agreement is void because it attempts to abrogate authority of the Board
to set salaries and give it to the shareholders
• IX does the same thing, so it is also void
• VIII is ok because shareholders can combine to elect directors. BUT the part that
says they will try and control the composition of the officers- which the
shareholders cant do because the directors must make these decisions
 Also, stockholders couldn’t have an agreement to divest the directors of their power to
fire an unfaithful employee
 Nor can stockholders by agreement control the director’s exercise of judgment
o Stockholders can only combine to elect directors
 But this is limited to election, they cant contract to control them afterwards in their
selection of agents
o Section VIII is partially valid- stockholders may combine to elect
directors, but shareholders can’t elect officers
o Section IX and X are invalid because the board, not the shareholders,
make the decision as to compensation
o Issue: Was the contract valid? (the part of the K that appointed the
directors themselves was not invalid?
o Ds argued that the K was void b/c the directors had a duty to act for the
corporation and use their best judgment and that any K that compels a director to vote to keep
any particular person in office and at a stated salary is illegal.
o NY Rule: Under NY law shareholders of a closely held corporation
CAN band together to make agreements to elect directors. However, a contract that
places a limitation on the power of a director to manage the business of the corporation
is improper and unenforceable as against public policy.
 S/H’s may not, by agreement among themselves, control the
directors in the exercise of the judgment vested in them by virtue of their office to
elect officers and fix salaries. Their motives may not be questioned so long as their
acts are legal. The bad faith or improper motives of the parties does not change
the rule. Directors may not by agreements entered into as S/H’s abrogate their
independent judgment .
 The other director’s duty was to the corporation and the S/Hs,
not to McQuade as an individual, to be exercised according to their unrestricted

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 lawful judgment. They were under no legal obligation to deal righteously with
McQuade if it were against public policy.
o Thus, the court would not give McQuade back his job as treasurer.
(You can’t take power from the Directors and put it into the shareholders pocket).
o Note: The holding here is only that the contract wasn’t specifically
enforceable; McQuade could not be reinstated as Treasurer, however McQuade probably had
an action for damages for wrongful discharge on breach of contract.
o Note: This would be fine as long as it was approved by the directors- it
is an employment K
o Note: NY has since changed its view from McQuade – in closely held corps, the shareholders
may enter into agreements controlling board decisions
 This is now the majority view
 Shareholders
• Villar v. Kernan – (Maine Case)
o Villar had 49% and Kernan had 51% of a brick oven pizza business.
They had agreed that nobody would receive salary – just distributions. After a while, Kernan
entered into a consulting contract with the business and started getting $2K a week.
 Stephan later became a 2% holder – taking one % from both
 Relationships fell apart
• Stephen became allied with ∆
o ∆ entered into a “so-called consulting agreement” with the corporation whereby he got automatic
payments of 2K a week
 This was ratified at a shareholders and board meeting at which the Π was not present
• ∆’s argument that this is outside the statute is wrong because controlling salaries
is a direct limitation on the judgment of the Board
 Π eventually filed suit for breach of the no salary agreement
o Maine Rule: Permits shareholder agreements to limit director and
corporate discretion as long as are in writing or in the articles of incorporation, or if an
amendment to the articles it must be adopted by a unanimous vote.
 Maine has a statute that allows such agreements to exist even if they
• restrict the powers of the directors,
• relate to a phase of affairs of the corporation such as management
• transfer management duties to the shareholders
 However, in addition to being in writing, the agreement must be included in the articles
of incorporation and any subsequent shareholders must be made aware of it
• If these requirements are not met, it can still be enforced if the rights of the TP
challenging them are not prejudiced there is no TP here but, the exceptions still
not cover the writing requirement – so all such agreements must be in writing
o Basically what they needed to do in this case was to follow the statute.
 Has to be in writing
 ∆ claims it isnt covered by this section because it doesn’t affect the right of shareholders-
wrong, it prevents ∆ from being hired as a consultant and it effects the distributions of
dividends because money that would go to salaries would reduce that available for
dividends – this is a direct limiation on the board, which is why its covred by the board
 Therefore this type of agreement is covered by the statute, and because it fails to meet its
requirements, it is not enforceable – therefore ∆ was able to hire himself as consultant
and pay himself a salary
o Holding: Since this agreement was oral, it was unenforceable.
o Most states say that if you meet many of the CL statutory requisites
you can have a McQuade like agreement, SC has a specific statute
 If the shareholders want to control the board – can they in SC?
• C-38
 There are 3 types of Corps in SC

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 • Regular ones – shareholders would have little control – these are the big ones
• §33-8-101 – Quasi- statutory close corporation
o Unless otherwise provided in the articles or a unanimous agreement of
the shareholders which is noted in the articles then you must operate in
accordance with the statute- meaning you cant mess with the board
o But if you make these changes, then you can
o If authority of the board is limited, the articles shall describe who is to
pick up these duties
• Statutory Close Corporation – see the Elders case
o On page C-105
o § 33-18-210 different paper work is filed, and you operate as a
partnership almost
o Lets you get around all the formalities
o If the agreement between these two had been in writing the case would
have come out differently b/c the statute clearly states that if it is in writing it is enforceable.
o Villar is stuck now. He can’t sell his shares b/c there is no market for
them. If the business was an at-will partnership, Villar could withdraw from the partnership
and dissolution would take place, allowing him to get something from his partnership.
 The problem is that if this is viewed as a Partnership for a
Term – he would be viewed as a wrongful dissolver – but he may be better off as a
wrongful dissolver than being tied in a closed corporation.
• 2 Options in SC that Give Shareholders Ways to Control the Board:
o See pages C105-106 for ways to change or do away with board and bylaws
o Book notes that most people use the term ‘close” or “closely held” corporation to refer to a
corporation with relatively few shareholders, the stock of which is not publicly traded, regardless
of whether the corportation was incorporated in one of the 18 states with a special statute like SC
o 33-8-101 – Burkie says this may be the most important section of
the corporate code!!!!!!!
 Shareholders can agree to limit or change the authority of
the board, but it must be:
• unanimous agreement among shareholders AND
• disclosed in the articles AND on stock certificates
 Can be added into the AI’s as an amendment via 33-10-103
– 2/3 vote to the amendment.
 You can put it in the articles and spell it out or you can put
it in a contract if the contract is mentioned in the articles (incorporated)
 Burkhard says this provision allows for a quasi-close
corporation!!!
 Basically makes a McQuade-like agreement possible (similar
to a partnership)
o 33-10-103 – Amendments to the AI’s by the BOD and S/H
o 30-10-104 –(d) – “shares are entitled to the voting rights granted by
this section although the articles of incorporation provide that the shares are non-voting
shares
o 33-18-xxxx: Statutory Close corporation
 Second option (instead of the quasi-close corporation)
 I can operate my corporation almost as if it were a partnership
(doing the kind of things they want to do in the McQuade and Villar case)
 You have to have special articles of incorporation and you
have to specify that the corporation is a Statutory Close Corporation.
 You can set up a business that operates very differently from
the standard normal business.

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  SO in SC you can get create a very different type of
corporation for your client as long as you abide by the statutory rules.
 33-18-200: Shareholders can agree to eliminate or restrict
the board
• 33-18-200(e) might give a way for a shareholder to
dissolve the corporation if the right is contained in the articles of
incorporation. (Villars could have had an option)
• One of the hallmark differences between a
corporation and a partnership is the ability to dissolve the partnership
 33-18-210 - If you are going to eliminate the BOD, you have
to do it by amendment in the articles. Also indicates what the corporation should
do if operating without a BOD.
 33-18-220: You don’t need bylaws
 33-18-230: You are not required to hold an annual meeting
 33-18-330: The articles can allow the shareholders to
dissolve the corp at any time
 People usually refer to a corporation as a close corporation or
a closely held corporation when there are few shareholders and the stock is not
publicly traded. However, these don’t always meet all the requirements to be a
statutory close corporation.
• Problems p. 210
o 1) shareholder agreement that restricts directors discretion
o 2) No, it wasn’t in the articles of incorporation, so the statute wont save it unless it doesn’t effect
another shareholder’s rights- which it does here
• Shareholder Voting Methods
o Shareholders vote to choose the board of directors
o Straight Voting
 A shareholder may vote their total number of shares for each
available seat
 There is a separate election for each seat on the board. Each
shareholder gets to cast her number of shares in anyway she desires for each of these
separate elections
 Each share = one vote and because you can cast all your votes
in each election, the majority shareholder will decide each one
 Ex – If I have 50 shares and the other shareholder has 20
shares, and there are 3 director positions, I get to vote 50 times for each position and
will basically determine who the 3 directors are.
 Result: if there is a majority shareholder, they will be able to
select every director
o Cumulative Voting
 Directors are not elected on a seat by seat basis
 Rather, each shareholder has votes = number of shares *
number of open seats
 Those total shares can be cast in any way
 This tends to give minority shareholders a better chance at
choosing a director or two.
 With the same example above, B would put all 60 of his votes
on one guy or himself and A will put at least 61 of his votes on 2 people so as to be
sure to get at least 2 people.
 Formula: Number of shares to elect one director:
• [S/(D + 1)] + 1
• S= total number of shares voting (not multiplied by
seats).

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 • D = total number of directors to be chosen at election.
 Formula for more than one: [(NxS)/ (D+1)] + 1
• N = number of directors the shareholder wants to elect
• S = total number of shares voting
• D = total number of directors to be chosen at the election
 Problems: there are nine directors to be elected and the
corporation has 1000 outstanding shares. How many shares to ensure Epstein is
elected to the board? 101 How many to ensure both Epstein and Roberts are elected?
201.
 Suppose now the board consists of only 3 directors. How
many shares would be needed to elect Epstein? 251
 Why would a corporation not want cumulative voting – it
protects the minority shareholder
 The less directors, the more shares you need – so majority
shareholders want fewer directors if they use cumulative voting
 If I’m a majority shareholder and I want power, it is to my
advantage to have a limited number of directors.
 Note that with staggered director voting, cumulative voting
tends to reduce the influence the minority can have
 P. C35: SC 33-7-280: Voting for directors: cumulative
voting
• Directors are elected by plurality of the votes cast by the shares entitled to vote.
Shareholders have a right to cumulative voting unless the articles say otherwise
o SO our default rule is to have cumulative
• But cumulative voting is only the default if the meeting notice or proxy notice
conspicuously states that cumulative voting is authorized –
o Or a shareholder gives proper notice – see statute-
o So you have to do something before you can exercise your cumulative
voting rights
• Unless provided otherwise, shareholder voting is
cumulative
• 280(c) - Triggering event must occur to allow
cumulative voting:
o The meeting notice needs to say the voting
is to be cumulative
o If a shareholder is going to vote
cumulatively, he must either give 48 hours notice OR give notice
at the meeting and then they have 2 hours
 If a shareholder gives notice at the
meeting of his or her intent to vote cumulatively - the
other shareholders have a right to adjourn the meeting to
figure out what they are going to do
 A minority shareholder would
prefer to announce at the meeting his intention to vote
cumulatively b/c there is a chance that the others will
screw up their math in 2 hours
 280(d) – prevents the majority from being able to amend the
articles of incorporation to prevent against cumulative voting = (if the # of votes
cast against the amendment would be sufficient to elect a person onto the BOD
if voted cumulatively)
 Note that cumulative voting is only used when adding (and
tangentially, removing) directors.
 Problems p. 213

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 • 1. Conflict of Interest - If you represent the majority shareholder they don’t
want cumulative voting, if you represent the minority shareholder they want
cumulative voting. If they come to you and ask whether you recommend
cumulative voting, you can’t say anything because it is a conflict of interest.
• 2. If a 48% shareholder is not a director, the company probably does not have
cumulative voting or he would have gotten on the board.
• 33-8-108: Removing directors
o You can remove without cause unless the articles state that cause is
required
 Cause = fraudulent or dishonest acts or gross abuse of
authority.
 There must be notice of the charges and the director must
have a chance to refute the charges
o If a director is elected by a voting group of shareholders, only the
shareholders in that voting group may participate in voting to remove him.
o If cumulative voting is elected – majority cant fire you – this is to
preserve the minority protections of cumulative voting
o With cumulative voting, you can’t remove a director if the number of
shares required to choose him as a director are cast against his removal (in other words, the
minority shareholder has trump power)
 § 33-7-280(d) does not allow the board to amend the articles
to remove cumulative voting if the votes casts against the amendment would be
sufficient to elect a director the board of directors
 Built in safety valve – once the minority gets someone on
board, you can’t just get rid of him by firing him. – you are protected against the
majority’s removal of him.
 If minority gets someone on board – the majority is stuck
with them.
o If cumulative voting is not authorized, a director may be removed only
if the number of votes cast to remove him exceeds the number of votes not cast to remove
him.
o The meeting to remove the director must contain some notice that a
vote to remove the director will be held
o So if 7-280(d) prevents you from doing away with cumulative voting, the majority will want to reduce
the number of directors so as to get more control
o BUT 8-103 throws up some blocks
 If the number of directors is in the articles, then it’s harder. But if its in the bylaws, the
directors can change it
o So next they will stagger the terms so that fewer are elected at a time, which means the majority’s
voting power becomes much stronger- this is also a takeover defense by making it harder to fire
off the directors if a outside buyer comes in
o Note – class shares are a better protection than cumulative voting
• 33-8-103 – Directors only serve their designated terms.
• 33-10-200 - the shareholders could amend the by-laws to reduce the # of
directors, all the way down to 1. The majority is the one who is going to be able to elect that one
(you can do that by combining § 33-8-103 with 33-10-200 and 33-8-108). But Ohio court voted
against this.
o SC is one of the few states that reduced the # of staggering to 6 (you
can have a staggered term board if you have a minimum of 6 directors)– done to protect
some majority shareholder of some corporation. § 33-8-105 allows the majority to reduce the
number of directors (or stagger the elections of the board; 33-8-106). This gives the majority
shareholders greater power. This is another end-run.
• Uniformly shareholders have the right to vote on 4 “fundamental corporate
changes”:

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 o Amendment of articles of incorporation
o Dissolution
o Merger with another corporation
o Sale of all or substantially all of the corporate assets
o In SC – Shareholder also has the right to:
 To create a SC corporation
 To change the form of business
o But on these decisions, the shareholder is merely giving approval of boards decision
o Normally a supermajority approval requirement
o No cumulative voting
o Note that shareholder votes other than selecting directors is
actually considered approval (or disapproval) of the board’s actions
o If I want to have a corporation run by the shareholders, the only
provisions that are worth a hill of beans are 33-7-101 or the section on creating a closed
corporation (above)
• Where shareholders vote and who votes: Special Terms
o 33-7-101: There shall be an annual meeting (usually the only thing
you do at an annual meeting is elect directors)
o 33-7-102: Special meeting (any meeting other than the annual)
 At the call of its board of directors or
 If it isn’t a public corporation (company whose stock is
publicly traded on the NYSE), if 10% of the voting shares demand a special meeting, they’ll
get one (this is unusual…most states don’t allow shareholders to call their own meeting)
o 33-7-104: Action without meeting
 Shareholder action can be taken without a meeting if the
action is taken by all of the shareholders who are entitled to vote.
 This is the way SC closely held corps vote
 If you don’t want to have an annual meeting you don’t have
to. You can have your lawyer prepare a set of minutes and have each shareholder sign
off (most SC corporations do it this way).
o 33-7-105: Meeting notice
 Shareholders with voting shares must get notice between 10
and 60 days prior to the meeting date.
 If it is notice of an annual meeting, no purpose needed. You
need notice of purpose for a special meeting
o 33-7-107: Record date
 The person who has the legal right to vote at an annual
meeting or special meeting of shareholders is the record owner.
 The bylaws can fix the records date
 § 33-5-105 allows for notice 10 days prior to the meeting
 Not more than 70 days before the meeting
 Shareholder as of record date gets to vote regardless of
whether they subsequently sold.
 If you bought after record date and it’s important to you to
vote, you can enter into an agreement with the seller to cast his votes for you, except in event
of a takeover vote
o Record owner – person who has right to vote at annual or special meeting
o corporation must send notice to them of meetings
o Record date – 33-7-107 problems with giving notice come up because shares are sold by the holders,
so corporation will fix a record date, and only record owners as of that date are entitled to notice of a
vote at a meeting
o So mainly used in public companies

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 o Brokerage firm – most people buy stock from brokers. The brokers are the ones who are the record
owners in the corporation records. The real owner is in the brokerage firm’s records. This is called
street name ownership
o Laws make the brokers give notice to the street name owners, and the brokers have to vote how
the real owner tells them too
o If a bank is given bond in a corporation as part of a loan agreement, that bank doesn’t have a right to
vote because they collect first. Because the shareholders collect last, they need to be in control
o A proxy can be revoked at anytime – even if it says it is irrevocable
o It is only irrevocable if it says that it is and is coupled with some interest in the stock – look at SC
statute for definition of this
o There are Federal Rules regulating proxies because without them, most shareholders in publicly traded
corporation wouldn’t vote
o R 14a-9 prohibits false or misleading statements in soliciting proxies
o 14a-8 deals with shareholder proposals
Problems page 217
o 1.1 looking at 105 and 107 – the latest would be 10 days before the meeting and the earliest is 70 days
before. There is not a precise answer to this question in our code. It must be between 10 and 70 days.
o 1.2 Capel because he was the owner at the record date even though he isn’t at the time of the meeting.
(so owner at record date gets to vote even if they don’t own at time of vote)
o 1.3 you need to know if that got changed on the company’s records. If it didn’t then Shepard might not
be able to vote
o 2) no they won’t have to approve this change; the board of directors can make business decisions
without the approval of the shareholders
• Proxy Statements – S/H authorization to Vote
o Proxies are simply an agency appointment (I, as a shareholder, grant
someone else the right to vote my stock because I don’t want to be present at the meeting)
o The agent is the party that is casting the vote
o Proxies are the exclusive province of shareholders – there are NO
director proxies.
o Proxies are generally only a feature of publicly traded companies,
b/c you can’t get everyone together to vote.
o Generally a proxy is a yes/no vote on the director/shareholder
action.
o Proxies are generally revocable UNLESS
 it states that it is irrevocable and
 is coupled with an interest in the stock
o 33-7-220 - Proxies
 Only a shareholder can vote by proxy
 A proxy appointment is effective when the appointment form
or electronic submission is received by the secretary or other officer to agent authorized to
tabulate votes. A proxy appointment expires if a time period is specified or within 11
months.
 Proxy appointment is revocable UNLESS the proxy form
states that it is irrevocable AND the appointee is
• a pledge (lender –who you pledge a stock of the
security)
• someone who bought or agreed to buy the shares
• a corporate creditor where the terms of the loan
required their appointment as proxy
• an employee whose contract requires their
appointment
• a party to a voting agreement under 33-7-310 –
“voting trust”

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 • We really need to have irrevocable agencies under
certain circumstances
 A solicitation in the proxy statement cannot contain a
statement which at the time it was made was false or misleading w/r/t a material fact or
which omits to state a material fact necessary to make the statements made not false or
misleading. We are one of the few states that has our own proxy fraud act; mirrors the
federal proxy rule below
 You have a state and federal proxy fraud action
o Proxy solicitation: when a shareholder receives a proxy, it usually
comes with a statement that solicits the shareholder to grant the proxy for their shares.
• Federal Proxy Rules: false or misleading statement of fact
o Rule 14a-9
 (a) – no solicitation shall be made in any proxy statement,
written or oral, containing any statement that is false or misleading with respect to any
material fact
 Non-disclosure of a material fact - Also specifies that an
omission of a material fact in a proxy is a violation.
 This changes the normal fraud statutes because you can’t have
a defense of silence; an omission is actionable; that’s key
o There is an implied right of action on behalf of individuals who have been injured by a violation of
proxy rules.
 The shareholder must show that there was a material misstatement or omission in the
proxy materials. All that is required is that the fact would have been regarded as
important, or would have assumed actual significance in the decisionmaking of a
reasonable shareholder.
 The shareholder does not have to show that he relied on the falsehoods. Instead, the court
will presume that injury was cause as long as the falsehood or omission was material.
 The defendant had to knowingly make a misstatement or omission (?). Scienter is not
required for insiders. Mere negligence is sufficient.
 There has to be an essential link between the solicitation and completing the transaction.
If the P’s votes aren’t necessary, the P may not recover.
 Remedies: damages, injunction, or in an extreme case an undoing of a consummated
transaction
o Virginia Bankshares v. Sandberg (VA Case)
 VB owned 85% of the stock of a bank, and solicited the
remaining shareholders for a proxy vote in favor of a merger that would get them “high value
for their stock” and a “fair price.” Minority shareholders sued for a violation of Rule
14a-9.
• The merger was going to force the minority shareholders to sell their stock
• The corporation was going to pay them $42 per share
• The law didn’t require their vote, but they wanted it
 corporation sent out proxy statement asking for their proxy
 Sandberg refused to give his proxy and sued for violation of 14a-9 which prohibits the
solicitation of proxies by means of materially false or misleading statements
• Claims that the proxy lied in saying they were getting a high value for their
stock. They should have gotten $60 per share
• The statement was conclusory in form – purporting to give the reasons for why
the directors were recommending the merger – when in fact it was the Π’s
statements and not the directors
• Also Sandberg’s approval wasn’t needed anyway since the corporation had
enough votes
 The P’s in this case are being cashed out; it is a freeze out
merger (the merger is going to force the shareholders to sell their stock). One of the issues

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though was when we are voting on whether to freeze out shareholders then we don’t need the
votes of the minority shareholders (15%).
 The Ps argue the directors lied was so they could keep their
position on the board (the motivation behind your lying was to preserve your jobs)
 Fundamental Test as to what is MATERIAL: The court
defined a material fact as one where “there is a substantial likelihood that a reasonable
shareholder would consider it important in deciding how to vote.” The court said that
even though “fair value” sounds like a statement of opinion, because in the corporate context,
a shareholder expects that opinions are based on facts that justify the statement. In this
case, the statement of opinion was material.
• Note: a misstatement as to the director’s motive for
seeking the proxy may not be material, but a misstatement as to value of company or
stock is material
• Note: if the statement includes enough correct facts
to allow a shareholder to neutralize the misleading statement, then it may not be
material.
• An opinion as to a general fact is not necessary a
material misrepresentation.
 But under the rule, Π must show the misstatement was knowingly made
• ∆ argues that by publishing true facts with what is a false conclusion makes the
misleading proposition too unimportant for there to be liability – after all its
only a material misstatement if it effects the shareholders vote, and if its obvious
that the statement isn’t true, then it shouldn’t effect her vote
• But this all depends on the mix of the true and untrue
• The jury here found that the true facts did not neutralize the false conclusions
 Second issue – should there be liability when the minority shareholder’s vote wasn’t
needed in the first place- this is the bigger issue here
• Mills v. Electric – ∆ had 50% of vote but there had to be a 2/3. court had to
decide if the minority shareholders had to show that the misstatement had a
decisive effect on the outcome ie that they were actually mislead – court said no,
just that the misstatement was made in tenor of the solicitation in the number of
minority shareholders’ needed to make the vote
o This relation is called the “essential link”
• But that court wasn’t dealing with a class of minority shareholders who had no
right to vote anyway – so no essential link
o Π claims Mills’ statement of the essential link is here trying to expand
it
 Either because ∆ wouldn’t have proceeded without minority
approval because of ill will that would stem
• Also claimed they were trying to keep their place on
the board and this would help
• So they wouldn’t have done it without them
 Or, because there was a conflict of interest issue because on of
the Bank’s directors was also on the ∆’s board, so the minority
approval was needed to keep this from voiding the merger
• Court disagrees- these 2 theories are the same as the essential link that
solicitation played in Mills
o Π is speculating about what the ∆ would have done. This isn’t going to
win the day. The COA only exists if the Πs vote is required and it
wasn’t here
o He says I see what you’re saying, but this solicitation would not cure
those two problems. He likes the second theory but the facts are wrong
here

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  CAUSATION: The solicitation doesn’t cause damages unless
the proxy is given because of the solicitation were necessary to complete the transaction; that
there was an “essential link” between the solicitation and completing the transaction. In this
case, because VB didn’t need the proxy to complete the merger, there was no causation.
 Holding: So in this case the misstatement as to the value was
material but there was no causation so no violation of Rule 14a-9.
 If the reason they wanted our vote was to keep the company’s
good name out there so that the board of directors can maintain their position, the minority
shareholders argued there was an essential link. Souter said nope because there is no way to
know the reason they wanted the minority shareholders to vote.
 The minority shareholders also argued that the minority votes
would cure a later attack on the merger based on conflict of interest. Souter said that the
minority votes were inadequate to ratify the merger under state law, and there was no loss of
state remedy to connect the proxy solicitation with hard to minority shareholders irredressable
under state law. Basically, Souter says not under these facts but maybe sometime under
different facts.
 As a practical matter you can’t determine if the reason
someone voted the way they did was because of the solicitation.
 It is very RARE that you have disputes over proxies b/c it is
usually very difficult for the shareholders to determine what is going on. Also, it is very
expensive.
• Proxy Rules: Shareholder Proposals and Exclusions
o It is important to distinguish between a full-fledged proxy solicitation
and a shareholder proposal pursuant to Rule 14a-8 (often a political statement; not something that the
shareholder actually wants to pass- not something that shareholders can mandate…they can only
request)
o Rule 14a-8 (handout): companies have to include shareholder
proposals up to 500 words if the shareholder has at least $2000 in securities that he’s held for at least a
year.
• Under certain circumstances, a shareholder can require the company to send out
a proxy solicitation regarding a proposal of the shareholder.
o In addition to corporation soliciting their holders for votes, occasionally a shareholder will also try
and solict the votes of other shareholders.
 Comes up when the shareholder is not happy with how the company is running
 But the cost is too expensive for this to come up a whole lot
o 14a-8 provides that a shareholder can ask the company to send out a proxy solicitation regarding a
proposal of what the shareholder wants and not the company. If you follow this rule closely, then
the company has to send it out at no cost to you – this saves you millions
o The SEC allows the shareholders of a public company to request that
the company send out a proposal for the shareholders to vote on. The company bears the cost of these
proposals – federal gov’t has stepped in and said this is something we are going to mandate on behalf
of all the shareholders of publicly traded company
o The company will submit and request a no-action letter by the SEC
granting the companies exclusion of the proposal in the proxy – if the SEC grants a no-action letter it
will be essentially permitting the company to leave the proposal out of the proxy.
o 2 Primary Types of Shareholder Proposals (most of the proposals
come from organizations or church groups).
 Mgmt control devices - Directly addressing management
issues of publicly traded companies.
 Politically & Socially Motivated – cheap & efficient way to
get the word out with our political concerns.
o The company will try to avoid putting it in, and there are some reasons
the SEC will allow them to keep it out – and not recommend enforcement action to the SEC if the co.
leaves the proposal out .

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o To resolve issues related to 14a-8 (ie things the corporation wants to put in or leave our of its proxy
solicitation), lawyers rely on SEC bulletins and no action letters
o No action letters are recommendations by SEC staff that the full commission not challenge
specified conduct
 Seek these in advance of taken a specific action- kind of like a declaratory judgment
o But the SEC can be bypassed and the injured party can still sue in court – but this is very rare
o Rule 14(a)(8)(i) –REASONS FOR EXCLUDING S/H PROPOSAL
(reasons SEC might grant a no-action letter):
 Improper under state law- if the proposal is not a proper
subject for action by shareholders under the laws of the jurisdiction of the company’s
organization (usually proper if phrased as a recommendation or request)
 Violation of law- if the proposal would, if implemented, cause
the company to violate any state, federal, or foreign law to which it is subject
 Violation of Proxy Rules – If the proposal violates Rule
14a-9 – prohibits materially false or misleading statements in proxy solicitation materials -
Materially or directly impugns character, integrity or personal reputation
 Personal grievance; special interest: if the proposal relates to
the redress of a personal claim or grievance against the company or any other person, or if it is
designed to result in a benefit to you, or to further a personal interest, which is not shared by
the shareholders at large
 Relevance: Proposal relates to operations that account for less
than 5% of net assets or net earnings and not otherwise significantly related to companies
business
 Absence of Power /Authority - Company has no power to
resolve the problem
 Mgmt Functions: Relates to company’s ordinary business
operations – Mcquade case
 Relates to election of directors (under the rules there is a
limitation on that)
 Conflicts with the company’s proposal: if the proposal directly
conflicts with one of the company’s own proposals to be submitted to shareholders at the
same meeting
 Proposal has already been substantially implemented
 Duplication
 Resubmissions (there are specific rules about this)
o Ex – McDonald’s shareholder proposal –
 Coordinated campaign to try to address human rights concerns
involving China.
 The lawyer used the word “request” in their resolution b/c,
given the McQuade case, it is not within the scope of the shareholder’s sphere of authority; it
is within the director’s sphere of authority.
o Ex – Xerox proposal.
 The primary reason this shareholder proposal was excluded
was b/c it related to the election of directors.
o See page 236 – Xerox wanted to exclude shareholder proposal asking for replacement of all inside
directors
 Holder had stock through Employee Stock Ownership Program (ESOP)
• 3 step process of getting new directors
o Inside – those employed by the company
o Outside – those not employed by company
 Xerox claimed that it could leave it out under 14a-8(i)(8) because it deals with the
election of directors

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  A 1976 release from the SEC said that 14a-8 is not the proper means for conducting
campaigns or effecting reforms in elections of that nature since other proxy rules
including rule 14a-11 [election contests] are applicable
• But these have been directed at proposal for specific nominees or select group
that the new directors are to be selected
 Also claims that 14a-8(i)(3) allows exclusion of anything against the proxy rules. Then
argues that the proposal contains misleading statements and therefore violates 14a-9 – for
attacking character and personal reputation without factual foundation
o SEC gave Xerox a no action letter
o Based on 14a-8(i)(8)
o So the SEC wont pursue an enforcement action to make this proposal be included in the proxy
Looking at 14a-8 – Shareholder Proposal
o See handout
o Motivation of SEC is that it wants shareholders to get involved in the operation of the company. And
to do this, we need some way to communicate with the other shareholders.
o Must own 2K or 1% of the company’s securities for at least one year
o You can only submit one proposal per meeting
o Proposal and supporting statement must be 500 words or less
o Deadlines – must be received not less than 120 days before the date of the company’s proxy statement
released to shareholders in connection with the previous years annual meeting
o Question 9 – if you have complied with the procedural requirements, on what other basis may a
company rely to exclude your proposal?
o Improper under state law
 Most proposals that are requests are ok
o Personal grievance
o Relevance – if it relates to less than 5% of company’s total assets
o Management – if the proposal deals with a matter relating to the company’s ordinary business
operation
 So its hard to fit something in between this one and the Relevance of 5%
o Election- or nomination – this seems contrary to the fact that the one thing they always have a
right to do, which is to vote for directors – which means its hard to communicate with other
shareholders about who they want to vote
o Resubmissions
 If you want to keep submitting the same proposal there are requirements – see # 12
• Shareholder’s Inspection Rights
o When can they look at books and records?
o Kortum v. Webasto Sunroofs – (DE CASE)
 Facts: WAG and Magna are 50% stockholders in the joint
venture of WSI. Kortum is CEO of WAG, and a director of WSI, of whom WAG owns 50%.
WAG also has a controlling interest in a competitor of WSI.
 WSI wants to prevent Kortum from having access to inspect
books and records because they think he’s going to give the information to WAG who will
give the information to direct competitor.
 Issue: What is the scope of a S/H’s right to inspection when
an agent of the S/H is a director of the Company.
 273 action in DE – DE has a law that provides a company like
WSI (2 shareholder co) either of those shareholders can bring an action to dissolve the
company.
 There are two requests for information: a director of the
company and a shareholder
 The director and the shareholder are the same person here and asked for records in both
capacities
• Director- to monitor performance

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 • Shareholder – to value its shareholder interest
• ∆ said it would let him view in his director capacity but he couldn’t share that
with WAG
 Shareholder has brought a 230 action to view the records – SC
has nothing like this
 TEST for DIRECTOR INSPECTION (Kortum): Director
has access to any records reasonably related to his position as director (almost unlimited
rights of inspection and the burden is on the other side to prove there will be a misuse of the
information). Once the director has demanded access, the burden is on the corporation
to show why access should be denied or conditioned. The court says that the speculation
that he will use the information competitively is not enough to restrict his access, and further,
since he has promised not to do so, he should be granted unfettered access
• SC has no statutory director rights, but you could
draft it into your AI’s as a statutory or quasi close corp.
 TEST for SHAREHOLDER INSPECTION (WAG): A
shareholder must show
• They complied with the form of making an
inspection demand: a written demand under oath
• The stated purpose of the inspection they seek is
the actual purpose and that purpose is legitimate.
o Valuing one’s shares is proper purpose,
regardless of whether you plan to sell or not
• The scope of their inspection is “essential and
sufficient” to their stated purpose.
o SC statue requires these things for S/H
inspection also!!!
 The shareholder has right to inspect. The court said that the
fact that a shareholder was a competitor didn’t reduce the entitlement, but may make
conditions proper. In this case, the promise not to disclose to the competitor was
sufficient.
 Notice that the shareholder has a much more restricted right to
look at the records than the director.
o In SC: 33-16-xxxx
 We have no director inspection statute like DE does
 33-16-101(e): Corporate Records:
• Mandates the types of records we have to maintain.
 SC 33-16-102: Shareholder Inspection Rights
• (a): Shareholder has a right to inspect anything in
101(e) with written demand and at least 5 business days notice. Also, if you have at
least 1% interest, you can also look at tax returns.
• But this wouldn’t give you what you need if you where in a Kortum squabble –
wouldn’t let you figure out the value or what the directors have been doing
• You get this info in the annual report
 (b): KEY RECORDS – In order to get the key records: minutes of the meeting,
accounting records & shareholder record, you must establish 3 things (note: so
for the good stuff, you have the DE limitations from Kortum.)
• (c) Your demand was made in good faith for a proper purpose
• Describe with reasonable particularity your purpose and the records you want
to inspect
• The records you want to inspect are directly connected to your purpose
 (d) the right to inspection granted by this section may not be abolished or
limited by the AI’s or bylaws.
 33-16-103: Scope of Inspection right:

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 • (a) The attorney or agent of the shareholder has the
same inspection rights as the shareholder.
• (d) If a S/H or agent requests a S/H record it must be
compiled no earlier than the date of the demand.
 SC 33-16-104: Court Ordered Inspection
• If the company gives you the Heisman on your
102(a) demand the court can order it, and if they do, copy costs go to the company.
 BIG NOTE: SC doesn’t have statutory director inspection
rights.
• Shareholder Voting Agreements
• Agreements btw directors are void – McQuade
o Agreements btw shareholders are valid – Ringling
o Ringling Brothers v. Ringling: DE Case - One of the most
landmark cases
 The two Ringling sisters are in an agreement to cast their
voting shares together, and if they can’t agree as to who to elect, they will talk to an arbitrator
who will decide for them. The arbitrator makes a decision, but one sister doesn’t go along
with it.
 At issue is a voting agreement bw shareholder regarding election of directors
• 3 shareholders – Edith, Haley and John. E claims H was bound to vote for a
certain slate of directors. H says the agreement was invalid or revocable
 Agreement said they would consult and vote together
• Arbitration was to be had if they failed to agree
• Said it could be terminated by mutual consent
 Voting was cumulative
• They each had enough individually to elect 2, and then a 5th by voting together
(there were 7 total)
• See ft note 1 for the math
 Dispute
• E was to vote for herself, her son, and Mr Dunn - complied
• H was to vote for herself, her husband, and Mr Dunn – voted only for H and her
husband
• As a result, John was able to get in 3 of his directors instead of only 2
 Trial court said the agreement was valid
• That when one party breaks the agreement, the willing party becomes the
implied agent in possession of an irrevocable proxy of the breaching party’s
votes
• The court ordered a new vote to be had with H’s shares cast in accordance with
the agreement
 ∆ alleges that a voting agreement is invalid that takes voting power irrevocably away
from the owner except an agreement that complies with § 18 of Corp Law
• This section covers voting, voting by proxy,
o Depositing stock in a person or corporation as a trustee with the right to
vote as a Voting Trustee for up to 10 years
o Her argument was that you had to set up a voting trust to do this
• Court says ∆ is wrong – there are numerous ways shareholder can make
agreements with each other about voting. This statute doesn’t cover the type of
agreement at issue here.
o Class shares, irrevocable proxy, etc
o So you can have shareholder agreements or a voting trust, and both are
ok
 Pooling agreement – this is what this is, and it is valid

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 • Shareholders have wide discretion to vote or agree however they want as long as
they don’t breach a duty owed to another shareholder
• Its fine for them to vote to gain an advantage
 Remedy
• Johns votes should count since he breached no agreement
• Likewise E’s votes should count
• But court throws H’s votes out completely, so the 6 people J and E voted for are
now directors
o Doesn’t decide what to do about the vacant spot
 Issue: Is a S/H voting agreement that provides in the case of
disagreement an arbitrator will decide the voting of the shares valid?
 Haley’s basic argument that she can do whatever she wants
with her votes (go against the agreement) Is b/s she suggests that you can’t contract away
shareholders voting rights – DE law says that the way you do what you want to do is set up a
voting trust
 Haley’s primary argument: Basically, the argument is that
Haley couldn’t be forced to vote her shares according to the agreement because that would
have required an irrevocable voting trust, which takes an interest in the stock along with
the proxy.
 Holding: The court says that an agreement among
shareholders to cast their votes in a certain way is valid and enforceable. As a remedy,
they invalidate the votes that were cast against the agreement.
 Court says that the voting trust should not be the only way
to control the voting rights – rejects Haley’s argument based on Section 18 of DE law.
• However, instead of requiring Haley to cast her
votes according to the agreement, the court invalidated her votes and the result
was that there ended up being only 6 board members when there should have been 7.
o SC Rule on Voting Agreements, we allow
specific performance of voting agreements as long as they are written
and signed, so this case would have come out differently.
o DE Rule: In order to mandate the votes
there would have to have been a proxy coupled with an interest.
Someone had to have agency authority to cast the votes.
o Court said they didn’t know if he had a
proxy, and even if he did it wasn’t irrevocable b/c it wasn’t coupled
with an interest (he didn’t own shares), so Haley had the right to cancel
this interest.
o If Haley cancelled the K right, she might
have been liable for damages but Ringling doesn’t have a right to specific
performance.
• Is the result in this case less favorable, more
favorable or in the middle result to Ringling? –
o Ringling had the most power until there was
a change in allegiance. If the votes had been required to be cast, then
Haley’s choice would have been elected and they would have had the
majority on the board. The decision clearly favors Mrs. Ringling b/c the
composition of the board when they throw the votes out makes any decision
a stalemate.
 Distinction between Ringling and the McQuade Case:
shareholders trying to influence a director’s right, here we are dealing with
shareholders trying to influence one another’s voting decisions. Shareholders are
allowed to influence voting but are not allowed to do what they did in McQuade.
o 33-7-300 - 310

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 To get someone to vote the way you want them to, you can
set up class shares, voting trusts, or pool agreements (contracts)
 33-7-300: Voting trusts
• You can place your shares into a voting trust. You
must file the trustee, beneficiaries, and agreement with the corporation.
o When you transfer them you know longer
have ownership of the shares and the person who contributed must now
vote the shares.
o One of the objections that was raised
initially with these voting trusts is that a voting trust is public information.
o Trustee has essentially absolute power over
the shares. The trustee has the right to vote the shares as he/she chooses
o If there are dividends, they are paid to the
voting trust certificate holder
• Only valid for 10 years unless extended or amended
• You can get as much as a 10 year extension with
approval of the trustee
• (d) – indicates that the voting trustee is allowed to
vote without the consent of the voting trust certificate holder – Also indicates
that the voting trust certificate holder has the right to dividends.
 Even though you have given up stock to trust,
• You get a voting trust certificate- so if there are any dividends paid, they are
paid through the trust to you as the holder of the certificate
• no article that alludes what would happen if the
voting trustee’s actions were injurious to them; he votes selfishly in a way that
benefits him- unclear what would happen
• Ex - You might use something like this when you’re
giving interest in the family business to the kids, but you don’t want them to begin
exercising their voting power until they’re older ‘cause they don’t know jack
• The only reason to do this is to tie up the voting
power - Why would you want to have a voting trust? (mostly an exclusive feature of
small corporations)
o You may have a small corp set up by one
person, looking for investors, but wanting to maintain voting power –
people will still invest
o Family situation – where the parents want
to control the votes and don’t trust their children yet.
 33-7-310: Voting agreements (Pool/contract agreement)
• 2 or more shareholders can agree to vote in a certain
way with a written and signed agreement.
• the agreement is not subject to the provisions of the
voting trust statute 33-7-300
• the agreement is SPECIFICALLY enforceable (note
distinction from Ringling – would have changed the outcome)
 33-8-104 – Election of director’s by certain classes of
shareholders:
• If the AI authorizes setting up different classes of
stock, the AI’s may also authorize the election of one or more director’s by holders
of one or more authorized classes of shares.
• It doesn’t matter how many shares of stock are issued
to each, the only thing that matters is that each one gets to elect one director, the
statute allows for this.
• Each class constitutes a separate voting group.

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 • Different classes of shares is the traditional
control device that lawyers recommend!
o Duties and Responsibilities of Corporate Decision makers: Stockholder Derivative Suits
 Director’s Duty of Care
 The directors of a publicly traded company are responsible to the shareholders. A closely
held corporation is run by the owners (completely different)
• Breach of Duty of Care by Improper Board Actions – BJR!!!
o Shlensky v. Wrigley (IL -DE law applies) – BJR Case
 Facts: Plaintiff was a minority shareholder in the Cubs. Sued
the directors for mismanagement in not putting lights in Wrigley field, stating that the club
would make more money if they had night games. Plaintiff states that the reason Wrigley
isn’t putting up lights is because he doesn’t like night games, which is against the
interests of the corp.
 This is a shareholder derivative action. The motivating force
here is the lawyer, b/c if there is a big win then they get the fees.
 The court is not convinced that the decrease in revenue
will be offset by installing lights b/c the decision may deteriorate the neighborhood.
 DE - BJR: The court will not evaluate the business decisions
that the directors or the officers make unless they border on fraud, illegality, or conflict of
interest.
o Issue – can a derivative suit be brought for something other than fraud, illegality or conflict of
interest? – should the Court evaluate the boards decision as good or bad
 Davis v. Louisville Gas & Electric – Directors had one view and majority of shareholders
have another
• They asked court to decide which view should prevail
• Court said it will not interfere with policy and business management
• The board is elected for this purpose- and their judgment absent fraud is final –
presumption that it was made in good faith and in best interest of the corporation
o Π claims that directors are acting on personal interest and not those of the corporation
 Court is unconvinced bc integrity of the game and concern for the surrounding
neighborhood are legit concerns for the company, and if the directors judge that this is
better for the corporation then increased cash from night games, so be it
 Absent fraud, illegality or conflict, this is a proper decision for the board to make and it
will stand
o Rule- Derivative suit must touch on
 Fraud
 Illegality
 Conflicts
 You must Touch these before the court will look any deeper
 Shlensky’s only option now is to sell his shares – get the
heck out of Dodge!!!!
 The laws of the state of incorporation, in this case DE,
govern the internal affairs of the corporation. So in this case DE law governs the internal
affairs of a baseball team that operates in Chicago.
o Joy v. North (U.S. Ct App – 2nd Circuit – I think NY Case?)(most
cited case on director’s duty of care)
 NY BJR Case
 Procedural Aspect: Shareholder filed a derivative suit on
behalf of the corporation. The board of directors created a special litigation committee which
decided to terminate the suit.
 The Special litigation committee is to act on behalf of the
Co. and whether it is in the best interests of the Co. to continue the litigation. The special
litigation committee decided to terminate the suit.

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 2 business decisions the court has to decide how to
evaluate:
• The liability of the “outside directors” – a director
who is not an employee of the corporation.
• The vote of the litigation committee to terminate
the lawsuit?
 BJR is the concept by which courts wont hold officers and directors liable for negligence
simply for making bad decisions that lose money
 NY BJR: Court said that the business judgment rule applies
unless there is evidence that a decision
• lacks a business purpose, OR
• is tainted by conflict of interest, OR
• Egregious as to amount to a no win situation
(gross negligence)
 Reasons for the BJ rule:
• Shareholders assume the risk of bad judgment
when they buy.
• It is very difficult to recreate the decision process in
hindsight - Looking back on a decision is a bad method of evaluation.
• The whole notion of risk is what is key to business –
the greater the risk, the greater the likelihood of return - Don’t want to create legal
incentives for directors to avoid risk.
 Holding: The Court said neither of these decisions are
protected by the BJR. Court evaluated the decision of the inside directors to terminate the
lawsuit b/c they had a conflict on interest. Court evaluated the process of the outside
directors’ decision making and found that they did not get the benefit of the BJR b/c they
were not informed
• Court says that lack of knowledge is not a defense,
allowing the other directors to make a decision for them will still be considered a
breach of fiduciary duty.
 Court discussed 2 forms of derivative suits:
• An action against the corporation for failing to sue
when it should have
• An action on behalf of the corporation (that the
corp. failed to bring) against the directors for harm to the corp.
 Court said that in most cases a shareholder must demand a
corporation sue on its own behalf before bringing a derivative suit, and when the directors (or
a committee of uninterested directors) refuse a demand, business judgment rule applies to the
refusal to sue.
• In this case, however, the decision not to sue was
so bad it could be considered gross negligence, and as such was not protected by
the business judgment rule.
 Special Litigation Committees
• Decision to bring a suit falls under BJR
o So shareholders must first demand the directors to bring suit, and then
the court will apply BJR to determine whether their refusal was proper
• The group that decides whether to bring suit is called the Special litigation
Committee- so the court looks at their decision and applies BJR to see if they
should have brought suit.
o If so, they will be liable
o If not, then the shareholder is out of luck
 Application
• Court looks at likelihood of success in bringing suit

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 • The Π wanted to sue its board of directors for being negligent in extending
credit to a risky investment that had little gain to offer
o The Board set up a special litigation committee to decide on the issue
of whether to sue
o Committee moved to dismiss action against outside directors – ie the
ones who aren’t officers because they weren’t given notice of what
North was doing
• North was in control of the Banks board and management
o He didn’t provide materials or agendas to other members before
meeting
• Under his direction, the Bank was extending credit to a developer named Katz
that was very risky
o It was no win – he continued to give extensions. Despite risk, the only
potential profit was the interest but the loss was the entire principle.
The interest could have been earned by diversifying
o So Special Litigation Committees report that there was only a
possibility of finding negligence was wrong
• Court says the inside directors may dispute the outside directors claim that they
had no knowledge of what was going on, and ignorance is no defense anyways,
so the action shouldn’t have been dismissed against them
 A directors who willingly allows others to make major decisions affecting the future of
the corporation wholly without supervision or oversight may not defend on their lack of
knowledge
• SO the BJR wouldn’t prevent the derivative action from prevailing
• The court remands to have an individual review of outside directors to determine
their role and why they didn’t act
o 33-8-300: SC BJR - General Standards for Directors –
 A director must discharge his duties as a director, including
his duties as a member of a committee,
• in good faith
• with the care an ordinarily prudent PERSON in
like circumstances would do (negligence std)
• in a manner he reasonably believes to be in best
interest of the corporations.
 (b) - lists the 3 sources that the director is reasonable to rely
on in making decisions
• Another officer or co. employee
• Legal counsel / Accountant
• Committee of the BOD which he is not a member
 (c) - a director’s decision is in bad faith if he knows it is NOT
REASONABLE to rely on one of the sources in (b) and he does anyway
 (d) SOL – an action for a director for failure to perform his
duties in this section must be brought within 3 years after the COA has accrued, or within
2 years after the time when the COA is discovered. SOL – does not apply if the breaches
of duty were concealed fraudulently.
 The duty runs to the shareholders and the corporation
o You can draft the duty out in the articles of incorporation if it is a
publicly traded company.
o Smith v. Van Gorkom (DE case) – BJR Case –
o (some lawyers say this is the worst decision, some say it is the best
decision)
 Class action by shareholders seeking either to rescind a merger
or get damages from the board. Van Gorkom negotiated a deal for merger of the company.

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He presented the possibility of the merger to the board at a meeting where none of the
attendees knew they would be discussing a merger. The whole proposal was made orally in
20 minutes, and no written materials were presented. Finally, the Board agreed to selling the
Co. for $50/share
 If the deal went thru in this situation – the shareholder
would have no choice – cash out merger – the shareholders would be forced to sell the
stock.
 He didn’t ask what the company was worth; rather he asked
how long it would take the buyer to pay off the note they were going to incur. Key executives
were opposed to it; they didn’t even know about it before the meeting; the board decided to
vote yes
 Subsequent to the Board’s decision, a # of steps were taken to
cover the Board’s decision, there was a gap period where the Co. put themselves up for
auction.
 “The rule itself is a presumption that in making a business
decision, the directors of a corporation acted on an informed basis, in good faith and in the
honest belief that the action taken was in the best interests of the company…Thus, a director’s
duty to exercise an informed business judgment is in the nature of a duty of care, as
distinguished from a duty of loyalty…The applicable standard of care…is predicated upon
concepts of gross negligence.”
 So this is also different from both Jones and Shlensky
 Π must rebuke the presumption that the decision was an informed one
 The problem is not the substantive decision that was made but
because they weren’t informed.
 DE - BJR: The court will not evaluate the business decisions
that the directors or the officers make unless they border on fraud, illegality, or deceit.
 DE BJR Exceptions – BOP is on P:
• Not making a informed decision or failure to use
all of the material information available.
o The court said that a director is fully
protected if he relies in good faith on reports or informal personal
investigations by corporate officers
o Must inform themselves of all material info reasonably available to
them prior to making the decision –
 This is a fid duty owed bc he is acting on behalf of others
• Contrasts duty of care from duty of loyalty
o Bad faith: Not investigating the source of
the $55 offering - failure to investigate that is a failure of good faith.
• Gross Negligence – DE BJR
o VG’s presentation did not rise to the level of
a report because he didn’t know about the information that provided the
basis for his report. Thus, the directors were did not exercise due care and
were grossly negligent in making this decision, and as such do not receive
the benefit of the business judgment rule.
• Exceptions to BJR:
o gross negligence – lack of due care*
o lack of good faith* - failure to investigate
o fraud,
o self dealing
o or other unconscionable conduct.
 Rule: The Burden is on the P with the duty of care - BJR
cases and court will focus on the process

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  Damages Award: The directors should have quit
immediately…some of the damages came from insurance $ but no one knows where most of
the money came from. However, most of the $ came from the co. that bought the company.
• Breach of Duty of Care by Director’s Failure to Act – Oversight Liability
 Barnes v. Andrews (NY)
• Andrews was a director of an auto part maker. While he was a director a bunch
of crap went wrong that cost the company money. There were two scheduled directors meetings,
and he missed one. He didn’t pay that much attention to the affairs of the company.
• The plaintiff claimed that the defendant failed to give adequate attention to the
affairs of the company which had been conducted incompetently
o No negligence in attendance of meetings
o If there is liability it must rest on his failure in general to keep advised of the conduct of the
corporation affairs
 So we see duty to stay informed
o Directors aren’t to be involved with the actual conduct of the corporation - that is for the officers
 Directors can act individually only by counsel and advice to them
• Directors don’t have to guarantee that his judgment is good
• Court said that:
o Rule: Directors have an active duty to keep themselves informed in
some detail of the operations of the company.
 BOP – P: Apparently the duty is on the plaintiff/shareholder
to show breach of the duty or director’s failure to keep himself informed!
 Directors must make efforts to learn of the actual affairs of
the corporation and not serve as a mere figurehead
o Loss Causation: Upon a breach of that duty, plaintiffs have to show
that had the director performed his duties, the loss would have been avoided (causation).
 Unfair to put the burden on the
Director: If we were to put the burden on the director, the director would be in a
very difficult decision to come up with the proof that they did in fact pay
attention to detail – they would be in a very hard position, and in part to protect
the American way of doing business, the burden is on the shareholder.
• In this case, the director violated his duty to stay informed. However, the
plaintiff was not able to show that if the director had known what was going on he could
have made a difference. Thus, no liability for director.
• SC- follows the Barnes standard – Duty is on the P to show failure to act
and Causation.
o RULE – An action against an inattentive director, a complaining shareholder must establish some
linkage between the director’s bad behavior and corporate loss – ie causation
o Sarbanes-Oxley increases the duty of directors to stay informed and involved
o Francis v. United Jersey Bank
• ∆ was warned that if her H died and she inherited the stock, she couldn’t trust the sons
• Her defense was that she wasn’t involved and didn’t know what was going on
• Court nails her anyway and holds her personally liable for the losses
• Graham v. Allis-Chalmers Mfg. Co.
• Several mid-level employees of a large corporation were indicted and pleaded guilty to violating
federal antitrust laws by engaging in price fixing
• Π shareholder brought derivative suit arguing that the directors breached duty of care by failing to
monitor the employees
o Court found in favor of directors
• Too many employees meant that board could only be liable for broad policy issues – not immediate
supervision
o Went so far as to say that the board did not have a duty to set up a monitoring system until
they had some reason to suspect that the employees were not being honest

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• Next case shows that while board can depend on subordinates, this dependency must be reasonable
 In Re Caremark (DE Case)
• Caremark violated a bunch of Medicare rules and ended up with fines over
$250M. Shareholders filed derivative action against directors for breach of duty of care in
supervising employees.
• Court says there are 2 ways to bring liability:
o BOD makes a bad decision that results in loss because it was ill
advised or negligent. In this case, we apply the business judgment rule, and as long as
the process used to come to the decision was rational and employed in good faith, there is
no liability.
• Substance of the decision isn’t important as long as the process is reasonable
and in good faith
• Concern of after the fact review
• All that is required is a good faith effort to stay informed
o * Failure to act or monitor in a situation where attention would
have prevented the loss. This includes a duty to make sure that an adequate corporate
monitoring system exists. The level of monitoring is a business judgment question.
• Before there had to be cause for suspicion before a duty to monitor arose
o But court says this is wrong, the holding in Graham merely means that
directors can’t be held liable for assuming the integrity of its employees
• Noting the need for information, the court says that the board does have an
obligation to ensure that its information is accurate
o But the amount of such systems falls under the BJR
 There must be a good faith judgment that the corporations
information and reporting system is in concept and design
adequate to assure the board that appropriate information will
come to its attention in a timely manner as a matter of
ordinary operations,
• “Thus, I am of the view that a director’s obligation includes a duty to attempt in
good faith to assure that a corporate information and reporting system, which the board concludes
is adequate, exists, and that failure to do so under some circumstances may, in theory at least,
render a director liable for losses caused by non-compliance with applicable legal standards…
Here the record supplies essentially no evidence that the director defendants were guilty of
sustained failure to exercise their oversight function.”
o For liability, there must be a sustained and systematic failure to exercise oversight
 Π hasn’t show this here- there was a good faith system and if they didn’t know, then there
is no fault
• Holding: In this case, there was no evidence of a sustained violation of the
oversight function, so no violation for directors.
• Most lawyers consider this to be a duty of care case, but the handout (Stone
Case) says that Caremark deals with a duty of loyalty.
 McCall v. Scott (DE Case)
• Another derivative suit against directors of health care company for breach of
duty of care. Senior management, allegedly with knowledge of board, was using illegal practices
to increase revenue. There was a clause in the articles that removed the duty of care for
directors for anything short of intentional misconduct.
o Gross negligence is the standard for bringing a derivative suit
o Test – only a sustained or systematic failure of the board to exercise oversight- such as an utter
failure to attempt to assure a reasonable information and reporting system exists
o However- Π doesn’t have to show a director intentionally acted to harm the corporation
 The ∆ had pointed to articles that says it requires intentional misconduct to overcome the
waiver of liability
 What waiver –they put in the articles that it had to be intentional

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 • There was a statute in Del that said you could put such a provision in your
articles
o However court interprets statute to mean that in addition to intentional wrongs, certain reckless
acts or omissions also would not be in good faith and are therefore not capable of waiver
 Taking the totality of the facts here, the conduct could arise to recklessness and therefore
could not be waived under the statute – so they can be liable
• The court did not address the validity of the waiver. However, the plaintiffs
alleged that because of the experience of the directors as managers, the only way the fraud could
have taken place is with either reckless or intentional disregard of warning signs, and as
such was enough to survive a motion to dismiss.
o In particular, the P’s alleged that intentional or reckless disregard can
be inferred from the failure to act in the face of audit information, ongoing acquisition
practices, allegations brought against Columbia is a qui tam action, the extensive federal
investigation, the NY times investigation into Col’s billing practices and the inaction by
the BOD.
• Holding: Ct held that the P’s pled particularized facts that presented a
substantial likelihood of director liability for intentional or reckless breach of the duty of care.
They reversed the motion to dismiss and remanded the case.
• Note that McCall seems to indicate that an allegation of recklessness is
enough to get you into court when intentional is the standard.
o South Carolina 33-2-102(e): Limiting director liability for monetary damages for breach of duty of
care
o The articles can limit liability of a director for violation of fiduciary duty as long as there are no
limitations on liability for:
 breach of duty of loyalty to the corporation or its stockholders
 **acts or omissions not made in good faith or made with gross negligence, intentional
misconduct, or knowing violation of the law** important
 duty imposed by 33-8-330 (unlawful distributions)
• note that 330 refers to 33-8-300 – Director’s Duties, which seems to set up a
negligence standard for the duty of care of a director.
• Note that 33-8-300 sets the standard for breach of duty of care for directors as
negligence, so you can draft that out in the articles.
 transactions from which the director got an improper personal benefits.
o Statutes like this were passed all over the country to negate the effect of the Van Gorkum Case.
o Plaintiffs can’t recover from directors who screw up.
o This only applies to certain corporations
o If the corp meets a bunch of qualifications (essentially, if you’re big).
• 33-2-102
o Publicly held corp with over 25 million in assets or 500 shareholders may in their articles
provide:
 A provision eliminating or limiting the personal liability of a director to the
corporation or its shareholders for monetary damages for breach of fid duty as a
director
 Provided that the provision shall not eliminate or limit the liability of a directors
• See C-10
 The key is “for acts or omission not in good faith or which involve gross
negligence, intentional misconduct or a knowing violation of law
• Different from Del is that you cant indemnify for gross negligence –
but this means that we can indemnify for Negligence
• In other words, you can sue most companies in SC for mere negligence
whereas in Del. They would have to meet gross negligence
• Knowledge and Notice – 33-44-102
o Question is often when does an entity receive knowledge or notice of some event

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  Actual knowledge
 Or when the event would have been brought to the entities attention if it had
exercised reasonable diligence- which means it maintains reasonable routines for
communicating significant information to the individual conducting the transaction
for the entity and there is reasonable compliance with routines
• Recent statement of the BJR
o Is that some decisions are just so bad that they are actionable
• SC and the BJR
• Dockside v. Dentions 294 SC 86
 Dockside v. Detyens (SC)
• The closest thing we have to a case that talks about business judgment in
SC.
• Probably holds that we recognize the business judgment rule in SC
o One amt of votes were needed to pass assessment, but a different amt was
needed if it was an emergency
o Votes came up short, so they declared it an emergency and it passed
• Court Said this decision fell under the BJR and that absent a showing of
o Lack of good faith
o Fraud
o Self dealing
o UNC conduct
• The directors wont be liable
 Disney Case –( DE 2006)–BJR – Present Standing – Handout!
• As evidenced by the language quoted above, the Caremark standard for so-
called oversight liability draws heavily upon the concept of director failure to act in good faith.
That is consistent with the definitions of bad faith recently approved by this Court in its recent
Disney decision, where we held that a failure to act in good faith requires conduct that is
qualitatively different from, and more culpable than, the conduct giving rise to a violation of the
fiduciary duty of care (i.e. gross negligence).
o Caremark says director may be liable if it fails to monitor what goes on to the company if there is
a sustained and systematic failure of the board to exercise oversight- such as an utter failure to
attempt to assure a reasonable information and reporting system
• The BJR - 3 Part Test: BOP on the P
o Presumption that “in making a bus decision the directors of a
corporation acted on an informed basis…and in the honest belief that the action
taken was in the best interests of the company (and its S/Hs).
o The presumption applies when there is no evidence of fraud, bad
faith, or self-dealing in the usual sense or personal profit or betterment” on the part
of the directors.
o In the absence of this evidence, the BOD’s decision will be upheld
unless it cannot be “attributed to any rational business purpose”
 When a P fails to rebut the presumption of the BJR, she is not
entitled to any remedy, legal or equitable, unless the transaction constitutes
waste.
o DE court makes a distinction between the a Breach of Fiduciary Duty
of Care – Gross Negligence associated with the Caremark case and Failure to Act in
Good Faith – which constitutes more culpable conduct.
o 3 Ex’s of Failure to act in Good Faith (test for bad faith):
 Fiduciary intentionally acts with a purpose other than
advancing the best interests of the corporation
 Fiduciary Acts with the intent to violate applicable positive
law

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  Fiduciary intentionally fails to act in the face of a known
duty to act, demonstrating a conscious disregard for her duties. – Necessary to
establish oversight liability!
• DE said that Caremark applied the correct std - held
that a necessary condition for oversight liability as a sustained or
systematic failure of the BOD to exercise oversight-such as an utter
failure to attempt to assure a reasonable information and reporting
system exists. Or having implemented such controls failure to monitor
or oversee its operations thus disabling themselves from being
informed of the risks or problems requiring their attention.
• Ct says Failure to comply with good faith is not a separate, breachable duty
– does NOT establish an independent fiduciary duty – only a subpart of the duty of loyalty.
 But then court goes on to say that failure to act in good faith is not ipso facto an
establishment of director liability – instead good faith goes to loyalty not care
• That good faith isn’t a separate fid duty but a subsidiary of loyalty
• This is hard to swallow
 This is not SC or NY, its Delaware, but its likely everyone else will follow
 If it’s a breach of loyalty, then when you go to the statute it doesn’t address loyalty in the
section about liability for breach of duty of care – so there is a defense here
• DE ct says that b/c a showing of bad faith conduct of this kind is essential in
establishing director oversight liability, that the fiduciary duty violated by that conduct is
really a duty of loyalty.
• Burkhard disagrees but this case is the law. He thinks Caremark is describing
a duty of care when they talk about good faith. The Disney case is calling it a duty of loyalty.
The Court has said in the LLC context that even though you can contract away your rights for
breach, you can’t contract away the duty of good faith. This might have an effect. He’s not sure
where all of this is going, but it’s probably going to have significant influence down the line.
• Elements of Finding Director Oversight Liability: Where director’s fail to act
in the face of a known duty to act, thereby demonstrating a conscious disregard for their
responsibilities they breach their duty of loyalty by failing to discharge that fiduciary obligation in
good faith.
 Duty of Loyalty (directors put own financial interests ahead of corporation)
o IN DE & SC – you can’t indemnify against breaches of a duty of loyalty!!!
o Breach of Duty of loyalty - Competing with the corporation
o Breach of duty is when your saying the board is lazy or dumb
o Breach of loyalty is when you say they are greedy and put their own interests ahead of the corporation
o Look for cases where the director
o Competes with the company
o Takes for herself a corporate opportunity
o Has some personal pecuniary interest in a corporation’s decision
 Jones v. Burke (NY):
• A bunch of the directors got together and formed a new competing co. before
they resigned. They got together to discuss buying out the business prior to resigning.
They were talking to existing clients and set up a corp before walking out.
 The dates are important in this case
• June 28th, there was a meeting of ∆s
• July 3rd – one of the ∆ told Jones that he either has to sell or they are going to set
up a new corp
• Aug 6th – negotiations fail
• Aug 22 a new corporation is formed
• Before any of these dates, the ∆’s had already talked with the clients about
coming with them
o If they had done it on Aug 22, there would be no sanction

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 o But since it happened prior to leaving the Πs corp, there is liability
because they were directors and had a duty of loyalty to the company –
so we look at what happened before, not after
 If you are the ∆s you have a serious problem that they have to deal with
• Jones is running the company into the ground- how do you fix it
 Ad agency, Duance Jones Co, began to suffer hard times because of behavior lapses of its
founder. Several of the officers start a competing agency
• The stole key clients and employees and then resigned from Duane Jones
o This cost the Π 6.5 million
 The Π had been flaking out, and the ∆ testifies that the customers either want the ∆s to
buy him out or start a new corporation
• They had entered into negotiations about buying him out, but it never went
through
• The ∆ had already “pre-sold” the customers on their plan, and they incorporated
before resigning from the Π’s corporation
o Also took majority of Πs employees with them
• The ∆’s here were shareholders and officers in the corporation
• Issue: Timing here is critical – did the director’s breach a duty of loyalty prior
to leaving the firm - must determine when the bad things occurred – prior to leaving the
firm or after they left – they are liable for disloyal acts while they were still employees
• Duty of Loyalty Test: Directors are prohibited from acting in any manner
inconsistent with his agency or trust and is at all times bound to exercise the utmost good
faith and loyalty in the performance of his duties.
• Holding: the directors are liable for advantages secured by them, after
termination of their employment, as a result of opportunities gained by reason of
their employment relationship. They pursued a course of conduct which resulted in a
benefit to themselves through destruction of the P’s business, in violation of the fiduciary
duties, imposed on defendants by their close relationship with plaintiff corp.
• They were bound to exercise the utmost good faith and loyalty in the
performance of his duties
• You cant benefit yourself to the detriment of the corporation
• If they had quit and then started a new corporation, it might have been ok. But
the conspiracy started while there was still a fid duty
o Ct rejected the defense that the directors did not avail themselves of the
benefit of the customers and personnel diverted from the P until after they
informed the P that they were leaving.
• Rest (2nd) – Duty not to Compete: Once you quit, then you may compete.
However, there are some limitations that you can’t use trade secrets NOR can you
violate a continuing existing duty.
• Rest (3rd of Agency) - Section 804; dead silent on all of this
• Lawyer Tip: A co. like Jones can always draft or set up a covenant not to
compete if it wanted to protect itself, although this is not easy.
 SC Case: Futch v. McCallister Towing:
• Rule: Pre-Competition Set up Activities are OK and does not constitute a
breach of loyalty.
 But some case law suggests that SC allows you to take some acts – such as filing for
articles of incorporation
 setting up the corporation
 going to the bank to get financing
 BUT CONTACTING EXISTING CLIENTS AHEAD OF TIME IS NOT OK!!!.
o Notes
 ALI says you cant compete unless

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 • The competition would benefit the corporation more than hurt it, or there is no
foreseeable harm
• The competition is authorized in advance and ratified by disinterested directors
• “” by disinterested shareholders
 Serving on another board does not qualify as competition because you are not pursuing
your own interests by doing so
• Breach of Duty of Loyalty - Usurping a corporate opportunity
o Must identify what a corporate opportunity is and what a director has to do when he is offered one
o Doesn’t matter if you are an officer or an agent
 Northeast Harbor Golf Club v. Harris (Maine)
• Facts: Harris was president of the club for a while. It is unclear if she was a
director. She was offered a piece of property b/c of her position. She bought it for
herself and notified the club afterward. Later, while playing golf with the postmaster
she found out about another parcel of land that might be available and bought it,
disclosing later to the board that she bought it but indicating to the club that she was not
going to do anything with the property that is not in the best interests of the club. The
club didn’t have the cash to buy the property anyway. Later, Harris decided to
make a little subdivision out of the property. The club sued for breach of loyalty
 ∆ was president of ∆ corporation. During her tenure, the club thought about developing
land to raise money but never did
• At one point, a broker contacted ∆ to see if the club wanted to buy some
adjacent land
o Fact that it was offered to her as President is key.
• ∆ bought it in her own name for 45K in 1979 without discussing it with the
board. The board however took no action. She then bought another parcel in
1985 (which she learned about in individual capacity) in which she didn’t tell
the board until after the buy. Then another lot
o She says she had no plans to develop at that time, and that such plans
didn’t develop until 1988
• Court found that the club would have been unable to make these purchases
because it never had any money- however this is somewhat disputed
• ∆ then tried to develop in 1988 and the board brought suit for breach of
fiduciary duties
 Π claims she breached in buying the lots without giving notice to the corporation and
time for it to buy the lots if it choose
• Seeks injunction and constructive trust
• Line of business test: If the opportunity is in the corporation’s line of business
and the corporation is financially able to undertake the opportunity, then the officer or
director can’t take the opportunity for himself.
o Court didn’t apply this test b/c it is hard to decide if an
opportunity is in a line of business and the ability to pay prong acts as a
disincentive to resolve financing problems.
• Maine applies- Corporate opportunity doctrine (5.05 -ALI test) – 2 prongs –
page 323
o A corporate opportunity is
 Any opportunity to engage in a business activity of which a
director or senior executive becomes aware either
• In connection with his job or under circumstances
that would reasonably lead him to believe the opportunity is
being offered to the corporation OR
• Through the use of corporate information or
property and would reasonably expect it would be of interest
to the corp.

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  OR Any opportunity that is closely related to a business in
which the corporation is engaged or expects to be engaged. – (Broz
Case would have applied here)
o In this case, the first opportunity would definitely be a corporate
opportunity because it was offered to her in her official capacity. The second
opportunity might be a corporate opportunity because it might be closely related
(they wanted to prevent development)
o If it is a corporate opportunity - director or senior officer can’t
take the an opportunity unless (full disclosure prior to taking the opp is
key)
 first offers it to the corporation AND
 the opportunity is rejected by the corp AND
• the rejection is fair to the corp (burden on the
insider to demonstrate fairness- they had proper disclosure)
OR
• the opportunity is rejected in advance by
disinterested directors following disclosure OR
• the opportunity is rejected by disinterested
shareholders and the rejection isn’t a waste of corporate
assets (can’t give away something that they shouldn’t give
away)
o Special rule Concerning Delayed Offerings – Way to Cleanse
liability after litigation commences: Relief based solely on failure to first
offer an opportunity to the corporation is not available if
 Such a failure resulted from a good faith belief that the
business activity did not constitute a corp opp
 Not later than a reasonable time after suit is filed challenging
the taking of the corp opp, the opp is offered to the corp and rejected
according to the criteria above.
• Application
o First lot it was offered to corporation
o Second – it was closely related to the business
o So if the opportunity is closely related or the director learns of it while
acting as director or with the understanding that it will be offered to the
corp, then there is a opportunity
 Facts support this here – ie first lot
 Board must then show it didn’t have an opportunity to take it
or that it didn’t reject it properly
 She can then defend on grounds that taking the opportunity
was fair – but she cant use this is there was no offer of the
opportunity to the corp
• Court adopts ALI test
o Thinks Guff test is hard in that it asks you to determine what is in the
line of business
 Also you shouldn’t worry about whether the company has the
ablity to buy the property
o Questions page 325 –
 1 – the fact that the corporation couldn’t purchase the
properties is not determinative; finances wouldn’t matter
 Broz v. Cellular information systems (DE) Approach to usurpation of corp opp.
• Facts: Broz was a director of CIS, and was also the sole stockholder of
another cellular company. Broz was given a chance to buy cellular licenses in
Michigan, and he did so without giving CIS a shot at refusal. CIS no longer had

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 operations in Michigan. There was a company buying CIS that would have been
interested in the licenses.
 ∆ never formally disclosed to the Π, but he did mention it to the CEO and one other
member who said they weren’t interested in the license. He bought it for RFBC. At this
same time, PriCellular was in the process of acquiring the Π, and it WAS interested in the
license
• DE Court applies the Line of Business Test:
o (1)there is an opportunity that is in the line of business of the
corporation AND
o (2)the corp is financially able to undertake it AND
 (3) the corporation has an interest or expectancy in the
opportunity AND
o 4) Director takes the opportunity, then he is breaching his duty
UNLESS
 the opportunity is presented to the director in his individual
capacity AND
 the opportunity is not essential to the corp AND
 the corp holds no interest or expectancy AND
 the director has not wrongfully used corporate resources to
exploit the opportunity
• Holding: Was not a Corporate Opportunity:
• Reasons ct held no corporate opportunity in this case
o He became aware of it in his individual capacity.
o CIS couldn’t afford it –not able to financially undertake
o CIS had no interest or expectancy
o Further, Broz was only required to consider the facts as they stood
when he accepted the offer, and therefore didn’t have to consider the interests
of the potential buyer. So, the fact that he didn’t present the opportunity to
CIS didn’t create a violation per se. So CIS could not have an expectancy.
• Important - Under the ALI approach – Corp Opp Approach: this could
have been a corp opp (don’t know if it was closely related or not) and if it had been then
Broz was required to make the offer to the Board.
• Issue: What do you do if you are on 2 different Boards?
o This problem only comes up in the context of closely held companies.
o This problem rarely comes up with publicly traded companies.
o Also – in SC there are NO reported cases having come up on this
issue
 REMEDY: Remedy is to unwind the transaction
 SC Rule: doesn’t have an explicit rule, but it is likely that we will follow the ALI
approach
• Breach of Duty of Loyalty- Self Dealing by Interested Directors
 Self Dealing: A contract or other transaction that occurs between a corporation and 1 or
more of its directors or any other corporation, firm or entity in which one or more of its directors
are directors or officers are financially interested. Cookies
 HMG v. Gray (DE)
• Facts: Gray is a director of HMG, and is their primary negotiator. He
negotiates a sale of land to NAF, in whom he holds an interest. He did not inform
HMG that he held an interest in NAF. There was also a director Fieber who had an
interest in NAF which he disclosed. Fieber knew of Gray’s interest and did not disclose
that interest.
 Gray and Fieber are two of five directors in Π corp, which buys and sells commercial real
estate.
• Gray negotiated a sale to NAF

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 • Fieber owns an interest in NAF but he discloses and abstains from voting
• Gray, through relatives and related business entities also owns an interest in
NAF but he does not disclose and he votes and he negotiated the sale to NAF
o He is on both sides of the company
• Fieber knows of Gray’s buy-side interest but doesn’t disclose it
o Court finds breach of fid duty of loyalty and care
• Bad behavior was discovered 13 years later and the court still dives into it
 Proof of undisclosed self-dealing is suffcient to rebut the presumption of the BJR and its
protections. Instead, the entire fairness standard is used
• Because the vote was made without disclosure it will be deemed non voidable
only if fair to the Π at the time is was made
• ∆ have BOP to show that it was fair under careful scrutiny
• RULE on Validity of Interested Director Transactions:
o Director self-dealing will not void a transaction if a majority of
disinterested directors ratify the deal, OR the shareholders ratify the deal,
but ratification is only valid if the material facts as to the director’s interest
are disclosed to the body that ratifies the deal. OR
o If there is no disclosure, the transaction is not void if the self-dealing
directors can establish the fairness of the deal: both fair dealing and fair price.
BURDEN ON DIRECTORS (defendants). The court applies the so-called
“Entire Fairness Test.”
 Fair Dealing – You have to show the Process was Fair:
Fairly timed, negotiated, disclosed, and assent to the deal obtained.
• In this case, there couldn’t have been fair dealing
because the main negotiator was on both sides of the deal.
• Cookies also added the BJR to evaluate this prong
and added the aspects of Good Faith and Honesty. The
defendants want the business judgment rule to apply so they
don’t have the BoP.
 Fair Price: You have to show that the result is fair. Just
because a price is in the range of market price doesn’t make it fair if the
corp might have refused to make a transaction if it had known
some material fact. Also profitability is not dispositive (Cookies)
• In its valuation the court says that the appraisals
were out of date. The rental income from these properties
was increasing.
o Holding: Gray, as the interested director, did not satisfy his BOP to
show that the price was fair – in other words HMG would not have gotten way
more if he had been disinterested.
 Also mistake in valuation in this case: Fee Simple Value vs.
Lease Value – Court says if the property is subject to a long-term
lease, you probably look at the value of the lease - however not the
case in this instance so you need to look at the fair market value of
the fee simple.
• REMEDY should be the difference in the fair value and the price they
should have received. The Court here hammered the defendants (fairly unusual
remedy). The Court partly unwound the transaction and gave some of the
properties back to the company.
 Distinguish corporate opportunity cases from interested director cases:
• In corporate opportunity cases, one would expect the court to impose the
following remedy: take the opportunity out of the pocket of the wrongdoing director and
give it back to the company
• Corporate opportunity takes something away from the corp

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 • Interested director probably causes less total harm (here no one is stealing…the
price just wasn’t right, so somehow we make up the difference as the remedy)
• The remedies for each bear this distinction out
 Cookies v. Lakes Warehouse (IOWA)
• Cookies made BBQ sauce, and they weren’t very good at marketing. Herrig
was a minority shareholder and owner of a distributing Co. They brought him in for help,
and he started kicking butt. Eventually, Herrig became majority shareholder and put his
guys in the director’s chairs. Then made a bunch of deals giving his own businesses
expanded deals and he gave himself a bunch of increases. Cookies, regardless of ass
kicking, did not pay dividends, so other shareholders got squat. Shareholders argument is
that he could have used the money he paid himself to pay off the loan so then they would
be able to pay out dividends.
 Why are shareholders suing when company is making bank
• The minority guys aren’t getting dividends and cant sell it on the stock market
because its not a public company – so its harder to sell
• But they couldn’t pay dividends because of the loan – so why would they bring
suit knowing this
o You could take the money they were paying him to pay off the debt
• Cookies test for self dealing transactions (very similar statute to previous case):
o The interest was disclosed or the deal approved by the BOD without
the votes of the interested director – (this case!), OR
o Interest is disclosed to shareholders who authorize such a transaction
by vote or written consent, OR
o The contract or transaction is fair and reasonable to the corp.
 BOP on director to establish that they acted in good faith,
honesty, and fairness in duty of loyalty cases!
 Fair price: Court said that profitability alone doesn’t
establish fairness. However, there was no evidence that Herrig’s fees
were too high.
 Fair Dealing: Court also applies the Business Judgment Test
to assess whether they were fair or reasonable to the Company.
o However, court says that in addition to showing one of these three,
there must be a showing of good faith, honesty and fairness on the part
of the interested party
 Seems like Del says the same thing but maybe not
• The question is had this deal been made nonvoidable by the statute: he disclosed
his interest to the directors and they voted. The concern is that he put all his own guys on
the board.
 Negotiations
• There must be an ear mark of arms’ length negotiations
• Π claims the court should look at market value of ∆’s services rather than the
success ∆ brought to Π
• Court agrees that success should not be the sole criterion, but these facts doent
show he was unfairly compensated
• Court finds the success is important though and court doesn’t think the company
would have been as successful without Herrig
• So they say they did meet this burden but they don’t say how – which is the
dissent’s problem
 Duty to Disclose
• The duty does not extend to minority holders
• The decisions are management activities, so disclosure to board is enough
• The board here was aware of Herrig’s interest, so there was disclosure
 SO no breach

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 • Holding: Court held that the self-dealing was ok b/c Herrig had disclosed his
transactions and the material facts to the BOD who approved it (although there is the
question of the fact they were all his guys).
• Dissent
• Agrees with law, but not with application
• Duty of good faith requires not just a showing of profitability, but also a
showing of the fairness of the bargain to the interest of the corporation –thinks
this was not shown here
• ∆ failed to show that his rates were comparable to others in the locality. It was
his BOP to show the fair market value and that his rates comported to that
o This was his burden and simply showing profit doesn’t meet it
 SC 33-8-300: General Standards for Directors: SC has specifically imposed a duty on
directors to act in the best interest of company and shareholders. This is different from most
states.
 A3 is unique to SC – director has to act in best interest of the company and the
shareholders – so there is an added burden compared to most states
 SC 33-8-310 – Test for Director Self-Dealing
• Apply the Same test in Cookies with 1 exception – BOP on P.
• (a) – If disclosure to directors or shareholders was proper and transaction was
approved by the BOD, then the burden of proving that the transaction was unfair falls
to the party claiming unfairness.
• Yes there can be challenges to the fairness of the deal – but if is proved
under (3) – director has showed it is fair – that is enough, but definitely is enough if
the BOD has approved it.
 Conflict of interest transaction statute
 Not voidable by the corp solely because of directors interest if
• Disinterested board has approved
• Disinterested and informed shareholders approve
• Fair to the company
 If one or two has been accomplished, the burden of proving unfairness is on the party
claiming unfairness
 Look at statute for other provisions
• Ie indirect interest if he has direct interest in another corporation is a party to the
deal
 SC 33-8-111: addresses director compensation
 Unless the articles of incorporation or bylaws provide otherwise the board my fix the
compensation of directors for their services as directors or any other capacity – ie officers
 So this insulates compensation decisions from claims of conflict of interest
 SC 33-44-409: The LLC statute is very different. (e) a member of a member-managed
company does not violate a duty or obligation merely because the member’s conduct furthers the
member’s own interest
 F) a member of a member-managed company may lend money to and transact other
business with the company. As to each loan or transaction the rights and obligations of
the member are the same as those of a person who is not a member subject to other
applicable law
 So LLC can have interested members
o Who sues and who recovers?
 Shareholder Derivative suits
o A derivative suit is when a shareholder sues to vindicate a claim that the corporation should have
made (questioning a corporate decision). On the one hand, we do not want to permit untoward second-
guessing of management. On the other hand, there may be cases in which we question the directors’ ability
to make an impartial decision about whether the corporation ought to sue.
o She stands in the shoe of the corporation in asserting the claim against TP

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  So the COA must be one that the corporation has
o Right to sue is a management decision ie they did something wrong, so the BJR will apply
 Most derivative suits fall into this category
o If the Corporation has a good faith reason for not wanting to sue, then the shareholder will not be
allowed to bring suit
o BUT if the suit is against a director, then there is a good chance that the corporation won’t bring suit,
but we may allow the shareholder to do so because the directors are not impartial
o But there will be strict limits on the shareholders right to sue
o One is that they must provide security against the corporation expenses
 Ie provide a bond in case he loses
 But many states don’t require this if the shareholder has a large amount of stock in the
company – because they wouldn’t sue and risk their investment unless it was really worth
it
o Distinguish derivative suits from direct suits in which the Π has a personal claim
o One hint is that the conduct affects only some shareholders rather than all of them
o Eisenberg v. Flying Tiger (NY)
 Plaintiff owned stock in Flying Tiger Airline which owned FTC which owned FTL.
Flying tiger merged into FTL, but the shareholders of Flying tiger got stock in FTC, which was
just a holding company, so they no longer had a vote in the company that runs the airline.
o Π (owned stock in)  Flying Tiger line (Flying Tiger) (freight and charter airline  Flying Tiger
Corp (FTC) (wholly owned subsidiary) FTL (subsidiary)
 Flying Tiger then merged with FTL – so that Flying Tiger ceased to exist and FTL
survived and ran the airline
 Stockholders in Flying Tiger got stock in FTC (not FTL)- so Π owns stock in the holding
company, which has FTL as a subsidiary
o Not saying the directors have done something bad and should be accountable, just that they made
a bad decision
o Π sues arguing that this merger deprived him of any control of the company that runs the airline
 Issue: Is it a direct claim or derivative suit?
 Court said that a derivative suit was one brought in the right of a corporation to obtain a
judgment in its favor.
 Ex of Direct Suit:
• Separate Injury –S/H injury that was separate from the corporation
• A director action that restrained the right of conversion from preferred to
common stock.
• Actions to compel dissolution are direct because the corporation cannot
benefit from the action.
• A proposed recapitalization that will benefit one class of stock more than
others is direct.
 Rule: Action by the directors that negatively impacts the ability of a S/H to vote his
or her shares is a direct claim – the harm is to the S/H not the corporation.
o But this case is in the gray area
 Π says it deprived stockholders of vote
 ∆ says it affected shareholders secondarily because the real affect was dissolution of the
corporation
 Note that if this suit had been characterized as an action against directors for changing
forms to a holding company, that would have been derivative because changing forms is a
business decision and the duty runs only to the company
 Majority Rejects the old NY Test: “whether the object of the lawsuit is to recover upon
a chose in action belonging directly to the stockholders, or whether it is to compel the performance
of corporate acts which good faith requires the directors to take in order to perform a duty which
they owe to the corporation, and through it, to its stockholders.”

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  P. 356: “suits are now derivative only if brought in the right of a corporation to
procure a judgment “in its favor.”
 Majority Test for Determining Whether a Suit is a Direct Suit or a S/H Derivative
Suit: Current DE test is found in Tooley:
• Who suffered the harm – Corp or S/H –
o Independent of the Corp, was the duty breached a duty owed to S/H?
o If you’re going to have a direct claim, the harm to the shareholders
must be separate from harm to corporation
o You can have a direct suit even if there are a number of harmed
shareholders
• Who will receive the benefit of recovery or remedy?
 Shareholder direct injury must be independent of any alleged injury to corp
 Shareholder must demonstrate that duty breached was owed to shareholders and she can
prevail without showing an injury to corp
o Court sides with Π and finds this is a direct suit
 Lazar v Knolls – held direct suit where shareholder was not allowed to attend a
stockholder’s meeting
• This is similar to what Π challenges here – that the ∆ has interfered with his
right as a stockholder
 Horwitz v. Balaban – Π sought to restrain the granting of conversion rights to the
president by the corp = direct
• Why is this direct rather than derivative
• Not sure what conversion rights mean in the context of this case but presumably
it gives the president some right to stock in the company, and if gets these shares
wrongfully then it hurts the stockholders
 The action has to be brought to procure judgment in favor of the corp, not the shareholder
– this is the new test
 Cases show that where shareholder sues on behalf of himself and other shareholders to
enjoin a proposed derivative right – he is enforcing a right common to all the
shareholders which runs against the company
• Here is it even stronger since the shareholders normally retain voice in the
company after the merger – here they no longer have voice in it
o Fact that Π didn’t sue for money is important because when you sue directors for money, there is a
big incentive for them to settle = a strike suit. Preventing strike suits is one reason there are
burdens in bringing derivative suits. Here is suing for his rights as a shareholder. Not for the
companies rights
o Whether it is derivative or direct depends on:
 who suffered the harm
 the Corp or
 shareholder individual
 who should receive the benefit of the recovery or other remedy
 corp
 shareholder
o Both of these are recent statements by Del SC –
 what was happening were a series of lawsuits where the defense was that it had to be a
derivative suit because it wasn’t to the individual shareholder, but to a number of
shareholders
• #2 clarifies that this fact is not a bar to a direct suit – the injury can happen to
many S/H just not the corporation
o Direct v. Derivative Hypo’s – problems pg 359
 Conversion Rights: - right of a shareholder to convert their shares into preferred stock –
Direct

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  Issuance of shares without regard to preemptive right (co. issues more stock and
doesn’t give the S/H the first right to buy more stock): Direct or Class Action
 Suit for failure to permit shareholder to inspect: Direct
 Directors enter into a new line of business not allowed under the articles: Derivative –
(nature of the business is something concerned to the corporation as an entity; trying to interfere
with business operations of the company).
 Directors waste funds: Derivative because how company uses funds is related to the
company
 Shareholder in a close corp improperly takes money from the corp: likely derivative
even though it might only hurt one shareholder; the injury is to the corporation
 Vicarious liability – problem 5.7 (bouncer punches guy the face)-: Direct; Shepherd
can sue Freer and the company for vicarious liability
 Usurping a corporate opportunity is generally: Derivative
 Payment of Dividends?: Derivative – step 1: must determine if $ should be paid out of
the corporation – and that consideration is a determination of what is in the best interests of the
corporation.
 Robert is the minority shareholder in Co. X, which is a close corp. He sues the
controlling shareholders, alleging that they have breached fiduciary duties by oppressing him.
Specifically, he alleges that while they have had the corporation hire them and purchase
their stock for cash, they have refused to allow the corporation to do such things for him:
Could be Derivative or Direct – harder to tell in this case
o Clearwater Trust – SC didn’t catch on to Del rule that a direct suit can involve injury to many
shareholders – instead it said that this type of case was a derivative suit
 Derivative Suit vs. Class action
• Rule: Derivative and class action suits are used to assert different substantive
claims
• People tend to see derivative suits and class actions either as (1) wonderful tools
for achieving justice or (2) legalized blackmail
• Burkhard thinks derivative suits are a method of preventing justice
• Derivative suit – an individual steps up to sue on behalf of the bests interest to
the corporation – basically b/c the corp has failed to bring suit.; meant to protect shareholders from
director’s wrongs because they cannot be expected to sue themselves
• Class action is a direct representation of a whole mess of similarly situated
shareholders; however, the representative is also asserting her own personal claim
o Common traits
o Representative cases – both Π’s are representing someone other than themselves
o DS and CA are often lawyer driven. Yes the Π in a DS could get higher dividends, and a CA Π
may get something, but the big bucks go to the atty. So attys look for these claims and then finds a
shareholder or class member to represent
o Potential for abuse is real – the ∆ will be willing to settle, which means the other class members or
S/H wont get much
 Which is why there are regulations
• Such as security bond in DS to pay corporation litigation expenses if it wins
• New Chancery Court Rules have limited class action solicitation activity by
atty’s : DE has stepped up with a new set of rules with who can be the head plaintiff and who can
be the atty
 Procedural requirements of derivative suit
• 33-7-400: Procedure in Derivative Proceedings: Derivative suits may be
maintained on behalf of SC corporations in Fed and State Ct in accordance with the applicable rules of
Civ Pro.
• Joinder of corporation and alignment of parties
o Corporation is a necessary party and must be joined because
 Recovery goes to corporation

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  To ensure that the claim that the judgment will have a claim preclusive – ie res judicta
effect
o Usually the corporation is joined as a defendant
o But because the corporation has failed to enforce the claim, it is named ad a “nominal ∆” – then
realigned as a Π
o Wrongdoers are joined as real ∆
o Because the corporation and the directors have different interests they will require different attys
 As a practical matter there has a been an atty representing the company for a long time
and has had no contact with S/H but lots with the Directors – so who do they represent in
the derivative suit
• Stock ownership and Standing – SC 33-7-400 and SCRCP 23(b) below
o Must have been a shareholder at the time of the transaction you are
complaining about
o A transferee by operation of law can stand in the shoes of the
shareholder who owned at the time of the transaction and sue. Idea here – inheritance of
shares after original shareholder died.
o No minimum value of stock necessary
o So you cant buy stock after the wrong and sue – contemporaneous ownership requirement
 Assumption is that he didn’t suffer an wrong because the stock would have had a lower
value in reflection of the wrong doing
 Continuing wrong – some courts allow standing if you owned stock at any point of the
wrongdoing – so you could buy it after the initial wrong and still bring suit if the whole
impact hadn’t occurred yet
• SC Civil Rule 23(b) – page C36: Derivative Actions by S/H
o Has nothing in the Code on Shareholder Derivative Suits – only have
RCP.
o Requirements of a Complaint:
 P must verify that he was a S/H or member at the time of the
transaction about which he complains and that his share or membership devolved
him by operation of the law.
 Must also verify with particularity efforts made by the P to
obtain the action he desires from the directors or reasons why he failed to make the
effort
 Action may not continue if it appears that the P does not fairly
and adequately represent the interests of the S/H or members similarly situated.
o B 39 LLC ‘s–33-44-1101-1104 - Derivative Suits Code Section
 So you have to consider both the Civil Rule and the Statute in
dealing with S/H derivative Suits and LLCs
 Most of the time there are no inconsistencies between these
two, however sometimes there are.
 Ex of a Difference btwn Corp and LLC:
• Corp - under Rule 23 if a S/H dies the stock
“devolves” on the beneficiary – beneficiary will still have standing
without the allowance, no one could bring the suit.
• LLC statute – person who receives an interest in
an LLC b/c of death doesn’t get same rights – gets financial rights but
not legal rights –no standing to bring suit these limitations do not apply
to an inheritance or devise of an interest in a corporation.
• Security for expenses
o Required in NY
o SC – no requirement
• Demand on Directors

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 o THIS IS THE BIG ONE!! 75% of all litigation involving derivative
suits revolves around this
o General Rule: you have to make demand on directors in a
derivative suit unless demand would be futile.
o Most states follow DE rule: the decision not to honor the demand
or demand refusal can be tested
 P can commence an action and make a demand
 BOD Refuses Demand
 P can complain that the BOD’s refusal to honor the demand
should be questioned
 BJR applied to BOD’s demand refusal - BOD’s decision will
be honored unless the P meets his burden of showing the demand was reasonable
under the circumstances. If BJR kicks in, you have to show lack of
informedness or conflict of interest
 P almost always loses!
o So the Norm in most jurisdictions is for the P to argue in their
initial complaint that they don’t have to make a demand – demand is futile– that is the
norm in most jurisdictions that follow the NY mold.
o Demand Requirements – Jurisdiction Depending:
o Note: Most states have a rule requiring you to make a demand
first.
o Marx v. Akers – (NY) - How to Argue the Demand is Futile.
o Plaintiff brought a derivative suit against directors both for giving themselves improper raises and
giving the executives improper raises. P moves to get the corp to reverse the increase in
compensation/ Plaintiff made no demand. D’s moved to dismiss the case based on the pleadings
– in all of these types of derivative actions you are dealing generally with what is in the pleadings.
D’s argument – P was required and failed to make a demand, and even if they had, there is
no cause of action for either of these types of behaviors
o Claim is that IBM wasted money by giving excessive compensation to its executives and outside
directors – ie self-dealing and breach of fid duty
 So two claims
• Paying officers too much
• Paying directors too much
o Issue: Is a Derivative Action based on Improperly Raising the Director’s Compensation a Demand
Futile Case?
o Two defenses
 Court finds that demand was not excused and no COA is stated so case dismissed –
reasoned that excusing the demand simply because all board members are named ∆’s
would completely undermine the BJR as it applies to deciding when to bring suit
 Demand is not excused and no COA is made because there is a statue allowing the board
to set compensation for its members without facing self-dealing accusations
 Remember that DS is brought on behalf of the corp to secure a judgment in its favor
o NY Ct states 3 Purposes of the Demand Requirement:
 Relieve courts from deciding matters of internal corporate governance by providing
directors with opportunities to correct alleged abuses.
 Provide corporate boards with reasonable protection from harassment from
litigation on matters clearly within the discretion of the court.
 Discourage “strike” suits commenced by S/h’s for their personal gain rather than
for the benefit of the corporation.
o 3 Different Approaches to Determining the Futility of a Demand:
o DELAWARE Approach: Must state with particularity the fact that you made demand on
directors unless it would be futile OR establish with particularity the reason you did not make
a demand was b/c the demand was futile.

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  DE/NJ/SC -To Establish Demand Futility- Aronson: P’s must allege with
particularized facts which creates a reasonable doubt that:
• Directors are disinterested and independent or there was undue influence by an
interested party AND
• The challenged transaction was a product of a valid exercise of business
judgment by the director’s.
o A reason to doubt that the action was taken honestly and in good faith
or
o SEE HANDOUT ON TWEN SITE
• Court says these two prongs are “disjunctive”
o Meaning that the “and” should be “or”
o So show either one and you win
• If you meet the first prong – ie you show director interest – the BJR is out and
demand is not required
o Or if you show the director was influenced by the interested party
• Whether there is valid business judgment depends on whether
o They were informed (procedural due care)
o And substantive due care - terms of the transaction
• Some criticize the reasonable doubt standard
 Note: in DE, making demand is an admission that the directors were disinterested,
and as such making demand is an admission that demand isn’t futile – SC does NOT
have this rule!
o UNIVERSAL DEMAND (ALI test): Demand required in all cases. Only allows filing before
response ot demand if there is threat of irrepariable harm. If demand rejected the decision to reject
the suit is tested by balancing the character of the suit against the deference the directors
must receive. This has been adopted by Georgia and NC among other states. This means that
derivative suits are worthless since demand is a kiss of death
 Problem: If you have a universal demand and you follow the DE approach as the
evaluation of the demand – which is he BJR – BOP on P, P always loses!
 This approach is somewhat plaintiff friendly.
 Series of complex rules to evaluate the BOD’s decision to reject the demand!
o NY – 3 Prong Test: Must make demand unless you can state with particularity that:
 A majority of directors are interested in the transaction OR
 The directors failed to reasonably inform themselves about the transaction OR
 The challenged transaction was so egregious on its face that it could not have been the
result of sound business judgment
 Considers Barr v. Wackman – board accepted less favorable terms for a merger after
being offered considerable compensation in various forms
• Demand was excused b/c of self-interest of board members for those receiving
benefit
• Demand was also excused for outside members that were disinterested because
it was a breach of due care and diligence to the company by rubber stamping the
interested directors plan
• But you can’t just make conclusory allegations
o There must be particularity
 After Barr, cases were allowing conclusory allegations, so court states new requirements
• Particular allegations that majority of board is either directly interested or that it
its members are controlled by interested directors
• Particularity that they did not fully inform themselves
• Particularity that it is so egregious that there could not be sound business
judgment
o Holding: The court applied NY and excused demand in the claim against the directors because 12
of 15 were interested. However, the case was still dismissed because the complaint didn’t state a

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 cause of action because directors set their own compensation and the complaint didn’t allege
compensation rates excessive on their face, etc.
 Π claims directors were interested because they were awarding themselves compensation
and tthat the others simply acquiesced
 Officers: demand was not futile to them because they do not make a majority
• Only 3 got a raise- there has to be a majority that is interested
• Doesn’t say they failed to use business judgment
• So demand is not futile as to the inside directors
 Outside Directors
• However, the Π also alleged that a majority of the board was interested because
the outside directors also set their compensation, and this consists of a majority
of the board – so demand would have been futile under this fact
 But there is no COA because the statute allows them to do this and the complaint only
makes a conclusory allegation that it is excessive
• He needed to show breach of fid duty or fraud
o BOP shifts depend on whether it was approved by interested of
disinterested shareholders
• Here the raises weren’t excessive on their face to give rise to breach of fid duty r
fraud
o The Court would be willing to question compensation in the case of fraud; where directors or
officers appropriate the income so as to deprive shareholders of reasonable dividends, or perhaps
so reduce the assets as to threaten the corporation with insolvency. If I was a shareholder, I would
much rather bring the case as a direct suit.
o Why do we care about demand?
 If a shareholder makes demand, and the corporation
rejects, that rejection is subject to the business judgment rule, P almost always loses.
 Thus, if the shareholder has to make demand, their suit is
likely dead in the water
o What if the Demand is deemed futile and Π is allowed to proceed
o Settle or litigate
o OR directors will move to dismiss arguing that the potential benefits from the corporation
continuing the suit are not worth the costs
o Traditionally such motions are proper when the suit is against a TP because the shareholders are
disinterested and the BJR applies
o But if the DS is against the directors, then the court wont recognize the motion bc of the conflict
o To get around this, the atty would have the board create a “special litigation committee” that
excluded the interested members. This committee would then make the motion
 Problem is that the interested ones are involved in appointing members to this board
 Courts vary on how they address these committees
o Special Lititgation Committee Hired to Evaluate Demand Refusal:
 Nowadays, usually a committee is appointed to evaluate
whether or not the lawsuit will continue; universally the committee will consist of directors
that have no relationship with the alleged wrongdoer.
 The committee will universally hire an expert to guide them in
their evaluation and this will usually be a retired judge and hire an expensive corp law firm –
almost universally they will always decide to file a motion to dismiss!
 After you file a Motion to Dismiss – these next cases deal with
that:
 These cases come after the demand futility mechanism as a
defense bar.
o Auerbach v. Bennett (NY)

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 Facts: Directors had been authorizing bribes, and shareholders
successfully initiated a derivative suit. The company created a minority litigation committee
of 3 disinterested directors to decide if they should pursue the litigation.
 Π argues that no SLC appointed by the ∆ directors should not
be recognized
• Court rejects – the directors are the only ones who can appoint such a board and
the only ones that can authorize suit against the interested directors
• So court just assumes that the SLC is disinterested and independent
• To side with Π would be to deny the board its ability to make business
judgments for the corporation regarding the suit
o If someone outside the board made this decision, it would be a breach
of the nondelegable fid duty of the directors to act in the best interest of
the corporation
 Issue: They decided not to pursue, and the question is whether
business judgment rule should apply to the decision to terminate the suit.
 2 Prong Test to Evaluate Committee’s Decision to
Terminate Litigation:
• Was the committee independent and disinterested
• Was their process satisfactory
 The court said that so long as the members of the committee
were disinterested (the court assumes the committee was disinterested in this case), the action
to dismiss was proper IF
• The committee’s procedures in pursuing the
decision to dismiss were appropriate.
o As long as the methodologies were created
and followed in good faith, it’s cool.
o This is the only consideration that the court
will review
o Courts are well equipped to review the
method and procedures used to investigate facts and determine legal
liability
o Must choose the methods of investigation in
good faith – if you do this, the court wont review the decision
o So basically have to show you were
informed- or took measures to be informed
• If the decision to dismiss was properly predicated
on the data produced by the process.
o This decision is classic business judgment,
so doesn’t get looked at much
• Application
o Record does not show deficiency in methods used by SLC. They made through
investigation of pertinent areas
o Use of special counsel
o Reviewed report of audit committee
o Questioners were sent out
• As a practical matter what these committees do today is to hire someone with high profile
to advise the committee – normally a retired judge = CYA
o Also use best corporate law firm they can think of
o 90% of the decisions are to dismiss – everyone knows they will dismiss
 Often hang hat on saying that yes we can get money, but dragging this
out will bring the corporation down or negatively effect the directors will
hurt the company more than its worth

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 o The reason they decide to dismiss does not have to relate to the merits
of the claim
o So Auerbach limits review to the procedures and good faith investigation of the SLC without regard to
the ultimate decision
o Zapata v. Maldonado (DE)
 Facts: Plaintiff brought derivative suit without demand.
He claimed that, since all the directors participated in the acts he specified, demand
would be futile. Four years after filing, we got some new board members who were by
definition disinterested, and Zapata made them into a litigation committee to investigate and
decide what to do. Committee (in the shocker of the year) decided to dismiss the suit.
 Required them to pay a tax – difference between the original
value the stock was issued at and the price the stock is now selling. So if the price of the stock
increased, it makes sense to exercise the option.
 It was to the directors’ advantage to have them exercise the
option early.
 But the issue in this case is that the shareholder was going to
have to pay tax on the differential. - $10 in this case.
 This is a derivative suit, so where is the injury? Who was
injured? It just don’t look right that you should be giving the directors this special benefit.
The corporation was also going to get a larger deduction if the stock options had been
exercised later down the line.
 And the company doesn’t get as large a tax deduction if they exercise the stock option
early like they wanted to do than it would if they waited to the date that they were
initially allowed to exercise it
 The SEC has gone after a # of companies recently for going
after stock options.
 How is the Co. hurt if they allow the S/H to do this? – what is
the injury to the Co.? (Remember: S/H derivative suits – must show an injury to the Co.)
 2 Theories:
• One argument was that it wasn’t right –
• Co. was going to get an equivalent deduction that
was equal to the amount of tax that the people were going to get; they would
have gotten a larger deduction later
o First issue was whether the SLC has the authority to make the decision to dismiss for the company
 Yes it does and this is the same in SC
 Issues
• S/H continuing right to maintain DS after the corporation decides not to sue
• SLC’s authority to move to dismiss
• Role of court in resolving conflict bw SLC and the S/H
o Right of SH in a DS
 No right to continue with DS once demand is made and rejected
 Sohland – prior case that says the SH could continue after the demand is rejected but
NOT when the motion to dismiss is made
 SH only has right to start the law suit, not to continue it if the directors elect to dismiss
 Also Sholand had special facts in that the board voted against the suit, but helped him to
bring it
o But BJR won’t protect decision to dismiss if there is a breach of fid duty – Two contexts
 Wrongful refusal to sue
• Meaning the BJR rule applies as well as its exception
o Lack of being informed
o Fraud
 When demand would be futile – conflict of interest

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o A big issue was whether the interested directors could appoint a SLC – would it really be
independent and disinterested
 Π says it can’t be
 Court says that it can
• Someone has to act on behalf of the company and the directors are the only one
to appoint the ones that will
o However, the decision to dismiss the case is NOT tested by the BJR
 Same as last case in looking at the procedure used
 But they differ on how they look at the decision made
• Del court is going to look at the decision if the corp shows it acted
independently
o Two Part
 Corp has to show that it acted independently and disinterested – procedure
 BJR to the decision
• Informed and in good faith
• But court says the lower court may look at this and in practice, few have elected
to do so
o If there is a SLC the practical matter under either NY or Del, the Π has lost
 Rule #2: The court says if the S/H makes a demand and it was refused, the refusal will be
evaluated using the BJR!!! – page 393 – FN.
 Rule #3: A committee of disinterested directors can dismiss the suit if the committee can
establish that
• it is independent, AND
• it acted in good faith, AND
• that there was a basis for its conclusions
o Balancing Test –: “the final substantive judgment whether a particular
lawsuit should be maintained requires a balance of many factors-
ethical, commercial, promotional, public relations, employee
relations, fiscal as well as legal – we are content that such factors are
not “beyond judicial reach”
• Note: the BOP is on the Committee, not on the P, as it would be under the
normal BJR.
• The court, applying its own business judgment rule – taking
account the various justifications above, will evaluate whether it thinks the case
should be dismissed. The court in essence makes its own business judgment as to
whether or not the case should be dismissed (THIS IS A HUGE CHANGE IN
THE PHILOSOPHY OF COURTS IN THE PAST!)
• The court, however, has rarely opted to exercise its own BJR.
o 33-8-250: Committees -you can establish an independent committee
to evaluate the litigation.
 NJ Demand Rules
• Look this up on TWEN
• The New Jersey rule will apply if there is a motion to terminate or if there is a
committee and a rejection
• Burden on the corporation to demonstrate that in deciding whether to terminate
the suit: the parties were independent and disinterested, they acted in good faith with due care
in investigation of shareholder’s allegation, and that the decision was reasonable (this last step
is different)
• Demand Futile – Does not have to be made – (Aronson – DE Test)
o Claim that the majority of the directors are interested in the
transaction OR
o Create a reasonable doubt that the transactions were a valid
exercise of business judgment

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 • Demand Made & Refused:
 BOD must prove 3 things to prove that refusal of demand was appropriate.
 Independent and disinterested
 Acted in Good Faith w/due care in their investigation of S/H allegation
 BOD’s decision was reasonable.
 A special litigation committee will almost always be appointed – and they will almost make
the decision to terminate the litigation b/c it is in the best interest of the company, then above
3 prong test. is used AGAIN to evaluate the committee’s decision to dismiss the litigation
o There is a split whether plaintiffs are entitled to a jury trial for a derivative suit in the Supreme
Court. In SC, the rule is clear that this is an equitable action so there is no jury.
o Court has to approve the settlement.
o SC Demand Cases
o When you read these three cases, it is definitely implied that the court would adopt 7.01 in the right
circumstances, even though it doesn’t actually apply it in any of the above cases.
o Is claim derivative or direct? If direct, you’re home free.
o If derivative, does ALI § 7.01 apply? If yes, you’re home free.
o If no, you have to decide whether to make a demand or claim the demand is futile.
o If the P makes a demand and the D rejects the demand  P challenges D’s rejection and the test is: (a)
Delaware=BJ or (b) NJ three prong  If the D wins, (1) DE finished or (2) SC  or if the P wins the
suit continues  Zapata p 395 suggests D may move to dismiss
o If the P claims the demand is futile, the D can do nothing and the defendant moves to dismiss in which
case (1) Auerbach, (2) Zapata, or (3) New NJ test
o If the P claims the demand is futile, the D can challenge the P’s futility claim (a) DE, (b) ALI, or (c)
NY  if the P wins (the demand is futile) the D can move to dismiss and (1) Auerbach, (2) Zapata, or
(3) new NJ test
o It is almost impossible from the plaintiff’s case to win a derivative suit
o Grant v. Gosnell (SC)
 Facts: Shareholder sued bank for mismanagement. Defendants claimed that the plaintiff
didn’t make demand, and as such the court didn’t have jurisdiction.
 Issue: Do you first have to make a demand on the BOD to rectify the problem?
 SC TEST: Court said that generally you have to make demand unless you can show
sufficient reason not to do so. Can do so by showing
• The directors or managing board are themselves the wrongdoers in a
breach of trust and had control over the corporation.
 In evaluating whether or not to require a demand, the court should be lenient (the Whittle
case cuts back on this a little bit)
 In this case, because Gosnell had control of the majority of the stock, it could be
presumed that he wouldn’t respond to demand and as such no demand was necessary.
 Factual question whether demand is excusable – so case by case
• Here it was because a named ∆ owned 51% of corp. he was also on the board
o Places more importance that the named ∆ have a majority of the stock
and dismisses a requirement that the named ∆ consist of a majority of
the board
o Funny because it’s a director decision not shareholder decision to
proceed – and there was a new board (maybe court is saying they are
not disinterested, but they don’t say so)
o Carolina First Bank v. Whittle (SC)
 Facts: Bank was involved with another company. The allegations were that the bank
loaned Affinity, company, a lot of money. In exchange, Affinity gave the bank stock
options. Some time later after that all occurred, the stock options were at a point that
they could be exercised, but the bank could not itself exercise the stock options because
of federal regulations. The bank simply gave the stock options to Whittle and some
others directors of the bank as bonuses. They valued the options at $0.88 a share. At the

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 time, they were worth a lot more money and Whittle and the board knew that or should
have known that. They were really getting stock worth somewhere around $10-$12. The
board had gotten a letter saying the shares were worth very little, but Whittle had a plan
to go public, and he knew the stock would go up 20 fold. The company went public, and
the bonuses went through the roof.
 Affinity was about to go public and Whittle knew it = insider trading
 Π didn’t make demand.
 The court said that demand must identify the alleged wrongdoers, describe the factual
basis of the wrongful acts and the harm to the corporation, and the requested relief.
 SC Heightened Pleadings Rule for Demand (SCRCP 23(b)(1)
• Court rejected the P’s claim on the basis that they did not make a sufficient
demand on the BOD:
o The plaintiffs attached their demand letter, but did not refer to it
as required in the rules of civil procedure, so the court said they
didn’t plead with particularity that they had made demand.
o So b/c they did not refer to this issue in their initial complaint, they
couldn’t raise the issue on appeal – Pleadings Rule!
o This Complaint is not particular enough
 RULE – at a minimum a demand must id the alleged
wrongdoers, describe the factual basis of the wrongful acts
and the harm caused to the corporation and request remedial
relief
 If you fail to make a demand, the business judgment rule applies, same as Delaware.
 Issue #2: Can the P’s claim that failure to make a demand can be excused.
• The SC court also rejects the Delaware trap by stating that making demand
is not an admission that demand isn’t futile – So if you make a demand and
it is rejected then you can still argue a demand was not required in SC (or
that demand can be excused).
• The court applied the SC test for demand futility from the Aronson
decision:
o Claim that the majority of the directors are interested in the
transaction OR
 Ex -All of the board members are interested
 Ex - Board is controlled by Whittle
 Ex - All the board members are named as defendants
 Test: did the directors get the same improper benefit they are
complaining about
 Argument that the board was controlled by Whittle (good
argument but no particularized facts that board members were
beholden to Whittle)
o Create a reasonable doubt that the transactions were a valid
exercise of business judgment.
 The Court found the plaintiff did not plead particularized facts that would excuse
demand, so the particularized part is really strict
 The plaintiffs couldn’t show that a majority of directors were interested b/c only 3 got the
stock and there was no evidence that the remaining shareholders were beholden to
Whittle. Further, judged under the available information at the time, the transaction
looked like proper business judgment (the court makes a really strange argument about
rescinding)
 SC –
• Court will be strict in requiring particularized facts
• But if such facts are there, it will be lenient in finding demand was futile
• Aronson test will be applied in determining whether demand should be excused
(Delaware case)

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 o Whether the board was disinterested
o Whether the decision was a valid exercise of the BJ
 Π claims that the following are basis for claiming futility
• The board is not disinterested
• The board is controlled by the wrongdoer
• Almost all board members are named as ∆
• The board was responsible for the original actions complained of, which creates
a reasonable doubt as to the boards business judgment
 WRONG
 First Prong of Aronson Test
• The interest must be more then involvement in the original decision- there must
be a personal interest involved
o The Π has claimed that only two members engaged in self dealing here,
so the majority was not involved nor had self –interest
• The second allegation – the Π only made a conclusory allegation that the ∆
controlled the board – must be particular in alleging that he controlled the other
members
o This argument would have worked if they had made particularized
allegations
• Merely naming the board members as ∆ wont make demand futile if they aren’t
interested
 Second Prong of Aronson Test
• Π then says if Del law is being applied then demand is excused if they create a
reasonable doubt that the board exercised valid business judgment in making the
decision and the ∆ fails to rebuke the assertion with particularized facts
• Court says the Π failed to create a reasonable doubt – they allege that the board
was misled in making its decision by Whittle and a few others. So no
wrongdoing other than bad info – so once the information became public the
court says there is no reason to infer that they weren’t capable of rescinding the
bonus if it thought it was good business judgment
o This analysis is pretty weird because we are looking at the original
decision. There is no mention of rescission
• Davis v. Hamm (SC)
o Facts: Davis was a shareholder and Hamm was president and director.
The company had borrowed money to buy a computer and couldn’t pay the loan, so the bank
demanded the computer. Hamm gave the computer to the bank, but he had no right to take
the computer from the company. Hamm tried to defend suit from Davis in that his duty ran to
the corp. Davis brought a direct suit against Hamm because he had to sell his stock at a
loss.
o Issue – Can a former SH bring a direct suit against an officer and
director of the corporation for breach of duty owed to the corporation
 Court rejects proposition that former shareholder has standing to bring a direct suit
• This action belonged solely to the corporation
• There is some support that a direct suit can be brought by a minority shareholder
in a close held corp – but these don’t apply here because Π sold his stock
 Jacobson v. Yaschick did allow a former shareholder to maintain a suit – but there were
only two SH in that Corp
• Rule from this case – Officers and directors of a corporation must make a full
disclosure of all relevant facts when purchasing shares from a stockholder
o This is a minority rule
• This rule is inapplicable here because there was no failure to disclose and he
sold to an outsider

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  He might have been able to bring suit as a minority shareholder for oppression from the
majority – but he sold his stock and lost this standing
• We still have this statute allowing a minority shareholder to bring a direct action
against an oppressive majority holder in a close corporation
• Court said it didn’t apply because he was no longer a shareholder, but Burcky
says he is being punished for doing the responsible thing in mitigating the
damages
o Rule: Any suit for misappropriation of the corp assets or liability
for mismanagement of corp assets should be brought as a derivative suit. Rule 7.01 only
applies if the suit would have been brought as a derivative suit but 3 requirements are
met.
o Court stated that 1) the assets of the corp belong to the corp, and 2) the
liability for mismanagement belongs to the corp. In this case, any suit for misappropriation of
the computer would have to be derivative.
o P argued close corporation exception for direct suit – where a plaintiff
need not employ the form of a derivative action even though the action alleges in substance a
corporate injury:
 if there was no danger to corporate creditors
 No danger of a multiplicity of suits, and
 No danger of prejudice to other shareholder interests.
o ALI – 7.01(d) (exception)– pg 417 – In the case of a closely help corporation the court in
its discretion may treat an action raising derivative claims as a direct action, exempt it
from those restrictions, and defenses applicable only to derivative actions, and order an
individual recovery, if it finds that to do so will not:
 unfairly expose the corporation or the defendants to a
multiplicity of actions
 materially prejudice the interests of the creditors of the
corporation or
 interfere with a fair distribution of the recovery among all
interested persons
o GA’s Thomas vs. Dixon – applying 7.01 - reasons for Allowing a Direct Claim over a
Derivative Claim:
 Prevents multiplicity of suits from shareholders.
 Protects corporate creditors by putting proceeds of recovery back in the corp.
 Protects the interests of all shareholders by increasing the value of their shares instead of
letting one shareholder take all.
 Adequately compensates injured shareholder by increasing the value of his shares.
 33-14-300: a shareholder who can allege and prove oppressive conduct; court responds
saying his claim is not valid because he is no longer a current shareholder
 SC may allow direct over derivative when none of those factors are present
 SC upholds this ALI test- stated in the GA Thomas v. Dixon Case.
 SC 33-8-300 – Directors fiduciary duty runs to corp & S/Hs!!!
 THERE is also a statute in SC that directors owe a fid duty to both the company and the
shareholder
• Doesn’t apply because she is no longer a shareholder
 Holding: Ct says that a director has a fiduciary duty to the corporation and the
shareholders. Davis would have been allowed to bring this as a direct suit for
misappropriation of corp assets under the close corp exception if he had not sold his
shares.
• Burkhard thinks this was BS and is dead wrong!
• One of the first cases to acknowledge there would be a close corporation
exception.
o Babb v. Rothrock (SC)

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  Facts here are irrelevant – squabble amongst the
shareholders. Shareholders tried to argue for the right to sue directly for misappropriation of
corporate assets. Relied upon a GA case which allowed a direct suit if certain criteria
were met.
 Holding: Court rejects the 7.01 claim – says you haven’t
met the requirements for the exception.
• Unlike in Thomas this case involves the protection
of corporate creditors (a reason compelling derivative action), by allowing the
individual s/h to bring claims it could jeopardize the corp.’s creditor’s claims.
 Π argues that ∆’s cant assert the claim for a setoff because it involved corporate property
and is therefore the corporation’s suit
• Court agrees, they should have brought a derivative suit
 ∆ cite Thomas v. Dixon – a Ga case where SH were allowed to bring a direct suit against
a director where the reason for requiring a DS were absent
• Court says the facts are different here because there is an interest to protect
corporate creditors
o They have priority over shareholders, so it would be detrimental to the
creditor to allow a SH to bring a direct suit to satisfy their personal
debts by asserting a claim that belongs to the corporation
• Brown v. Stewart (SC)
 Brown bought 20% of mid Atlantic. As it turned out, the other shareholders used the cash
he paid for his share to cash out their own investments in the corp (fraudulent
representations). Value of corp went way down. Sued for breach of fiduciary duty and
Brown tried to argue that he should have a direct claim – that the duty should run to him,
not the corporation.
o Allegation
 Two Basic Claims
• Fraudulent Stock Sales ( you told me my money was being used for
one thing, but it was used for something else)
o Direct claim
• Mishandling of sale (breach of fid duty)
o Derivative
 ∆ told Π they had each invested 25K when in fact they had characterized their
funds as loans- they then used his investment to repay these loans with an interest of
16%. They had told him it would be used to buy equipment and hire people
 Also made misreps about the state of the company
 Also alleges breach of fid duty in negotiating a sale that was favorable to them
and unfavorable to the Π
o ∆ claims defenses for fraudulent stock sales
 They had no confidential relationship with Π to justify his reliance on their
statements and that they didn’t misrepresent anything
 Also that Πs loss is his own fault in failure to exercise due diligence
 Court concludes there were issues of fact that should go to trial
o The fraudulent stock sale is a direct claim (even though he didn’t win, the fraudulent
stock sale claim is a potential winner)
 Did he have a right to rely – jury issue
• He didn’t have a right to rely and he should have
used due diligence and his failure to do that wipes out any fraud claim he might
have had.
 Did he have a breach claim?
• Basic Defense against this claim: standing- should
have been a derivative claim – basic derivative suit

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 o P says they have a way to get around it - can
argue the 7.01 exception.
 Rule: Breach of duty of loyalty runs to the corporation. To
get an individual action as a stockholder, your loss has to be separate and distinct from
that of the corporation, which can only happen in this case if the fiduciary duty runs to
the shareholder.
• The court stated the Thomas factors in Davis, but
declined to apply them b/c the injury to Brown was the same injury the corp had
incurred (not separate and distinct). Brown didn’t join the other stockholders (he
originally joined them but then he dismissed them; this was a silly mistake)
 Burkhard said that he could have also argued corporate
opportunity. They started another company and excluded the plaintiff from that
company. Burkhard says this behavior is more egregious than what is being argued in
the case itself.
Right to Jury Trial
• In SC you don’t get one because the derivative suit arises from equity
• Federal Court – if the COA that you are asserting on behalf of the company would entitle you to a jury trial
(ie being an action in law) then you get one
Court Approval of Settlement or Dismissal
• Because it is a representative action, the court must give approval it like it would for a class action
Recovery in Derivative Suits
• The corporation recovers, but the shareholder is allowed to recover costs and fees
o Recovery in derivative suits
o Generally, the corporation gets the recovery
o The successful plaintiff gets costs and attorneys fees
o There is also a res judicata effect of the suit if the corporation wins
o Who really pays with regards to these
o Directors seek to protect themselves
o Statutes allow them to limit liability except for
o Intentional or reckless or gross negligence (in SC)
o but these only cover claims brought by the shareholder or company
 and don’t cover breach of loyalty
 Insurance
• All publicly traded companies have director insurance
• it is rare for small SC corps to have director insurance
 Indemnity
• Directors do not have a common law right to indemnification because the
director isn’t the agent of the company. So it has to come from statutes, bylaws and
articles, and K
o Rest 2nd – Exceptions to CL director’s right to indemnification: If
Director’s actions
 Illegal, OR
 Not to the benefit of their employer, OR
 Negligent
o Rest 3rd of Agency–814 - Agents of the corporation are entitled to
indemnification
 Principal has the right to indemnify an agent in accordance
with the terms of the contracts, when an agent suffers a loss that should be
borne by the principal under the circumstances
o 33-8-500(5)
 Distinction in capacity – was it in his official capacity or was he working for someone
else at the time?
• 33-8-510: Authority to indemnify

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 o May indemnify if director (pre-conditions to getting the Cash)
 Conducted himself in good faith
 Reasonably believed that his conduct was in the best
interest of the home company
 In the case of a criminal proceeding, he had no reason to
believe the conduct was unlawful.
o Rule: A guilty plea or a finding of liability do not preclude
indemnification – as long as the 3 requirements above are met –
o May not indemnify if
 Director is liable to the corporation
 Director gained an improper benefit from the transaction
• 33-8-520 – Mandatory Indemnification
o If a Director is found not liable (wholly successful on the merits or
otherwise) he has the right to recover reasonable atty’s fees
o This is still true even if he or she prevailed on a technicality such as a
SOL.
• 33-8-530 – Advance to Expenses:
o Normally a corp can loan fees to its directors to defend, although this is
not allowed under Sarbanes Oxley.
 The corporation may advance the director expense of the litigation if
• Written affirmation of his good faith
• Written underpayment in to repay the company if he looses
• A determination that the facts are such that he wouldn’t be denied
indemnification
• 33-8-540 –Court Ordered Indemnification - court can order indemnification
in some situations.
• 33-8-550 – Determination and Authorization of Indemnification: Board has
to determine if indemnification must be made, but they have to make the determination if
the person is entitled to money and if they are entitled whether or not the payment can
be made.
 Asking the company to indemnify
 Company cant do it unless
• Determination that director is qualified to be indemnified – by the board
• Authorization- that the amount is reasonable – got to make sure there is enough
money to pay
• 33-8-560 – Indemnification of Officers, Employees and Agents: an officer
who isn’t a director is entitled to indemnification.
• 33-8-570 –Insurance: You can buy director insurance and it can be broader
than the insurance provided for by statute
• 33-8-580 –Application of Article: cannot change the scope of the statute in
your articles.
o If the AI’s limit indemnification or advance for expenses, it is only
valid to the extent it is consistent with the articles.
o 33-44-403 Indemnification for LLC
o Members SHALL be indemnified for liabilities incurred in the ordinary course of business
o It is possible to opt out of this requirement
Questions 405
o 1) she may be indemnified in both
o 2.1 – maybe but not likely
o 2.2 Always put indemnification provisions in the articles
Insurance
o Corporations can buy liability insurance for their directors and officers (D/O insurance)
o Most close held corps don’t have this

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 o Claims don’t come up
o Its to expensive
o 411 – Question 3: Our statute says in this case they are not allowed to pay (510)
o D&O - Insurance – Most states have provisions authorizing corporations to purchase and maintain
liability insurance to cover their directors. For closely held businesses insurance is probably
unavailable at economic cost. B/C there is no question as to whether or not a corp can purchase this
insurance if they are willing to pay a premium.
o Corp. Consideration in Purchasing D&O Insurance:
o Business questions such as whether to buy D&O Insurance and if so what kind
o Contract law questions such as what is covered by the policy and who makes what decisions
with respect to litigating and settling claims.
o How does a corporation grow?
o To Grow, a corporation can
o Borrow Money
 Lenders like borrowers with unencumbered assets that can be used as collateral for the loan
 Covenants – used by lenders to require financial and operational commitments until the loan is
repaid – ex- limits on distributions
 Default is defined by the parties – so it could reached if the assets reach a certain level
o Sell interests in the corporation
o Use Earnings
o Borrowing
 Businesses often prefer debt over equity
 Adv of Debt
• Allows for leverage
• Less risky than equity
• Costs less to co.
• Interest pmts are deductible
• Loan payments get paid first
• Debt doesn’t usually vote
• SC, we allow for voting debt
 Equity Adv
• Lenders only lend amt they are sure will get paid back
• fear of bankruptcy – too much debt in low cash flow yrs
• Reduces risk in capital structure by lowering amt of debt and the fixed costs
associated with debt.
Debt v. Equity
o Equity holders get higher return than creditors because they take a bigger risk
o They are not guaranteed to be paid back
o Have no collateral
o Creditors get paid first
o So you pay less for debt, and you get a tax discount – so there is big incentive to use debt financing
o But bankers will only give you so much, and debt has a greater risk of bankruptcy
o Issuing more stock
o Dilution – if stock is issued so that the percentage of ownership changes, your interest is diluted if you
own a smaller percent
o Preemptive rights – if you have this, then you have the right to purchase the number of shares of any
new issuance of shares that will enable you to maintain your percentage of ownership
o Hypo
o Close held corp- SH A, B, C
 Each owns 10 shares, so each can elect 1 of the 3 directors
 If A and B decide to gang up on C, they might cause more shares to be issued and have
them issued to themselves or to a TP

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 • The would then be able to outvote C and get him out the picture
• So ability to issue more shares is very important
o Now we have 5 SH
 Each puts in 200 per share
 Then sell more at only 100 per share
 The old guyes shares become less valuable – so
o So preemptive rights can be used to prevent diluting control and to prevent sell of shares at
such a low price as to dilute the equity value of the shares of the prior SH
o Preemptive Rights and Other Rights of Existing Shareholders
o Byelick v. Vivadelli (VA)
 Defendant held 90% of the outstanding stock, made a vote to eliminate shareholder
preemptive rights, and then issued 50,000 shares, which he bought, reducing the control
of the plaintiff from 10% to 1%. There is a question as to whether these 50,000 shares
were originally authorized in the AI’s or whether the shares had to be additionally
authorized by an Amendment to the AI. If there needed to be an amendment to the AI’s
to issue more shares, whether the Minority shareholder would have had enough voting
power to stop something from happening that will injure them down the road.
 Π owned 10% and ∆ owned 90%
• ∆ changed bylaws to do away with preemptive rights
• Issued more stock so Π only had 1%
o If these shares were not already authorized, then they would have had
to change the articles
 If so, there is a chance that the Π could have vetoed this – SC
would allow him to do so unless 2/3 voted to amend
 Π claims ∆ breached fid duty to him as a shareholder
• Close held exception applies here
o Including fid duty to minority shareholders
o Similar to SC in calling for duty to both the company and the
shareholders
• Says Π had right to sue individually because shareholders in close corporations
are similar in relation to partners
o Cites Donahue case that says a close held corp should be treated more
like a partnership than a corporation
• Applies ALI 7.01
• BUT this might be able to be a direct suit regardless – the argument is that they
have reduced the Π’s voting power and that you haven’t hurt the company
o The counter is that the value of the company was diluted and so the
company was injured
 But counter to this is that the shares have devalued and not the
company so the individual shareholders can sue directly
 Issue #1: Do the Directors owe a parallel fiduciary duty to shareholders as well as
the Corp?
 Holding: The court stated that the Defendant owed a fiduciary duty to the plaintiff, and
the dilution of the shares implicated that duty.
 VA Rule: Under VA law the directors owe a fiduciary duty, not only to the Corp, BUT
ALSO to the shareholders!!!
• SC Rule equivalent to Davis Case
 Issue: Was it ok to bring this suit as a Direct Suit rather than a Derivative Suit?
• Notions why a Derivative Suit would be appropriate- Injury to the Co – they
wanted a price less than the fair market value.
o If bought at a price less than the FMV is there an injury? – No b/c the
corp bought at a price less than the FMV.

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  Holding: Direct Suit is OK - 701(d) – Exception for Close Corporations- when a ct
may treat an action raising from a derivative claim as a direct claim Even though
this is a federal case, VA would recognize and apply 701(d).
o No indication of injury to creditors by virtue of successful
challenge to the issuance of stock
o no risk of multiple lawsuits b/c only 2 shareholders
 Issue #3: D alleges that P is only asserting a pre-emptive right in this case and that VA
laws allow Dir to remove this right.
 Holding: Court says NO – there was a general breach of fiduciary duty claim in this case,
not just a claim about pre-emptive rights
 the preemptive statute does not relieve the ∆ of his fid duty to the shareholders
• Even if there are no preemptive rights, there is a still a fid duty in the issuance of
shares- issuance at favorable prices to directors (but excluding other
shareholders) or the issuance of shares on a non-proportional basis for the
purpose of affecting control rather than raising capital may violate that duty
 VA Rule - BOP on the D to show – no benefit of the BJR
• the board’s consent to the issuance was fair to the corporation and
• the sale itself was fair
 If the Corp was able to show this was fair, then no breach of fiduciary duty.
 MAIN RULE OF CASE: dilution of shares without via removing a S/H to
preemptive rights is a breach of directors duty.
o 33-6-300: Shareholder’s preemptive rights
 Shareholders automatically have preemptive rights unless the articles say otherwise.
(opposite of the MBCA)
 If there is no express statement that there are no preemptive rights in the articles
• shareholders have preemptive rights to get proportional amounts of shares
issued by directors
• shareholder can waive the right
• No preemptive right if the shares you’re holding are:
o Issued as compensation (stock options)
o Issued to satisfy conversion or option rights
o Shares issued within 6 months of incorporation (1st person to buy
would then have the right to keep buying all of the stock, but we would
allow the Co. to be able to sell the shares to a whole group of people).
o Shares sold for something other than money.
• (d) – IMP. - dilution of shares without regard to preemptive rights is a breach of
directors duty. Codifies the result in the Vivadelli case!!!!!
• Burky says soon will be changed to apply only to close held corporations
o Venture Capitalists
 Venture capitalists are looking at 4 things before they invest:
• Downside protection – such as liquidation preference
• Upside opportunities
• Voting and veto rights
• Exit opportunities
 One of the real concerns today is whether or not these types of firms will invest in LLCs.
 VC’s will do this through private placements –an exempt transaction.
 One third of venture capitalist companies wind up in bankruptcy. Consequently, venture
capitalists demand high returns because the successful one-third of their investments
must cover the losses generated by the other two-thirds.
 Venture capitalists demand protective covenants.
o Going Public
 Why go public
• Cheapest source of a lot of capital

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 • The folks on the inside use it as a way to make a lot of money. It is a way for
the folks who start the business to convert their investment into cash.
• Should attempt to raise at least two years of operating capital – maybe more
depending on how long it will take to make a profit
 Why not?
• Expensive:
o It costs hundreds of thousands of dollars to go public – the stock is not
priced until after all the hundreds of thousands of dollars are spent.
o Sarbanes-Oxley makes it much more expensive to be a public
corporation
 How to go public
• You hire an investment banker who goes out and shops your stock for you.
• 2 methods to go public:
o Best Efforts – the IB will give their best efforts to sell the stock at a
specified price – new companies…most are best efforts
o Firm commitment – the IB buys all of the stock – usually at a
discount – and they take the downside risk – big companies with a
track record are usually firm commitments
• Where does the $ go after the offering?
o To the Co.
o To the existing S/H
o If venture capitalists were involved with the offering from the
beginning, some of the $ goes to buy them out.
o New shareholders benefit more if their money went into the company,
where it could be invested on their behalf to generate earnings, rather
than merely go to the old shareholders to make them rich
 How Much $?
• Fear vs. Greed
o Greed- the more you raise, the more ownership you give up, which
gives incentive to raise as little as is needed to grow
o Fear – go after as much as you can because if the Intial Public Offering
goes bad, you might not get a second chance
o This balance normally results in raising enough for 2 years- burcky
doesn’t agree
 Market value – price of shares x number of outstanding shares
 But if you haven’t gone public yet, your valuation is harder to calculate and depends on
future earnings, not past ones – so its got a little art to it
 Then you figure our your current value – often by comparing yourself to similar publicly
traded corps
 Ie if McDonalds sells for 20 times it past earnings. Then Bubba’s should sell for 20 times
it expected future earnings
• Then divide that number by shares outsanding = value per share
• So if Buba’s expected value is 10 Million – then the current value is 200million
(10 x 20).
• If it has issued 8 million shares to its founders, then the value per share =
$25/share
o This is the price it will sell new shares for
• If the company wants to raise 30 Million, then it needs to issu 1.2 million (30 /
25 = 1.2)
Public Offering
o Involves a registration process and a marketing program

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 o Underwriter – normally an investment bank that manages the process of drawing up the offering
memo that is filed with the SEC. it is responsible for structuring the offering, pricing the securities amd
maintaining a market for the securities after the offering
o The underwriter and the corporation officers go on a road show to do some marketing
o The offering price is set the night before it goes public because the market changes so fast
o Got to watch out for tricky underwriters that might undervalue the price so as to pass savings onto
clients
o Where does the money come from
o Underwriter activities are conduct one either a firm commitment or a best efforts basis
 Firm commitment – the money comes from the underwriter
• It buys all the shares that are being offered and then resells them
 Best Efforts underwriting
• Money comes from the public
• The underwriter helps with the marketing
• Most new companies only get this one
o Where does the money go
o Underwriters and attys take a large amount
o If they are new shares, the corporation gets the money
o If the founders are selling their own shares, then they get the money
 If a VC is selling, then its no big deal
 But if the CEO is selling then it is viewed disfavorably
o Costs continue after the offering
o Legal Constraints on issuing stock
• Registration requirements for public offerings
o SEC – Federal Requirements
 Securities Act of 1933 requires
• The Securities Act generally requires companies to
give investors “full disclosure” of all “material facts,” the facts investors would
find important in making an investment decision.
• Prospectus (this is the offering document)
o Preliminary
o Final
o The prospectus must be delivered to all
offerees- all people who might buy your stock (probably not enforced)
o Prospectus May Include:
 Description of business,
 What property you own,
 Competition
 Info regarding officers and
directors and their compensation,
 Material transactions involved with
your directors,
 Who the co. is selling securities to
 Legal proceedings involving
company and its officers or directors
 Where the $ is going to go
 What the risk is in investing in this
company
 The SEC does not evaluate the merits of offerings, or
determine if the securities offered are “good” investments. The SEC staff reviews
registration statements and declares them effective if companies satisfy disclosure rules.

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  However, if something doesn’t seem right, they can require
the company to make disclosures that would likely make it impossible to sell your stock.
Practically make you tell the world that you are stealing.
 The SEC’s job is to review all documents to make sure that
the corporation has made full disclosure of all factors an investor would want to
look at – “The SEC staff reviews registration statements and declares them
“effective” if companies satisfy disclosure rules. The key date is the “effective date.”
This is when you can start selling.
 Registration Rule: Basic deal is if you’re not subject to an
exemption, and you sell a security without registering, your sale is unlawful
 Registration Rule: Even if the co. does fall under an
exemption, you are still subject to the anti-fraud provisions.
 If you are a public co. and therefore have a “federally
covered” security, then you are usually not required to register with the states – SC USA.
 In addition to federal registration requirements, there are
also SC registration requirements.
Common Law Fraud and Misrep and Rule 10b-5 Constraints on Any Stock Issuance
• If you are exempt from registration, you are sill subject to CL fraud and Misrep
o An investor can bring K claim of misrep to rescind her K to buy stock
o Or bring a tort claim of fraud for damages
• 10b-5 covers all securities (there are no exemptions) and applies an antifraud rule
o Comes from 1934 act
• 10b-5
o Unlawful for any person directly or indirectly by use IC, mail or facilities of a national securities
exchange (or anything related to it)
 To defraud
 To make any untrue statement of material fact or omit to state a material fact necessary
in order to make the statement made in the light of the circumstances under which they
were made, not misleading
 Engage in any business that would operate as a fraud or deceit upon any person in
connection with the purchase or sale of any stock
o Most of the law around this rule deals with resale of stock or corporate combinations such as
mergers rather than at the initial sale
o Majors v. SEC (SC 2007)
 People in MB were selling tax lien certificates. Two issues: claimed they were selling
unregistered securities and they were engaging in securities fraud. Mark Knight found they were
selling unregistered securities but they were not engaging in securities fraud.
 Once a tax lien is filed on the property, the owner usually has a 1-3 year period to pay the
taxes that are due as well as the interest and penalties. If the taxpayer doesn’t pay within that time
period his or her taxes, the property is either foreclosed and bought by the government or the holder of
the tax lien now owns the property. The government sometimes sells the tax lien for the cost of the
taxes and some of the interest that’s due. Within a three year period, the homeowner will pay off the
debt to the owner of the tax lien certificate. The problem is that sometimes the homeowner will elect
not to pay the taxes and then the tax lien holder owns the house. In this case, the company, TLA,
makes the deal that if that happens the tax lien holder owns half of the house and TLA owns half of the
house.
 The way you can lose on this is if the taxes were worth more than the value of the
property.
o Π is president and sole shareholder of TLA, a SC corp
o TLA is a purchasing agent of tax liens for its Principles
o For each one it buys on the principals behalf TLA gets a cashiers check made payable to the
County Treasure for Tax Liens
o Complicated process. If the lien is redeemed, the Principle keeps all the monies. But if not, TLA
get 50% ownership

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  So basically the principles invest money that TLA uses to by title lien certificates (TLC)
these were all over the country.
o If the Principle sells any of the liens, TLA gets first right of refusal
o TLC
 Tax payer defaults
 State puts lien on the property and the owner has 2-3 years to pay it off plus penalties and
interest
 If he doesn’t pay it off, then the property is either foreclosed by the government and sold,
or the holder of the tax lien owns the property
 People normally cant pay these liens off, so the county wants money and will sell the tax
lien to people, and TLA assists in those sales
• You pay the county the taxes plus interest- put it will be a lower amt then the
taxpayer owes
• Then the tax payer has to pay you the full amount what he would have owned
anyways – so you make money on the difference of what you paid
 But sometimes the taxpayer doesn’t pay, and then you own the property – if this
occurred, TLA says it owns 50% of the property, and then you can sell the property
 You can loose out if the taxes are worth more than the property
o SC Sec Commission saw this as an investment K, and thus a security that has to be measured
 The other way this could be a security is that it is a profit sharing agreement – the opinion
doesn’t talk about this much
 Side note – 33-1-102(29) if freaking broad – any note!
o The ∆ alleges that Π is selling unregistered securities and engaging in securities fraud
o Gave Π a notice of a right of hearing
o The hearing officer found that Π was selling securities because all the K’s it had with its many
principals were investment contracts
o Major Issue – was Π’s investment opportunity a security
 The court held that the sale of tax lien certificates is a sale of securities that requires
registration in SC.
o First sub issue
o Commission did have authority to issue a cease and desist order under § 35-1-60
o Second sub
o Violation of DP because Commission had already issued the order before giving a hearing and had
thus developed an interest in winning
o WRONG – there was no violation of DP
o The Hearing Officer had no direct involvement in the case even if the Commission did
 DP is only violated when the admin officer who is involved in the investigation is also
involved in the adjudication
o So its ok that it issued the first order and then investigated because a non involved member was
later appointed
o Security
o If it is a security, it must be registered or exempt
o Defined as any certificate of interest or participation in any investment K or, in general and any
interest or instrument commonly known as a security
o Also includes any profit-sharing agreement
 Possibility #1 is that this is an investment contract. Under the Howey test, an investment
contract exists where there has been (i) an investment of money, (ii) in a common enterprise, (iii) with
an expectation of profits garnered solely from the efforts of others.
• There was an investment of money in this transaction. People are buying these
certificates with cash.
• The three things that might be a common enterprise are vertical or horizontal
commonality or both. Vertical might be divided into two parts.

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 o An example of horizontal commonality is if you used several different
investors to purchase one TLC. Horizontal commonality is the pooling of investor
funds and interests.
o As a general guide, vertical commonality requires only a pooling of the
interests of the developer or promoter and each individual investor, while "horizontal
commonality" requires as well a pooling of interests among the investors. Vertical
commonality is the dependence of the investors' fortunes on the success or expertise
of the promoter. The courts have further identified two kinds of vertical
commonality: broad vertical commonality and strict vertical commonality. To
establish "broad vertical commonality," the fortunes of the investors need be linked
only to the efforts of the promoter. "Strict vertical commonality" requires the
fortunes of investors be tied to the fortunes of the promoter.
o Every state will accept horizontal commonality. The language in the
opinion signals that is true.
o The question is what kind of vertical commonality would work if
anything? The court says that since this case was tried the legislature has amended
the statute and has spoken as to the issue. They look at § 35-1-102(29)(D): “a
common enterprise means an enterprise in which the fortunes of the investor are
interwoven with those of either the person offering the investment, a third party, or
other investors.” Thus, the court adopts strict vertical commonality as the test.
• Π claims Commission erred in applying a strict vertical commonality test –
wrong
o Horizontal commonality is not here because the Π had individual K and
investments with each principal that resulted in one title lien certificate
for each investor.
 To have horizontal commonality, he would have had to have
pooled the investors money to purchase the TLC
• Courts have struggled whether a vertical or horizontal commonality is needed or
both
• Vertical – pooling of the interests of the developer and each individual investor
• Horizontal – also requires pooling among the investors – ie investor uses funds
from several investors to buy one security
• There are two kinds of Vertical
o Broad- fortunes of investors need be linked only to the efforts of the
promoter – where investor provides the money and the broker invests it
o Strict- requires the fortunes of investors be tied to the fortunes of the
promoter – ex- when there is profit sharing between the two ( so are
you linked with their work or with their profit)
• Strict is adopted, so because this exists under the current facts, there is a
common enterprise – 33-1-102(29)(D) – spells out that we apply strict vertical
commonality and we also allow horizontal commonality – so both
• The third part of the Howey test is the efforts of others. Do the others have to
do everything and I do nothing? The courts have said that is not what is required. You as the
investor can have some involvement in the transaction and that doesn’t defeat it from being a
security. Investment contracts may be found where the investor has duties that are nominal
and insignificant or where the investor lacks any real control over the operation of the
enterprise. The key determination is whether the promoters' efforts, not that of the investors,
form the "essential managerial efforts which affect the failure or success of the enterprise.
 Π asserted that the principals had a say in the TLCs and therefore were not solely
dependant on the efforts of others
 BUT This is a relaxed prong
 As long as the Πs efforts form the essential managerial efforts which affect the failure or
success of the enterprise – which they did here

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  The key determination is whether the promoter’s efforts not that of the investors form the
essential managerial efforts which affect the failure or success of the enterprise
• They failed to register with the state of SC. That is what they did not do
correctly.
• You have to go through the same three steps for interests in a limited
partnership, a limited liability corporation, and maybe a general partnership. Almost every
limited partnership interest will be a security. For an LLC, you need to know if it is a member
run LLC (if member run the third element might not exist under the Howey test) or a manager
run LLC. See § 35-1-102(29)(E).
• Howey Test is applied to LLC and limited liability partnerships and probably
general partnerships if one doesn’t act as a manger
• For the LLC you must look to see if all the members are running it – if so, then
its not a security – ie efforts of others
• If you set up a professional corporation for five doctors and they each invest
money in their own professional practice and they are going to set it up as a PC and each
doctor will receive from that PC shares of stock in the professional corporation. Do the shares
have to be registered with the SEC and SC? The answer is yes unless there’s an exemption.
So, what I am usually doing is asking if there is an exemption at the state and federal level.
 Possibility #2 is that his is a profit-sharing agreement (this disappears from the opinion,
but Burkhard thinks it is important b/c of the definition below)
 § 35-1-102: a security means any note; stock, treasure stock, security future, bond,
debenture, evidence of indebtedness, certificate of interest in a profit-sharing agreement, collateral
trust certificate…investment contract, etc.
 Burkhard thinks the court could have also said this was a certificate of interest in a profit-
sharing agreement
 Look up article on security exemptions and a table on Reg D on Westlaw and look
at the securities problem and read leventis case
o Chapter 35 - SC Securities Registration Requirements
 35-1-20(15) defines a “security”
• Note, stock, bond…INVESTMENT CONTRACT
• Investment contract brings business relationships like
partnership interest into the area of securities
• Interest in an LLC
o If member run, not a security
o If manager run, the interest is a security
 35-1-810: Registration of SC Securities
• Must be registered in SC to sell a SC security unless
it is federally registered
o Common exceptions to federal registration requirements – PLI
Article
 § 4(2): Private placement exception - provides an
exemption for transactions "by an issuer not involving any public offering."
• Ralston Purina – co. wanted to allow their
employees to buy stock at a discounted price/bargain price.
• This case is still sort of the gospel even thought it’s
really old
• Issue: was this offering public – Supreme Ct says
that this offering does not qualify as an exemption under 4(2).
• In order to come within Section 4(2):
Qualifications of a Private Placement:
o Must look at everyone who is an offeree, not
just purchasers

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 o Offeree qualification – each offeree must
be sophisticated investors
o Availability of information –must have
access to the same type of information that would have been made if the offering
been public; doesn’t necessarily have to be called a prospectus or have all the exact
same information as long as the same type of information is provided
o Manner of offering -
o Absence of redistribution
• Lawyer Tip: Try to structure your deal such that
your offering has another exemption, with 4(2) being your last safety net!!! Never rely on
4(2)!
 Reg D Exemptions –See Chart
• Note that all regulation D registrations require notice
of sale to be filed with commission within 15 days of first sale.
• If you qualify under Reg D, you are NOT deemed to
be a Fed Covered Security, still have to meet state requirements
• Rule 504 -See Chart!!!
o Amount: Limited to $1M in a 12 mo
period
o Eligible issuers:
 No Exchange Act or “Blank
Check”
 Not available to development
stage corps with no business plan
 No large publicly traded corps
 No investment companies
• Rule 505- SEE Chart
o Amount: Limited to $5M in a 12 mo
period
o Eligible issuers: No issuers involved in past
securities wrongdoings
o # Offeree restrictions:
 Unlimited accredited
 Not more than 35 non-accredited
o Registration requirements:
 If purchased only by accredited:
none
 If purchased by non-accredited: see
List on sheet.
• Rule 506 (this is the 4(2) safe harbor)
o Amount: No Limit
o Eligible issuers: None.
o Offeree restrictions:
 Unlimited accredited
 Not more than 35 unaccredited
 Investor Qualifications: sophisticated
 All unaccredited investors must be
qualified by having financial knowledge such that he can evaluate
risks/benefits
• Rule 501(a) - Accredited Investors. (8 categories of
potential investors who will be deemed to be "accredited" for purposes of Rule 505 and 506
offerings)
o certain types of financial institutions,

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 o any entity with total assets in excess of $5
million,
o directors, executive officers or partners of
the issuer (this is the troubling one- a lawyer may try to end run the regulation
process by saying all the buyers or offerees will become partners or executive
officers- that may get them in trouble),
o Persons whose net worth (or joint net worth)
exceeds $1 million,
o Persons whose individual income or joint
income with spouse for each of the past two years exceeds $200,000 and $300,000,
respectively, and is expected to exceed that amount in the current year.
 § 4(6) exemptions
• Eligible issuers: no restrictions
• Amount: no more than $5M
• Offeree restrictions: accredited investors
• Method restrictions: no general solicitation
• Must file some notice with the SEC
 Regulation A offerings
• Limited to no more than $5M in a 12 month period
• Number of offerees: no limit
• Resale restrictions: none
• Must be non-publicly traded US or Canadian
company
• No securities may be sold before the actual
registration
• Registration requirements: must make a mini-
registration to SEC with offering statement
• Must include offering circular to offerees
 Rule 147 - Intrastate Offering – page D18
• The exemption was intended to apply only to issues
genuinely local in character, which in reality represent local financing by local industries,
carried out through local investment.
• Persons claiming the availability of the rule have the
burden of proving they have satisfied all of its provisions.
• Eligible issuers (must meet all):
 Company must be resident of same state as offerees (see D20 for more specific
requirements)
 Issuer must derive 80% of gross revenues from operations in the state
 At least 80% of issuers assets must be located within the state
 At least 80% of proceeds from offering must be used within the state
 The principal office of the issuer is located in the state
• $ amount: no limit
• Offeree Requirements: All offerees must reside in
the same state as the issuing company
o corps: residence = principal office,
individuals, residence = principal residence)
o Ex - principle office must be in SC.
o Must obtain a written representation from
each purchaser as to his residence
• Manner of offering: no restriction as long as offer
is only made to residents of the state; however an inadvertent bad offer can spoil the
deal

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 • Resale Restrictions: May not be resold for 9 months
except to resident of same state
• Registration requirements: None
o SC Registration exemptions – SC USA
 Must meet federal and state exemptions
Official Cmts to 35-1-102
o Reread them – explains the Howey test in Majors.
o Risk capital test – there is a security when an investment is subject to the risks of an enterprise with the
expectation of profit or other valuable benefit and the investor has no direct control over the
management of the enterprise
o You can be a seller of securities without being the owner if you solicit a purchase and are motivated in
part by the desire to serve your own financial interest or the interest of the seller – Pinter v. Dahl
o SC is guided in defining the term security by federal cases interpreting the 33 Act
o Look at economic reality, not the form of the security
 2 Types of Exemptions in SC:
• 31-1-201 – Exempt Securities
• 31-1-202 – Exempt Transactions
o (13): may sell to an institutional investor or a federal covered
investment adviser
o (14): no more than 25 purchasers over 12 months, no general
solicitation or advertisement, no commission to anyone other than the broker-dealer,
and the issuer reasonably believes that all the purchasers are purchasing for
investment
 Sell or offer to sell to
• An institutional investor
• A federal covered investment advisor
• Any other person exempted by rule adopted or order issued under this chapter
 A sale or an offer to sell secured by or on behalf of an issuer, if the transaction is part of a
single issue in which
• Not more than 25 purchasers are in SC during a 12 month consecutive period
other than specified by the above bullet
• A general solicitation or general advertising is not made in connection with the
offer to sell or sale of the securities
• A commission or other remuneration is not paid or given directly or indirectly to
a person other that a broker-dealer registered under this chapter or an agent
registered under this chapter for soliciting a prospective purchaser in this State,
AND
• the issuer reasonably believes that all the purchasers in this State other than
those in paragraph 13 are purchasing for investment
 35-1-320: Exempt Transactions
• 1-8 - not important
• 9 – Limited offerings
o Must meet residency requirements of
Rule 147(c) – intrastate company and offerees
o Offered to no more than 25 people
 Important: the commissioner can
modify this exemption
 Commissioner has narrowed this to
less than 10 purchasers (see below), no solicitation, no commissions
paid
• 10 – Limited pre-organization subscriptions
o Exempt if there are less than 25 subscribers

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 o There is no remuneration paid for soliciting
a subscriber
o No subscriber makes a payment prior to
filing articles of incorporation
o Note: this section being eliminated in the
revised statute
 Commissioner Rule - 113-22
• Narrows 35-1-320(9) – limited offerings- so that
you are exempt if there are less than 10 purchasers
• No solicitation: You can’t have general solicitation
or advertising
• no commissions/renumerations: The person doing
the soliciting can’t receive a commission
 Commissioner Rule 113-21
• You still have to file with the state commissioner
Integration
• two or more issues can be integrated and potentially destroy the exemption
• Two tests
o 6 month buffer before and after the offer or sell during which no other issue can
be distributed if integration is to be automatically avoided
o If a second issue does occur in this 6 month buffer, then we look at the
following factors
 Are the offering part of a single plan of financing
 Do the offerings involve issuance of the same class of securities
 Are the offerings made at or about the same time
 Is the same type of consideration to be received and
 Are the offerings made for the same general purpose
Shrimp Boat Problem
Is he exempt under Fed Regs
• Reg D
o Does it comply 504 –
 Problem with the advertising
 Advisable filing requirement to the SEC of the prosepectus and he
doesn’t want to file anything
o So NO
• 4(6) – accredited investors
o No – the advertisement
• R 147
o No prohibition on ads
o May not because the advertising will go outside of SC – but you can get around
it by saying offers only good to SC residents
o But one issue is that Offers can only be made to SC residents as well – so when
talking with people, you got to make sure they all live here
o Make sure you disclose enough to avoid fraud
o Yes, you can pay broker commissions
o No filing required
o Does it comply with part C of this rule
 Nope if the boat goes into international waters or Ga waters (would
have to stay in SC waters for the exemption to work)
• So you try and rely on 4(2)
o But it’s a crap shoot and you need to know a lot about the offerees
o Cowburn v. Leventis (SC)

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  Facts: Cash for title program. Ponzi scheme - $ contributed by
later investors generates artificially high dividends for the original investors, which in turn attracts
larger investments. Cowburn sued the lawyer for securities violations. Plaintiff believes Leventis is
liable because he is selling unregistered securities (as an unlicensed broker). Notes are considered
“Securities” under the SC USA. Cowburn also raises a Breach of Fiduciary Duty Claim Against
Leventis in this case.
o The Program, as it was described to Cowburn, engaged in the business of issuing short-term, high
interest rate notes and bonds for the purpose of funding the automobile title lending industry
o ∆ atty talked him into it
 He set up an account at Fidelity National Bank which allowed the Bank to invest in the
program
o Program got busted as illegal Ponzi scheme and Π lost money- so he sued bank and atty
o Does the Security Act apply
o Yes the definition of security includes any note or bond. The Π received both of these for his
investments into the program, so his securities were bought
o But does the ∆ sale of those securities fall under the act?
 The act does provide a private action for fraud
o There was a violation of the Act because ∆ failed to register these securities
o FN2. Section 35-1-1490 states that any person buying a security from someone acting in violation of
sections 35-1-410 or -810 may "recover the consideration paid for the security, together with interest at
six percent per year from the date of payment, costs, and reasonable attorneys' fees, less the amount of
any income received on the security, upon the tender of the security, or for damages if he no longer
owns the security. Damages are the amount that would be recoverable upon a tender less the value of
the security when the buyer disposed of it and interest at six percent per year from the date of
disposition."
 Issue #1: Were the short-term promissory notes from
Leventis considered “securities” and if so were they exempt from registration?
• If the security is NOT exempt - Leventis will be
required to pay the $ back that the other guy lost.
 Holding: Yes – the statute says notes are securities. There
are two kinds of notes – short-term (9 month) and long-term (several years). Court finds that these
long-term notes are not exempt as rollover transactions.
• Questions of fact as to whether he is a seller or broker
and whether the securities are exempt
 Section 35- 1-310(9)exempts short-term commercial paper from the registration
requirements of
 Some of Π’s investments were short term commercial paper, but some were not- so there
is no exemption
 ∆ claims these were rollover transaction – but they aren’t because the Π didn’t invest
with the same issuer each time
• "[a]ny transaction pursuant to an offer to existing security holders of the issuer,
including persons who at the time of the transaction are holders of convertible
securities, [is an exempt transaction], if (a) no commission or other
remuneration, other than a standby commission, is paid or given directly or
indirectly for soliciting any security holder in this State or (b) the issuer first
files a notice specifying the terms of the offer and the securities commissioner
does not ... disallow the exemption...."
 Issue #2: Is Leventis Acting as a “Seller”
o An "offer to sell" securities is defined in section 35-1-20(13)(b) as "every attempt or offer to dispose
of, or solicitation of an offer to buy, a security interest in a security for value." In this case, Leventis's
role in the Program went beyond simply recommending an investment to a friend; rather Leventis
played an integral role in the Program
o Evidence supports a finding that he did make an offer of sale

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  Holding: yes he is a seller; Court also finds that Leventis is a
broker – still argues that the securities are exempt and the court says this won’t get him out of trouble
b/c they’re not sure if the securities are exempt
 To be a seller, Leventis does not have to own the notes and
then transfer title to a purchaser – other factors show that he is considered a seller
• Has introduced investors to the program
• Received referral fees – this is probably what got
the court’s attention
• Provided investors with appropriate forms
• Regulation 97003: requires brokers to file some
papers, which Leventis did not do (this regulation is probably no longer in existence)
• Questions of fact as to whether he is a seller or broker
and whether the securities are exempt
o So there is a real issue of fraud, and also that ∆ didn’t register as a broker – so SJ shouldn’t have been
granted
o Section 35-1-20 defines a "broker-dealer" as "any person engaged in the business of effecting
transactions in securities for the account of others or for his own account" and an "agent" as "any
individual, other than a broker-dealer, who represents a broker-dealer or issuer in effecting or
attempting to effect purchases or sales of securities."
o Issue #3: Was Leventis a Broker and if so, was he exempt?
o Broker: Assists in the Sale
o Defense: Although I might qualify, since I am selling exempt securities, I haven’t run afoul of the
statute.
o Didn’t file so there is no protection under regulation.
o Coburn brings break of fiduciary duty. Burkie says lawyer may have made a tactical mistake.
o Brings this against him as the broker RATHER than as his role as an attorney. Presumably,
defense would have been that Leventis wasn’t his attorney. Burkie says this defense is weak
because courts focusing on what is “reasonable expectation of the client” and it would be a
reasonable expectation on Coburn’s part.
o ∆ argues he is exempt from registering because he only dealt with exempt securities- but there is
an issue of fact about this as explained above – ie they aren’t exempt so neither is he
o ∆ also argues that he is exempt from registering because he acted on behalf of the company and
didn’t except payments – court says he didn’t comply with the requirements of this section
o Also another argument that the company was a class D company that is exempt from registering
securities- but this wasn’t argued at trial
o But fraud claim’s dismissal was upheld because Π failed to specify any misrepresentations
o Cowburn argues there was a material issue of fact regarding his claim that Leventis owed him a
fiduciary duty, violated that duty, and acted negligently. Cowburn maintains Leventis's duties to
him arose because Leventis acted as a seller of securities, and Leventis breached this duty by
failing to investigate investments under the Program. We disagree.
o A broker or dealer of securities is an agent of the buyer, and therefore, generally owes the buyer
fiduciary duties. These duties often include the duty to account for all funds and property
belonging to the buyer, to refrain from acting adversely to the buyers interest to avoid engaging in
fraudulent conduct, and to communicate any information he or she may acquire that would be to
the buyers advantage. However, Cowburn has not cited any case that imposes a fiduciary duty
upon a broker to investigate for any unknown potential risks of investment.
• So no duty on broker to invest in the wiseness of the investment
 Leventis is an attorney. He brings the breach of fiduciary duty action against him in his
role as broker rather than his role as attorney. Burkhard says to watch out for this. Did the client think
you were representing him? If it had been pursued this way, it seems like Cowburn would have had a
much stronger claim.
o Gordan v. Drews (SC)
 Facts: Drews was going to start a hardware store in West
Ashley, but they decided they needed shareholders. Drews went out and solicited potential buyers and

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 got 11 shareholders. Gordan was one, and he bought in after assurances that a loan from the SBA was
“in the bag.” Gordan sued under the SC Security act 35-1-810, and Drews tried to defend that he was
exempt from registration
 Issue: Was his offering exempt under 35-1-320 – as a
limited offering?
 35-1-1490 - creates liability for the seller of stock in
violation of registration requirements, and he is liable directly to the person who he sold the
stock to, so Drews is hosed if he can’t find an exception
 Holding: Not exempted under 35-1-320
• To be exempt, Drews would have had to OFFER to
less than 25 people, and he couldn’t prove that he offered to less.
• Even with the changes with 113-22 he would have
been in bad shape because they got 11 purchasers
• Drews also tried to defend in that he received no
remuneration.
• Received remuneration: However, there was a plan
where he’d get ½ share for every share sold (to retain voting control), and the court said that
this was remuneration
 Not a seller defense:
• TEST to determine “Seller” of Securities
• solicit the purchases
• be motivated at lest in part by a desire to serve
either his own financial interest or the interest of the owner of the security he is selling
 Holding: In this case, he got a ½ share for every share sold,
so he was clearly soliciting and motivated, so Drews was liable for the sale
 Important note: the remedy included the loss on the security
as well as lawyer’s fees for the purchaser
 Unique SOL on securities transactions (Ct talks about
Laches which Burkie thinks doesn’t have any real bearing on the case).
o Common Law Fraud and Misrepresentation and Rule 10b-5 Constraints on Stock Issuance
o No transfer of stock is protected from Rule 10b-5, the securities anti-fraud rule promulgated by the
SEC. Every securities transaction lives under its protective shade.
o 10b-5 provides: It shall be unlawful for any person, directly or indirectly, by the use of any means
or instrumentality of interstate commerce, or the mails or of any facility of any national security
exchange,
 (a) To employ any device, scheme, or artifice to defraud
 (b) To make any untrue statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in the light of the circumstances under
which they were made, not misleading, or
 (c) To engage in any act, practice, or course of business
o which operates or would operate as a fraud or deceit upon any person in connection with the
purchase or sale
o This is different from the common law fraud requirements because silence is actionable under
10b-5. The cases that apply 10b-5 are primarily non-disclosure cases.
o See problems on p. 440
o Rule 10b-5 does not require that the issuer be the bad guy
o See outline in a couple of pages
o How do owners of a corporation make money?
o Typically, the decision about what to do with earnings for the year goes to directors (majority of
the board of directors)
o Problems on page 443
o Majority of the Board
o Same

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o SHAREHOLDER OPPRESSION
o Who decides which shareholders get salaries
o Often, in a small corporation, people buy shares with employment as the only guaranteed return. Over
the years, both legislative and judicial efforts have been made to ease the plight of the oppressed close
corporation shareholder. Two significant avenues of relief have developed. First, many state
legislatures have amended their dissolution statutes to include oppression or a similar term by the
controlling shareholder as a ground for involuntary dissolution of the corporation. Moreover, when
oppression is established, actual dissolution is not the only remedy at the court’s disposal. Oppression
has evolved from a ground for involuntary dissolution to a ground for a wide variety of relief.
Particularly in states without an oppression-triggered dissolution statute, a second avenue of relief has
developed for close corporation shareholders. Some courts have imposed an enhanced fiduciary duty
between close corporation shareholders and have allowed an oppressed shareholder to bring a direct
cause of action for breach of this duty.
o Salaries do not qualify as distributions. Distributions are considered to be dividends and stock options.
See SC 33-6-400 but this doesn’t cover salaries
o Hollis v. Hill (S/H Oppression Case) –MA law applied
 Hill and Hollis were both 50% owners of a corp. that made loans. Hill didn’t think Hollis was
carrying his weight. Hill stopped paying Hollis’ salary and proposed a buy out which Hollis
rejected. Hill stopped sending financial reports for a while. Then the business went really bad,
and Hill reduced Hollis’ salary to zero again. At the time of the lawsuit, the company’s value had
declined to $100,000.
 Issue: Hollis sued for shareholder oppression. The question was whether Hill owed a duty of
loyalty to Hollis, and whether a buy out was the proper remedy.
 First, note that the Texas court applied the internal affairs doctrine and applied the law of the state
of incorporation: Nevada (doesn’t have an oppression statute or case law, so they have to look at
the law of other states)
o Internal affairs of the foreign corporation, “including but not limited to the rights, powers, and
duties of its board of directors and shareholders and matters relations to its shares,” are
governed by the laws of the jurisdiction of incorporation
o NV does not have a statute for oppression. (most states allow petition for dissolution when there is
oppression) So the court turned on principles of duty
o FFUSA seems to be more of a partnership than a corporation so court imposes fiduciary duties
akin to a partnership. Ie two shareholders at 50% and splitting the managerial duties
o Because NV doesn’t have any laws on point, it doesn’t necessarily mean that we will
automatically find a duty exists. Court declined invitation to apply law of DE, instead applies a
serious of cases out of MASSACHUSETTS .
 MA Rule: Duty of S/H to other S/H: Court followed Massachusetts law and found that there is a
duty between shareholders in a close corporation that is the same as the duty between
partners, so Hill had a fiduciary duty to Hollis. Shareholders in close corporations owe each
other a duty of utmost good faith and loyalty.
 They argued that there was a legitimate business reason to do what we did. When a legitimate
business purpose exists, the minority shareholder must be given an opportunity to demonstrate that
the purpose could have been achieved through means less disruptive to shareholder interests.
 STEP 1 (Wilkes test): Determination as to whether a fiduciary duty to pay the S/H a salary
existed: you would have to show that the shareholder’s interests in the investment took the
form of employment.
• FACTORS:
• Whether the corp typically distributes profits as salaries.
• Whether the shareholder/employee owns a significant percentage of the corps shares.
• Whether the shareholder/employee is a founder of the corporation.
• Whether his shares were received as compensation
• Whether the shareholder/employee has made a significant capital contribution
• **Whether the shareholder/employee has shown that he had a reasonable expectation that
the return on his investment would be in the form of continued employment

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 • *Exception: There is no breach, however, if the oppressed shareholder has an
opportunity to redeem his shares at a fair price, or if the corporation
redeems his shares for a fair price
 STEP 2 -(Wilkes test)
• BOP on P - Plaintiff must allege that the defendants have done something bad – here, it’s
termination of employment – breach of a fiduciary duty.
• BOP on D - If the majority can show that the reason they did that was for a legitimate
business purpose, this is a defense
o Purpose - it’s the need to downsize b/c of lack of business.
• BOP back to P - When a legitimate business purpose exists, the plaintiff has the opportunity
to show than the means could have been achieved by a less disruptive means to his interest.
o The court found that the corp never paid dividends, so that without the salary,
Hollis’ shares were worthless.
 Same analysis has been seen in SC, but not necessarily in business cases
 Remedy: Buy out - Ct held that the date to value the company for the buy-out remedy was
the date the oppression began, which was when Hollis’ salary was reduced to 0.
 Dissent: NV would not apply MASS law. NV is a mgmt friendly state so they would apply
DE law
 DE Rule – no S/H oppression
• Dissent says that they should have followed Delaware law, which doesn’t have
shareholder oppression
• Although, Burkie notes that Grady states that if directors act on both sides of a
transaction (which is essentially what Hill was doing), they have to show they acted
with fairness, which might come to the same result, so DE might not be that much
different from MA.
 Brodie v. Jordan – MA Supreme Court
• 3 guys ran machine shop. One retires, then dies. Wife inherits. After that, co.
stops paying her. Wife brings claim under Donahue-Wilkes rubric.
• Court says beh might have been viewed as oppressive but that doesn’t give her
the right to be bought out – she would be getting more than entitled to.
• Unless she’s bought out, she’s still stuck in a mess. Value is in the stock which
she now can’t do anything with.
• MA cuts back a little bit.
o What are the legal limitations on salaries
o Exacto Spring v. Commissioner of IRS (Fed – Tax Ct)
o Facts: IRS brought suit against Exacto Spring to show that they were giving an excessive salary to
their CEO and principal owner (which is deductible) instead of awarding dividends (which are
taxable).
o ∆ was a close corporation
 Paid CEO 1 million in salary
 IRS thought this was excessive and applied the excess to the ∆’s income, which meant
that ∆ was deficient in the taxes it paid
 Trial court found that a reasonable salary was somewhere between the numbers offered
by the two parties
o The purpose of § 162 is to prevent dividends, which are not deductible from corporate
income, from being disguised as salary, which is.
o Issue: Was the salary reasonable?
o Trial court applied this test: Director Salary Reasonableness Test: 7 Factors:
 Type and extent of services rendered
 Scarcity of qualified employees
 Qualifications and prior earning capacity of the employee
 Contributions of the employee to the business venture
 Net earnings of employer

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  Prevailing compensation paid to employees with comparable jobs
 Peculiar characteristics of employers business
o Court does not like the test the lower court applied because
 They are vague and non directive
• Doesn’t say what weight is to be given to the factors
• Also they don’t tie up well with the statute that allows the corporation to pay
salary (or to prevent deductions when dividends are being paid out as salary)
o That statute is mainly to prevent gifts from being disguised as salary –
so as long as services are rendered the corporation can determine what
is a reasonable amt
• Also the tax court shouldn’t be second guessing these decisions
• Lack of direction will result in arbitrary decisions
• uncertainty
o Posner - Indirect Market Test: Btm page 467 (“killing the goose that lays the golden egg”)
 Hangs hat on fact that the directors that approved the salaries were disinterested in the
sense that they were the ones being hurt if anyone was by the payment of these large
salaries to the officers
 Rule: When the investors of the company are receiving a far higher rate of return than
they had any reason to expect, the CEOs salary is presumed to be reasonable
 Rule: Presumption can be defeated by showing that the return is not due to the CEOs
work (ex – a company finds that it is sitting on oil reserves).
 Indirect market test – a corp can be conceptualized as a K in which the owner of assets
hires a person to manage them. The owner pays the manger a salary and in exchange the
manger works to increase the value of the assets t that have been entrusted to his
management – the increase can be expressed as a rate of return to the owners investment
• The higher the rate of return (adjusted for risk) that a manager can generate, the
greater salary he can command
• So the more he is making, the more he can be paid
o However it must also be a bona fide salary- so evidence of it really
being a dividend could make it fail this test
o Criticisms of Posner’s analysis & the Indirect Market Test:
 Ratios may not be that accurate – nothing says how to establish the baseline projections.
 Methods of proof that the increase on return is due to the efforts of the executive.
o Holding: His salary was reasonable
 Ct rejected the gov’t argument that low level dividends paid by the co. indicated that the
corp was paying Heitz dividends in the form of the salary.
 Ct noted that S/H may not have wanted dividends and instead have wanted to increase the
value of the co.
 Also important factor in the result is that a bunch of directors who were getting paid
nothing voted for the director to get this raise. His salary was approved by
disinterested board members.
o This Case represents a problem of closely-held corporations b/c:
 No market for shares if shareholders are unhappy with executive salaries
 Shareholders and directors and officers are often the same people
 SS taxes not paid on dividends – this be a good or bad thing, depending on whose
perspective is taken into account
o Giannotti v. Hamway (VA)
o Facts: Plaintiffs were minority shareholders. They asserted that the defendants controlled the
majority of the voting shares of stock, and that they voted huge salaries for themselves while
not paying dividends. Plaintiffs sued to have the court dissolve the corp, liquidate the assets, and
remit some of their salaries on the theory that the actions were oppressive.
o The Hill v. Hollis case is based on common law; this case is based on a statute. That’s why both
of these cases are included in the book.

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 o VA View on S/H oppression: conduct by corporate managers toward stockholders which
departs from standards of fair dealing. To comply with the standard, they must show that
their actions were fair to the corporation.
 BOP on D’s b/c they are interested: (they voted big salaries for themselves), and as
such they bore the burden of showing that the transaction was fair to the corporation.
 § 33-8-111 might reverse that burden, but we don’t know
o Holding: The court relied upon the fact that the “profit per bed” of their nursing home
business was far lower than average and found that, without the big salaries, the company would
have been more profitable. Thus, the defendant’s didn’t carry their burden, and were guilty
of oppressive conduct.
o Remedy: As for remedy, the court looked at the statute and decided that dissolution was the sole
remedy, and the court couldn’t use equitable powers to arrange to pay back the corporation.
Thus the directors didn’t have to pay back their salaries
o The statute doesn’t allow them to just pay a greater dividend to the shareholders and to just say
they won’t pay such high salaries in the future.
o Dissent noted that while profit/bed was low, overall profitability numbers were through the roof.
o Judicial Dissolution
o Kiriakides v. Atlas Food Systems (SC) – S/H Oppression Case
o Facts: Atlas was a family owned company. Plaintiff was one of the brothers who had a 37%
share. The plaintiff stopped getting along well with his brother who unilaterally made some
business decisions without consulting him. He was offered $1 million and an $800 cancellation of
a loan for his share, which was WAY low. Plaintiff sued for shareholder oppression.
o ∆ (Alex) is majority holder and has been in charge of finance and corporate affairs
 He controls the board
 Alex and Π John had a rift between them and John became distrustful of ∆’s management
of the corporation
 Alex pretty much ignored John’s impute on the company and acted unilaterally without
putting decisions to a vote – and also acted contrary to decisions that were put to vote
 John said he was going to quit. He then made it clear that this was not his intention
 Alex then told John he was no longer to be president of the corporation. Alex’s son then
became a board member and president
 Alex and ∆ corp then offered to buy out John’s interest
• John believed the offer was too low
 Π brought suit for accounting, buyout of his shares, and damages for fraud
 Subsequent offer of 4 million was made – Π believes his shares are worth 10 million
 Trial court found evidence of fraud and oppression and that a buyout under 33-14-300(2)
and 310(d)(4) were in order
• This statute allows a court to order a buyout rather than dissolution
o Court cited to 33-14-300(2)(ii) that allows the court to force dissolution if it can be established
that the directors or those in control acted in a manner that is illegal, fraudulent, oppressive,
or unfairly prejudicial to any shareholder.
 Before the Kiriakides opinion, you would have said that the SC statute was more
protective than the NC opinion/statute. However, the analysis in the case says we cannot
focus on the interests of the minority shareholders. You almost have to focus on the
expectation of the minority shareholders to recover.
 Burkhard says a compromise in SC would be to apply the Wilkes test.
 33-14-310
• Allows a court to grant relief other than dissolution, including a buyout
o SC Rule on Opp - Court will find oppression using the totality of the circumstances on a case by
case basis. Factors the court will look at are:
 A visible departure from the standards of fair dealing and a violation of fair play on
which every shareholder who entrusts his money to a company is entitled to rely; or
 A breach of the fiduciary duty of good faith and fair dealing; or

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  Whether the reasonable expectations of the minority shareholders have been frustrated by
the actions of the majority; or
 A lack of probity and fair dealing in the affairs of a company to the prejudice of some of
its members; or
 A deprivation by majority shareholders of participation in management by minority
shareholders.
o SC rejects NC View on S/H Oppression: focuses on the reasonable expectations of the
minority shareholders (like Hollis).
o The statute seems to say we can apply the reasonable expectation of the parties, but FN 25
then seems to say that we can’t apply it (a court may never consider the parties’ reasonable
expectations)
o SC says this is too broad (really focuses on the reasonable expectations element – burcky says
he’s not sure this was such an important factor in the crt app test)
 Notes amendment adding “unfairly prejudicial conduct” allows remedy for the frozen-out
minority shareholder when there isn’t any fraud
• Note policy concern for the oppression of minority shareholder was a nation
wide issue and particularly for close held corporations
 The meaning of oppressive fraud or unfairly vary from case to case and court looks at
case law
• Lack of dividends
o Not oppressive where suspended for purposes of improving the
corporations finances
o Yes where suspended to freeze out the minority shareholder
• Actions taken to depress value of corporate stock
 SC finds the factors listed by the Crt App are too strict bc the Leg didn’t list such
requirements
o Leg didn’t intend for there to be dissolution based on the party’s reasonable expectations
 This would require court to look into the intentions of closely held family corps – it aint
gonna do this
• Other courts place emphasis on rights and interests of the minority shareholder
BUT SC places emphasis on the conduct of the majority – so the Crt Apps. Reasonable
expectations test was wrong
o Statute focuses on conduct of majority shareholder, not the rights and interest of
the minority shareholders as the NC statute says
 Criticizes reasonable expectation approach for providing too much
protection to minority holder and not requiring a bad faith prong against the
majority before holding them at fault
 BUT burcky says Toal was smoking some gonga – the SC statute has
much more language regarding the shareholder and that you have to focus
on what the minority holders lost if you are to determine what the majority
did
o The court wont define oppressive or other terms absent Leg direction, so it must
be a case by case determination
 They are “elastic terms”
o You can consider the reasonable expectations, but they are not determinative
o Lots of factors are listed at headnotes 11 and 12
o It’s a bigger mess the Higby on a Saturday night after a fifth of tequilla and a
shot of jager
• Application
o This is a classic example of freeze out
o Close held corps enable the majority holders to allocate the benefits of
ownership arbitrarily

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 o Occurs where the shareholder has a trapped investment and an indefinite
exclusion from participation in business returns
 This is magnified in close corporations because there isn’t the
protection of being able to readily sell your stock
• So they are held hostage
o Looks at lots of factors that show how ∆ benefited and how
o BJR does not apply in S/H oppression cases: directors only get the benefit of the rule when they
can demonstrate that they acted in good faith.
o We find this case presents a classic example of a majority “freeze-out,” and that the referee
properly found Atlas had engaged in conduct which was fraudulent, oppressive and unfairly
prejudicial. Common freeze out techniques include the termination of a minority shareholder's
employment, the refusal to declare dividends, the removal of a minority shareholder from a
position of management, and the siphoning off of corporate earnings through high compensation
to the majority shareholder. Often, these tactics are used in combination. In a public corporation,
the minority shareholder can escape such abuses by selling his shares; there is no such market,
however, for the stock of a close corporation. The present case presents a classic
situation of minority “freeze out.” The referee considered the following factors: 1) Alex'
unilateral action to deprive Louise of the benefits of ownership in her shares in Atlas, and
subsequent reduction in her distributions based upon the reduced number of shares, 2) Alex'
conduct in depriving John and Louise of the 21% interest of Marica stock, 3) the fact that there is
no prospect of John and Louise receiving any financial benefit from their ownership of Atlas
shares, 4) the fact that Alex and his family continue to receive substantial benefit from their
ownership in Atlas, 5) the fact that Atlas has substantial cash and liquid assets, very little debt and
that, notwithstanding its ability to declare dividends, it has indicated it would not do so in the
foreseeable future, 6) the fact that Alex, majority shareholder in total control of Atlas, is totally
estranged from John and Louise, 7) Atlas' extremely low buyout offers to John and Louise, and 8)
the fact that Atlas is not appropriate for a public stock offering at the present time.
o SC Dissolution Statutes
o 33-14-300: The court can grant dissolution
o 33-14-310 - 320: Procedure for judicial dissolution
 allows for appointment of a custodian
o SC Close Corporations - Dissolution
o 33-18-400 – Court action to protect S/H: a S/H of a close corp may petition the court for any of
the relief in 410-430 if
 the directors have acted illegally, oppressively, fraudulently, or unfairly prejudicial to the
petitioner (whether in his capacity as a S/H, director, or officer of the corporation)
 Directors are deadlocked in the mgmt of corp affairs
 there exists other grounds for judicial resolution under 33-14-300
• S/H can not commence a proceeding under this section if has agreed in writing
to non-judicial remedy
• If S/H also has dissenter’s rights with respect to the corp action, he must
commence a proceeding under this section 1st.
o 33-18-410 – ordinary relief
 Remedies for oppression basically allow the court to resolve the problem internally
without dissolving the company. If one of these remedies will solve the problem, then
order it.
• Reversal of action
• Termination of office or director
• damages
• pmt of dividends
• etc….
o 33-18-420 – extraordinary relief
 If ordinary remedies don’t work those remedies won’t work, order the company to
buyout the complaining s/h – intermediate step.

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 o 33-18-430 – dissolution
 If the internal remedies and the buyout won’t solve the problem, then the court may
order dissolution
o Receiving dividends from the corporation
o Dividend is a payment to shareholders by the corporation out of its current or retained earnings in
proportion to the number of shares owned by the shareholder
o It’s a management decision and most corps don’t pay them (close held corps don’t want to pay them
because you would be taxed more, so they do it in salary; and most corps are close corps) – but its
more common for the big boys to pay them
o Most publicly traded corps do pay dividends, but it’s a decision based on attracting investors
o Two views
 Paying them may attract more investors making the company more valuable
 Not paying them demonstrates confidence that it has attractive investment opportunities
that might be missed if it pays dividends
o Creditors will complain if the corporation pays out too much in dividends
 Most corporations do not pay dividends; this is true because most corporations are
closely held with salaried employees so they don’t want to pay double tax; every corporation will
avoid paying dividends if at all possible
 Many publicly traded companies do pay regular dividends- it depends on whether it will
attract investors
o When can/must a dividend be paid
o Definition
o The SC code defines anything that goes out to the shareholders as distributions
o 33-6-400: Distribution to S/H’s
 Board of directors authorizes distributions subject to limitations in articles of incorporation
 If record date not set otherwise, it is the date the board authorizes the distribution
 You CANNOT make a distribution if
• The corporation would not be able to pay its debts as they become due in the normal
course of business OR
• Total assets would be less than total liabilities of the corporation + the amount due
to satisfy the preferential rights of shareholders whose preferential rights are
superior to those who receive the distribution
 (e) how to calculate the value of a distribution when it is something other than cash.
o 33-8-330: Liability for unlawful distributions
 A director who votes for a distribution that violates the distribution rules is personally liable to the
corp for anything over the amount that would not have violated the rule IF it is shown that he
didn’t act in accordance with 33-8-300: SC BJR
 The director can get contribution from every other director who could be held liable under
 (a) as well as every shareholder who accepts a distribution knowing it violated 33-6-400
o Modern approach: so dividend is valid as long as the corp is not insolvent and the dividend doesn’t make it
insolvent
o Traditional approach (NY and Del)
o Requires references to different funds or accounts
o Earned Surplus (Retained Earnings)– net income retained by the company; consists of value generated by
the business itself
 Consists of all earnings minus all losses minus distributions previously paid
 This means you are making real money, and it is a proper source from which to pay dividends
o Accounts from sale of stock
o Stated Capital
 Par value of a par issuance plus the amount allocated to stated capital on a no-par issuance
• Par means minimum issuance price – if you are selling stock at $2 par value – you must
receive at least 2 per share
o So 10,000 shares at 2 par = at least 20K and this goes to the stated value

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 o This cannot be used to pay dividends because it is a cushion for creditors
• But par is set at 1 cent to avoid the restrictions of the stated capital fund
o Capital Surplus
 Whatever is raised in excess of the par value can be used to pay dividends
o In a no-par issuance
o There is no par value and the directors are free to allocate funds from stock issuances to either stated capital
or capital surplus
o But if they do nothing, the funds automatically go to the stated capital and cannot be used to pay
distribution
o three common types of distributions
o dividends
o repurchases
o redemptions
o can be paid in money or property
o SO a company MAY pay distributions
o In a Traditional approach when it uses only capital surplus funds or earned capital
o In a modern approach as long as it isnt insolvent or would become so
o Earned surplus (retained earnings): consists of value generated by the business itself; money made from
running the business that hasn’t been distributed as salaries, etc.
o Stated capital: par value of the issued stock; under the traditional approach, stated capital can’t be used for a
distribution
o Capital surplus: additional amount from sale of stock over the par value; can be used to pay a distribution
o Zidel v. Zidel (OR)
o Facts: Defendant owned 3/8 of the stock of a closely held corp, and was employed as a director. When his
demand for a raise was refused, he quit. Then he demanded that the corp pay dividends. He then
complained that the dividends were too small and not set in good faith.
 Claims that the corporations had large retained earning and that the actions of the majority shows
a concerted effort to deprive him of his right to profits
o OR Rule: Co’s have a duty of good faith and fair dealing toward minority shareholders.
 But concerning dividends, that duty is met if the decision is made in good faith and reflects legit
business purposes rather than the private interests of those in control
o BJR - BOP on P – complaining S/H must show that the decision was not made in good faith and did
not represent legitimate business purposes
o The result might have been different if he had argued that their salaries were too high. The BOP might not
have fallen on the P. He basically conceded the main point.
o The defense in Van Gorkam was that we knew the corporation, so it doesn’t matter that we didn’t study all
the reports. In Van Gorkam, the court said it wasn’t enough and found them liable. In this case, the P is
arguing that the directors did not really make their decisions on the basis of the factors they claimed to,
pointing to documents that they didn’t rely on any documented financial analysis. The court doesn’t buy
that.
o Holding: The plaintiff was able to show that the company could have paid a higher dividend. However, he
didn’t show that the dividend paid was so small as to be unreasonable. Thus, he didn’t carry his
burden and lost like the big fat loser he was.
Notes
o Some criticize the court’s approach to the duty to minority holders – it reduces it to not intentionally
harming the minority holder rather than encouraging active pursuit of their interests
o Case mainly just shows what to consider and how to approach a claim of oppression for failure to pay
dividends
o There are no cases were a court has ever forced the board to pay dividends
 Exception is the Dodge v. Ford case
o Dodge v. Ford Motor
o The only known case where the court required payment of dividend to shareholders. Ford kept the cash in
the company and paid high salaries and had lower profit margins (but made an assload of cars).

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 o Ford had legitimate business reasons to use earnings for purposes other than paying dividends including
expanding facilities and paying high salaries. He could have testified at trial that he wanted to use earnings
to make cars less expensive and to pay higher wages to increase profits. He would have won. Instead, he
said that the American public would benefit from his making cars as cheaply as possible.
o Court thought this behavior made no business sense, and as such forced Henry to pay dividends
o Sinclair Oil v. Levien (DE)- Parent/Sub Case
o Facts: Sinclair had a subsidiary, Sinven. Plaintiff held 3% of Sinven, while Sinclair owned the rest.
Sinclair had total control over the directors of Sinven. Sinven paid out huge dividends (which go back to
Sinclair), and plaintiff, as a minority S/H, brought a derivative suit because he thought Sinven lost
opportunities for not having cash on hand. Plaintiff thought the motivation behind the dividends was
Sinclair’s need for cash.
o SH claims the corp paid too much in dividends as opposed to too little (they also complained about
diversion of business from Sinven to other subs and a number of other complaints)
o Derivative action of a SH in Sinclair Oil Corp to require Sinclair to account for damages it sustained when
it subsidiary (Sinven) paid out dividends
 Sinclair owns 97% of Sinven’s stock
• So Sinclair ran Sinven and was basically taking all of Sinven’s funds for itself
o Lower court found that Sinclair had a fid duty to Sinven, which causes the DOP to shift and for it to meet a
test of intrinsic fairness – ie under careful judicial scrutiny that its transaction with Sinven were objectivly
fair
 Sinclair argues the BJR should apply and not the intrinsic fairness test with its shift in BOP
o Plaintiffs argued for the court to apply the “intrinsic fairness” test to the dividend, which would place
the burden on the directors to show that the dividend was fair to the corporation.
o App
 Sinclair caused Sinven to pay out so much that it became a corporation in dissolution
 Π concedes that the dividends were in compliance with the statute but were improper because they
were motivated by Sinclair’s need for cash
 Court says this isn’t enough since the statute was complied with – they will have to show that the
decision wasn’t grounded on reasonable business objectives – BJR
o Rule: Court said that the intrinsic fairness test only applies in cases of self-dealing (Sinclair is getting
a benefit that the minority shareholders aren’t getting), and in this case since the shareholders all
received the same proportional benefit, Sinclair was not self dealing. Since intrinsic fairness wasn’t
applied, the court applied the BJR and the P’s lost.
o If this is a derivative suit, the injury is supposed to be to the corporation. The court technically should have
focused on Sinven. We have to ask whether Sinven was injured instead of the minority shareholders.
 But this may be wrong – this is a derivative suit, so the determination whether there was self-
dealing that injured the ∆ - we should have looked at injury to Sinven, not the shareholders
• So court is inconsistent with the principles of a derivative suit
o * Note: Intrinsic Fairness Test – BOP on Directors – applies to Self-Dealing, where BJR – BOP on P,
applies to S/H oppression cases.
o § 33-8-310: there is a conflict of interest in this case under 33-8-310(b)(2) because these directors are not
disinterested so that their votes can cure the conflict. Therefore, even though they have approved it, since
they are not disinterested under the SC statute, they don’t get the benefit of the business judgment rule and
the SC court would likely come out the opposite.
o Types of stock:
o Cumulative preferred: if the dividends are to be paid in a certain year and they can’t be paid then in
subsequent years those dividends that were missed will be paid when the company has the money to do so.
Would take precedence over common shareholders.
 So same facts as below, but its been 3 years since dividends were last paid out – so 4 years worth
are to be paid = 8 per share before the CS gets a cent
• Leaves 24K for the 10000 CS = 2.40 per share
o Preferred participating stock not only gets paid first (because it is preferred), but also gets paid again.
Participating thus means that these shares also get paid, along with the common shares, in what is left over
after payment of the preference. So they get paid twice!

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  Ex – PPS gets $2 preference
• There are 2000 PPS and 10000 common stock
• Declared dividends = 40K
• PPS – first paid out $2 per share = 4k (2000 * 2)
• = 36K left / 12,000 (10 CS and 2 PPS) = 3 per share
• CS = total of 3 per share
• PPS – total 5 per share
 PPS – is not cumulative, so if its not paid out one year, the holders would still only get 2 per share
o Common stock
o Preferred stock: paid first
o All the shares in a particular class must have the same rights, but different classes can have different rights
o Buying and selling stock at a profit
o Common law Fraud and Rule 10b-5
o Rule 10b-5 - Securities act of 1934
o It is unlawful for any person by the use of any means of interstate commerce in connection
with the purchase or sale of any security
 To employ any device, scheme, or artifice to defraud.
 To make an untrue statement of material fact OR
 to omit to state a material fact necessary in order to make statements made not
misleading.
 To engage in any act which would operate as a fraud or deceit on any person
o Note: Any security means any security. Registration exemptions have no effect on whether a
transaction is subject to 10b-5
o Basic Inc v. Levinson (Federal Case – 10b-5) – Public Cause of Action
o Facts: Defendant directors of Basic had conversations regarding a
merger. They were asked questions and publicly denied that they were in merger talks.
Plaintiffs brought a class action on the theory that they sold in reliance on the fact that there
would be no merger, and they would have held on otherwise. They sold there stock at a lower
price than they would have had they known about the merger.
o Issues:
 What should the standard of materiality be with regards to
preliminary merger negotiations?
 Whether a presumption of reliance based on the Fraud on
Market Theory is appropriate to certify a class action?
o An omitted fact is material if a reasonable S/h would consider it
important in deciding how to vote. – TSC Industries.
 In addition: “There must be a substantial likelihood that
the disclosure of the omitted fact would have been viewed by the reasonable
investor as having significantly altered the “total mix” of information made
available. – Basic Test
o The Management argued that this test should be applied and a line
should be drawn: the discussions become material at the point where they have agreed on
price and structure.
o Materiality Holding: Court rejects this argument and indicates the
general materiality test in this case should be applied on a fact dependent basis – indicia
of interest in the transaction at the highest corporate level -
 Probability / Magnitude Test - The court stated that the test
would be a balancing of the probability of the event vs. the significance of the event.
• Probability factors:
o indicia of interest at the highest corporate levels.
o Board resolutions,
o instructions to investment bankers,
o and actual negotiations.

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 • Magnitude factors:
o the size of the corporate entities,
o potential premiums to be paid over market
value.
 The Court remands the case on this issue for reconsideration of the question whether
summary judgment is appropriate on this issue.
o Presumption of Reliance Holding: The court also allowed reliance to
be shown with a “fraud on the market” theory. This states that false public information
creates a presumption of reliance for anyone suing on the transaction.
 Only four justices approved of this part of the opinion
 Theory that in public trading, the price of the company’s stock is determined by the
available material information regarding the company and its business. Misleading
statements defraud purchasers therefore even if they don’t rely on the misstatements
directly
 Should there be a presumption of this reliance?
• Without it, there wont be a class action because each member would have to
show personal reliance and then the individualized issues would overwhelm the
common issues
• ∆ claims that allowing it means that the Π wont have to show reliance on the
statements
 Court says reliance is an element of 10b-5, but the realities of modern market means that
the concept of reliance must also evolve – there will be a presumption because it would
be an undue burden for Π to show
• The reasoning behind the theory is sound to sense information directly effects
the price and therefore indirectly effects the shareholder
 A rule 10(b)5 action involves reliance.
 Fraud on Market Theory – only applies to public
misrepresentations - the market has incorporated misleading information into it and
I have relied on this information, even if not directly, b/c the market reflects this
information into the stock price.
 Court says these types of presumptions are helpful,
supported by empirical evidence, and are common sense. Also the presumption
can be defeated by:
• Rebut Loss causation – show that “market makers”
knew the truth and as such the market price wasn’t effected – No in this
Case OR
o Burkhard: Correct information shouldn’t be out in
the market. There’s something wrong with inside
information.
• Rebut Transaction causation – show that the seller
would have traded anyway. – No in this Case
o Note: the court also says that the only way you can respond to a
direct question in a way that isn’t false is with a “no comment” Rule 10b-5, silence,
absent a duty to disclose, is not misleading under Rule 10b-5. “No Comment “
statements are generally the functional equivalent of silence –
 If you don’t like it then you can have legislature change the
law.
 Bottom page – 503.
o Additional Notes:
 The Defendants in this case where the directors of Basic and
the Corporation.
 Damages - conceivable the damages could skyrocket and
become huge in this case, the stock could be sold a number of times after the merger.
o Lentell v. Merrill Lynch

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o A securities fraud plaintiff must prove both loss and transaction causation
o Transaction causation is akin to reliance, and requires only an allegation that “but for the claimed
misrepresentations or omissions, the plaintiff would not have entered into the detrimental
securities transaction.”
o Loss causation “is the causal link between the alleged misconduct and the economic harm
ultimately suffered by the plaintiff.” Thus to establish loss causation, “a plaintiff must allege ...
that the subject of the fraudulent statement or omission was the cause of the actual loss suffered,”
i.e., that the misstatement or omission concealed something from the market that, when disclosed,
negatively affected the value of the security. Otherwise, the loss in question was not foreseeable.
• EP Medsystems v. Ecocath. (Federal – 10b-5) –Private Cause of Action
o Burkhard: This is the typical case for a small firm, typical SC law
matter.
o Ecocath made a fancy ultrasound machine. Ecocath IPOd and of
course issued a prospectus that detailed risks. Six months after IPO, Ecocath CEO met with
Medsystems to get them to invest. He told them in a private meeting that a bunch of
contracts to sell the machine were imminent. Contracts never materialized, Ecocath
tanked, and Medsystems sued under 10b-5 for making false statements in connection
with sale of securities.
o Court says this case in not the typical fraud on market case b/c here the
P is not basing its claim on public misrepresentations or omissions that affected the stock
price purchases, instead it deals with direct inducement as a result of personal
representations made to its executives by EcoCath’s executives and that those
representations were false and misleading.
o 1) Have to show materiality of statements
 Materiality: court said for a misstatement to be material the
disclosure would have to be viewed by a reasonable investor as having significantly
altering the total mix of available information. – TSC/Basic Test
 2 Defenses to Misrepresentations:
• Statutory safe harbor – 1995 Reform Act - an
issuer is not liable for statements identified as forward looking and
accompanied by meaningful cautionary statements
• “Bespeaks caution” doctrine – CL doctrine not
statutory - Cautionary statements, if sufficient, render a misrepresentation
immaterial as a matter of law. However, the statement must be forward
looking, and the cautionary statements must be directly related to the
statements.
 The court said that a term like “imminent” could not be
forward looking, as it implied that the contracts were certain, rather than possible.
 The court was also pretty sketchy on allowing cautionary
language in a 6 month old prospectus was proximate enough to the
misrepresentations to apply
o 2) Have to meet Scienter requisites
 There is no definitive test in a private COA as to what
scienter is – most lawyers think that the P must show the statement was made
either intentionally or recklessly, nothing less.
 Scienter: court said that a complaint must plead with
particularity facts that give rise to a strong inference that the defendant acted with
scienter.
o 3) Was there Reliance? (FOM theory not applicable b/c not dealing
with public misrepresentations)
 Reliance: the plaintiff must show reasonable reliance on a
false statement or omission of material fact.

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  Waiver? - Weird Result - The court said that reliance
followed as a matter of law, and ignored the fact that the plaintiffs signed a
waiver stating that they did not rely on any representations
o 4) Was there Transaction & Loss Causation?- Not the Usual Case
o Normally the Π must show how the misrep caused the stock to decline in value
and not just that it induced the transaction
o But this case is different from most cases sense the misrep was personal and
caused the Π specifically to purchase shares at an inflated value
o This issue should be left to the jury after it makes a determination of causation
o For along time there have been to notion of causation in 10b-5 claims
 Transaction causation – the misrep was the but for cause of the
investment
 Loss Causation – the misrep caused the loss in value
 But this opinion doesn’t clearly explain what loss causation is
and how to apply Loss causation: Plaintiffs must show two kinds of
causation
• Transaction “But For” causation:
Misrepresentation caused the person to make the transaction or sale AND
• Loss causation: P must show that the
Misrepresentations caused the pecuniary loss- decline in value. This is a
huge burden, as the lie itself has to cause the decline in value. –
o Ex – so the authors suggest that under the
reform act, a P can only recover if the decline in the value of stock
was a result of the misrepresentation.
Notes
o But-for causation – you wouldn’t have bought the stock but for the lie
o Loss-causation – must show both that the lie caused you to both buy the stock
and to suffer a loss
o So if the stock plummets for something other than the lie, you cant
recover because of the Reform Act
o But courts are still struggling with how to apply loss causation
o For instance, how do you show an omission causes a stock to decrease
in value?
• Note: Birnham rule – a S/h who sits on their stock and does not “buy or
sell” has no cause or action – in order a private cause of action for damages under 10b-5, you
must have bought or sold in the face of misleading information. See Case Below!!!!! If you
decide not to act because of a misrepresentation or omission, you have no cause of action under
10b-5
• Malone v. Brincat –(DE) – common law-state fraud action – not 10b-5!!
o Facts: Defendants were directors of Mercury, which overstated its
earnings for 4 years. Plaintiffs sued for breach of fiduciary duty of disclosure.
 Π bring action for misreps that caused them not to sell their stock – Birnbaum rule
doesn’t apply because they only bring state claims
• The misrep was in a document that was not related to any shareholder action
 Mercury had overstated its earning for 3 years. When it used the correct numbers, the
Market capitalization (# of shares * value) fell by 2 billion
 Π alleges they breached fid duty of disclosure (∆ is one of the directors)
o They didn’t bring this as a 10(b)(5) COA because the plaintiffs didn’t
buy or sell anything. 10b-5 requires you to be a purchaser or a seller (not just holding on to
stock).
o Issue: Was there a duty of the directors to provide accurate information
to the S/H’s without a S/H action?
o Rule: This case deals with a state action for breach of duty, not a
10b(5) COA, b/c the guy that holds onto his stock.

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o Rule: The DE supreme Ct says YES – there is a duty. Even in the
absence of a request for information, directors who knowingly disseminate inaccurate
info have violated either a corporate duty or a duty to the shareholders. In Delaware and
SC, directors owe a duty to disclose.
o Court said that directors have 3 duties that run to the shareholders:
due care, good faith, and loyalty. There are three situations where a disclosure to the public
can implicate the duties – since this case was decided in 1988 – the DE court has massaged
this language dramatically. Reminder: the Disney case has substantially changed that; now
good faith is apparently a subset under the duty of loyalty, at least in the corporate arena.
o 3 types of Corp Disclosures that Trigger the Director’s 3 Duties :
 Directors make a public statement to the market;
including S/Hs
• any public statement is governed by SEC rule 10b-5.
o May include routine advertising
 Directors make a statement to shareholders, but do not
request shareholder action (this case)
• This gives rise to a state common law action
• The duties of care, good faith, and loyalty apply
• If the misinformation is deliberate, then there is a
breach, which can result in a derivative claim or a cause of action for
damages
• Informing S/H about the affairs of the company
• In order to have a claim against the directors for
breach, all you have to show is that the misrepresentation is material.
 Directors make a statement to shareholders in conjunction
with a request for a S/H action (request to vote)
• The court doesn’t tell definitively how much
information the company has to give when it is asking the shareholders to
vote but it wants to keep information confidential for the benefit of the
company.
• When action is requested, the MBC governs
• What are legal duties applicable to buying or selling
stock
o Holding: Directors owe a fiduciary duty to the company as well as
to the shareholders to not make material misrepresentations to S/H
 Reason this duty should be imposed – policy reasons to
protect the beneficiary interests - Control is separated from ownership.
 DE rejects the Fraud on the Market notion
• No state claim because it is covered by federal regulations and because there
was no sell here, Fed law wont give a coa
 Claim may be brought as a derivative claim, a direct claim
or both. The plaintiffs, however, never expressly assert a derivative claim on
behalf of the corporation.
• Here the complain it bad because it says the corp lost all its equity, so it should
have been a DERIVATIVE suit but the Π filed a direct claim
o But they should have leave to amend and file a derivative suit or make
proper pleadings for a direct suit
o On remand, the plaintiffs will have to prove reliance and damages.
o Possibility of a Tort Action – Rest 552 (p. 531) – If the person
provides false information for the guidance of others, the person may be subject to
liability. This liability is limited to loss suffered by the person (or groups of persons) the
informer intends to use, or rely on the information – Has been used frequently by SC
Courts (so far not against lawyers)

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  3rd Party info: Lawyer gives advice to a client, client passes
it on to a 3rd party, who is a buyer of the client’s company – SC sup ct says buyer can
definitely sue the atty or the accountant based on 552
 This section gives third parties a claim against a lawyer;
extends lawyer exposure
Notes
o So I think this case says
o 1) if the info was requested, you just have to show that the misrep was
material
 But if it was nto requested you have to show all the factors
laid out in the EP Medsytems case including reliance and lost cauastion
 But fid duty still applies
o 2) if it’s a fed claim you have to have sold or bought
 But a state claim exists if you just sit
• 10b-5 and buying or selling with inside info
o Dura Pharmaceutical v. Broudo (Federal 10b-5 – Private COA)
 Facts: Purchasers of stock in Dura brought securities fraud
action (10b-5) against company and certain managers and directors, alleging that defendants' false
statements regarding expected future (FDA) approval of a new asthmatic spray device artificially
inflated price of stock.
 Issue: Is the 9th Circuit statement of Loss Causation Accurate.
NO
 Holdings: The Supreme Court, Justice Breyer, held that:
• an investor may not establish loss causation by
alleging that security price was inflated because of misrepresentation, and
• investor’s allegations were insufficient to state fraud
claim.
 Analysis: The Ninth Circuit held that a plaintiff can satisfy the
loss causation requirement simply by alleging that a security's price at the time of purchase was
inflated because of the misrepresentation, Ninth Circuit's approach would allow recovery where a
misrepresentation leads to an inflated purchase price, but does not proximately cause any economic
loss.
 An inflated purchase price will not by itself constitute or
proximately cause the relevant economic loss needed to allege and prove “loss causation.”
• First, as a matter of pure logic, the moment the transaction takes place, the
plaintiff has suffered no loss because the inflated purchase price is offset by ownership
of a share that possesses equivalent value at that instant.
• And the logical link between the inflated purchase price and any later economic
loss is not invariably strong, since other factors may affect the price.
 Holding: Thus, the most logic alone permits this Court to say
is that the inflated purchase price suggests that misrepresentation “touches upon” a later economic loss,
as the Ninth Circuit found. However, to touch upon a loss is not to cause a loss,. The Ninth
Circuit's holding also is not supported by precedent. The common-law deceit and
misrepresentation actions that private securities fraud actions resemble require a plaintiff to
show not only that had he known the truth he would not have acted, but also that he suffered
actual economic loss. The complaint's failure to claim that Dura's share price fell significantly
after the truth became known suggests that the plaintiffs considered the allegation of purchase
price inflation alone sufficient. The complaint contains nothing that suggests otherwise.
o Burkie says the problem with this case
seems to be that ???
o Dupuy v. Dupuy (Federal 10b-5)
 Facts: Defendant was trying to get his brother to sell his
shares of the company at a deep discount, so he called him up and asked for the shares. He told him a

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 project was stalled, and kept secret that he had sold land for a ton of money. Tried to defend on the
fact that the telephone calls weren’t interstate commerce.
 Issue: What involvement of interstate commerce is
required to have a 10b-5 claim?
 Holding: Court found that intrastate use of a telephone is
enough to constitute interstate commerce, and grant federal jurisdiction over the cause of action.
Also it went through the banking system which involves commerce
 Note - 10b-5 actions can be brought by a buying or selling
defrauded S/H – the S/H does not have to be involved in the mgmt of the company.
 It is not hard to find enough of a interstate connection to
bring a 10b-5 action.
o Goodwin v. Agassiz (MA) - (prior to 10b-5).
 Facts: Plaintiff sold stock in a mining co. on a public
exchange, and it turned out that the defendant, who was a director of the mining company, bought the
shares. Director bought shares b/c he was aware that the co. was buying land that was rich in copper
deposits. Co. essentially stopped all mining activities in Michigan – b/c they would be able to get the
land cheaper. There was no communication between plaintiff and defendant b/c the trades were done
on the open market.
 Plaintiff did not sue for buying with inside information but
rather for failing to disclose material, the information that had he known, would he would have not
sold his shares.
 Classic Case – facts are identical to Texas Gulf Sulfur Case
 Issue: Do directors have a duty to their shareholders when
buying their stock?
 Holding: Court said that the fiduciary duty of directors runs to
stockholders, but generally a director has no common law duty to disclose inside information
when buying or selling stock.
 Exception:
• Where a director personally seeks a stockholder for
the purpose of buying his shares without making disclosure of material facts in his
knowledge that the stockholder can’t get from other available information, then relief may
be granted to the stockholder.
o In this situation, it was clearly an arms-
length transaction on an open market, so there was no breach of fiduciary duty to
disclose. In addition, there was no representation here. The court found no grounds
for inferring fraud or conspiracy.
o If it had been a face to face transaction, the
result might have been different.
• Court also took into consideration that the P in this
case is a stockholder who has particular knowledge of this kind of injury (he was
sophisticated).
 Note that this duty only arises from one who receives his
information because of his position as an insider
 Also note that this duty only runs to shareholders, so it
only exists on the buy side (unless the buyer already has some stock).
o Jacobson v. Yaschik (SC) (1967)
 Facts: Plaintiff owned ¼ of the stock in a Charleston
corporation, Defendant owned the remaining ¾. D bought Ps shares for $30K, but didn’t tell the P that
he had entered into a contract to sell all of his shares for much more, and he shorted her about 20%.
 Court stated 2 rules
• Majority (Goodwin Rule): there is no duty for a
director to volunteer inside information when buying stock from a shareholder.

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 o “Special Facts” Exception: The exception is when the insider has
knowledge of “special facts” (facts not available on the books that enhance the value
of the stock) that are not known to the shareholder, in which case he must disclose.
• Minority Rule (adopted by SC): Officers and
directors stand in a fiduciary relationship with shareholders and regardless of special facts,
the fiduciary duty requires full disclosure of all relevant facts when purchasing from a
stockholder.
o Key Language from the Case: The duty to
disclose may be reduced to 3 distinct classes:
 where it arises from a preexisting
definite fiduciary relation between the parties;
 where one party expressly
reposes a trust and confidence in the other with reference to the
particular transaction in question, or else from the circumstances of the
case, the nature of their dealings, or their position towards each other, such
a trust and confidence in the particular case is necessarily implied;
 where the very contract or
transaction itself, in its essential nature, is intrinsically fiduciary and
necessarily calls for perfect good faith and full disclosure without regard to
any particular intention of the parties.
 Election of remedies: plaintiff can choose whether they
want equitable or legal remedies. The problem is that the P might not know what they can
prove. The courts generally force the plaintiff to make the election pretty darn early.
 SC Rule, unlike Goodwin, probably applies on buy and sell
side
o Problems – Page 540-41:
 Under the Goodwin rule, a person that accidentally overhears insider information does
not presumably does not have a duty to disclose b/c there is no fiduciary duty – probably safe under SC rule
too. Under Goodwin, the P loses. In SC, it is questionable whether it fits within the 3 classes of the duty of
disclosure.
 These problems are easier to answer in SC because almost all of the answers in SC would
be to pay up.
o SEC v. Texas Gulf Sulfur (Federal 10b-5)
 Facts: Defendant found a huge mineral deposit in Canada.
Kept it quiet for a while in order to buy land on which to dig. A director, some employees, and their
“tippees” bought stock. When the news broke, the stock went nuts. SEC brought a 10b-5 against
defendant and directors. SEC alleged that defendants had bought on material inside information, and
that defendants had tipped others for use in buying stock.
 A call option is a contractual right to purchase stock at a
specified price in the future. If the stock doesn’t go up in value, then the call is worthless.
 The nature of the investments in this case are key – the
fact that they purchased call options is indicative that they knew the stock was going to rise.
 Rule on Insider Trading: Directors with insider information
that is MATERIAL must either disclose the info to general public or abstain from trading in the
securities until disclosure is possible:
 The general rule under 10b-5 is that anyone trading for
themselves who has direct or indirect access to information intended to be used only by the corporation
knowing that the person they are trading with doesn’t have the information is precluded from doing so.
 Material Test (insider info): balancing of the probability
the event will occur with the magnitude of the event. The basic test of materiality is whether a
reasonable man would attach importance in determining his choice of action in the transaction in
question. When it is material, the people entrusted with the corporate information must either disclose
or refrain from trading.

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  Holding: Information was material and omission/non-
disclosure of the material facts prior to trading was a violation of 10b-5(3). 10b-5(3) makes is
unlawful to “engage in any act, practice, or course of business which operates or would operate as a
fraud or deceit upon any person in connection with the purchase or sale of any security.”
 The court also found that the tipper in this case was just as
liable for any transactions that his tippees were involved in.
 If all of the guys in this case are liable then what do you do as
a corporate officer if you want to purchase stock in your company.
• Co’s can have pre-existing stock options and
employee purchase plans
• You can’t buy stock immediately preceding the
occurrence of a major corporate event.
 Rule: because this was not an action by a stockholder to
recover but instead an action by the SEC against insider trading by a director, there was no need to
show causation (transaction or loss).
Notes
• One issue is when can insider’s buy stock in the company (which is something we want so they
have a personal stake in the company)
o One method is to have a set amt of stock to be bought by them each month
o Others allow them to buy after a public disclosure, but that they have to wait a reasonable
amt of time for the info to fully disseminate and act
• Mr. Dark is also focused on here
o He was the one who tipped of the tippees, which also makes him liable
o One question is whether he is also liable for the amounts that these tippees made – but
not sure
• Damages
o Courts have held that the wrongdoers have a duty to cover the amt that the seller missed
out on
Questions
2– no liability under Common law or Goodwin.
a. Under Jacobson, yes he would be liable – fid duty to share holder
Reread note 6
• Be sure that you do not give insider information that you obtain as a lawyer to your friends
o Chiarella v. United States (Federal 10b-5)
 Facts: Chiarella worked at a print shop that published merger
materials. He was smart enough to piece together the inside information and invest and make some
quick money. US indicted him for violation of 10b-5.
 The court stated the general rule that a corporate insider must
abstain from trading in shares of his corporation unless he has disclosed all material inside information
known to him. However, the duty arises from the fiduciary duty to the shareholders, so doesn’t run to
Chiarella.
 Rule: The court held that, absent a pre-existing duty to the
shareholders, Chiarella committed no fraud, and as such did not violate 10b-5. NO criminal
violation.
• But in Cady the court held that a corporate insider couldn’t trade in its own
stocks unless it disclosed
o So if you work for the company, you have a duty to disclose al material
info that you learn about because of your position as an insider before buying or selling
stock in that company
o There is special relationship between the insider and shareholders of his
corp
 So the fid duty creates a duty to disclose

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 • But if there is not a fiduciary relationship, then you would have to make an
actual misrepresentation to commit fraud. Mere silence would not be a fraud without a relationship
that creates a duty to disclose
• Therefore the ∆ did not violation 10b-5 or common law fraud because he had no
duty to the shareholders that would require him to disclose
 Dissent wants to extend the duty to include people who have
misappropriated nonpublic information – he suggests we focus on the way in which the buyer
acquires the information which he conceals from the vendor should be a material circumstance.
 The majority says that they disagree b/c the jury wasn’t
properly charged on that theory. They don’t necessarily say that they disagree with the theory.
Notes
o The holding in Chiarella is said to espouse the “Classical theory” of insider trading
o Note – SEC 14e-3(a) makes it unlawful to trade on material nonpublic information concerning a
tender offer
o Chiarella is probably consistent with the special facts doctrine (ie fid duty)
o Dirks v. SEC (Federal 10b-5)
 Facts: Dirks was a broker, and got a tip from someone at
Equity Funding that they were overstating revenue. He investigated and decided it was true. He
couldn’t get any of the newspapers to print it, but he did tell his clients. SEC brought him up on a 10b-
5, and tried to assign liability to him as a “tippee.”
o ∆ worked for a broker-dealer firm and specialized in analyising insurance companies
o A former officer of Equity Funding of America told him the company’s assets were overstated
because of fraud and asked him to investigate
o Some evidence corroborated the story. ∆ had no stock in the company, but he dicussed his finding
with his investors, who sold their stock = 16 million
o Equity eventually got caught and the SEC investigated Dirks
o SEC found that Dirks violated 10b-5 by giving the info to investors = tippees
o Dirks really both a tipper and a tippee, but this opinion focuses on his role as a tippee
o Where tippees—regardless of their motivation or occupation—come into possession of material
corporate information that they know is confidential and know or should know came from a
corporate insider they must either publicly disclose that info or refrain from trading
 Issue: When will a tippee be liable under 10b-5?
 Unlike insiders who have independent fiduciary duties to both
the corporation and its shareholders, the typical tippee has no such relationships.
 Tippee responsibility must be related back to insider
responsibility by a necessary finding that the tippee knew the information was given to him in breach
of a duty by a person having a special relationship to the issue not to disclose the information. In
determining whether a tippee is under an obligation to disclose or abstain, it thus is necessary to
determine whether the insider’s tip constituted a breach of the insider’s fiduciary duty. The tippee is
liable when the tippee:
• Receives the information improperly.
o It comes from an insider in breach of his
fiduciary duty to the shareholders - there has to be some type of improper
behavior on the part of the tipper and the tippee must know about it AND
o The insider received a personal benefit
from the disclosure (benefit is required to show the breach). The test is whether the
insider will benefit directly or indirectly from his disclosure.
 Some type of financial benefit
 The elements of fiduciary duty and
exploitation of nonpublic information also exist when an insider makes a
gift of confidential information to a trading relative or friend
 Reputational benefits that will
transfer into future earnings

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 • OR the tippee could also have entered into a special
confidential relationship with the business and are given the information solely in regard to
that relationship. This type of tippee carries the same insider duty. Sometimes the tippee
will not be treated as a tippee but will instead be treated as an insider. “Under certain
circumstances, such as where corporate information is revealed legitimately to an underwriter,
accountant, lawyer, or consultant working for the corporation, these outsiders may become
fiduciaries of the shareholders. The basis for recognizing this fiduciary duty is not simply that
such persons acquired nonpublic corporate information, but rather that they have entered into
a special confidential relationship in the conduct of business with the enterprise and are given
access to information solely for corporate purposes.”
 Holding: Dirks is not an insider. So he can’t be liable on that
theory AND the tipper received no personal benefit so Dirks did not receive the information
improperly.
Notes
o Doesn’t matter that insider was a former officer in this case because he obtained the info while he was
still serving as an officer and had a duty to the shareholders
o There can be temporary insiders
o Such as a lawyer or accountant working for the company – these people will have a Cady duty
o They will be treated as a tipper not a tippee – ie as an insider, and the rules will be stricter
o But they wont be liable if all they do is assist another insider
o US v. O’Hagan (Federal 10b-5)
 Facts: D was a partner in a law firm hired by Grand Met to
help acquire Pillsbury. D didn’t work on the case. He bought Pillsbury stock and made a shit ton of
cash. He was indicted for criminal violation of 10b-5.
o ∆ worked with a law firm in Minneapolis. His firm was retained by Grand Met to negotiated a tender
offer to acquire Pillsbury Co.
o ∆ didn’t work directly on the matter, but he learned of it and bought stock and stock options in
Pillsbury
o After the acquisition, ∆ sold his stock for a profit of 4.3K
o Charged with 17 counts of securities fraud under 10b-5
o Side issue, ∆ used some of the profits to replenish client trust fund that he has converted money
from
o Trial court found him guilty, app crt. Reversed. SC found him guilty and adopts the
misappropriation theory
o Classical Theory of insider trading also applies to attorneys
o But this theory doesn’t apply in this case because he wasn’t an insider since he didn’t work for
Pillsbury Co. He worked for Grand Met. So he owes no fid duty to the Pillsbury shareholders
o So classical theory applies only if you use inside info that you learn from your company to trade in
shares of your company
 There is a theme running through the text that we shouldn’t
assume 10b-5 is the only thing out there, there are other ways for the SEC to prosecute the case.
 Misappropriation Doctrine: when someone
misappropriates confidential information for securities trading purposes in breach of a duty
owed to the source of the information. Under this theory, a fiduciary’s undisclosed, self-serving
use of a principal’s information to purchase or sell securities, in breach of a duty of loyalty and
confidentiality, defrauds the principal of the exclusive use of that information. The
misappropriation theory is thus designed to protect the integrity of the securities markets against
abuses by outsiders to a corporation who have access to confidential information that will affect the
corporation’s security price when revealed, but who owe no fiduciary or other duty to that
corporation’s shareholders.
 So there must be a duty owed to source by the
• “Outsider”
• who has access to
• Material confidential information

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 • If someone receives this information, they can defeat
the misappropriation theory by disclosing to the person that gave them the info that they
are about to trade on it (then there is no deception)
 Of course, as soon as you make that statement, you have the proof for common law fraud
(Burkhard says this is not true…you would be fired and the law firm would stop you
from doing it, but it would not be common law fraud according to him). The fraud is
consummated, not when the fiduciary gains the confidential information, but when,
without disclosure to his principal, he uses the information to purchase or sell securities.
 The Court also focuses on the fact that deception is a fundamental notion of 10b-5.
o Court holds that misappropriation theory falls under 10b-5(1) – “conduct involving a deceptive device
or contrivance used in connection with the purchase or sale of securities” But breach of duty isnt
enough. There must be a deceptive act – there is one case where the outsider stole from the company
but no 10b-5 violation because the docs they used said they were stealing
o Deception found in fact that ∆ took information the company trusted him with and used to to make
a profit
 O’Hagan is not liable under a misappropriation theory b/c
he bought the shares of the target, not his client, so there was no pre-existing duty against
misappropriation.
 Holding: Hagan is liable under 10b-5- “classic” insider
trading is when a corporate insider trades on the basis of material nonpublic information, and this
qualifies as a “deceptive device” under 10b-5. This was not classic insider trading because he had no
affiliation with Pillsbury. However, he violated the trust and confidence of his employer.
 10(b)(5)(2) – SEC attempt to define when there is a fiduciary
relationship, that if breached in a securities violation, there is a 10b-5 violation. This new rule creates
a fiduciary relationship when a person receives or obtains material, non-public information from
his/her spouse, parent, child, or sibling. However, there can be circumstances when that doesn’t apply.
If the communication is intra-family, that information is supposed to remain confidential.
o Deception is Important
o If youd used the CL rule of a trustee relationship, then the ∆ would need consent to use the
property entrusted to him
o Under misappropriation theory or 10b-5, all you need is disclosure to be able to use the info
o Court is adopting narrower sense of misappropriation theory – the disclosure need only be
made to the source – here his law firm and Grand Met- this is different than the
misappropriation theory advanced by Burger in Chiarella, which would require disclosure
to the market
o SO 10b-5 isn’t violated if the outsider discloses to the source that he plans on trading on the
nonpublic information
 But your gona get fired and stopped from doing it
o The source of the information does not have to be involved in the transaction because the fraud occurs
when he uses the info, not when he obtains it – this is important because the fraud must be “in
connection with the purchase or sale of stock”
o 10b-5 says it applies to fraud connected with any sale or purchase. Not to the defrauding of any
seller or purchaser – so the fraud need only attach to the act, not the seller or purchaser involved in
the trade
o Remember that 10b-5 comes into play only if the ∆ uses the info to trade stocks
o Finally says that misappropriation was not rejected in Chiarella because the argument was never
submitted
 Questions on p. 578:
• Chiarella would be held to have violated 10b-5 after O’Hagan because he had a
relationship of trust and confidence with his employer.
• Burger’s misappropriation theory is different from the misappropriation in
O’Hagan because in O’Hagan, the disclosure obligation runs to the source of the information as
opposed to Burger’s reading that the disclosure obligation ran to those with whom the
misappropriator trades.

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 • FN 6 suggests that the shareholders of Pillsbury would not have a private cause
of action.
• O’Hagan could have been charged as a temporary insider under Chiarella fn#14
if Pillsbury knew that they were going to try to buy them, but in this case they didn’t know so
fn#14 wouldn’t apply.
o Reliance v. Emerson (covered at end of semester)
 16(b) of the Securities Act requires an owner to pay back money to the corporation
because it assumes you have used inside information (has something to do about within 6 months- look this
up). The question is who is a beneficial owner. That is what the case is all about. The statute talks about
being a 10% shareholder at the time of purchase and at the time of sale. The problem presented in this case
is that Emerson Electric acquired 13% of Dodge Manufacturing. The problem was that Reliance Electric
came along and made a better deal. The question is whether Emerson has to pay profits back. Yes. So
they tried to take advantage by selling stock to reduce their holdings to 9.96%. The argument is that the
second sale that would occur shortly thereafter wouldn’t be covered because they would no longer be a10%
shareholder so they wouldn’t have to pay back the company. Reliance said that doesn’t work so you owe
us the balance on all of it.
 The Supreme Court said that the lawyers for Emerson are correct and you don’t link the
two transactions together. Therefore, the profits on the second sale did not have to be paid back to the
company.
o §16B – if you own 10% or more of a public company and buy stock and sell it within 6 months the
corporation will be able to recover the profit you make
o You don’t link two sells together if there is a difference of time and buyer
o Purpose is to prevent insider trading
o Must own the 10% both at purchase and at sell, otherwise you wont be a “beneficial owner” and the act
ownt apply
o The company only gets the profit – so if you by at $10 and sell at 20 – the company only gets $10 a
share
o Government only looks at the difference, so even if you loose money, you stilll have to pay the
difference – see number 3 page 585 – he made 1 million
 See problems on p. 584
o Bradley v. Hullander (SC)
 The buyers of this automobile dealership noticed the following things were wrong:
information in some of the financial statements was wrong, there were arguments that they hadn’t disclosed
changes in their accounting methods, there is an allegation that the offering document was
wrong/misleading
o Δ was given exclusive right of sale over corporate stock of Paul’s pntiac –Buick – a SC corp
o Π hired Glen Covey Associates to locate a dealership for them to buy. They met the Δ. And put
down 10,000 in earnest deposit
o Δ retained control of the dealership unitl closing of the stock purchase agreement
 At closing the Π paid an additional 55K
 And gave a note for 160K
o The total purchase price was 200k subject to any increase in value occuring between May 31
1974, and the takeover. There is always a gap between signing of K and closing – nothing
material is supposed to happen during this period
o Originally only 90K was to be paid at closing, but the additional 34K was added and was to be
used in opperating the business after the takeover at which time it would be paid to seller once the
total net worth of the business was determined
o After the Π took over, they had a CPA audit the corporation to determine the net worth and determine
how much it owed to Δ
o Brings suit under 62-309
 Which says it is unlawful to offer or sell securites by means of any untrue statement of
material fact or by omission
 The buyer does not have the BOP to show that he didn’t know the truth
o Buyer may sue in law or equity to recover consideration paid plus 6% interest per year

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o How would you go after these guys
o Fraud
o Breach of K
o 10b-5
o 35-1-509 / § 12 unser SEC
o Breach of warranty
o The first cause of action is to sue them for fraud and try to rescind the contract.
o I also might sue them for breach of contract.
o Could sue for negligent misrepresentation
o Could sue under 10b-5
o Might be able to sue under the Unfair Trade Practices Act
o Could sue under § 35-1-509 (which is what they did sue under in the case)
 There is an argument that this isn’t a security at this point because they were selling the
whole business, not a security. The courts today say that because you are buying the stock of the company
instead of the assets of the company, there would be no problem today bringing a security claim.
o But this doesn’t fly bc technically you are buying all the stock and the assets just come along with
it
 The opinion seems to say that everyone is interested in the company’s balance sheet so
that automatically becomes material information (automatically material to the transaction).
 See discussion of § 35-1-509 below (and additional discussion of differences below)
o The SC 35-1-509 at issue is taken from 12(2) of the Sec. Act of 1933 – I think the following applies
only to the SC statute though because there are some differences between the two as discussed below –
plus we looked at 10b-5 in class, not 12(2)
o To recover the Π must show
 The Δ misstated or omitted to state certain material facts,
 That such misstatements or omissions rendered the statements made misleading
 And that Π did not know the truth
o A material fact is a fact about which an average prudent investor ought reasonably to be informed
before purchasing the security
o Π DOES NOT have to show reliance, causation, or that the sale would not have occurred absent
the omission (ie transaction causation)
o Π’s sophistication in the securities and the availablity of the information to Π is immaterial
 And they do not have to show that they could have discovered the falsity upon reaonable
investigation
o Δ violates 12(2) by mere negligent misreps or ommissions
o And BOP is on seller to show that he was not negligent or reckless or acted intentionally
o SO under 12(2) all the Δ has to show is that there was a material misreprestnation. The Δ will then
have to show that he didn’t act negligently
o As to Culpablity what is the difference between 35-1-509 and 10b-5
o In SC you need only be negligent
o In 10b-5 you need to be reckless
o How about a due diligence defense
o SC allows this – ie that Π didn’t use due dilligence in finding out the truth
o Not clear if 10b-5 would allow this
 In SC negligence is enough for culpability but under 10b-5 you have to be at least
reckless. That is why you would bring an action under 509 instead of 10b-5.
 In SC you don’t have to show reliance. Under 10b-5 you have to show loss causation and
transaction causation.
 In SC, you bring a 509 claim in state court. You would bring a 10b-5 claim in federal
court.
 Should the sellers be responsible for the prospectus (offering document) that they did not
prepare? Yes…if the accounting firm only used information that the sellers gave them. If the accounting

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 firm/broker generated these on their own, it is a very difficult agency question to answer (unclear whether
the sellers would be liable).
 “Section 12(2) does not require that plaintiffs show reliance, causation or that the sale
would not have occurred absent the omission.”
Biales v. Young
o Δ negotiated a 275K loan from Π for use in a Garden City Resort
o Gwin served as Δ’s atty
o Loan secured by promissory note and a second mortgage in the units. Also the Π received 2% equity
participation in Litchfield plantation once the Δ bought it
o Gwin was to hold the loan in escrow until the plantation was purchased
o But Gwin says he didn’t know he was to act as escrow and distributed the funds directly to the Δ
o Gwin gave notice to the Π that he had distributed the money and Π did not respond
o Δ never bought Litchfield and eventually went into bankruptcy after spending the money
o Π claims Gwin breached his fid duty as escrow and violated SC Uniform Sec Act
o Trial court found no breach because of waiver
o And that no violation of Sec Act because Gwin was not a seller
o Sec Act Violation
o 35-1-1490(2) “ Any person who: Offers or sells a security . . . (same language as above)
o An offer or offer to sell includes every attempt or offer to dispose of or soliciation of an offer to
buy a security or interest in a security value.
o A sale includes every K of sale of or disposition of a security or interest in a security value
o Pinter Test:
o A person who offers or sells is not limited to the owner of the sec. but they must
 Solicit the purchase
 And be motivated at least in part by a desire to serve his own financial interest or that of
the owner of the security (ie a broker)
o SO you don’t have to have Privity to come under the act, but you must try and sell it
o Gwin did not offer or solicit an offer nor did he pass title
o Thus there was no offer or sale = no violation
o Clearwater v. Bunting (SC – 10b-5/501)
 Facts: S/H were trust beneficiaries who relied on one of the
officer, Bunting’s, statements that they were not going to merge in deciding to sell their stock back to
the corporation. They lost $1.3 million because they didn’t wait to sell the stock after the merge.
 Issue: Why wasn’t this a classic 10b-5 case – why didn’t they
sue under 10b-5? – SOL problem.
 They also did not argue 35-1-509(c). Why not? This is a
recent amendment to the statute that did not exist at the time this transaction occurred.
 2 Basic claims:
• Claim #1:
o 1) Misrepresented the status of the company,
2) Breached his fiduciary duty of disclosure, or
o it is a violation under the S.C. equivalent to
10b-5? – all the same claim.
• 35-1-501 – however at the time of this case the law
was clear that there was no private cause of action; this was enacted after the case was
decided
o SC - Now by legislative enactment there is
a 10b-5 private cause of action in SC, but at the time of this case there wasn’t.
• The plaintiff tried to argue that certain amendments
created a private cause of action…the court says no go!
• The plaintiffs argue that he had a dual role as a
shareholder (as well as an officer) because the officer SOL had already run out, but another
SOL hadn’t run out.

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 • This opinion indicates that the reporter’s comments
involving the code sections dealing with directors and one involved dealing with officers.
o 33-8-300 – BJR - General Standard for
Directors: the comments then clearly indicate that the legal principle of a direct
duty to S/H was retained in SC.
 Scary result for the court to say
the ONLY fiduciary duties to a S/H are the ones read in the statute and
that all the common law duties are null and void.
• Holding: Any duty that Bunting had owed was
negated by the fact that the SOL had run – the code rules and the SOL had run – no chance of
a COA on common law duties. – Burkie says Incredible Result!!! – for better or worse.
• Claim #2: Insiders issued stock options to themselves
– they are able to buy the stock cheaply, so when the merger occurs they are getting a larger
share of the pie than anyone else
• Holding: The court throws this out saying this
should have been brought as a derivative suit and the guy brought it as a direct claim – the
injury is not to the Co. it is to the individual S/Hs who are bringing the lawsuit.
o Differences between SC 501 and 10b-5
 Jurisdiction:
• for 10b-5 to attach, all you need is interstate
commerce which is never a problem
• For 501 to attach, the offer must originate from SC.
 Standing to Sue:
• 10b-5 covers buyers and sellers of securities
• 501 only allows the buyers of the security to sue the
sellers
 Materiality
• About the same, although 501 talks about the average
prudent investor which may be a lower standard
 Culpability
• under both 10b-5 and 501 the seller must be reckless
in his omission or false statement
 Due diligence defense
• There is no defense to 10b-5
• 501 has the defense but you probably can’t prove it
 Plaintiff’s knowledge of the truth of the statement is a
defense in both cases
 Causation
• 10b-5 and 501 requires proof of causation
 Remedy
• 10b-5 private cause of action - doesn’t carry
attorney’s fees
• 501 – private cause of action thru 509 carries
o the security
o consideration paid
o interest
o attorney’s fees
o SC USA - Fraud & Liability Statutes
 35-1-301 – Registration of securities
 35-1-501 (Used to be 1490)–SC equiv to 10b-5 – Fraud –
• It us unlawful for a person, in connection with the
offer, sale, or purchase of a security, directly or indirectly,
• to employ a device, scheme, or artifice to defraud

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 • to make any untrue statement of a material fact or
• to omit to state a material fact necessary in order to
make the statements made, in the light of the circumstances under which they were made, not
misleading or
• to engage in an act, practice, or course of business
that operates or would operate as a fraud or deceit upon another person.
• 501 - places liability on a seller’s to buyers for
illegal or fraudulent sales or offers
• Court also said that that selling an entire dealership is
the same as selling a security
• Note the split – the US supreme court has said
that sale of a whole business is not a security
 35-1- 509 – Civil Liability- applies to buyers and sellers
• (b)A person is liable to the purchaser if the person
sells a security in violation of 301 or 501 or, by means of an untrue statement of a material
fact or an omission to state a material fact necessary to make the statement made, in
light of the circumstances under which it was made, not misleading , the purchaser not
knowing the untruth or omission and the seller not sustaining the burden of proof that
the seller did not know and, in the exercise of reasonable care, could not have know of the
untruth or omission.
o 501 violations in 509- only requires proof materiality; does not
require not loss or transaction causation, reliance.
o Standard is negligence
• (b)(2) Purchaser can recover You can also just sue
for damages r recover
o Consideration paid for the security + 6%
interest
o Costs and ATTORNEY’S FEES
o Minus any income received for the sale of
the security
• (g) – Aider and Abettor J/S liability –
o Person who indirectly or directly controls
person liable
o Manager, officer, director
o Individual who is an employee who
materially assists in the conduct – much narrower than the persons who used to be
liable (under the Uniform Act the language is “an individual associated with” which
opens up liability, but SC does not have this language)
o A person with actual knowledge that a
person is committing an act sufficient to violate § 501 and intentionally furthers the
violation becomes an aider and abettor and thus jointly and severally liable
• (j) – cause of action must be brought in three or five
years depending on which section is violated
• (m) – unless there is a specific statutory remedy
there isn’t anything else – purpose to cut off any implied private cause of action.
 Why would you want to bring a COA under 509b and not
501? Differences between 501 & 509:
• See Bradley case above for further discussion of
the differences between 509 and 10b-5
• There are no 501 cases in SC.
• Presumably all the jurisprudence that has grown up
around the federal cases will be applied in SC, but we don’t know if SC is going to adopt
fraud on market.

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 • 501 – requires the showing of scienter – but the
standard is recklessness or intentional.
• 509b – standard of conduct is negligence
• Causation is another critical difference
o 501 requires loss and transaction causation
be proved
o 509 – Bradley case - NEITHER loss nor
transaction causation need to be proved (at least under (c)). Essentially the only
thing that needs to be proved is materiality.
o Another thing that 509b does that the federal
statute does not do is clarify what the remedies are – there is not a private cause of
action under SC 501.
 Common law duty of selling shareholder.
 Looking at situations where a majority SH is made an offer and knows that a minority SH also wants
to sell
o Is there a duty to condition sell on the offeror also buying the minority share
 Also where the SH has two offerees- one that is higher, but from a buyer that will ruin the company,
and one that is lower but from someone who will help the company
o Nothing tells us what to do in the statutes
 Control Premium
o Extra amount a buyer will pay over the value of stock because that block will give him majority
control
o Some see this as a company assets but nothing requires the SH to actually demand it on the sale
 CL gives guidance to these issues
o DeBaun v. First Western Bank (CA) –Derivative Suit
 Plaintiff was a minority shareholder in a closely held corp. The majority shareholder
died, and the bank was the executor for his estate. The bank sold the shares to a guy who was
clearly a corporate looter, and they didn’t do any checks for outstanding judgments – they trusted
his reception at the Jonathan Club. The looter killed the company.
o Π brought a direct and a derivative action against the bank
 Case proceeded as a derivative action
 Trial court found that Bank liable for breach of duty owed as the majority shareholder to
the corporation it controlled
• Awarded 473,836
o Computed by adding 220K (value at time of transfer)
o Plus amt equal to anticipated after-tax earnings of the corporation of the
ensuing 10year period – and considering an 8% growth factor
o Also gave sum needed to defend against its creditors claim
 Rule: Duty of Goof Faith and Fairness encompasses an obligation of the controlling S/H
in possession of facts “such as to awaken suspicion and put a prudent man on his guard that a
potential buyer of his shares] may loot the corporation of its assets to pay for the shares
purchased”
o RULE – In any transaction where the control of the corporation is material, the controlling
majority SH must exercise good faith and fairness from the viewpoint of the corporation and those
interested therein
 This duty requires the controlling shareholder in possession of facts
 Such that awaken suspicion and put a prudent man on his guard
 That a potential buyer of his shares
 May loot the corporation
 To conduct a reasonable and adequate investigation of the buyer
 Rule: Selling S/H, in any transaction where the control of the corp is material, has a
Duty of Good Faith and Fairness- obligation to conduct a reasonable investigation of the

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 buyer and not to sell if he finds facts that would put a reasonable person on notice that the
buyer would loot the corp.
 In this case, the Bank clearly had the duty and breached. The court measured the
damages that the bank was to pay TO THE PLAINTIFFS (this was a derivative suit).
 Damages:
• pay the debts incurred during the looting
• pay S/H’s - their share of the value the corp would have had had it not been
looted
• Attorney’s fees – b/c the real party in interest here is the trust, so thus it is
appropriate to award atty fees.
 Goodwill factor and anticipated profits were properly added to the damages
• As was requiring Bank to pay off claims against Corporation by creditors
 Trial court found that Bank liable for breach of duty owed as the majority shareholder to
the corporation it controlled
• Awarded 473,836
o Computed by adding 220K (value at time of transfer)
o Plus amt equal to anticipated after-tax earnings of the corporation of the
ensuing 10year period – and considering an 8% growth factor
o Also gave sum needed to defend against its creditors claim
 Is this overkill?
• Why does he have to put the company back to 100% of where it was when the Π
only owned 30%
o The other 70% goes back into the trust that the bank was presiding over
for the family of the maj. Share holder
 If this had been a direct suit by just Debaun, presumably the remedy would have been
much more limited
 How does the Lawyer help them investigate –
• Pull a Dun & Bradstreet report on the buyer.
• Bank references – ask for Certified Financial Statements if they are available –
• Internet Search
o (It could be malpractice not to do this).
o Perlman v. Feldman – Case is in every Corporate Text, has not been followed but the
language in the opinion is important to think about.
 37% shareholder of a publicly traded steel company sold his shares to a steel company
that wanted to guarantee supply during tight markets. Shareholder got a premium for the
controlling share.
o Minority SH bring derivative suit against ∆ for damages incurred from his sale of his controlling
interest in Newport Steel Corp
 ∆ was also CEO and President
o Π claim along with shares, the ∆ sold a corporate asset- a power held in trust by the majority
shareholder to control the corporate product in a time of scarcity- this was transferred by the ∆ act
of resigning his old board upon the sale, which allowed the buyer to elect its own board
 So he didn’t just sell his shares, he agreed to allow the buyer to replace the entire existing
board
 You don’t have to have 51% to control, it can be a lot less – ie here it is only 30%
• If you can transfer control with your block of share, you will get paid more
o Π claims that the minority SH should get a cut of the consideration given for this “power” – ie the
Control Premium – the amt given in excess of the value of the shares in exchange for the control
those shares confer
 Trial court said such a right doesn’t exist and that majority shareholder is free to act in his
own best interest absent a threat that the buyer will loot the company
 Also says Π failed to show inadequate consideration was given
o What did he do wrong according to Π

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  Sold control shares for a premium – ie more than what anyone else could sell theirs for
 Corporate opportunity – ie missing out on building business relations with other
purchasers during this time of scarcity because they sold to a purchaser (and he got a
premium)
• But the flip side is that the purchaser will be buying from them
 Loss of Feldman Plan
• Way to get money – they couldn’t up the price of steel because we were at war
and needed it. but they could get these loans in exchange for selling them steal
• Counter is that the purchaser is going to improve the company itself because it
wants as much steel as possible
 Another issue was that there was another buyer who offred to pay a premium as well, but
it would have gone to all the shareholders rather than just the him
o Book value of stock was 17.03 – but it was selling for only 12 per share.
 The ∆ sold his block for 20 a share – so we see a control premium
o ∆ did have a fid duty (as a maj SH and as a director) to corp and to minority SH
 As a director his conduct is closely scrutinized, and he must not have allowed his
personal interest affect his business decisions
 He has this same duty as a majority SH becaue he selects the directors and thereby
assumes their liability
o This isn’t normally breach of fid duty
 But court is holding them to the “punctilio of an honor” standard
 So fact that ∆ took advantage of a favorable market situation is not consistent with the
undivided loyalty he should have for the corp and minority shareholders
 Here he has taken a corporate opportunity for himself
• The opportunity need not be absolute – as long as there was a possibility of
corporate gain, the Π are entitled to recover
o Here the possible gain was to get Feldmann plan funds – interest free advances from purchasers in
exchange for a promise to supply them with steel. These funds could have been used to improve
the corp
 However, because the ∆ sold his controlling shares, the buyer was able to make the Corp
a supplier for only itself – thus limiting it opportunity to grow = lost corporate
opportunity
 ∆ had BOP to show that such opportunity did not exist, and it did not meat its burden
o Court not saying you can never sell majority shares to a buyer that has an interest in your product,
but that you cant do so if it results in sacrifice
 Rule: Majority shareholder has a fiduciary duty to the corporation and to minority
shareholders. The duty means he must exercise business judgment with respect to any
dealings that may affect the corporation, including selling his shares.
• BOP on D - D had to show fairness in the deal by proving that there was no
possibility that the company would do better under the Feldman plan
o fiduciaries always have the burden of proof in establishing the fairness
of their dealings with trust property.
 IN this case the sale meant the company would no longer operate the Feldman plan,
where he used tight markets to secure interest free loans to expand the business.
 3 Theories of what he did wrong in this case:
• Sale of Control and the receipt of a premium for that share is wrong – can’t
usurp control of that.
• Usurped a corporate opp that belonged to the Co., the premium really
represents a corporate opportunity.
• Cessation of the Feldman plan. – See above. –
o Although there is another argument that the buyer themselves would
actually put in the case to improve the facilities.

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  Remedy is unusual in this case – the Court says even though it is a derivative suit – the
remedy/award goes straight to the minority S/H’s not the corporation b/c the extent that the
buyer should get any recover here they may still be in cahoots with Feldman - that they
couldn’t pay the proceeds of the suit back to the corporation, or the guy would probably just
re-loot the money
o Stock deals that stack the board
 This is when a majority shareholder sells his share along with an agreement that his
directors will quit, leaving room for the new guy to put his people in place immediately.
 The question is raised…aren’t you really selling your vote.
 Rule: sale of a true majority of stock can carry such a deal. Many courts say that lesser
shares can carry such a deal, and that deal can be enforceable.
 To whom can a shareholder sell
• Redemption and Equal Access
o Donahue v Rodd Electrotype (The Equal Access Rule) MA
 This case and the Wilkes case has been cited in shareholder
friendly jurisdictions – unlike those DE.
 Harry Rodd was the majority shareholder of Rodd electrotype.
He wanted to retire, so the company bought out his shares. Plaintiff wanted to be
bought out too, and the company denied her request. She sued the company to either
force Rodd to buy back his shares or to buy her out.
• Π claims this breached the majority SH’s fid duty to her has a minority
shareholder
o Ie that the majority shareholders were allowing corporate assets to be
distributed to the majority shareholders but not the minority
shareholders because it would only repurchase the majority
shareholders shares
• ∆ claims there is no right to equal opportunity for such purchases
 Equal Access Rule: Court said that in a closely held
corporation shareholders have a duty of utmost good faith and inherent fairness
obligation – similar to the heightened duty that partners have towards each
other.
• So, if a stockholder whose shares were purchased
was a member of the controlling group, the controlling shareholders
must extend the same offer to all other shareholders.
• So Court found that a close corporation is
essentially a partnership.
 Definition of a Close Corporation:
• a small number of stockholders
• no ready market for the corporate stock
• substantial majority stockholder participation in
management
 Court concludes that we apply partnership standards of fid duty when it’s a close
corporation as opposed to normal corporate standards
• The two are similar
• A close corporation is one where
o There is a small number of stockholders
o No ready market for the corporate stock
o Substantial majority stockholder participation in the management,
direction, and operations of the corporation
• Long opinion but basically says that SH in a close corporation depend on
confidence and trust of the other SH, and it is much more like a partnership, so
the same fiduciary duty applies
o Majority SH cannot “freeze-out” the minority SH

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  When the directors make self-serving decisions, the minority shareholders can bring
action as a violation of the directors fid duty to the corporation
• The problem is that when it comes to dividends and salaries, the BJR will
protect these decisions,
• SO when there is a freeze out, the minority SH must either suffer or seek a buyer
– this is a problem for minority SH in close corporations because there is no
market and he lacks ability to dissolve the company
o So they can only deal with the majority – which is the whole purpose of
the freezeout – ie to make them sell at an inadequate price
 This duty therefore requires majority SH in a close corporation to act in good faith when
entering into repurchase agreements – so if the repurchase agreement is with the majority
SH, the controlling SH mut cause the corporation to offer each stockholder an equal
opportunity to sell a ratable number of his shares to the corporation at identical price
 This concept applies to any situation where the majority SH acts to confer a benefit or
opportunity to the controlling group – there must be equal access to this opportunity for
the minority SH
 Court found that he did 2 things - utilized corporate assets in 2
ways - that were injurious to the minority S/H
• For a provision to market your own shares
• To provide access to corporate assets for your own
use
 Alternatives Remedies: Court found that this was a close
corp, and as such had two options.
• First, they could force Harry to buy back his shares,
or,
• They could buy all of the plaintiffs’ shares at the
price they paid Harry – which is the option the P wanted – they wanted
equal access.
 Note: this is a direct suit, although much of the language in the
case focuses on the derivative nature.
 Also, no one is contesting that the amount paid was invalid –
what is not contested is that the book value and the liquidating value is the same this
is never the case as a practical matter.
 This rule applies in SC??(see below where it says it doesn’t
apply)
o Shoaf v. Warlick – (SC)
 Facts: Owners of the coke bottling plant in Asheville wanted
to buy out the Anderson plant and they bought out the controlling S/H. The minority
S/H’s complained that the controlling S/H should not be able to get a premium on
his stock over and above the amount the minority S/Hs were going to get.
• Court said that the majority S/H has an absolute right to receive a
controlled premium for his stock
 SC Rejects Equal Access Rule: it’s not a breach of fiduciary
duty to sell a controlling share for a premium and not share the premium with the
rest of the shareholders – Favors Majority S/H.
• Opposite of Feldman Case
Notes
o Selling Fiduciary offices with the controlling interest
o Sells of controlling blocks of stock often include agreements that directors that
are friendly to the seller will resign
 =delivering a stacked board to the buyer
o Everyone agrees that sell of a true majority of the stock will make such deals
legit

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 o But for those sells of less than 50%, courts require that the buyer purchase
sufficient stock to give working control in view of the high dispersion of the remaining
shareholders
o Unlike Partnerships, there is no corporation law that requires the corporation to
repurchase stock from its shareholders
o BUT there is an “equal access rule” as developed in Donahue – this will only come up in
a close corporation because in a public one, there is a readily available market for the stock
• Buy-Sell agreements- Close Corporations
o The stockholders of a close corporation will usually agree to limit the transferability of shares in the
corporation. There are five principal techniques by which the transfer of shares in a closely held
corporation may be restricted:
o Right of first refusal
o First option at fixed price; price determined by the agreement
o Consent required for sale
o Buy back rights: enable it to buy back shares on the happening of certain events whether the
holder wants to sell or not
o Buy-sell agreements: corporation is obliged to go through with the purchase upon the happening
of the specified event
 Authors say that anytime you are involved in a small business, you should anticpate the Donahue typs of
problems and should set up a mechanism that allows the minority shareholder at some point to exit the
corporation – ie buy-sell agreements
o Every corporation should have one
o This is a contract that requires the corporation or the majority
shareholders to purchase shares in specified situations at a specified price
o 3 Requirements in a Buy-Sell Agreement
 What events triggers the sale
 What price will be paid for the stock
 How the stock purchase will be funded.
• Sinking fund – very uncommon
• life insurance – owners in the corporation will buy
these policies that will fund the repurchase of shares at certain events
o usually someone’s death
o sometimes at disability or retirement
o You have to worry about estate tax and
income tax -
o Majority of the buyouts are paid over time.
o Generally 4 types of Buy-Sell Agreements
 One way: Enables a 3rd party to buy shares of a dead or
departing owner.
• Tax rule: Usually the life insurance proceeds are not
subject to tax unless they are owned by the decedent.
 Cross purchase: obligates surviving owners to purchase a
deceased owner’s interest directly from the decedent’s heirs. All of the S/H would buy a % of the
stock at a certain time.
• If using life insurance proceeds for the buy-out then
there has to be many policies.
• Can shift control of the corporation so you have to be
careful.
 Entity or Stock Redemption: Each owner agrees to sell
back to the entity upon a triggering event, and the business agrees to purchase such interest.
• Requires less life insurance policies.
• Can shift control of the corporation so you have to be
careful.

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  Wait and see: Owner or estate is obligated to sell, but the
business is not obligated to buy. If any stock remains after the corporation and S/Hs have had the
opport. to exercise their options then the corp is required to purchase the remaining shares.
o Ways to value the business
 Goodwill multiplier
 Rate of return on assets
 Last five years’ average earnings
 Use of a capitalization factor
 2 book value methods
• Most common method is the combination book value
approach – establishes a value for the business based on its past and present financial position,
general economic conditions, book value and earnings.
 Rule: The parties must all agree as to the valuation
method and the value.
• Different prices depending on different triggering
events. (i.e. firing vs death)
• In your agreement you need some sort of method as
to deal with defining what constitutes “disability”
o SC - Buy-Sell agreements
o 33-6-270 – Restriction on Transfer or Registration of Shares or Other Securities - When the
company can place restrictions on a shareholder’s ability to sell his shares.
o Must be noted conspicuously on the stock certificate and the stockholder must have knowledge of
the restriction.
o A restriction on the transfer or registration of shares is authorized
 Make sure that you comply with the federal requirements for s corporations
 To maintain the corp’s status when it is dependent on the # or identity of its S/Hs.
 To preserve exemptions under Fed or state securities laws
 For any other reasonable purpose.
o One way, cross-purchase, entity/stock redemption, and wait and see all valid agreements
 A buy sell agreement can require the approval of the corp as long as the requirement is
not manifestly unreasonable
 A B/S agreement can prohibit the transfer of restricted shares to a designated class
of persons as long as it is not manifestly unreasonable..
o B/S agreements can include stock options or convertible securities.
o 33-18-103 – definition of close corporation
o Must contain a statement in the AI that it is a close corp
o Can be incorporated into the AI by amendment - must be approved by 2/3 of the S/H – of each
class
 If a S/H objects he or she has dissenter’s rights.
 33-18-109 – Close Corp - notice must be printed on shares.
“the rights of a S/H in a close corp may differ from those of a regular corp, the AI’s may restrict
transfer or affect voting rights –
• A S/H receiving notice of these restrictions is
bound to them and even if they did not receive notice if they have knowledge they are bound
to them.
• The notice required by this section satisfies all
requirements of this chapter and of section 33-6-270 that notice of share transfer restrictions
be given
 S/H may request these documents that indicate the restrictions
at any time upon the S/H written request and the corp must provide them.
 33-18-110 – Close Corp share transfer prohibitions –
limitations on ability to transfer stock, not sell stock.

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 • Start with the notion that you cannot transfer
stock of a statutory close corporation
• Can only not transfer shares except as permitted by
the AI’s.
o Exceptions – unless the AI provides
otherwise:
 Transfers within the corp to the
same class or series of shares
 Transfers to immediate family or to
a trust of which the beneficiaries are immediate family (most people don’t
like this and you can prevent it by putting a restriction in the articles)
 Transfers approved in writing by
all of the S/H’s
 Transfer to an executor upon death
or a trustee as a result of bankruptcy, insolvency or dissolution or similar
proceeding brought against the S/H
 Transfer b/c of a merger or share
exchange
 Transfer of a pledge for a loan or
collateral – as long as the pledge has not voting rights
 Transfers made after the corp
terminates as a close corp.
 33-18-120 – Close Corp Share transfers – Corp has 1st
Right of Refusal
• A S/H wishing to transfer his shares must first offer
them to the corporation by obtaining an offer for the shares for cash from a 3rd person who is
eligible to purchase the shares under 33-18-110(b). (Offer from the 3rd person must be in
writing and state all the specifics)
• The S/H must offer the corp to purchase the shares on
for the same price as offered by the 3rd person
• The corp has 40 days to call a S/H meeting and the
offer must be approved by a majority vote of the shares entitled to be case at the meeting.
• If the corp does not deliver acceptance to the offeree
within 75 days the offer is rejected. If the corp makes a counteroffer the S/H has 15 days to
accept the counteroffer or it is rejected. If the corp accepts the S/H’s offer or the S/H accepts
the Corps counteroffer the certificates must be delivered within 20 days.
• If the corp decides to purchase the shares it may
allocate them as it wants, but the remaining holders of the same class of shares are given the
first option to buy any remaining shares that have not been allocated.
• If the corp rejects the offer, the S/H has 120 days to
transfer his shares to the third person in accordance with the terms of his offer to the cop – 3rd
person must purchase ALL of the shares.
 33-18-130 – Close Corp - Attempted share transfer in
breach of prohibition.
• If a transferee received shares in violation of a
transfer prohibition that is not binding on the purchaser b/c he didn’t have notice, the corp has
the right to purchase the shares from the transferee for the same price he purchased them and
can specifically enforce this sale obligation
 33-18-140 – Close corp-if provided in articles, you can
force the co. to purchase of shares after death.
• If this provision is being added or deleted to the AI
by amendment it requires the 2/3 votes of each class of shares approval.

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 • If a S/H votes against the amendment he is entitled to
dissenter’s rights if the amendment would alter or modify his rights to have his shares
purchased.
• § 33-18-150 through 33-18-170 do not prohibit any
other agreement providing for the purchase of shares upon a shareholder’s death nor do they
prevent a shareholder from enforcing any remedy he has independently of these sections
 33-18-150 – Close Corp – If the estate of a S/H wants to
exercise his compulsory right to have the corp purchase the shares then it must provide this request to
the the corp via written notice within 120 days after death (Burkhard says this time period is way
too short cause no one will think of it that fast)
• Corp has to call a S/H meeting within 20 days of
receipt of notice and the vote to purchase requires a majority of S/H votes entitled to be cast at
the meeting. Corp must deliver a purchase offer to the person within 75 days after the effect
request notice accompanied by the corp’s financial statements. S/H must accept within 15
days.
o Problem is that the period is too short – in
SC they probably will not be able to close out the estate within that time period.
• If the price and terms of the compulsory purchase are
fixed in the AI’s then the corp is bound to these terms and if they do not uphold them then
they are in default and it is grounds for dissolution.
 33-18-160 – Close Corp - If the offer is rejected or no offer
is made then the person exercising the compulsory purchase may commence a court action to
compel purchase.
• Co must notify all of its S/H of the proceedings
• Court determines the fair value of the shares.
o Co. can show financial reasons why the
court should modify the value.
• Ct can order the corp to purchase shares or right to
have corp dissolved.
o Jordan v. Duff Phelps (Federal 10b-5) – Close Corporations.
 Facts: Plaintiff had purchased stock in a closely held corp
pursuant to an agreement that required him to sell it back if he quit or was fired. He left for
personal reasons and sold back his stock. He found out later that when he left the company was in the
final stages of negotiating a merger which would have shot his value through the roof. If he had
known, he would have delayed his decision to end his employment.
 Issue: Did the Co. have a duty to disclose the information or
the pending merger negotiations to Jordan before he cashed out on Dec 1, 83?
• Was the info material
• What was the date of the sale?
 Rule on Duty in Close Corporation: when an insider or the
corporation is buying stock, there is a duty to disclose material facts – S/H have a duty to each
other as in a partnership.
• The court said that you can contract this duty out
in the stock sale, but that didn’t happen here
o Page 632 – lists information about mergers and intentions of board that the Π clams are material and
that should have been disclosed at time he sold his shares
o ∆ claims that nothing after Nov. when the Π offered resignation had to be revealed
o Π also claims there was info before November that should have been disclosed
o When was the Sale
o Nov 16 - ∆ argues that resignation = irrevocable sale with differed delviery
 But court notes that ∆ agreed to value the stock at the Dec 31, 1983 date rather than the
1982 value, which suggests the sale may have been on the day of delviery

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  There is also a possiblity that Π could have revoked resignation, so couple this with
possiblity that jury could find the sale took place on the later date, and there may have
been a continued duty to disclose
o Note – court says that if the sale is found to be in Dec. then as a matter of law, the information is
material and had to be disclosed
o Was there even a duty
o ∆ claims that it had not affirmative duty to disclose this information
o Wrong – Close corporations have a duty to disclose material information when buying their own
stock – Jaceabson case in SC
o This is also analogous to the special facts doctrine which holds that principle insiders in closely
held firms may not buy stock from outsiders in person to person transactions without informing
them of new events that substantially affect the value of the stock – this doesn’t apply in SC
 Timing: the judge decided that the information became
material when they had structured the merger, and this was before his stock was valuated, so a jury
could have reasonably found that the defendant had a duty to disclose and breached that duty.
o Was the sale when he announced his retirement or when he got his
check? Court said could be date he announced retirement
o Was the withheld information up to that date material? Court said the
information was material when they were negotiating
 Problems w/bringing this as a 10b-5 claim: difficult to
show proper degree of
• Scienter
• Loss causation – Non-disclosure caused the stock
to rise
• Transaction causation – problem showing that the
non-disclosure caused Jordan to sell his stock.
 The Court also held that this was a close corporation – if
not the fiduciary duties of the shareholders would have changed a great deal.
Notes
o 2.1 wouldn’t do any good to say this is not a trade of securities – you cant modify out of it
o But maybe you can say that termination of employment does not create duty to disclose
o Berreman v. West Publishing (Minn) Close Corp - Common Law
Non-Disclosure Case
 Facts: Berreman was an executive at West and had a bunch of
stock. He decided to retire, and as part of the buy-sell agreement, West bought his shares. About 4
months later, West announced a merger that made the stock worth a lot more. At the time Berreman
retired, there had been no discussions, but the directors had started to think about a merger
 First, the court noted that although there were hundreds of
shareholders in West, it could still be considered a close corp because of the other close corp factors
(Donahue Case).
 Holding: West was a Close Corporation and as such the
shareholders owed one another a fiduciary duty as in a partnership – utmost duty of care –
which includes a duty to disclose material facts.
 Factors to Determine Close Corp:
• Lack of a public market
• Managerial role of West’s S/Hs
o West’s decision making was concentrated
in only a few individuals and the numerical structure should be analyzed from that
viewpoint.
• Rationale supports – b/c majority S/H of a close
corp can deny minority S/H income from their investment, minority s/h are in a
vulnerable position.
 Materiality Test - Failed

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 • Court used the reasonable shareholder standard from
Levinson to decide if it was material
• Probability Magnitude/Basic Test Applied:
probability at the time of retirement was too low to be overcome even by the large
magnitude of the transaction.
o West had made no decision to solicit bids
for the sale of West, much less initiated discussions with any potential buyers.
o 7th circuit has gone no further than to say a
corp’s decision to seek a buyer may be material.
 Burkie says this is a strange result, b/c most people would say
that the Board’s decision to consult with an IB firm and discuss financing alternatives would be
material to someone considering selling their stock – would be enough to meet the materiality test.
 One question is whether this case would have fared better
in Federal Court – 10b-5 claims are federal jurisdiction and common law non-disclosure claims
end up in state court.
o Corporate Endgames (Fundamental Changes to the Corp)
o Fundamental Changes- things the BOD cant change on it own
o Amendment to articles
o Dissolution
o Merger
o Sale of all the substantially all the assets
o Fundamental changes all follow the same pattern
o BOD has to recommend it
o Notice to SH
o Special meeting to vote
o If approved, sometimes SH that oppose it may have a right to force the corporation to buy them out
(Dissenting SH right of appraisal)
o Inform the state of the change by filing with Sec of State
o Sometimes there are events that the SH can trigger
o If SH approval is required, then a vote
o All these events require filing with Sec of state
o Voting schemes for these events can vary greatly depending on the event and the statutes also vary from state to
state
o By the time we take bar, SC requirements will be changed
o For nonfundamental decisions, you only need a majority of the votes that are cast
o This is the modern view
o But for fundamental decisions – the states vary – many require a higher number than for nonfundamental issues
 DISSOLUTION – Steps page 468
o Dissolution does not mean that the co. has ended
o Co goes into a wind-up mode.
o Must pay all debts bf giving any $ to S/H
o Creditors who are not paid during dissolution may seek to recover from S/H
o Notice of dissolution has to be filed with the Sec of State’s office – give creditors notice of their
right to be paid
o No document that the Co. can file to bring finality.
Dissolution
• Judicial dissolution – allowed when a SH establishes that those in control have acted in a manner that is
illegal, oppressive or fraudulent
• Voluntary Dissolution
o Follows scheme above – ie BOD approve it, SH vote, ect
• In both
o The corporation continues after dissolution for limited purpose of winding up
o Winding up includes

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  Collecting and liquidating assets and usig the proceeds to pay creditors
o Creditors must be paid in full before SH get anything
 If creditors not paid,, they can recover from SH to extent that they received money after
dissolution
o Notice filed in same records as articles
o Written notice shall be given to known claimants and publication may be used for unknown
Question page 648; see also p.649
• How much will it cost them dissolve when they owe 100K to creditors and assets are only worth 90k
o How do you get out of this mess. If you do it in the right way, there won’t be any personal
liability, so the SH won’t owe anything
o so what does the atty do
 follow the statute step by step to make sure it is done correctly
o 33-14-102 – Dissolution by the BOD and S/H – how they approve
o BOD must recommend the dissolution to the S/H unless it determines that b/c of a conflict of interest or
some other circumstance it should not make a recommendation and communicates the basis for its
determination to the S/H.
o If the holders of at least 10% of any class of voting shares of the corp propose dissolution, the BOD must
submit the proposal at the next meeting
o Dissolution must be approved by 2/3 of the S/H entitled to vote – unless the AI’s require a different
vote but it must be at least a majority.
o 33-14-103 –Articles of Dissolution
o After dissolution has been authorized co. may officially dissolve by delivering the articles of dissolution
to the Sec of State’s office – this will be the effective date of dissolution.
o 33-14-104 – Revocation of Dissolution
o Dissolution may be revoked within 120 days – must be authorized in the same manner it was approved
unless the authorization permitted revocation by the BOD alone.
o 33-14-105 – Effect of dissolution
o Dissolved Corp continues its corporate existence but may NOT carry on any business except as appropriate
to wind up and liquidate assets.
o 33-14-106 – Effect of known claims against the Corp
o Co must provide written notice of dissolution to creditors and claim of creditors may be cut off if they don’t
respond to notice of dissolution in time.
o If the Co. rejects a claim and the rejection gave the heads up on the 90 days deadline, a creditor only has 90
days to commence a proceeding.
o A claim does not mean contingent liability or events post dissolution.
o 33-14-107 – Effect of unknown claims – give notice one time in newspaper of general circulation with a
mailing address and the notice must state that claims must come forward within 5 years after the publication
date.
o A claim can be enforced against the corp’s undistributed assets or against a S/h of the dissolved corp, but
only to the extent of his pro-rata share or the amount he received from the co’s liquidation assets.
o 33-14-420 - If you have a corporation dissolved before 1999, no one can get any money from anyone connected
with the corporation.
o MERGERS - 70% of mergers are structured in order to cash out on minority shareholders.
o 70% of mergers are structured to cashout minority shareholders
o Surviving Corporation and Disappearing corporation (one that disappears after merger)
o Find out whether there the surviving corp assumes debts and liabilities of disappearing
o Stockholder protection (4 types)
o Sue the directors who approved the merger alleging breach of common law or statutory duty of care
 See 33-11-101
o Vote against the merger
o Assert the dissenting shareholder’s right of appraisal
 No state requires unanimous vote – but those that dissent may have right to be bought out at a “fair
value” as determined at a judicial appraisal process

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  Ex – A merges into B – merger agreement says A is work 3 million. SH owns 10%. Rather than
accepting the 300K that SH would get from the merger (which could be stock in B, other stock,
property or cash), he may assert the dissenting SH right of appraisal – the court could appraise A
at 5 million, so SH gets more
 But there are lots of requirements to get this
o Sue the directors who approved the merger alleging a breach of loyalty
o Question 1 page 649
o 33-11-106
 Holds that McDonalds as the surviving corporation would assume the debts of Bubba’s
 This applies to both secured and unsecured creditors
 Capel as a SH of Bubba’s is entitled only to what is provided in the merger agreement
• This could be shares in the survivor
• But more than likely it will be a cash buyout of your shares. The value of which will be in
the agreement
o Unless you are able to bring a dissenting shareholder right of appraisal action
o Often the SH does not want to be cashed out
o To do this, you have to bring it to a vote. So we look to 33-11-103 (e) and (f)
 This requires 2/3 votes – so Capel at 51% could have stopped the merger unless he got stock
o Triangular Merger
o M creates Newco. M transfers some shares into newco and Newco transfers all of its shares to M
o B then merges into Newco and the shareholders of B now own shares of M whereas M now owns all the
shares of B
o Purpose
o Don’t have to get approval of M’s shareholder (which you probably wont need anyway)
o You might not want B to be a part of M – there are more protections if you keep B as a subsidiary
o Question on 651 – see 33-11-101 and 103
o 33-11-101 – Definition of merger
 Sets forth what must be included in the plan of merger
o 33-11-102 – Share Exchange
 A corp may acquire all of the outstanding shares of one or more classes or series of another corp if
the BOD of each corp adopts and its shareholder, if required by 33-11-103, approve the change.
o 33-11-103 – Action on Plan - what is required for a merger to be approved –
 (a) Co. being acquired submits a plan of merger or share exchange to be approved by its S/Hs.
 (b) – For the plan to be approved the BOD must recommend the plan and the S/H entitled to vote
must approve the plan.
 (d) Corp must notify each S/H of the meeting, whether or not they are entitled to vote, and the
notify them that the purpose of the meeting is to vote on the merger or proposed plan.
 (e) – require 2/3 vote entitled to be cast on the plan (2/3 from each voting group).
 (f) the AIs can require a different vote but it must be at least a majority of the S/H of each voting
group entitled to vote on the merger.
 (g) Separate voting by voting groups is required if the plan of merger contains a proposed
amendment to the AI which would require action by separate voting groups under 33-10-104.
 (h)Vote of the surviving co’s S/H is NOT required if
• The AIs of the surviving corp will not be different
• If the increased shares (voting or participating) are not going to exceed 20% of the shares
of acquiring co pre-merger then a vote of the surviving S/H corp is required (if the
number of outstanding shares will go up by more than 20%, then the shareholders in
McDonalds also have to vote)
• See the statute for other circumstances
• The notion is that the shareholders of the surviving company normally do not vote on the
merger. Normally it is only the shareholders of the disappearing company who are
entitled to vote.
o 33-10-104 – voting on amendments by voting groups

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  Holders are entitled to vote as a separate group in the following circumstances…
o 33-11-104 – Merger of Subsidiary into Parent
 A parent corp owning at least 90% of the outstanding stock of the subsid. Corp may merge the sub
into itself without approval of the shareholders of the parent of sub,
 Articles of merger under this section may not contain amendments to the AI’s of the parent corp.
o 33-11-108 – Merger of parent into subsidiary
 A parent corp owning at least 90% of the outstanding stock of the subsid. may merge the into the
sub without approval of the shareholders of the parent of sub,
 Articles of merger under this section may not contain amendments to the AI’s of the sub corp
except for amendments under 33-10-102 by the BOD.
o 33-11-105 – Articles of Merger or Share Exchange
 Surviving or acquiring entity must deliver to Sec of State – a merger or S/E takes effect upon the
effective date of the articles of merger or S/E.
o 33-11-106 –Effect of Merger or Share Exchange
 Everything vests into the surviving corp
 Surviving Corp has all the liabilities of each party to the merger
• A proceeding pending against a party to a merger may be continued as if the merger did
not occur or the surviving entity may be substituted in the litigation.
 Former S/H are entitled only to rights provided in the articles of merger or dissenter’s rights
under Chapter 13.
o 33-11-107 – Merger or Share Exchange with Foreign Corp
o 5 Steps for all 4 Methods of Corporate Change:
o BOD approves the change
o BOD must notify the S/Hs and its recommendation of the fundamental change must be approved
o Special meeting of the S/H must be held, at which they vote on the deal. If it is approved the corp will go
thru the change.
o If the deal is approved the S/H who did not approved the change might have a right to force the corp to
buy them out
o Corp is usually required to inform the state of the fundamental change by filing a document with the sec of
state.
o Stockholder Protection – Rights of S/H who are unhappy with the fundamental corporate change
o Sue directors for breach of duty of due care.
o Vote against merger.
o Sue the directors for breach of duty of loyalty (see below in outline-green)
o Assert Dissenting shareholders’ right of appraisal –
o Chapter 13- “Dissenter’s Rights”
o Rule: If stock is traded on a public exchange, you can’t have dissenter’s rights.
o 33-13-101(3) – Definitions –
 (1) – Dissenter must own the shares before the corporate action, or the surviving or acquiring
corporate action by merger or share exchange of that issuer.
 (3) “Fair value” = With respect to a dissenter’s shares, the value immediately before the
effectuation of the corporate action to which the dissenting shareholder objects, excluding any
appreciation or depreciation as a result of the action to which the dissenter objects. The
value of the shares is to be determined by techniques that are generally accepted in the financial
community.
o 33-13-102 – Right to Dissent
 A S/H is entitled to dissent from, and obtain payment of the fair value of, his shares in the
event of any of the following corporate actions:
• Merger
o Must have right to vote against merger (and thus have done so) in order to be
entitled to have right to dissent.
• Share Exchange
• Sale of Assets

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 • Amendment of the AIs that materially or adversely affects the rights in respect of a
dissenter’s shares
o Alters of abolishes a preferential right to the shares
o Modifies a right to redemption
o Modifies a preemptive right
o Modifies the voting rights of the shares
o Reduces the # of shares owned to a fractional amount if that amount is
to be acquired for cash.
• Any corporate action that the AI’s or bylaws provide a right to dissent
• Conversion or plan of conversion of the Co. into a LLC, GP or LP pursuant to
33-11-113
 (B) – no dissenter’s rights if the co. is publicly traded b/c theoretically you can share
your stock easily if you don’t like it
o 33-13-103 – Dissent by Nominees and Beneficial Owner
 Partial Dissent is ok by Record S/H– but must dissent as to all of the shares of a
beneficial owner
 Beneficial owners of shares may assert dissenter’s rights only as to all of the shares
they are the beneficial owner of –Must notify the corp in writing and include the contact info for
the record S/H.
o 33-13-200 – Notice of Dissenters Rights
 If it is an action that is going to trigger dissenter’s rights you must tell them at the first
available time – or meeting that this action will trigger dissenter’s rights. If the action is taken
without a vote of shareholders, the corporation shall notify in writing all shareholders entitled to
assert dissenter’s rights under Section 33-13-102.
o 33-13-210 – Notice of Intent to Demand Payment
 Person who wishes to assert dissenter’s rights must
• Give a written notice to the corp prior to the vote of his intent to demand pmt for his
shares
• Must NOT vote his shares in favor of the corp action (have to make a decision real
quick)
• A vote in favor of the corp action by the holder of a proxy solicited by the corp will
not disqualify a S/H from demanding pmt for his shares (? Statute doesn’t say this
and Burkhard didn’t mention)
o 33-13-220 – Dissenter’s Notice
 If a corp action is authorized at a S/H meeting corp must notify w/in 10 days S/H who
voted against it and satisfied their dissenter’s notice requisites under 33-13-210 and there is a
deadline for re-submitting the payment demand back to the corp.
o 33-13-230 – Shareholders’ Payment Demand –
 If the payment demand is not submitted in a timely fashion then S/H loses his right and
is not entitled to payment.
 If a S/H complies with the time requisites he is entitled to all other rights of a S/h until
these rights are canceled or modified by the taking of the corp action.
o 33-13-250 – Payment
 If you comply with the payment demand requisites as soon as the corp action is taken, co
must pay you the fair value of the stock plus interest, must be accompanied by an explanation of
how the fair value was calculated, certain co. financial statements, and a notice of what steps to
take if the S/H does not like the payment.
o 33-13-260 – Failure to take Corp Action
 If the co. does not take the corp action within 60 days after the date set for demanding payment,
the co. must return the share certificates and release the restrictions imposed.
o 33-13-280 – Procedure if shareholder dissatisfied with payment or offer

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  A dissenter may notify the corp in writing of his own estimate of the fair value of his shares
and demand pmt of his estimate or reject the corps offer if he believes that the amount paid is less
than the FMV or the interest was calculated incorrectly OR
 the corp fails to make pmt within 60 days after demand or fails to return the certificates after not
taking the corp action.
 If the dissenter does not notify the corp of his demand in writing within 30 days after the
corp makes the offer, he waives this right for additional pmt under this section
o 33-13-300 – Court Action – provision for the court to set the value.
 If demand for additional payment under 280 remains unsettled, the corp shall commence a
proceeding within 60 days after receiving the demand for additional payment and the court will
determine the FMV.
 If the corp does not do this w/in 60 days they must pay the dissenter the additional amount
requested
 Dissenter is only entitled to Ct’s determined amount if it exceeds the amount paid by the corp/
o 33-13-310 – Court Costs and Counsel fees
 The court shall assess the costs for the attys and appraisers against the corp except to the extent
the court can allocate part of the costs to the dissenter’s if the court finds that the dissenter’s
acted arbitrarily, vexatiously, or not in good faith in demanding pmt under 33-13-280.
o HMO-W v. SSM (WI) – Appraisal Case
o This was a Direct claim
o A bunch of corporations each formed a health care system (corporation), and each took a minority stake.
HMO-W was set to merge, but SSM didn’t want them to. SSM got a pre merger appraisal and it said the
business was worth $18M. The HMO Board approved the Merger and sent a proxy statement to the S/Hs.
When the merger was approved, SSM demanded appraisal. HMO-W went out and got a new appraiser and
found the value to be $7.4M. SSM was pissed, and sued. SSM’s expert said the value was $19M.
o Issue – Can “minority discounts” be applied to determine the fair value of the dissenter’s shares in an
appraisal proceeding –
 NO
 Minority Discount address the lack of control one the theory that non controlling shares of sotck
are not worth their proportionate share of the firms value because they lack power to control
corporate actions
 This is different from Marketability discount which address fact that there is a limited market for
shares in a close corporation (not addressed here)
o 2 Issues:
 Whether a minority discount may apply in determining the fair value of a dissenter’s shares
 Whether a court in making its fair value determination may consider evidence of unfair dealing
relating to the value of the dissenter’s shares. – Whether the S/H is entitled to bring an action for
breach of fiduciary duty?
 Rule: When appraising shares, two types of discounts commonly apply
• Minority discount: reduce value for lack of control of block of shares – non-controlling
shares of stock are not worth their proportionate share of the firm’s value b/c they lack
voting power to control corp. actions (they did apply this discount)
• Lack of marketability discount: reduce price for relative lack of liquidity of the shares
on the theory that there is a limited supply of potential buyers in a closely held
corporation (they didn’t apply this discount in this case)
 Rule on Minority Discounts: Court said that the intent of the dissenting shareholders rights were
to give the shareholders their proportion of the business, and as such a minority discount cannot be
applied.
• Are we valuing SSM stocks individually or are we valuing the business as a whole.
(SSM argues that you should value the entire business and give them their proportionate
share)
• Court agrees with SSM - Appraisal rights represent a legislative response to the
minority’s lack of corporate veto power and the consequential vulnerability to majority
oppression.

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 • To fail to accord a minority shareholder the full proportionate value of his shares imposes
a penalty for lack of control, and unfairly enriches the majority shareholders who may
reap a windfall from the appraisal process by cashing out a dissenting shareholder, a
clearly undesirable result. A dissenting shareholder is thus entitled to the proportionate
interest of his or her minority shares in the going concern of the entire company.
• SC about to amend the statute to say this!
o Rule: Consistent with the statutory purpose in granting dissenter’s rights, an
involuntary corporate change approved by the majority requires as a matter of
fairness that a dissenting s/h be compensated for the loss of the S/H
proportionate interest in the business as an entity.
 Rule on Considering Unfair Dealing in Valuation of Minority Shares: Evidence of unfair
dealing by the corporation when valuating shares can be considered in an appraisal proceeding.
• However, in this case getting an independent appraisal wasn’t enough to make the court
factor it in, so this argument was out.
 Court points out that the petitioners did not assert detrimental reliance.
 This is a very strange result b/c if the SSM shareholders had approved the merger to begin with
they would have received the higher amount, even though the court ruled that they had to be
paid the 16-18MM amount in the initial appraisal for their shares, the HMO S/Hs lost out b/c they
paid too high a price. This case demonstrates that trying to value a co. is not a precise science, and
it is a lot of guess work.
 The United shareholders appear to have been defrauded because they paid for the company based
on the first appraisal.
 Appraisers are Important: If we were representing any of these companies you would need to
know how your experts went about valuing the company.
 Tracing DSRA
• Arose to reconcile victimization of minority shareholders when states started allowing
majority consent for fundamental changes (use to be that there had to be unanimous vote,
so the minority shareholder had a veto power)
• Court concludes that applying such a discount frustrates the equitable purpose of DSRA –
so its not applied in appraisal
 Which Appraisal
• Π alleges unfair dealing, but didn’t claim breach of fid duty
o Ie that the corporation misrepresented the value on the proxy and then after vote
they were told its worth a lot less
• Appraisal is the only remedy for a dissenter absent fraud or breach of fid duty
o Π is trying to bring a claim for appraisal and for breach of duty – that the misrep
is wrongful and that they should get something for it
 But court says there are not two COA, there is only one
o States split on whether breach of fid duty and fraud must be brought as separate
action from appraisal
o This court doesn’t answer this question because it finds that unfair dealing goes
directly to appraisal
• However, the unfair dealing here didn’t change the value of the Π’s shares because the
inflated value was never accurate. Its not the same as if the ∆ had done something to
affect the true value – the misrep was of the Valuation, not the value – ie you just
miscounted the money, you didn’t take anyway
o Court finds the Π failed to show that the misrep was the but for cause of the
merger
 The didn’t rely on it because they didn’t vote for the merger, and they
asked for the appraisal
• The court is the sole body that determines the fair value, so the court was free to set the
value regardless of what the prior appraisals said
 Therefore the value adopted by the trial court is fine, but the minority discount should not be
subtracted from the Π’s shares

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 Appraisal Process in SC
• 33-13-101
o Fair Value – make sure you know it
• 102
o Right to Dissent
 Includes that an amendment to the articles could trigger rights
• Look at all the notice statutes as well
• Know all of the 33-13-200’s
o And 300s
 Its real easy to screw up as a minority SH if you are trying to bring a
DSRA
o SC is changing statute to say that minority discounts are not to be applied
o Woodside – Finance prof COC
 Used comparable companies analysis – of other co’s like Dillard’s – Ct rejected this method
 DCF analysis – court accepted this method but this is weird b/c essentially you use cash flows
from comparable companies like Dillards to run this model so it is essentially the same.
 Method of Valuation – Ct takes from the Santee Case: Apply DEe block method, which
entails looking at the net asset value, the market value, and the investment value, and then the
court weights each assessment based on the relative value to the evaluation
• Net asset value – the total assets minus liabilities
• Market value – what shares have sold for recently
• Investment Value of the Dissenting Stock
o look at similar companies
o look at their published market cap
 Problem with this method - There is no indication in this opinion how the court assigned the %
weights to each of the variable methods
 DE has actually rejected the DE block method, the question is should this be the method in SC?
 3 Things the Court said the Appraisers did wrong
• Earnings method used an only 1 year average
• Used the wrong multiplier – used a price earnings multiplier for a # of publicly traded
securities which was wrong b/c they are not comparable – Belk stores are privately
owned.
• Have no idea how they got their ratio’s and they did not do any weighting of the methods.
 Court in this case gave low weight to market value because other recent transactions were not at
arm’s length, gave low weight to investment value because there weren’t any really close
examples of similar companies. Said the key factor in this case was the net asset value – you
can actually go out and value those assets. Presumably because it is the most reliable
method. –
• This is weird b/c with an ongoing business Net Asset Value is really not a good
assessment of value.
 Finally the Court approved the using the block method in this case and assessed a 60%
weight to the Net Asset Value, 15% to the market value using and EPS multiple, and 15% to
the DCF multiple. – No idea where they get these ratios.
 33-13-103(3) –key statue in SC for stock valuation
• Any legitimate method of valuing stock is acceptable in SC.
• Often you would use you look at what the stock would sell for at an arms length
transaction (Problem in Close Corps b/cno marketability for the stock and selling to
family members is not an arms length transaction.
• Rule: You should essentially use the most reliable method.
o But probably in this case the shares were between family members and so they
were sold at a reduced price so it is hard to get a FMV of the stock.
o 12 S/H have no control of the company, it was a close corporation and therefore
the minority shares were sold at a discount b/c there was no marketability.

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 Liability of Interested Directors who approved the merger for Common Law Breach of Duty of Loyalty
o Weinberger v. UOP (DE) – Breach of Duty of Loyalty
 Facts: Signal owned 50.5% of UOP and controlled 7/13 directors. 2 of those directors who were
also officers of Signal prepared a report for Signal that stated Signal (parent) should buy the rest of
the shares of UOP (subsidiary) at up to $24/share. Signal’s people are controlling the UOP’s
board. They used information that would only be known to UOP and said it would be a good deal
up to $24 a share. That information was never disclosed to UOP. The board of Signal and the
board of UOP had to approve the merger. The UOP board approved a cash-out merger at
$21/share, and the Signal directors didn’t vote. UOP then solicited its shareholders recommending
to vote for the deal.
 Arledge and Chitea were 2 of the Signal directors that made the disclosure to the Parent and not the
Subsidiaries. They created reports suggesting that the Co. be valued at $20-21 instead of $24 – but
this difference would have limited impact on Signal but a significant impact on the S/H.
 Dissenting plaintiffs sued and wanted rescissory damages, case for rescission (undo the deal)
not appraisal – the plaintiffs want the value of their stock, but they have pursued this according to
the common law notion that there was a breach of duty. If the merger were rescinded, it does not
exist. They are asking for a valuation of the stock they currently hold as if there was no merger.
Presumably, the stock will go up in value.
 Court said that since UOP had interested directors on both sides of the transaction, UOP had the
burden of showing the overall fairness of the deal or be in breach of their duty of loyalty to UOP,
meaning they had to show fair dealing and fair price.
 Rule: When directors are on both sides they are held to the utmost good faith and the most
scrupulous fairness. They most show fair dealing and fair price in order to withstand a
breach of the duty of loyalty
 Court said in a case like this must focus on Fair price and Fair Dealing (aka fair process):
• Process was not fair– deal was controlled exclusively by Signal who also controlled the
negotiations - looks at the timing (only gave them 4 days) and negotiation of the deal. In
this case, there were no negotiations, and the UOP directors weren’t made aware of
the $24 study.
o Rule: If directors that are of both sides of the deal are involved in the merger
negotiations – there is no fair dealing b/c they could not have been at arms
length.
o Footnote 7: Although perfection is not possible, or expected, the result here
could have been entirely different if UOP had appointed an independent
negotiating committee of its outside directors to deal with Signal at arm’s length
• Price was not fair: the question would be based on an appraisal of the company. Court
decided that in DE fair value would be calculated using all relevant factors: Rejected
the DE method of weighting various methods (which is the Belk method of appraisal).
o “In this breach of fiduciary duty case, the Chancellor perceived that the
approach to valuation was the same as that in an appraisal proceeding.
Consistent with precedent, he rejected plaintiff’s method of proof and accepted
defendant’s evidence of value as being in accord with practice under prior case
law. This means that the so-called Delaware block or weighted average method
was employed wherein the elements of value were assigned a particular weight
and the resulting amounts added to determine the value per share. This
procedure has been used for decades. However, to the extent it excludes other
generally accepted techniques used in the financial community and the courts, it
is now clearly outmoded. It is time we recognize that in appraisal and other
stock valuation proceedings and bring our law current on the subject…We
believe that a more liberal approach must include proof of value by any
techniques or methods which are generally considered acceptable in the financial
community.”
o Court in this case said they would permit any generally accepted
method of valuation considered acceptable in the financial community-

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  Recommended DCF as the best analysis– try to predict what
the future cash flow over a relevant time period. Must pick out a DCF
multiple.
• Court reversed for a determination under this calculation.
• Rule on Rescissory Damages: As to rescissory damages, the court said they
would only be awarded when appraisal of a company isn’t an adequate remedy. So
you only get rescissory when appraisal wouldn’t be fair to other parties who relied
on the transaction.
o In this case the court says they will allow them to have rescissory
damages. But said P should bring an appraisal action instead of breach of loyalty
claim.
• Rule: This case suggests in DE, You need to bring an appraisal case before
you bring a common law breach of duty of loyalty action for a merger that was
approved by interested directors
• Finally, the Plaintiff tried to get the DE court to adopt a test that requires the
merger to be a legitimate business purpose, and that a freeze out couldn’t be a legitimate
business purpose. Court shot that down b/c they say they can’t see a business purpose if
UOP is going out of business.
• Belk of Spartanburg v. Thompson (SC)
o Merger btwn Belk of Spartanburg and Belk of Clinton. Thompson is
one of the dissenting shareholders of the surviving corporation – Belk of Spartanburg. She
wants her stock to be re-valued. Under the SC statute, it is unusual for the S/Hs of the
surviving corporation to have dissenter’s rights. Probably what is going on here is that Belk of
Clinton bought Belk of Spartanburg but retained the Belk of Spartanburg name (similar to
FU/Wachovia merger).
o Issue: How to value the stock – there was a large discrepancy.
o Another weird thing is the scope of review here, the Ct of appeals gets
to decide the facts de novo.
o Three factors are usually considered in assessing value: they use the
DE block test (see the factors from Weinberger); even though Weinberger threw it out years
ago, SC recently applied it. The court does allow some modifications of the methods that are
suggested.
o § 33-13-101(3): Fair value, with respect to dissenter’s shares, means
the value of the shares immediately before the effectuation of the corporate action to which
the dissenter objects, excluding any appreciation or depreciation in anticipation of the
corporate action unless exclusion would be inequitable. The value of the shares is to be
determined by techniques that are accepted generally in the financial community.
o The court said that the experts did not apply all three of the Weinberger
factors and that the experts didn’t determine a method of weighting the factors.
o Appraisal is not an exact science, and the precise weight to be given to
any factor is necessarily a matter of judgment for the court in the light of circumstances in
each case. Santee Oil Co., 265 S.C. 270, 217 S.E.2d 789. In arriving at his final valuation,
Woodside weighted each of his four methods equally; the trial court adopted Woodside's
weighting. Although we largely agree with Woodside's methods (except, of course, the
guideline public company value method), because we have some qualms about his reasonings,
we accordingly distribute the weighting differently than the trial court.
o The court uses large department store models to determine the ratios,
but adjusted the figures to correspond to the size of Belk. The court allows the ratio for
discounted cash flow (weighted it 15%), but it does not allow other types of ratios to be used.
Burkhard says the court goes back and forth in its analysis.
o The court throws out some of the factors based on the fact that they
occurred after the time of the merger and cited to 33-13-101(3). Burkhard says this is wrong
because the factors were not affected by the merger.

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 o The court ultimately concludes that most of these transactions were
arms length, but they say that that factor (market value) is not the be given much weight.
Market value is the price paid for sales of stock.
o Resulting Total Valuation. Based on our discussion above, we arrive at
the following valuation:
Determined Weighted
Value/Share Weight Value/Share
Net Asset $1,474.21 0.60 $ 884.53
Value:
Discounted $1,606.93 0.15 241.04
Cash Flow:
Market $1,493.90 0.25 373.48
Value:
Final Determined Fair $1,499.05
Value:
o Using this value, the value of Thompson's BDS stock on October 5, 1996, was
$134,914.50 (90 x $1,499.05). Because BDS paid Thompson $132,749.10 on October 4,
1996, we find Thompson is due the additional sum of $2,165.40 from BDS. There is nothing
in the opinion that they use to justify the weight that they give to the different factors.
o It is odd that the Court of Appeals criticized the appraisers for not following Santee
and the Court of Appeals also does not follow Santee in arriving at the weight to be given to
each factor.
o Clarkson and Way are the dissenter’s experts.
 Clarkson is a CPA and a lawyer and the former tax
commissioner in SC and Way was a financial planner out of Charlotte – no PHD.
 Used the Block Method
 Pick your experts wisely!!
o Coggins v. New England Patriots (MA) (Not an Appraisal Case –
Class Action for Recission)
 Owner of NE patriots issued a bunch of nonvoting common
stock. Owner was ousted, and had to borrow a bunch of money from the bank to buy back all
the voting shares. A condition of the loans was that he had to structure the team to best pay
back the loans, which included getting rid of those nonvoting shares as a marketing tactic. He
made a new company and performed a cash out merger. The state law required majority vote
of all affected classes of shares. Plaintiff had some of the nonvoting stock, dissented, and
sued. He was supposed to pledge the corporate assets for the securement of the loan he used to
cash out, and he cant do that so he tries to get rid of all the minority S/Hs
 He used the corporation to secure a personal loan. That is a
serious, serious problem. He decides to get rid of all the minority shareholders so that he
would be the only person who could complain (which he obviously wouldn’t do). He set up a
new company to merge with (the nonvoting stockholders voted for the merger). The
nonvoting shareholders don’t get stock in the new company but they are cashed out at $15 a
share.
• SC – 30-10-104 –(d) – “shares are entitled to the voting rights granted by this section although
the articles of incorporation provide that the shares are non-voting shares
 Issue: Is appraisal an exclusive remedy for an unhappy S/H?
No see below
 This is not an appraisal case; it is a class action – class being
all the S/H who challenged the transaction.
 Sullivan argued that there were 3 corporate reasons he
structured the deal in this way, when this was rejected he argued that this claim had to be
brought as an appraisal claim.

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  MA Rule- Court says that although the statute indicates
appraisal is an exclusive remedy, in this case the Court can allow the action to proceed as a
non-appraisal action (CL) for rescission. Applied the Business Purpose Test
 SC Rule: a decision was made NOT to include a provision,
similar to the Mass one, that appraisal actions are the exclusive remedy of an unhappy
shareholder. In SC, an unhappy S/H can bring a breach of fiduciary duty claim similar to
Coggins.
 DE Rule: Appraisal is still an exclusive remedy, if a S/H is
unhappy with the merger, and they are asking for more $.
 MA Court applied the business purpose test – Rejected the
DE Rule
• DE Rule: There does not have to be a legitimate
business purpose.
 MA 2 Part Test to determine the fairness of a Freeze-Out
Merger:
• Was there a legitimate corporate purpose
• If Yes, then was the merger fair given the totality
of the circumstances.
o P bears the initial BOP of showing that a
freeze out was taken for no legitimate business purpose.
o Then…the BOP shifts to the defendant to
show that the freeze out was for a legitimate business purpose.
o If the D can show a valid business purpose,
then the court will analyze under fairness-TOT – whether it it was fair to
the minority (maybe by proving the value of the price was fair).
 Ct rejected Owner’s arguments that there were legitimate
football reasons not to have the nonvoting stock floating around. Found that the real reason
was to pay back personal loans, which cannot be a legitimate business purpose. So court did
not have to go to the fairness analysis.
 Rule of Rescission Damages: Court said that while the
typical relief for an improper freeze out is rescission of the merger, because it has been so
long since the merger, other folks besides the minority S/H are effected by the merger, the ct
said rescissory damages were allowed to be considered
• Rescissory damages are given as the present value of
the stock as it would be if the merger were rescinded plus interest.
o SALE OF ASSETS - Successor Liability/ Effect of sale of assets on creditors
 General Rule: a buyer of corporate assets is not liable for seller’s corporate debts
 Rule: A sale of assets doesn’t automatically end existence of selling corporation unless
the corporation subsequently dissolves.
 Effect of sale of assets on shareholders of seller and buyer
• First, creditors of the seller are paid
• Then, the seller distributes the remainder to its shareholders
• Franklin v. USX (CA) Successor Liability – Sale of Assets
o Girl was exposed to asbestos from her dad who worked for WPS. All
of the WPS assets were purchased by ConCal, and ConCal agreed to assume all
liability. ConCal then sold those assets to ConDel with no agreement. ConDel
merged into US Steel who became USX.
o Issue: Whether the WPS liability followed through the ConCal to
ConDel sale. – Whether Condel acquired successor liability.
o 3 Ways to Acquire a Company:
 Buy all of the stock of the co. – the acquired co. is a wholly
owned subsidiary or merge the 2 cos into one.
 Acquire by Merger

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  By all of the Outstanding Assets of the Co – When you buy
the assets you don’t acquire all of the liabilities unless you expressly agree
to it.
o Rule of Successor Liability on a Sale of Assets: On a sale of all
assets to another corporation, liability doesn’t follow the assets UNLESS
 Agreement - Purchaser expressly or impliedly agrees to the
assumption.
 De Facto Merger- Transaction amounts to a consolidation or
merger.
• Key: Inadequate cash consideration
o Cash purchase is more predictable than a
stock purchase, because presumably there are creditors of
the seller to protect, and they are going to want a solid
asset to come after for debts.
 Continuation: Purchasing corporation is just a continuation of
the selling corporation.
 Fraud - Transaction is entered into fraudulently to escape
debts
o Court said this could possibly be a de facto merger or a mere
continuation of the business
 Test de- facto merger:
o If consideration paid for the assets was solely stock of the purchaser.
o If the purchaser continued the enterprise after the sale
o If the shareholders of the seller became shareholders of the
purchaser
o If the seller liquidated
o If the buyer assumed the liabilities necessary to carry on the
business of the seller
• Test for Continuation of the Business (Ray v. Alad):
o No adequate consideration paid for the corporate assets (most
important)
o Officers/directors of the seller became officers/directors of the
buyer
o Holding: The court said that since the transaction was adequately
financed with cash, neither exception could apply, so USX can’t be liable.
o Additional Policy Reasons not to Impose Liability:
 Significant Time lapse: Also said that the imposition of
successor liability on a purchasing co. long after the transfer of assets
defeats the legitimate expectations the parties held during negotiation and
sale.
 Ensure Marketability: Also b/c they want to make sure there
is a market for troubled companies
o 33-13-102 provides dissenter’s /appraisal rights for the selling corp.’s
S/Hs.
 Although SC does have the rule that a surviving co’s S/H get
must approve a merger if the it will increase the stock more than 20% - did
not adopt the rule from the MBC that the buying co.’s S/Hs in a sale of
assets get to vote on the assets purchase if it would require the issuance
of more than 20% issuance of additional stock.
• Hite v. Howard & Howard (SC) – Share Exchange- Dissenter’s Rights and
Equitable Remedies for Minority S/H
o 2 SC Co’s – Florence & Columbia Companies. The people who are
driving all of these transactions are the people of the Col. Co. – their objective was to

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merge the 2 companies into one. You would assume that an easy way to do that
would be to merge the two companies together.
o Hite was minority shareholder of Flo co, and majority shareholder was
another corporation, Col. Col authorized the issuance of more shares from Flo and
then organized a stock exchange between the companies where Col rolled into Flo.
The result was that plaintiff’s control went from 33% to 11% and he wasn’t allowed
to have his shares purchased for fair market value.
o Issue #1: Do the Col. Shareholders have sufficient voting power to
approve the merger?
 Yes- 32-11-103(e) – only requires 2/3 of the S/H votes to
approve share exchange. The defendants had the exact number of votes
required to approve the merger (Hite owned 55 shares and the majority
shareholders owned 110 shares (2/3))
 If they had merged the companies, Hite would have had
dissenter’s rights. They decided to do a share exchange instead so they
didn’t have to deal with dissenter’s rights.
o Issue #2: Does Hite have dissenter’s rights if it were a Merger?:
 33-13-102 and 33-11-103(e) – Yes - says if Hite has the
right to vote he is entitled to dissenter’s rights for a merger.
• Scen #1: 33-11-103(2) If the surviving Co. is
Columbia, Hite would have the right to vote.
• Scen #2: 33-11-103(h)(3)- -If Florence is the
surviving Co., Hite would still have the right to vote against the
merger b/c the # of shares of the surviving corp, Florence pre-
merger would have increased by more than 20% post merger (165
to 600). Therefore, Hite would still have the right to dissent.
 So b/c Hite had dissenter’s rights either way if it were a
merger, then, Columbia’s lawyers decided to do a stock exchange instead
o The first thing the first step they took in order to implement the
share exchange was to increase the number of shares. They did this my
amending the articles of incorporation. Hite had the right to vote on the
amendment. He did not vote no to stop this b/c of § 33-10-103(f) because even if
he had voted no they still had enough votes to pass this. § 33-13-102(4) does not
allow for dissenter’s rights by virtue of this action that they wanted to take.
o Columbia distributed 110 shares to Florence shareholders so it was
wholly owned by Florence.
o Issue #3: Does Hite have enough shares to vote against the share
exchange?
 No - 33-11-103(e) No he has less than 2/3.
o Issue #4: Does Hite have dissenter’s rights in a share exchange?
 No - 33-11-102(a) – Share Exchange: A corp may acquire all
of the outstanding shares of one or more classes or series of another corp’s
stock if the BOD of each corp adopts and its shareholders , if required
by 33-11-103, approve the exchange.
• So both boards will undoubtedly approve the
exchange in this case. The directors of Columbia will undoubtedly
approve the exchange and the director’s of
• Florence will approve the exchange b/c it is
controlled by directors of Columbia
• 33-11-103(a) only the S/H of the corporation whose
shares are to be acquired in a S/E must approve the deal; since
Florence is the acquiring co., Hite has no right to vote and thus
no dissenter’s rights under 33-13-102(A)(3).

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 • Ct rejected Mich Rule: where reduction of
ownership percentage of an acquiring corporation could allow
for dissenters rights where the acquiring corporation issued
more than 100% of its original shares.
o Our ending structure at this point in the game is that the plaintiff owns
55 shares. The defendants own 531 shares. Florence owns 4143 shares. In the next
step, they are going to conduct a parent/subsidiary merger and the rules are different.
o Issue #4: Should Hite have brought this as a derivative suit? - No
 The defendants also argued that this should have been brought
as a derivative claim and not a direct suit.
• Loss of Voting Power Separate to Hite: No - Court
concludes that this was properly brought as a direct suit b/c the fact
that Hite lost his voting power was individual to him, “separate and
distinct.”
• Loss in value separate to Hite: Also, if Hite is
claiming loss in value, he can bring it as a direct claim b/c co
hasn’t really lost anything-it is just a shift in who owns the value
o Holding: Court first said that this was a corporate action that caused a
specific loss to a particular shareholder (voting rights), and therefore he could bring
his suit directly rather than derivatively
o Issue #5: If Hite has no dissenter’s rights under a Share Exchange
were does this leave him?
o 3 Things Hite is Mad About- Reasons he brings this action.
 Cut out of his dissenter’s rights
 His voting power has gone down the tubes.
 His shares have depreciated (his share value has gone
down) – exchange ratio is unfair – D’s proportion of the entire co. is
unfair
o Hite argued that this was equivalent to a merger and he should have
dissenter’s rights.
o Holding: Court said rejected Hite’s argument that it was equivalent to a
Merger and said that he did not have a right to vote under 33-11-103 and was not
entitled to dissenter’s rights under 33-13-102 BUT said he had a remedy under 33-
14-310(d)(4).
o Court says this is a free-standing remedy. Make sure you don’t
lose track of this case for other situations. There is no evidence that the
grounds for dissolution have been met here. ****
o 33-14-310 Procedure for Judicial Dissolution: provides for judicial
dissolution and broad equitable remedies
 (d)(4) In any action filed by a S/H to dissolve the corp on the
grounds enumerated in 33-14-300, the court may mane such order or grant
relief, other than dissolution, as in its discretion is appropriate, including,
without limitation, an order:
• (4) providing for the purchase at their fair value of
shares of any S/H, either by the corp or its S/Hs.
o What triggers this remedy is when the S/H requests dissolution under
33-14-300 and in this case Hite did not make the request – Ct said it didn’t matter but
Burkie questions this.
o Another question is whether Hite would have met the threshold under
33-14-300 that constitute grounds for dissolution
 33-14-300 – it is likely that he would have requested
dissolution under (2)(iii) – the directors in control of the corp have acted,
are acting, or will act in a manner that is illegal, fraudulent, oppressive, or

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 unfairly prejudicial either to the corp or to any S/H (whether in his capacity
as a S/H, director, or officer of the Corp.
o Why didn’t Hite bring up the Pre-emptive Rights provisions – why
these provisions did not help him out
o Burkhard wanted to know why Hite didn’t argue preemptive rights. He
couldn’t because of the way the share exchange was structured.
• Simmons v. Mark (SC -2005) – Successor Liability – Tort Case
o Worker brought products liability action against manufacturer of a
scissor lift and company that purchased manufacturer’s assets at bankruptcy sale.
 SC Test for Successor Liability in Sale of Assets (Brown
Factors) – Similar to Test in USX - CA
• Agreement- There is an Agreement to assume debts
o Note: article in SC Lawyer Magazine - If
the K between the seller and the buyer is silent, then the
successor is deemed to have assumed liability and
accepted those liabilities.
• De-Facto Merger: Circumstances around the
transaction warrants a merger of the 2 corps
 If a company transfers all of its assets in exchange for stock in
a new company and then the company passes the stock along
to its shareholders, that should be treated as a merger.
• Continuation: Successor co was a mere continuation
of the predecessor
 Footnote: “Essentially, the dissent advocates an expansion of
the mere continuation exception. However, as noted by the
dissent, the majority of courts interpreting the mere
continuation exception have found it applicable only when
there is commonality of ownership, i.e., the predecessor and
successor corporations have substantially the same officers,
directors, or shareholders. We decline to extend the exception
to cases in which there is no such commonality of officers,
directors and shareholders.”
• Fraud: transaction was entered into fraudulently for
the purpose of wrongfully deceiving creditor’s claims
o Issue: was the purchaser of assets liable for a torts claim of a prior
worker as a successor?
o Holding: Co was not liable?
o Dissent – Burnet
 If you buy the goodwill, then you ought to get stuck with the
liabilities that come along.
 Also critical of the notions that if you hold successor
companies liable that lots of bad things will happen as a result.
o Domestication: In order to just legally move an existing corporation from Connecticut to
South Carolina without merging (used to have to merge), you can use § 33-9-100. It allows
for the movement of a company from another state to SC.
• Chapter 9 –- Domestication of a Foreign Corporation –
• 33-9-100 – Articles of Domestication: Contents
o The motivating force being this chapter was the insurance co.’s in SC, a
captive insurance company is essentially an insurance company that is
owned by its insured.
o (a) Domesticating co. - Must file articles and an initial annual report
o (b) –Domesticating co. must file articles of dissolution with
previous state w/in 5 days of domesticating

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  Burkie objects to this b/c the co. has the option to merge
the two
o (c)(4) – no S/H approval needed
o (f)(1) - Addresses title search issue- if you have changed you co. name
and the previous entity owned prop in SC – must give notice of name
change to the SC register of Deeds
• 33-9-110 – Effect of Domestication:
o All the former liabilities stand, co. is essentially the same co.
o After domestication laws of SC apply and for prior claims laws of the
foreign state apply
o SC is maybe the 11th state in the US to add this domestication process
in, we do not require confirmation of good standing with the foreign
state.
o From a Federal Tax point of view there are no tax ramifications.

o Conversion of corporation to limited liability company: See § 33-11-111. 2/3 votes are
required for approval. There are now 11 separate code sections that provide for conversions
of entities. Everything in SC can be converted into another thing.
 If you are converting and everyone is not getting an ownership interest, normally they
would be protected by giving them dissenter’s rights. The conversion from a corporation
to an LLC does provide dissenter’s rights. However, not all of the conversions provide
for dissenter’s rights. That is one possible way to get rid of someone.
 You should never convert a corporation to an LLC because it will usually create terrible
tax problems. Going from an LLC to a corporation will probably not create a huge tax
problem.
o Hostile Takeover Defenses
 Rule: A hostile takeover is an acquisition to gain control over the objections of a
corporation’s directors
 Takeover defenses
• Unocal Corp v. Mesa Petroleum (DE)
o Mesa (Raider) was trying to takeover Unocal (Target). Mesa already
had 13%. Mesa had a 2 tiered offer where it would pay $54/share in cash for the first half of
the shares it needs (37%) to reach the rest of the stock, and pay junk bonds for the rest of the
stock. After it reached 51% it would go thru a merger, where it would be a cash-out
merger, $54 per share but it would be in the form of junk bonds.
o Defensive Tactic- Unocal’s board adopted a defense that if Mesa got
close to control, Unocal would buy the rest of the stock for $72/share in debt securities
(promissory note), but they are making the offer to every S/H except Mesa (cause that would
defeat the purpose), also by offering debt securities the financial position of Mesa changes
dramatically. Part of the motivation is to put Unocal into debt to make them less attractive.
o Mesa sued because they are already minority shareholders and this
exclusion breaches a fiduciary duty to Mesa.
o Note: the directors are in a bad position b/c they have a duty to
Mesa as a minority S/H, but they also have a duty to the other shareholders, and the
corporation (to determine if it is not in the interests of the co.)
o Issue: Can Unocal’s Board exclude Mesa from the offer?
o A defensive measure like this one can get business judgment analysis if
it meets some requirements.
o Unocal thought this was okay because if they made the offer to Mesa,
they would be financing Mesa’s takeover. They would be giving Mesa some value they could
use, etc. They would be helping Mesa in their tender offer.
o Unocal thought they were justified because Mesa’s bid was inadequate
and coercive.

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o Unocal 2 Prong Test: duty to the minority S/H can be overcome
and defensive measure upheld if: (different from the Business Judgment Rule, looks
more like the fairness test- and the burden is initially on the board to show the
reasonableness of their actions and decisions)
 BOP on Directors must show that they had reasonable
grounds for believing that a danger to corporate policy and effectiveness existed
(i.e. junk bonds are bad for the co. Satisfied by Showing:
• Good Faith
o enhances when independent outside
directors approve the defensive move b/c it prevents the minority
S/H from arguing that they are approving the defensive tactic only
to save their job (essentially b/c disinterested directors are not
officers of the corp).
o “Because of the omnipresent specter that a
board may be acting primarily in its own interests, rather than
those of the corporation and its shareholders, there is an enhanced
duty which calls for judicial examination at the threshold before
the protections of the business judgment rule may be conferred.”
• Reasonable Investigation
 Directors must show that the response to the takeover
attempt was reasonable in relation to the threat posed :
• Factors to Consider in the Element of Balance:
o the inadequacy of the price offered
o Coerciveness: nature and timing of the offer
o impact on constituencies other than
shareholders (creditors, customers, employees)
o risk of nonconsummation
o quality of securities being offered in
exchange
o the board may consider the basic
stockholder interests at stake, including those of short-term
speculators, whose actions may have fueled the coercive aspect of
the offer at the expense of the long term investor (Burkhard thinks
this statement is wrong)
o can also consider the effect on both short
and long term stock price
• The term greenmail refers to the practice of buying out a takeover bidder’s
stock at a premium that is not available to other shareholders in order to prevent the
takeover.
• Chesapeake – If an offer is too low, but isn’t coercive, then board response
might not satisfy Unocal. Chesapeake case: “A board’s unilateral decision to adopt a
defensive measure…is strongly suspect under Unocal and cannot be sustained without a
compelling justification.”
• Holding: In this case, because the offer was both inadequate and highly
coercive, the threat was high, and the response was properly tailored to the threat.
o Further, because the action was approved by disinterested directors,
Unocal satisfied its burden of good faith and due care, and since Mesa couldn’t
prove that the directors were acting to save their jobs, the defensive
measure gets the business judgment rule.
• ALI Test 6.02(c) Different from Unocol Test b/c the BOP is on the P - a
person who challenges an action of the board on the ground that it fails to satisfy the
standards of subsection (a) has the burden of proof that the board’s action is an
unreasonable response to the offer. Burkhard says this isn’t very different from the
Unocal test.

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• Revlon v. Forbes (DE) (Director’s Duty in a Bidding War)
o Pantry Pride tried to takeover Revlon. First they offered $47.50/share.
Revlon countered with an offer for $47.50 and 1/10 share of preferred stock that included
covenants not to incur additional debt. Then FLC came in and offered $56/share, but would
be getting more debt (in violation of the agreement on the preferred shares). Pantry Pride re-
upped, and then FLC re-upped and offered to take care of the preferred stock. Revlon
accepted that deal which included a bunch of bad provisions if the deal fell through.
Obviously, Revlon directors had stopped the bidding to protect themselves from a law suit
from the preferred shareholders.
o Issue: To what extent can the corporation consider the impact of a
takeover threat on constituencies other than S/Hs?
o Issue: What is the extent of a director’s duty in the course of a bidding
war?
o Rule: Court restated Unocal rule that since Directors defensive
measures always carry the appearance that they are self interested, they have to show
reasonable investigation and reasonable response to threat to get business judgment for
the defensive measures.
 “There is a presumption that in making the business decision,
the directors of a corp acted on an informed basis, in good faith and in the honest
belief that the action taken was in the best interests of the corp.”
o Revlon Rule: Director’s Duty During a Bidding War: However,
once it is clear that there is a bidding war and the breakup of the company is inevitable,
the directors’ duty changes from preservation of the corporation to maximization of the
company’s value. Director’s duty job is to get the highest value possible for
shareholders.
 No shop provision was a breach - “market forces must be
allowed to operate freely to bring the target’s S/Hs the best price available for their
equity.”
 Thus as the trial court rules, the S/H interests necessitated the
Board to remain free to negotiate in the fulfillment of that duty.
o Court shot down the argument by Revlon directors that they were
protecting “other constituencies.” Court said that the concern for the other constituencies
(i.e noteholders) has to be rationally related to the benefits accruing to the shareholders.
o Holding: In this case, the concern wasn’t related because stopping an
auction with active bidders is never related to shareholder interests. Also the directors could
not make the requisite showing of good faith by preferring the noteholders and ignoring
its duty of loyalty to the S/H, when the noteholders needed no further protection, their
rights were already fixed by contract.
 Note a “poison pill,” also known as a “Rights plan,” is an
action by the target’s board that creates rights in the target’s existing S/Hs other than
the bidder, to acquire debt or stock of the target at bargain price upon the occurrence
of specified events such as the bidder’s acquisition of a specified % of the target’s
stock. A poison pill makes a raider negotiate with management.
 We don’t want to have these supermajority provisions for the board of directors, etc
because we don’t want new management to decide what is good for me. There is a fine line
between management being able to negotiate a higher price and management interfering.
• Paramount v. Time I (DE) (Board Knows Best Rule)
o Paramount made a big offer for Time. Time was in the middle of
finalizing a deal with Warner that the directors said would be in the long term best interests of
the S/Hs. Even though Paramount’s offer was way over the share price, Time thought that the
bid was a threat to the “Time Culture” and was concerned that the time shareholders wouldn’t
recognize the long term benefits of the Warner deal. Time directors approved defensive
tactics. Paramount brought a Revlon claim and a Unocal claim.

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 o Revlon duties to maximize corp value are triggered only in 2
circumstances.
 Π is claiming that by entering into merger agreement with Warner, the BOD of Time
imposed the duties discussed in Revlon to maximize SH value – this is wrong
 A merger doesnt trigger this role, it has to be inevitable that there will be a dissolution or
a breakup
 When the corporation creates an active bidding process
looking to sell itself or
• The director’s can place the co. in an
unintentional bidding war (Paramount v. QVC)
 In response to a bidder’s offer, a target abandons a long
term strategy and decides to break up.
 In this case, Time was doing neither of these, so Revlon duties not triggered. This is
unlike Revlon where the BOD considerd a bust up sale, and authorized agents to
negotiate a sale
 If te BOD resoponse is found to only be defensive measures and an abandonment of
existence is not intended, then Revlon doesn’t apply – but Unocal does
o no violation of the Unocal rule.
 No violation on the first offer because they didn’t put in
defensive measures – Unocal not implicated.
o so Unocal doesn’t come into play until a defensive measure is taken
• – basic BJR applies
 When Time took the defensive measures, Unocal was
implicated. Although it would appear that there was a violation because the price
offer was more than fair, the court gave wide berth to the Time directors to
preserve the long term strategy. It also helped that 12/15 directors were non-
interested.
• Court also found that Time was well informed about risks and benefits of
Paramont because of prior negotiations with it
• SO the threat can be more than inadequate cash value or threat of coercion– it
can be threat to long rang plans
o Rule applied in this case: “Board Knows Best” rationale for
implementing takeover defenses. - court gave wide berth to the Time directors to preserve
the long term strategy.
• Paramount v. QVC (DE)
o Now we have Viacom and QVC bidding for Paramount. Paramount
entered into a deal with Viacom that basically would have placed complete control of the
company in one man, since the Paramount shareholders were getting mostly non-voting stock
in the exchange. The agreement with Viacom had some pretty stiff provisions if it were to
fall through (no-shop, termination fee – waiving of the poison pill, stock option). The
stock option agreement is significant b/c if Paramount’s stock went up then they would have
to pay Viacom. Also, president of Paramount was going to get to stay on. QVC made a big
offer anyway – $80 a share.
 Paramount entered into a deal with Viacom that basically would have placed complete
control of the company in one man, since the Paramount shareholders were getting
mostly non-voting stock in the exchange.
• The CEO of Viacom owne 85% of its voting stock, so he pretty much runs the
show
• Viacome initally offerd 61 per share in stock and cash, but Paramount wanted 70
• Final agrement held that Parmount would merge into Viacom
o each share of Paramount was to be .1 share of Viacom voting stock and
.9 share of nonvoting stock. Plus 9.10 in cash
o Note- at this time Viacom’s stock value had increased allegedly
because Redstone was infalting the market value by buying up stock

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o Both Viacom & QVC are close corporations.
o Features that made this company less attractive to other buyers: There
is a termination fee and there is a stock option with a feature that requires Paramount to pay to
Viacom the difference between the value of the shares and what they would ultimately be paid
in a competing offer back to Viacom.
o Viacom upped their offer to $85/share. QVC then upped their offer to
$90 a share.
o “Although a number of materials were distributed to the Paramount
Board describing the Viacom and QVC transactions, the only quantitative analysis of the
consideration to be received by the stockholders under each proposal was based on then-
current market prices of the securities involved, not on the anticipated value of such securities
at the time when the stockholders would receive them” suggesting that is something the
board should have done
o Court said the normal rule of director’s actions is the BJR, however
the Court said that there are rare situations where enhanced scrutiny of the director’s
conduct are necessary
 There are two alternative tests that the court talks about: (1)
the enhanced scrutiny test and (2) even higher scrutiny if there is self-interest which
could possibly implicate the entire fairness test (they don’t apply it but they alert you
that is a possibility)
 This court applies the enhanced scrutiny test (see below)
o “The key features of an enhanced scrutiny test are: (a) a judicial
determination regarding the adequacy of the decisionmaking process employed
by the directors, including the information on which the directors based their
decision; and (b) a judicial examination of the reasonableness of the directors’
action in light of the circumstances then existing. The directors have the burden
of proving that they were adequately informed and acted reasonably.”
o “Board actions in the circumstances presented here is subject to
enhanced scrutiny. Such scrutiny is mandated by: (a) the threatening diminution
of the current stockholders’ voting power; (b) the fact that an asset belonging to
the public stockholders (a control premium) is being sold and may never be
available again; and (c) the traditional concern of Delaware courts for actions
which impair or impede stockholder voting rights.”
 Unocal – the approval of a transaction in a sale of control
 Revlon – adoption of defensive measures in response to a
threat to corp. control.
 Court when the sale of the control of a company gets the
enhanced scrutiny of the Unocal test with the burden shifted to the board to show
• that they investigated and
• that their response was reasonable.
• Then the court will insert its own judgment on the
reasonableness of the director action
o The theme that runs through this case is that if we are “selling control”
then the transaction changes. Control gets shifted from the public S/Hs of Paramount to
Viacom.
o Holding: Unocal Rule triggered in this case. As far as sale of control,
Paramount was originally controlled by a “fluid aggregation of shareholders” and that control
would go over to a single person in the Viacom deal, so the enhanced scrutiny is applied.
The public stockholders are in the majority now and after this transaction a single person is
going to have the majority voting rights. The former stockholders would end up owning only
non-voting shares and have no control. There would no longer even be any public
shareholders. The right to control is valuable and when that is being sold or transferred, those
people who had it are entitled to be paid for it.

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 o Triggers Revlon Rule: Court said that in a sale of control, the
director’s duty is to maximize shareholder value. Some of the ways a board can fulfill
its obligation to seek the best value are:
 Conducting an auction
 Canvassing the market. etc.
o Key features of enhanced scrutiny test
 Judicial determination regarding the adequacy of the decision
making process employed by the directors, including the information on which the
director’s based their decision
 Judicial examination of the reasonableness of the director’s
actions in light of the circumstances then existing.
• Actions don’t have to be perfect, just reasonable.
o Paramount argued that they did not shop around because of the no-shop
provisions. The Court essentially says you cannot contract away your fiduciary duties.
“Such provisions, whether or not they are presumptively valid in the abstract, may not validly
define or limit the directors’ fiduciary duty or prevent the directors from carrying out their
fiduciary duties.”
o Holding: The realization of the best value reasonably available to
the stockholders became the Paramount directors’ primary obligation under these facts
in light of the change of control. That obligation was not satisfied, and the Paramount
Board’s process was deficient. The directors’ initial hope and expectation for a strategic
alliance with Viacom was allowed to dominated their decisionmaking process to the
point where the arsenal of defensive measures established at the outset was perpetuated
(not modified or eliminated) when the situation was dramatically altered. QVC’s
unsolicited bid presented the opportunity for significantly greater value for the
stockholders and enhanced negotiating leverage for the directors. The court shot the
whole thing down, and it appears the primary reason is that the QVC offer was so large, and
there is no way the director’s argument in favor of the reasonableness of their decision based
on corporate vision cannot be justified b/c the shareholder’s are losing over $1B (Viacom’s
offer was $1 billion less than QVC’s – Director’s primary duty in this case shifted to the
maximization of S/H value.
o Court also reiterates the Weinberger rule: where actual self-interest
is present and affects a majority of the directors approving a transaction, a court will apply
enhanced scrutiny.
o Court rejected Paramount’s argument of the holding Time Warner case
in that the court clearly stated that in addition to the 2 circumstances there are “other
possibilities” where Revlon duties may be implicated. In addition the Court said that this case
also falls within the 1st category in that the “Paramount Board, although unintentional, had
initiated an active bidding process seeking to sell itself by agreeing to sell control of the
corporation to Viacom in circumstances where another potential acquirer (QVC) was equally
interested in being a bidder.
 Federal and State statutory regulation of Hostile takeovers
• CTS v. Dynamics (Fed) – Preemption –IND law
o Indiana had a law that kicked in when a company got a control share of
a public Indiana corporation. Only impacts a company incorporated in Indiana. If a
company got control shares, the raider’s shares immediately become non-
voting, and are not able to become voting unless the remaining target S/H’s
approve or give them their voting rights back and it must occur at the next S/H
meeting (which can be a long time) or the raider can ask for a meeting within 50
days (but the raider has to pay for the meeting). If the shareholders do not vote to
restore voting rights to the shares, the corporation may redeem the control shares
from the acquirer at fair market value, but it is not required to do so. The statute
also says that it is not automatic; the co. has to elect to have the statute apply to
it.

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 o These types of statutes are passed to protect the Board and the Indiana
Operations. It was passed to keep the companies safe and the jobs in the state. It is
to protect the corporations.
o Corporate raider tries to argue that the Indiana Law was
preempted by the Williams Act and violated the dormant commerce clause.
o Preemption Analysis
 Williams Act:
• Under the Williams act you have to disclose to the
SEC whenever you get a big chunk of stock, and there are
provisions that protect shareholders through the period of a
tender offer.
• Court distinguished the Indiana law from an Illinois
law that changed the Williams process.
• Rule: Court found that the Indiana law actually
furthered Williams. The delay in getting the approval to vote the
shares is ok under Williams. So, this isn’t preempted.
 Dormant Commerce clause
• Rule: To violate the dormant commerce clause, the
law has to favor Indiana raiders over other raiders. All raiders
here are treated the same.
• Further, the court shot down an argument that this
would impede tender offers. Court said that there are all sorts of
ways states impede tender offers now (like higher votes for
mergers under corporate law or staggered directors), and those
don’t violate DCC. Also dissenter’s rights are accepted.
 General rule is that corporate law is state law; law where
you are incorporated governs.
 Holding: the ILL he statute can be said to protect S/H and
there are substantial connections with the state’s interest.
• Amanda Acquisition v. Universal Foods (WI)
o This is not a Sup Ct opinion; it is a 7th circuit opinion.
o Wisconsin had a “third generation” takeover statute that forced
corporate raiders to wait 3 years after gaining control to merge the target or
acquire more than 5% of its assets. The statues also say that the board of the target
can waive that provision. State created defensive mechanism that makes it way more
difficult for a raider to take over a Wisconsin Co. that the gov’t doesn’t like. Statute,
unlike Indiana statue, was not self-electing but automatic.
o Issue: This statute screwed Amanda because their financing was
dependant on a quick second step merger. The financiers are after a lien on the
assets. Getting to the assets is what secures the loan. Without the merger they can’t
do that.
o Ct says the practical/economic effect of this is to eliminate all hostile
leveraged buyouts of Wisconsin Corporations. The tender offer is the device for the
shareholders to get rid of ineffective management. “We believe that antitakeover
legislation injures shareholders. Managers frequently realize gains for investors via
voluntary combinations (mergers). If gains are to be had, but managers balk, tender
offers are investors’ way to go over managers’ heads.” (this statute protects
management)
o Skepticism about the wisdom of a state’s law does not lead to the
conclusion that the law is beyond the state’s power.
o Court said that as long as the state law doesn’t alter the process in
Williams, there is no preemption. The waiting period doesn’t change the
Williams disclosure procedures, so no federal preemption.

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 o Court said that a Wisconsin buyer gets no advantage over a buyer
from another state, so no dormant commerce clause violation.
• SC: 35-2-101 & 35-2-201, we have an equivalent of BOTH the Wisconsin
and Indiana statutes. Since enactment, neither of these statutes have really come into
play; the reason is that we don’t have many publicly traded SC corporations left.
o Summary (ways to evaluate the director’s behavior); page #s correspond to what has triggered
the test and what the test might be; gets more strenuous as you go
o Business judgment test
 282+handout: Van Gorkam: the rule is a presumption that in making a business decision
the director’s acted on an informed basis, in good faith in the honest belief that the action
was taken in the best interests of the company. Thus, the party attacking a board decision
as uninformed must rebut the presumption that its business judgment was an informed
one. In Deleware, the standard is gross negligence (maybe not in SC)
 Handout on TWEN: quote from Disney test: the business judgment rule is not actually a
substantive rule of law but instead is a presumption that the directors were informed,
acted in good faith, and in the honest belief the action was taken the best interest of the
company and the shareholders. Fraud, bad faith, and self-dealing will knock out the
application of the test. In the absence of this evidence, the board’s decision will be
upheld unless it cannot be attributed to any rational business purpose (allowed to consider
the substance of the decision) or I can attack the substance of the provision and show no
rational business purpose or that the transaction constitutes waste
o Unocal (may be a separate test from enhanced scrutiny or they might be the same)
 Trigger: 699 and 711: if management purchases shares in response to a tender offer, that
would trigger Unocal; when the board implements antitakeover measures
 Test: 699 and 711: directors have the burden of proving they had reasonable grounds for
believing there was a danger to corporate policy and effectiveness, a burden satisfied by a
showing of good faith and reasonable investigation
 If there is a conflict (even if we don’t think they did anything wrong but they are faced
with a conflict), maybe there is a reason to apply Unocal instead of the BJR.
o Enhanced Scrutiny
 Trigger: 740, 742, and 599: defensive purchase of shares (unocal) or breakup of the
company (Revlon) or Paramount; language in the Pearlman case that says the trigger is
the sale of control by Pearlman of 33% of the company
 Test: 743: (a) a judicial determination… and (b) a judicial examination… and 599:
burden of proof and fiduciaries language
o Compelling Justification
 Blasius v. Atlas, 542 A.2d 651
 Not covered in our class!!
o Entire Fairness (both sides of the deal)
 Trigger: 664, 489: because of fiduciary duty and its control over S, its relationship with S
must meet the test of intrinsic fairness; when there is an existing conflict situation (look
at Weinberger and Sinclair for examples)
 Test: 335, 670, 489: involves high degree of fairness and a shift in the burden of proof;
where directors stand on both sides of the transaction, they have the burden of
demonstrating entire fairness (utmost good faith and the most scrupulous inherent
fairness); fair dealing and fair price
o No Decision and Good Faith (off on its own)
 No decision has been made at all by the board and the shareholders argue that you should
have done something and you didn’t
 Trigger: 296: failure to act
 Test: 296+handout: we won’t penalize the board for failing to act unless there has been a
systematic failure…; handout confirms that Caremark case is the current state of the law
today (stone case) but more importantly in the Stone case the court talks about the role of
good faith (see the handout)

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LIMITED PARTNERSHIPS
o Why worry about Limited Partnerships?
 What would have been a limited partnership would now probably be registered as an
LLC.
 There are a lot of them out there.
• Historically a lot of real estate deals were done as limited partnerships.
• A lot of people invest in Hedge Funds which are done as Limited partnerships
 Estate Planning Area – Limited Partnerships as opposed to LLC’s are the desired estate
planning tool
• Ex – I own a large tract of timber land in SC and I want the prop to be inherited
by my kids and I want the least amount of tax possible. If I transfer all of the property into a
limited partnership and start gifting out limited partnership interests to my kids, one of the
things you can argue is that the limited partnership interests are entitled to discounts so
you can transfer the property at a lower cost. At death, the property transferred is
entitled to certain marketability discounts.
 Almost all hedge funds are done as limited partnerships; a lot of it is tax-motivated
 Because of the hybrid nature of limited partnerships, they are subject not only to
limited partnership laws but also to general partnership laws. Rule: regular partnership statutes
usually apply - If something is addressed in a limited partnership statute, go find it in the regular
partnership interest.
 Limited partnerships are also subject to federal securities laws such as 10b-5 and
state securities laws. Rule: Almost always, an interest in a limited partnership is going to be
viewed to be a security and triggers registration rules.
o Generally
 Like a partnership with two types of partners
• General partners – personally liable for the debts of the limited partnership
• Limited partners – not personally liable for debts
 Subject to state and federal securities laws
o Advantages: 2 significant benefits over general partnership
 Less liability than a regular partnership
• if it is done right the limited partner is protected from any of the debts of the
business
• General partners are still liable
o You can make a corporation the general partner, which essentially
means that no individual will have personal liability for the liabilities of the LLP
 Same Tax Benefits as Partnerships
• Taxed as a partnership rather than a corporation (no double taxation problem)
 Non-Dissolvable entity – unlike partnership (need careful drafting to make it non-
dissolvable)
• If someone leaves a limited partnership, it does not automatically trigger
dissolution
• You can structure the Lim Partnership if someone leaves the business or dies
this does not affect the business
 Profit Distributions – unlike partnership
• Are usually according to each partner’s contributions if the agreement is silent
whereas with a normal partnership the distributions would be equal.
o What are the legal problems in starting an LLP?
 Do not come into existence until there has been a public filing
 33-42-210 – Certificate of Limited Partnership
• (a) Must file a certificate of limited partnership with state including:
o Name
o Address of office and name and address of agent

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 o Name and address of each general partner
o Latest date the partnership is to dissolve
o Any other matters
 Some lawyers like to put the pship agreement here
 Clients don’t want this stuff public since the agreement
probably sets forth their shares
 (b) LLP is formed at the time of filing with sec of state or at any later time specified in
the certificate if there has been substantial compliance with 210
• Filing is required b/c the limited partners are not personally liable for the
obligations of business, but they can file in any state they choose – probably advantages and
disadvantages to doing this.
• There are restrictions in naming the LLC.
 33-42-60 – at minimum there has to be a written agreement/document at their office
that contains certain limited information about the business.
• Need an Atty: Almost crucial that a lawyer be involved in forming a limited
partnership b/c it is critical that the agreement be carefully drafted.
 33-42-300 – General Partner’s Authority
• SC LLP has to file the names of the general partners who are authorized to
transfer property with the deeds. This is to help with title searches and make sure that
property was transferred with proper authority.
o What are the legal problems in operating an LLP
 Control
• Start with the assumption that limited partners never have the right to vote
although the partnership agreement can give them voting rights (almost all will give
them voting rights in some circumstances)
• 33-42-420: Voting
o Subject to 33-42-430, the agreement can grant the power to vote to all
or a specified group of limited partners.
o By default, the general partners make the decisions.
o Different from a general partnership, in a limited partnership the
decisions are generally made by the general partner, the limited partners don’t
vote.
 So usually the limited partners are in it strictly as
investors, they have no mgmt responsibilities or control rights.
• Although the limited partners do not usually have voting rights, they can be
granted voting rights.
o 3 options of Voting rights of the Limited Partners
 Unanimous vote to do certain things
 Majority vote of limited partners to do certain things
 limited partners get no vote (consistent with statute).
 Liability
• To 3rd parties – most critical
o 33-42-430 – Liabilities to 3rd Parties
 Unless provided otherwise, a general partner is liable for debts
to third parties just like a partner in a regular partnership.
 If a limited partner’s participation in the control of the
business is not substantially the same as the exercise of the power’s of a general
partner, the limited partner is liable only to the persons who transact business
with the limited partnership with actual knowledge/reliance on his
participation.
 Rule: The General Partner’s liability to 3rd parties can not be
limited by the partnership agreement
o 33-42-630 – General Powers and Liabilities:

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  GP has the liabilities of a partner in a regular partnership
 A GP is liable to the other partners just like a partner in a
partnership
 the obligation and duties amongst and between the parties in
an LLP can be changed in the partnership agreement: BUT NOT the GP’s liability to
3rd parties.
o 33-41-390 – Liability of a Partner Joining Late
 someone who becomes a partner subsequent to the partnership
formation is not liable for the pre-existing obligations of the partnership.
Presumably, this statute would apply even though we are dealing with a limited
partnership and not a regular partnership.
o Zeiger v. Wilf (NJ) (Limited Partner’s Liability TO 3RD parties for
acting like a GP)
 Wilf and his general partnership were limited partners in an
LLP to renovate a hotel. Things started to go bad, and Wilf took over acting as an
officer for the LLP. Things collapsed, and the plaintiff who was owed significant
money came after Wilf under the theory that he had acted like a general partner, and
therefore should be liable as one. Wilf was the bad guy - he negotiated the leases,
ran the renovation project, arranged for financing, and has been in charge of the deal.
When the Plaintiff transferred his rights to the partnership, the P was supposed to get
a consulting payment for several years - $27K. When the deal fails, Wilf stops
paying the P.
 Issue: Can Wilf be held personally liable for the $27K
contracted and owed to P under the partnership? Under the statute is Wilf liable?
 Court said that
• you need control—a limited partner is not liable for
the obligations of a limited partnership unless he takes part in the control of
the businesslike a GP (the language in this case is exactly the same as the
language of the SC statute, which is strange because most statutes don’t
have the same language)
• you need reliance and knowledge by the other
party: if the limited partner’s control of the business is not substantially the
same as the power of the general partner, then the limited partner is only
liable to people who transact with the LP with knowledge of the limited
partner’s participation in control and rely on him.
• Statutory Safe Harbor Provision - Court noted that
a limited partner acting as an officer, director, or shareholder cannot be
found to be exercising general partner control
o Important to note that the safe harbor
provisions in the law have to be adopted into the agreement to take
effect
 Holding: Wilf was not liable to the 3rd party:
• Wilf was acting as an officer not as a GP
o It didn’t matter that he didn’t represent that
he was acting in his capacity as an officer to the third parties.
• No reliance on the part of the plaintiff that Wilf
was a general partner.
o The plaintiff was aware of the structure of
the business and knew Wilf wasn’t a general partner
 There is an argument that even if P did rely, Wilf still might
not be liable. There is an argument that the K to pay $27,000 was made before Wilf
became a partner and there is a statute that says if that occurs you are not personally
liable. § 33-41-390. This is not discussed in the case but Burkhard brought it up.

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  Wilf court says there is a distinction btwn the exercise of
control and participation in control. If the person is really running the LLP and
has all the powers of a GC then they are liable, but if they are just a
participating a little bit in the running of the business then they are only liable
to people who rely on them. SO that was the P’s problem in Wilf, he admits he
never relied on Wilf as a participating general partner – knew he was acting as
VP of Trenton.
o 33-42-430 – Liability to 3rd Parties
 (a) - A limited partner is not liable for obligations of an LLP
unless he is also a general partner or he takes part in the control of the business.
– that is the phrase that has caused all the litigation.
 However, if control is not substantially the same as the
exercise of the powers of a GP, he is liable only to third parties who have actual
knowledge of his participation in control.
• Divides a limited partners wrongful behavior into two
types:
o Exercise of the powers of a general
partner.
o Knowledge of Participation in Control.
 (b) - Not participating in control if (SC’s statutory safe
harbor)
• Being a contractor for or an agent or employee of the
LLP or of a general partner or being an officer, director or S//H of the GP
that is a corporation.
• List of many other actions that do not constitute
“participation in control”
o GA Rule on Limited Partner Liability: A limited partner may take
part in control of the business and if they do that is ok - says you can never hold a limited
partner liable as if he were a general partner.
o 33-42-440 – when you erroneously believe you’re a limited partner
 If you make a contribution and erroneously but in good
faith believe you’re a limited partner, you are not a general partner and are not
bound by it’s obligations if, when you learn of the mistake, you
• Get the right certificate of limited partnership
amended OR
• withdraw from future equity participation of the
partnership
 If you do one of these two things you are protected against
future claims and to some extent past claims against the P.
 However, you’re liable to any third party who contracted
before you withdrew or amended the agreement if that third party believed in good
faith that you were a general partner.
o Recent NC Case involving 33-42-440 -A # of people in a partnership
bought condo units as investments in a condo complex, the problem was that the condo had
financial trouble and there were huge assessments made against the units. The argument was
that each of the partners was liable for a portion of the assessments. One of the investors says
that she bought as a limited partner and was not liable for the assessments. She actually
entered as a GP, but she doesn’t know that.
 Court relied on SC 42-440 – with regards to the Condo complex there is no clue as to
who the partners are so it is highly unlikely that the folks who sold her the unit believed
that she was a GP. So she was not liable.
 Rule: 33-42-440 - applies to ALL BUSINESS TRANSACTIONS where the person
actually believed they were a limited partner.
• Ohio Case (Similar to Zieger)

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 o 2 corporations created the general partnership of a limited partnership.
Since they are corporations they can only act by the officers of the company. The P,
a plumber, sues as the LP is going one of the vice presidents of one of the corporate
general partners. Ohio court went back to Agency law and said that the partners were
not acting as agents for a disclosed principal
o Issue: Issue arises out of the Wilf case, Can you ever recover from a
director of a corporate general partner?
o Rule: A director of a corp GP can be personally liable to 3rd parties
for his actions as an agent of the corp/GP if they did not disclose to the plumber
that they were acting as agents of the corporation.
o Burkhard: The Ohio Court said that they were liable. In order to get the
protection, the plaintiff has to know who they are dealing with. There has to be
disclosure that you are acting as a corporate officer who is one of the general
partners in a limited partnership. The plaintiff has to basically understand the whole
picture for the D to avoid liability.
o The P did not rely on “piercing the corporate veil” case law in Wilf b/c
there was no evidence that the corp was undercapitalized or the franchise was (the
other factors necessary to pierce the veil).
o Another theory you could argue for recovery is agency § 602 or § 603
of the restatement. Undisclosed or partially disclosed principal.
• Kahn v. Icahn (DE)
o Derivative suit against the general partner of AREP, a LLP that buys
and sells real estate. The general partner, API, is a corporation that is owned wholly
by one person (Icahn). Suit alleged that Icahn made some investments on his own
that he had a duty to offer to AREP first. The partnership agreement stated that API
could compete directly with AREP.
o Issue: Did the GP Usurp a Partnership Opportunity.
o DE law: the partners can modify the fiduciary duties between the GP
and the LLP - can be expanded or contracted by statute and this particular
partnership agreement allows him to compete
o DE Law post Kahn: after this case, the DE lawyers got the legislature
to expand the law to say that duties could be expanded, contracted, or eliminated all
together.
o Issue: Is there a difference between usurping a corp opportunity
and competition?
o Then court looked at corporate opportunity doctrine:
• 3 Part Test:
 Opp is either essential to the corp or is one in which it has an
interest or expectancy
 Corp is financially able to take advantage of the opp itself
 The party charged with taking the opportunity did so in an
official rather than individual capacity.,
• Court held that the corporation has to have an interest or expectancy in the
opportunity before it can raise the argument.
• Holding: In this case, because of the compete clause, AREP had no legitimate
expectancy, and thus could not raise the doctrine. Also the facts indicate that this
opp did not come to him as a result of his status in the partnership, so there is the
notion that it was not a corporate opportunity.
• In SC, would you be able to put a similar clause in a partnership
agreement? You can’t contract out a fiduciary duty in SC. But this is a limited
partnership, so that probably wouldn’t apply. However, if it is not covered in
the llp sections, then the partnership sections apply. Look through the llp
sections carefully to see if anything applies so we know if the partnership

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 provisions can apply. See § 33-42-630 for the answer. No, you wouldn’t be
able to put a similar clause in a partnership agreement in SC.
o In re USACafes (DE)
 Metsa bought all of the assets of USACAFEs LLP. A Corp
was the GP of the LLP. Plaintiffs were the limited partners who thought the GPs got
kickbacks from Metsa to sell at too low a price. The director’s of the GP all received
substantial side payments that induced them to authorize the sale of the LLP assets
for less than the price that a fair process would have yielded.
 Issue: Whether directors of a corporate GP are fiduciaries
for the LLP?
 P’s Claim: The GP caused all of the assets of the Corp to be
sold too cheaply; the price was not fair to other members of the LLP. They are suing
the corp and the directors for fiduciary breach of duty of loyalty and breach of duty
of care.
 The directors said their duty runs to the corporation but not the
LP’s who were investors
 Court analogized to trust law, and said that a corporate trustee
cannot intentionally use trust property in a way that benefits the holder of the trust in
a way that harms the beneficial owner.
 Rule: GPs are like trustees for the LPs, and gave them a
duty to the LPs not to convert property for their own use. Thus, the LPs at least
have a cause of action against the GPs for this presumably self interested sale
for too little.
 Rule: The Director of a Corp GP has a fiduciary duty to
the LLP with regards to dealings with the partnership’s property or affecting
its business. – duty not to use control over the partnership’s property to
advantage the corporate director at the expense of the partnership.
• Ct analogized to trust law where a director or
officer of a trust institution who improperly acquires an interest in the
property of a trust administered by the institution is subject to personal
liability.
 How do owners of an LLP make money?
• Salaries
• Distributions
o These statutes are different from the regular partnership statutes in
terms of profit sharing and distribution provisions.
o 33-42-830 – sharing profits and losses
 Divided according to agreement
 If agreement is silent, divide according to contributions made
by partners that is received but not returned.
 Note the difference between this and the default
distributions for regular p-ships, which defaults to “equal.”
o 33-42-840 – Sharing Distributions
 Divided according to agreement
 If agreement is silent, divide according to contributions.
o 33-42-1220: Assignment of Partnership Interest
 Pship interest is freely assignable unless agreement says
otherwise
 Assignment doesn’t dissolve the limited pship
 All the assignee gets is the distribution the seller would
have been entitled to
 If the partner assigns his interest, he’s no longer a partner
unless the agreement states otherwise
o 33-42-1020 – Withdrawal of GP

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  The general partner can withdraw at any time
 But if the withdrawal contravenes the agreement, the
partnership can get damages from him resulting from breach
o 33-42-1030 – withdrawal of LP
 Can only do so at the time or upon happening of events
specified in the partnership agreement if the partnership was formed on or
after July 1, 1998.
• SC LP would qualify for special estate tax treatment
if drafted correctly.
 If the LLP was formed prior to 7/1/98 and it doesn’t state in
the agreement a LP wishing to withdraw must give 6 months prior notice to
each GP
 They tried to make it retroactive, but Burkhard says it
might not work for LLPs formed prior to 1998. You can redo the
partnership agreement to make sure it applies.
 An LLP agreement formed prior to 7/1/98 can be amended to
state specific events when an LP can withdraw
 This statute tried to be retroactive – but there is still some
question as to whether this applies to pre-1998 limited partnerships unless
they specifically state it in the agreement.
 A bunch of this stuff is designed to make sure a SC LLP
qualifies for tax benefits
o 33-42-1410 – Non-judicial Dissolution (one of the adv of a LP is it
can be made to be non-dissolvable
 LP is dissolved upon one of the following
• time specified in the agreement ends
• any events specified in the agreement
• written consent of all partners
• withdrawal of a GP unless
o there was another GP and the agreement
specifies that the remaining partner can carry on, OR
o within 90 days all remaining partners agree
in writing to continue the business and to the admission of
more GPs, as needed
• Judicial dissolution

LIMITED LIABILITY COMPANIES

o Most business today are being formed not as corporations but as LLCs
o SC has adopted the Uniform Act – DE has not.
o Rule: Almost all of the provisions indicated in the LLC statutes can be modified in the LLC agreement
with the exception of fiduciary duty and protection of 3rd parties (anything dealing with creditor’s claims).
o 2 Reasons why LLC’s are advantageous
o Tax Advantages
o Limited Liability for the Investors
o Do not need at atty in SC
o Do not need to file an annual report
o Important Notes on LLC’s – Problems page 815
o Rule: Distinction Between Member Run & Manager Run LLC’s: If it is member run, then we
apply about the same rules that are required for a partnership – any person can essentially bind the LLC
if it is mgr run then only managers can bind the partnership
o If you have a client who is considering contracting with a bus structured as an LLC it is crucial
that they know whether it is member run or manager run, depending on which one it is different persons
have different degrees of authority.

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 o To make this determination you must check with the Sec of State’s office.
o Rule: Members and managers of LLC’s are usually not personally liable as investors, they are
like S/H’s
o Exceptions:
 if you are a manger acting as a member of an LLC and you commit tortuous actions, you
are still liable as an agent for your actions
 Also, courts will pierce the veil of LLC’s – they will use the veil piercing test in the
corporate are will be applied to the LLC transaction
• There have yet to be any cases in SC, but in every other state where the issue has
been raised, the courts have applied the corp test for piercing the corporate veil.
o Rule: In almost all States the Corp Opp Doctrine applies to LLC’s
o SC LLC STATUTES
o 33-44-203 – LLC Articles of Organization
 Name of the Co.
• Just b/c the Sec of State’s office accepts the name does not mean you can use it
in SC
 Address of the initial designated office
 Name and street address of the initial service of process
 Name and address of each organizer
 Whether the co. is to be a term company, and, if so the term specified
 Whether Member run LLC (looks like a GP) or a Manager run LLC (looks like a
Corp)
• This is where the atty needs to spend a lot of time with the client to see what fits
 Whether one or more of the members of the co. are to be liable for its debts and
obligations under 33-44-303(c)
 Articles of organization may include operating agreement, but most LLPs would want
operating agreement to be private so wouldn’t put it in the articles of organization.
 Articles of organization may not vary the nonwaivable provisions. As to all other
matters, if any provision of an operating agreement is inconsistent with the articles of
organization, the operating agreement controls as to managers, etc. and persons who reasonably
rely on the articles to their detriment.
o 33-11-111 – Conversion of corporation to LLC
o After adopting a plan the board must submit it to the S/H to be approved.
o The vote must be approved by 2/3 of the S/H’s entitled to vote.
o There may be required to be voting by voting groups
o A S/H may dissent to the plan of conversion and get the FMV for his shares according to 33-13-
101 – 33-13-310.
o After approval must submit to secretary of state’s office.
o 33-11-112 – Status of LLC post conversion
o conversions takes effect it is essentially the same entity
o all the debts/liabilities are the same
o All S/H of the converted corp remain as members of the LLC – but that can be changed according
to the plan.
o 33-44-102(e) – Knowledge and Notice:
o Attempts to lay out rules as to what circumstances an LLC or an entity will be charged with
information that may be known by one or more of its members. (So there is a notion that this statute may
apply to every SC business entity today)
 Ex - Bus operates as an LLC- one member of the business knows that it has received
$10k, another person knows that if the organization gets $10K it has to report it to the fed agency.
–
• So this section puts the 2 of these together to know when we will hold the
business to be accountable for the information

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 • Rule essentially mandates that business businesses must come up with an
internal reporting system.
 33-44-201- LLC is an entity -
• Attempts to solve the UPA problem as to whether an LLC is an entity or an
aggregate.
o Exception: LLC is treated for tax purposes as an aggregate – each
member reports his or her taxes separately.
 SC 33-44-208 – Certificate of Existence –
• you can ask the Sec. of State’s office for info regarding the status of the LLC
(whether or not they are in good standing).
 SC 33-44-211 – Annual Report not Required –
• LLC’s are not required to file an annual report with the gov’t – maybe one
advantage over corp. (as a result of logistical problems with Sec of State’s office).
 33- 44-301 – Agency of Members and Managers – Liability
• When someone acting on behalf of the LLC will be able to bind the LLC.
• Each member of an LLC is an Agent and any act of a member in carrying on the
normal course of business will bind the company, unless the member had no authority to
act for the company in the particular manner and the person with whom the member was
dealing knew or had notice that the member lacked the authority.
• An act of an agent not in the course of business will only bind the LLC if it was
authorized by the other members.
o broaden the exposure of the LLC for a member owned LLC – so it
is a lot easier to hold the LLC liable than a partnership liable for actions of the
members.
o (c) Addresses this hypo: If you have a member run LLC – 20 people
have invested and own a condo complex. One of the members sells the condo
complex to Smith for x amount
o Important: – (c) says this is valid unless you put in the AI’s a
provision saying you can’t do that – all of the Law firms that file AI’s for
LLC’s negate this provision.
 33-44-303 – Liability of Members & Mgrs
• (a)A member or manager is not personally liable for obligations and liabilities of
the co. soley by reason of being or acting as a member or manager.
• (b) failure of an LLC to observe the usual co formalities or requirements relating
to the exercise of its powers is not grounds for imposing personal liability on the
members.
• (c) a provision in the LLC agreement can bind all LLC members liable for the
LLC debts and liabilities.
 33-44-404 – Mgmgt – Voting of an LLC
• (b)(3)A New mgr must be approved by a majority vote
• (c) Lists of matters requiring a unanimous vote
o if you don’t like that you can change most of it by contract.
 33-44-405 – Sharing and Right to Distribution
• -any distribution made by the LLC in winding up must be in equal amounts to
each member- if you don’t like it you can change it in your operating agreement.
 33-44-406 - Limitations on distributions - parallel the corporate model
• you can’t pay any money out of the business if
o 1) you can’t pay your outstanding bills coming due OR
o 2) your debts > than assets –
 if either one of these two occurs, distributions should not be
made out of the LLC.
 33-44-407 - Liability for unlawful Distributions
 33-44-408 - Member’s Right to Information

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 • To Access & Inspect Records, Operating Agreement
 33-44- 409 – Gnrl Stds of Member and Mgr’s Conduct
• Members of a Member owned LLS owe eachother Duty of Care and Duty of
Loyalty & Fiduciary Duty
o Duty of Loyalty
 To account to the co and to hold as a trustee for it any
property, profit, or benefit derived by the member in the conduct or
winding up of the business or derived from the use of the co. property
or appropriation of a corp opp
 Not to deal with parties having adverse interests
 To refrain from competing with the co. in the conduct of
the co’s bus. Before the dissolution of the co.
o Duty of Care
 Limited to refraining from engaging in grossly negligent or
reckless conduct, intentional misconduct, or a knowing violation of
the law
o Must exercise rights consistently with an obligation of good faith and
fair dealing.
o A member does not violate this section merely b/c the member’s
conduct furthers his own interest.
• Members of a Mgr owned LLC Do not have a Fiduciary Duty to Eachother
 33-44-410 – Actions by Members –
• grants to an LLC member the right at any time to bring a direct action –
legal or equitable relief
o Different from partnership model: If a partner is unhappy with
another partner’s actions he can bring an action in equity for an accounting
action– adv of this an accounting action seems to be a direct claim – maybe
LLC member can do the same thing,
• (b) – You can ask the court to reach back and account for prior wrongs - this
statute says you can’t do this but there’s a gap – may still bring a claim where the LLC
is going on.
 33-44-501 – Member’s Distributional Interest:
• Similar to UPA – LLC owns property not members
• If you have a distributional interest in LLC – this interest is personal property
and may be transferred in whole or in part.
• You can have stock certificates.
 33-44-502 – Transfer of Distributional Interest –
• Distributional interest does not entitle the transferee to exercise any rights of a
member, you will also have voting rights or mgmt rights with respect the LLC
 33-44-5-503 – Rights of a Transferee –
• a transferee can have rights to an LLC if they receive a distributional interest – if
the operating agreement says that someone can transfer his financial and voting
rights or if all the other members agree on it
• Transferee also becomes liable for the transferor’s liability to make
contribution
 33-44-504 – Rights of Creditor:
• Provides what a creditor has to do is get a charging order against the
membership interest – exclusive remedy
• Different from the partnership statute – says this section is the exclusive remedy
by which a judgment creditor of a member or a transferee may satisfy a judgment.
 33-44-601 – Events Causing a Member’s Disassociation (Be careful the comments to
this statute have not been updated)
• Disassociation in LLC context means someone has left the LLC.

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 • Dissolution means the actual process of going out of $.
• Attempts to define EVERY method by which someone could quit.
o Notice of Quitting
o Per the Operating Agreement
o Transfer the member’s distribution interest (all of their financial rights)
 602 suggests this may be modified in the operating
agreement.
 Presumably cover this in the operation agreement indicating
this is not an event of dissolution.
o Member becomes a debtor of bankruptcy
o Death of Member
o If a member is an entity and ceases being an entity
 33-44-602 : Member’s power to disassociate; wrongful dissociation
• (a) – a member has the power to disassociate at any time rightfully or
wrongfully, unless otherwise provided in the operating agreement.
o so LLC can lock member’s in by putting in a provision saying that
a member can’t voluntarily quit and you can’t withdraw when you die
• Wrongful Withdrawals-
o If a member disassociates by becoming a debtor in bankruptcy
o If a member quits
 At Will LLC – Get cashed out
 Term LLC –member becomes as assignee of the corporation
– entitled to financial interests, and then the term is over, member gets
his share with everyone else.
o A member who wrongfully dissacosiates from an LLC is liable to the
co. and to the other members for damages caused by the dissacosiation.
o If an LLC winds up as a result of a member’s wrongful disassociation,
damages the co sustained must be offset by the distributions to the member
 33-44-701: Company Purchase of Distributional Interest
• Buying out a person when they quit
• You can put in the operating agreement if a person quits an LLC they get
nothing.
 33-44-703- A Withdrawing member can still bind the LLC after a period of
withdrawal
 33-44-704 – Notice of Withdrawal:
• But if the withdrawing LLC member files a notice then this puts people out there
on notice that their action will not bind the LLC
 33-44-801 – Events Causing Dissolution and Winding Up of Company’s Business
• Just b/c a member quits doesn’t mean the LLC has to go out of business or wind
up.
 33-44-802- Post Dissolution Liability
• same as corp modes
 33-44-803 – Winding Up Process
 33-44-805 – Articles of Termination
• You can file an article of termination that put everyone on notice that the
LLC is dead – starts clock running to put creditors on claims
 33-44-806 – Scary section: Distribution of Assets in Winding up-
• Creditors paid first
• Then owners
o Tax Regulation issues – attempts to address the default rule – If the Co.
is required to maintain a capital account per tax code, the rest must be
distributed to members per IRS regulations.
o This can be changed in the operating agreement

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 33-44-807: Known Creditors Claims against Dissolved LLC
• LLC Must give Notice
 33-44- 808 –Unknown Creditors Claims against Dissolved LLC
• Must give Notice
 33-44-1101-1104 - Derivative Suits –
• Problem – if someone dies and there interest transfers to a family member, that
assignee may not have standing to bring a suit, unlike the corporate model,
 33-44-1205 - Term Partnership includes LLC’s
• Rule: Anytime the word partnership appears elsewhere in the SC code, it
automatically includes LLC’s (mostly applies to regulations of hunting, motorcycles)
 LLC vs. Corp - Director’s Duty of Care and Loyalty
• DE Rule: LLC’s can eliminate the duties of loyalty and care in their articles
of organization.
• SC Rule: you can’t eliminate the duty of care or loyalty – you can tinker
with it but no elimination.
• DE: Good Faith in the LLC context is deemed not to be a fiduciary duty
but a contract principle.
o SC follows this model – Good faith is a contract principle.
• Waste, Water & Land Case- Prob 2 age 816
o The court says the fact that the card said EFRS does not give the client
notice that they are dealing with an LLC; therefore he is liable.
o If Roberts was the agent, Epstein was a principal. B/c it was a
disclosed principal/agency relationship, Epstein is liable as the principal even
though he did not do the negotiations (Clark was a disclosed agent for Lanhan
not PIII- different names because actual case not covered in book)
• Rule: In dealing with 3rd parties you must advise your clients that they
MUST disclose that they are dealing with an LLC.
• Lynch v. Carson (Kansas)
o Three entities. Lynch, Rainbow, and Carson Trust, all own a portion of
CLR. The three entities hired Carson the individual as the president of the
company. The agreement had two relevant provisions: corporate opportunities
have to be presented to the LLC and another provision saying you can do
anything you want (engage in ventures) without owing income or proceeds to
CLR. In the fall of 1996, Carson discloses opportunities to the other members.
In 1997, Carson told Lynch about other opportunities. He then discussed this
again with the other folks involved and running CLR. There is so question as to
whether CLR was really interested. In October 1998, Carson sent proposed
plans to other members of CLR for purchasing. Finally, Carson actually
purchased the companies himself.
o The key question is whether he has made an offer to the CLR members
in a manner required by the operating agreement. Carson says that he just has to
make them aware of the possibility of acquiring it.
o The Court says all that is required is that the member offer the
knowledge of this opportunity so he hasn’t violated the operating agreement.
o Rule: In almost all states, the corporate opportunity doctrine is
going to apply to LLCs.
 Court held that the corp opp was disclosed to the other
members of the LLC and thus Carson was ok to do what he did.
Subsequently the members of the LLC threw him out and he filed
another lawsuit saying they couldn’t do it (breach of their duty to him
and a breach of their duty to CLR).
 The first question is whether there is a fiduciary relationship
between CLR and Gabelli (in charge of some of the members of the
LLC). By influencing the managers to do what they did, Gabelli’s

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 actions were injurious to CLR. Gabelli points out that Carson should
have brought the suit as a derivative suit. He says he has a way around
it because there is an ALI exception (close LLC exception).
 The court suggests that the lawsuit can go forward because
they don’t see any reason why a demand should have been made.
 The lawyer for Carson made another mistake because he
didn’t plead oppression.
 The defendants argued that all of this stuff is protected by the
BJR, but the court says no. The BJR presupposes that directors acted
on an informed basis and in the interest of the company. The BJR does
not apply because the complaint shows they acted independently of
business interests.
 Rule-Different Duties for Member vs. Mgr Owned LLCs:
A member of a member-owned LLC owes a fiduciary duty to the
LLC and to the other co-members of 33-44-409(d) – but a member
of a manager owned LLC does not owe a fiduciary duty to the
other members of the manager owned LLC. 33-44-409(h)(1). This
is what the statute says but Burkhard says don’t assume it is that
simple
 It appears that this suit should have been brought as a
derivative claim.
• Lieberman v. Wyoming (Wyoming)
o The issues in this case are mostly state specific so you need to look at
the state LLC statutes.
o Lieberman invests $20k in the business (in the form of services
rendered and to be rendered) and he is credited with a 40% ownership of the
capital of the bus for his $20k contribution. B/C the contribution was in the
form of services it raises an immediate red flag for counsel b/c presumably
that transaction created tax problems for Lieberman (this is something the
atty for Lieberman should have covered on the front end).
o There was an increase in capitalization of the LLC – from 2 new
members – representing 2.5% of the ownership interest in the LLC – it seems
the math is wrong b/c these guys invested much more than Lieberman and they
are worth much less – but it suggests there was a drastic appreciation in the
value of the LLC or that they were getting profit sharing
o Lieberman was terminated as VP of the LLC – Note: a SC LLC can
have officers. He files a notice – asking the LLC to cash him out if they are
going to fire him – he says he is entitled to $400K, they say that he is only
entitled to $20K – the initial amt of his initial capital contribution.
o Court says he is definitely entitled to $20K – initial capital contribution
- but the issue is he entitled to more?
o Holding: Even though he withdrew and the statute suggests he is
entitled to $20K given his interest, he is also entitled to
o his right to manage and
o his capital contributions
o share of profits
 *Court also focuses on the fact he has a certificate of
interest
• Lieberman argues the statute on p. 829 should be applied because he would then
be entitled to the value in his capital account. Court says no because the LLC
hasn’t been dissolved.
• The court implies he is still entitled to his equity which hasn’t been paid to him.
We don’t really know what this means. Is he still entitled to his voting rights in
the interim? We don’t know.

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• See SC statutes: § 33-44-701, 33-44-501: doesn’t affect my voting rights in the
LLC; also see § 33-44-801 which talks about events causing dissolution: if after
the expiration of the specified term, the applicant may be able to request
dissolution; presumably it would end and I would be paid off by virtue of
receiving my share of the LLC
• If this happened in SC, you would want to see the operating agreement. You
would want to see if it was a term LLC or an at-will LLC. If this is an at-will
LLC. See SC statute below. If it is a term LLC, see the same statute (diff
section). At the end of the term, you either buy them out or liquidate and
distribute according to the winding up.
o Rule: In these cases you have to pay close attention to the statue and
the inter-relation of the operating agreement. – must focus on the notion that the
LLC member may be entitled to the FMV of his shares.
o SC Rule: 33-44-701 –LLC will purchase interest at the FMV at the
date of disassociation: a term or at will LLC can purchase the distributional
interest of a member who chooses to withdraw for its fair value determined as
of the date of the member’s dissociation if the member’s disassociation does
not result in a dissolution of the co. If you do this, he would no longer have
voting rights.
o Burkhard said the remaining members of the LLC could by unanimous
vote extend the life of the LLC to prevent the term ending.
o What do you get during the delay while you’re waiting to be paid out.
If you look at § 33-44-603, you would be treated the same as a transferee. If
you look at 33-44-503(e), he would be entitled to distributions. Although the
section seems to suggest I have a right to early dissolution, Burkhard thinks this
only applies when it is actually time for dissolution (so no early dissolution).
o The remaining members would vote to change the distributions. The
question will be whether or not this is a breach of fiduciary duty.
o § 33-44-806(b): all remaining cash must be distributed according to
their positive capital account balances

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