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Business Associations Outline

I. Chapter One. What Do Businesses Do and What Do Lawyers for Businesses Do?
a. The Purpose of “Doing Business”
i. Generally, what is the purpose of doing business? To make money.
ii. How can a business make money w/out creating value? Buy a business and thus makes
a profit. Sell widgets and make profit w/out creating value.
iii. How can a business create value w/out making money? IT start-up example. You-tube
is a good example.
b. A.P. Smith Mfg. Co. v. Barlow
i. Stockholders argued that there was no express grant in articles of incorporation for
corporation to act as it did (Board of Directors adopted resolution that it was in P’s best
interests to join others in 1951 Annual Giving to Princeton University, and appropriate
$1,500); action was ultra vires  outside the legal power or authority of a person,
official, or body v. intra vires  within the legal power or authority of a person, official,
or body.
ii. Policy Reason Behind Court’s Decision: public policy in furthering along idea that
corporations could do what they did here.
iii. Assume there was no statute that allowed corporations the express authority to give
money to Princeton. Would gift be upheld? Yes, because good-will is created for public
which benefits the company. If don’t like board members’ decision, vote them out.
iv. Business Judgment Rule: informed and good faith decisions that respect interests of the
corporation, such a decision will be upheld, even if it was incorrect or bad.
v. Difference between agent and a principal?
1. Agent acts on behalf of principal.
2. Principal wants something done and delegate responsibility to agent to act on
their behalf.
3. Shareholders are Principals. Board Members are Principals. The Officers (CEOs
and CFOs) are Agents of the Corporation.
vi. What can a shareholder do if doesn’t believe in Board Members decisions? Sell shares
or vote off Board Members.
c. Financial Statements
i. What is GAAP? Generally Accepted Accounting Principles. Regulates accounting
principles of business.
ii. The main financial statements are:
1. Income statement (computes profit = revenues – costs);
2. Cash flow statement (measures cash made available to a business); and
3. Balance sheet (computes equity = assets – liabilities).
iii. Financial statements are prepared according to GAAP – Generally Accepted Accounting
Principles. 2 important GAAPs:
1. Matching  costs or expenses should be “booked” in same period as revenues
those expenditures helped generate, and
2. Conservatism  data should be conservative – they should present firm’s
financial data in an accurate way, but err on side of understanding its revenues
and value of its assets, and on overestimating its costs and liabilities.
i. Example of when principle of conservatism is violated: Enron and “off-
balance-sheet” financing  theory is that certain activities of the firm
may be carried out in other legal entities (special purpose entities)
(subsidiaries) and that the firm need not show the obligations of those

entities on its balance sheet as long as there is no chance that it, the
parent company, could be forced to make good on those obligations.
iv. Income Statement
1. What information does the I/S provide? Profits of a business over a particular
2. What is depreciation? Get to expense the amount you actually use. Amount
that object decreases over a given amount of time. GAAP lays out the life of an
object (useful life).
3. What is straight-line depreciation? Depreciation is the same amount each
year. How it’s calculated: Total amount of expense divided by the number of
years of use (GAAP provision provides useful life of an item).
4. Accelerated Depreciation? Deduct proportionally more of the cost of the
equipment in the earlier years and less later on.
5. How does depreciation affect the I/S? Decreases the profit on I/S. But at the
same time helps the owner because it reduces the taxable income of the
6. What if take full depreciation expense in year one? Would pay less money in
taxes due to lower profit before taxes.
7. Why can’t we take the full depreciation expense in year one? Because you
will use the item and not have to pay for it.
8. Would an owner prefer to take the full depreciation expense in year one? Yes,
if he generated enough revenue to overcome the expense.
9. To see how profitable a business will be in the future? Can use past I/S to
make future prediction.
10. Profit (before taxes) = Revenues – Costs (COGS – Salaries – G&A –
v. Cash Flow Statement
1. What information does it provide? How much you have taken in or paid out.
Whether or not you can pay debt or obligations when they come due.
2. Importance of CFS? Tracks flow of cash in and out of business.
3. What statement do we need to create cash flow statement? Income
statement. CFS is an extension of the I/S.
4. How is the CFS different from the I/S? Add the depreciation back in the CFS,
and subtract investments.
5. ***Cash Flow = Profit After Tax + Depreciation – Investment***
6. If invest in something, your cash flow will decrease.
7. Why do we have to add back in depreciation? Depreciation is not a cash
vi. Balance Sheet
1. What information does it provide? How much the company is worth. How
much equity there is.
2. Snapshot of a particular moment versus how an IS and CFS capture activity
during a period.
3. Three Main Sections of a B/S:
i. Assets:
a)Total Assets = Shareholders Equity + Total Liabilities
b)Things a company owns that have value. Typically assets are
cash, land, buildings, accounts receivable, and machinery and

c) When equipment is depreciated, the dollar amount of that
depreciation charge is deducted as an expense on the
income statement; the same amount is deducted from the
value of the asset on the B/S.
d)Assets like cash are NOT depreciated because they don’t get
used up.
e)A/R are NOT depreciated but may be “written off.”
ii. Liabilities:
a)Opposite of assets: they are what the company owes. Debts
you owe.
b)Typically liabilities are accounts payable, wages that it owes to
its employees, and any debts the company incurs.
iii. Owner’s Equity:
a)OE = Assets – Liabilities
b)Equity/Intrinsic Value of a business.
c) When liabilities exceed assets, the OE is negative =
4. How does depreciation affect an asset? Reduces the value of the asset.
5. Accounts Receivable is an asset. Example  Macy’s charge cards.
6. Cash cannot be depreciated. It can be de-valued in the sense of inflation.
7. In putting together a balance sheet, the principle of conservatism requires that
you do not overvalue your assets.
8. Principle of conservatism means that assets appear on the B/S at the lower of
cost (what pay for it) or market (what can sell it). Example, a piece of land
purchased in 1950 would appear on the B/S w/ a value equal to its original
price. Thus, the B/S may not accurately reflect the current market value of the
company’s assets and might not tell a prospective buyer how much to pay for
the business.
i. Clark’s Example:
a)Cost = $100
b)MV =$50
c) FMV = $1,000,000
d)Have to use the MV ($50) under the principle of
e)This was one of the principles that led to the collapse of
financial markets. Instead followed mark-to-market
accounting purposes.
9. Exam Question  explain mark-to-market problem.
10. What is the difference between book value and fair market value?
i. Book value can be the cost you paid and
ii. Fair market value is how much you can sell it for.
11. What will happen to cash flows if you have a net increase in assets other than
cash? Less cash. Spent money to acquire an asset.
12. What will generally happen to cash flows if you have net increase in
liabilities? More cash (generally).
vii. Cash Flow Statement A Second Look
1. What will happen to the B/S if the company receives $18K in credit sales as
opposed to the $22K? Increase in A/R for $4K. What affect will this have on the
CFS? Cash flow will go down by $4K. (p. 20)
2. A net increase in assets other than cash results in decrease of cash flow.

3. What happens to the B/S if the company issue stock worth $100K? Increase in
Assets (generally cash) of $100K and increase in Shareholder’s Equity of $100K.
4. Cash Flows = Profits from Income Statement (Revenues – Expenses) +
Depreciation (not a cash transaction) – Net Change in Balance Sheet Asset
Accounts Other than Cash (+ or -) + Net change in liabilities + Funds from new
Issues of Stock.
5. CF = Profits from IS + Depreciation (added back b/c its never paid) – Net
change in B/S asset accounts other than cash (if assets increase then that
means that cash decreased, can’t get anything for free) + net change in
liabilities (increase may result in an increase in cash flow) + funds from new
issues of stock(cash would increase a swell in SE and remember an increases in
cash increases CF)
6. Problems  p. 21. Question (1)  No, looking at equity. For second
question, still need to look at CFS and I/S before can make a good decision.
Question (2)  Wouldn’t sell for $3.7K, need to look at I/S and B/S.
7. Question: If have $1B in Assets and $0 in Liabilities and $1B therefore in
equity. Don’t know if we are making any profit. May want to stay away from
this business. There is an interpretative aspect that must be discussed. There
is an opportunity cost that is not being utilized.
8. ***Must use all three statements to make correct approximation of a
d. Choice of Entity
i. Each of these entities is defined by:
1. The tax treatment of the business’s profits and
2. The liability exposure of the owners for the business’s debts and other
potential liabilities.
ii. Sole Proprietorship:
1. Oldest and simplest form of organization  person undertakes a business
w/out any of the formalities associated w/ other forms of organization;
individual and the business are one and the same for a tax and legal liability
2. SP does NOT pay taxes as a separate entity. Individual reports all income and
deductible expenses for the business on her personal income tax return.
3. These earnings of the business are taxed to the individual regardless of whether
they are actually distributed in cash.
4. For liability purposes, the individual and business are also one and the same.
iii. Partnership: all partnerships are flow-through entities (no double taxation)
1. General Partnership (GP):
i. No Double Tax. Each partner is taxed at their effective personal tax
rate  “pass through.” Earnings are distributed according to the
partnership agreement. Very important because you can control how
much income the partner earns for tax purposes.
ii. Each general partner is jointly and severally liable for the liabilities of
the company. Thus, ANY general partner can be held for the entire
amount of the liability.
iii. Default legal standard for any company that has two or more
owners. Flow-through entity.

iv. Business earns $100K, 2 partners which receive 50%, each partner will
be taxed once for $50K.
2. Limited Partnership:
i. Consists of both limited and general partners.
ii. Flow through taxation.
iii. The GP assumes the management responsibility and unlimited
liability for the business.
iv. The LP has no voice in management and is legally liable only for her
capital contribution plus any other debt specifically accepted. LP
looks a lot like the shareholder in a corporation. LP has liability up to
how much they contribute. Flow-through entity in respect to tax.
v. ***Have to have one GP.***
3. Limited Liability Partnership:
i. Provide GP w/ limited liability UNLESS the partner’s own negligence
makes him personally liable.
ii. Can all be LPs.
iii. Flow-through entity.
iv. Corporation:
1. Shareholders have limited liability. The owners are protected from liability.
Shareholders are the owners.
2. ***Double-tax, not a flow-through entity***
i. The company is a separate tax-paying entity.
ii. Thus, when profits are earned, the company pays taxes (35%) then
when profits are given to the shareholders, the shareholders pay taxes
on that money. Double taxed.
3. Dividends are taxed as ordinary income, whereas the sale of stock is taxed as a
capital gain (15%).
4. Cannot sue the shareholders personally unless you can pierce the corporate
5. Why would you be a corporation? Because can receive deductions for certain
expenses, thus taxable income go down. Can deduct reasonable value of
certain salaries. Also, have additional controls of when people receive money.
v. Limited Liability Corporation (LLC)
1. Hybrid of partnership and corporation.
2. Gives you the best of both worlds: limited liability as well as the option to
elect to be taxed as a company or a partnership.
vi. S Corp
1. Won’t be tested. Must be a domestic corporation and cannot have more than
75 shareholders.
II. What Is a Sole Proprietorship And How Does It Work?
a. Sole Proprietorship
i. What is the default structure for a one person business? SP, jointly and severally liable.
ii. What about a business with 2 or more persons? GP jointly and severally liable
iii. For tax purposes, what type of entity is sole proprietorship? Flow-through entity.
b. Agency Relationship
i. Must first establish a principal/agent relationship.
ii. To establish an agency relationship you must establish each of the following elements:
1. The agent owes the principal a fiduciary duty in discharging her responsibilities.

2. There must be some “manifestation of consent by one person (principal) to
another (agent) that the other (agent) shall act on his (principal’s) behalf and
subject to his (principal’s) control.
3. There must also be “consent by the other (agent) to do so.”
c. ABC (Agency Analysis for Clark)
i. Assent – informal/formal agreement between principal and agent;
ii. Benefit – agent’s conduct must be for principal’s benefit.
iii. Control – principal must have the right to control the agent by having the power to
supervise the manner of the agent’s performance.
d. Agency Relationship Cont.
i. What does it mean when a principal delegates authority? Giving someone else
authority to make a decision or act on your behalf.
ii. Does an agency relationship have to be evidenced in writing? No.
iii. Can it be based on conduct? Yes. Acquiescence by conduct.
e. Duties of Principal to Agent
i. Duty to Compensate:
1. Principal has at least an implied duty to pay for the agent’s work. The duty to
compensate may also be established by agreement. If no compensation is
established by oral or written agreement, a reasonable fee will be set.
2. Look at example.
ii. Duty to Indemnify:
1. Principal has a duty to indemnify the agent for expenses and liability the agent
reasonably incurs on behalf of the principal. To indemnify means to be legally
and financially responsible for something.
iii. Duty to Cooperate:
1. Principal has a duty to cooperate w/ the agent as necessary. This duty
includes the duty not to interfere w/ the agent.
f. Duties of Agent to Principal
i. Duty of Loyalty:
1. Agent cannot appropriate for himself an opportunity or benefit that was
present for the principal.
ii. Duty of Obedience:
1. Agent must obey the reasonable instructions of the principal. Illegal
instructions of the principal are not reasonable.
iii. Duty of Reasonable Care:
1. If the agent is negligent, the agent is liable to the principal for damages.
g. Principal Anlaysis:
i. Is there a principal/agent relationship? Look to ABC’s.
ii. Is the suit in K or Tort?
iii. Is the 3P trying to sue principal or agent?
iv. If suing principal, did agent have authority?
v. If suing agent, did agent disclose?
h. Next question, is principal being sued in contract or tort. Next question is whether agent had
j. Determining Principal Liability in Contract: The Issue of Authority
i. Actual express  P expressly gives A power to act on P’s behalf.
ii. Actual implied authority  A has power to do what is reasonably necessary to get the
assigned job done, EVEN if P did NOT spell it out in detail.

iii. Apparent Authority  P may not have given A any authority at all, in fact P may have
forbidden A to act. Instead authority is created by P’s manifestations to 3rd parties.
The manifestation must be:
1. Must be attributable to the manifestations of P (Principal)!!!!!
2. Must get to the 3P
3. And must lead 3P to reasonably conclude that A is an agent for
4. There is no requirement of detrimental reliance.
i. Example:
a)Robbie the robber is robbing the banker. Police sees robber in
the building and PO come in. Robbie tells PO he will give him
a free donut for coming to check on building. PO shows up
the next day and asks for his donut.
b)1st question, there is an agency relationship? ABCs. There
was no agency relationship between bakery owner and
c) Change hypo, employee of bakery told PO I will sell you all of
the donuts we sell today for $100. PO comes back later,
employee isn’t there and owner won’t sell to PO. PO sues
owner. Can PO successfully prevail against owner?
1. 1st question. There is an agency relationship (ABC).
2. 2nd question. Torts or Contract? This is K.
3. 3rd question. Authority? No actual authority.
Apparent authority? Critical determination, whether
there was a manifestation of the principal.
iv. Lingering apparent authority  where P terminates the authority of A, but does not
inform 3P of this termination. How might P avoid liability for LAA? Business owners
can avoid being liable by giving public notice of the termination of authority, and by
contacting any individual third parties who would have had reason to know of such
v. Agency by Estoppel  A acts on P’s behalf, but P never told A to act. P knew that A
was acting on his behalf and could have stopped A, but failed to do so. A then does
something w/ 3P, while acting on P’s behalf. As a result, P is liable. What is the different
between Apparent Agency/Agency by Estoppel and Apparent Authority?
vi. Inherent Authority  word inherent itself refers to a built-in characteristic of
something/someone. In this case, inherent authority refers to the existing/built in
authority that is part of whatever position/laws/etc it may apply to. An example of
this would be: “The governor’s position offers inherent authority over decision making
for the city.” Example: VP of employee relations, would believe would have inherent
power to hire or fire.
vii. Apparent Agency  no real agency relationship. If there is truly an agency relationship,
3P will use apparent authority.
k. If ABCs are met, there is agency. Does not automatically mean principal is liable for agent’s
actions. Next question is if this transaction arises in a tort or K? In K, if want to hold principal
liable, must show agent has authority.
l. Determining Agent Liability in Contract: Disclosure
i. Disclosed – NO agent liability.
ii. Partially Disclosed – agent liable (I work for someone but can’t tell you who it is)
iii. Undisclosed Agent – agent liable.

iv. Main Point  if the agent wants to avoid K liability, they must DISCLOSE the existence
of their principal to the 3P with whom they are contracting.
v. Do these issues help to determine the liability of the principal?
vi. If agent doesn’t want to be liable, he should disclose he is an agent for a principal.
vii. Example: I work for NCCU and I’m selling computers. I tell you I’m selling on behalf of
NCCU. If problem, sue NCCU. Agent has disclosed that he is agent, and thus won’t be
liable. If don’t disclose, can sue agent and principal.
viii. To determine agent liability first thing to do is ask whether there is agency relationship?
ix. If yes, 2nd question is K or tort?
x. If K. Must determine who is being sued.
xi. If agent, must determine if he disclosed he was an agent.
m. Contract Liability
i. Is the principal liable? What do we have to ask to answer this question?
ii. Is the agent liable? What do we have to ask to answer this question?
iii. Does the type of authority determine whether the agent will be liable?
iv. Contract questions p. 36-37.
v. Casebook Problems (p. 36)
1. Problem 1
i. (a) Yes;
ii. (b) No. Clear that 3rd party was transacting w/ Bubba’s Burritos.
2. Problem 2
i. Assume agency relationship, and this is K.
ii. (a)Is there authority? Only authority to buy $1K. Agent is liable for
$1.2K. There is no actual authority. Is there apparent authority? Look
to manifestations of the P. Here the P did not make any manifestations
to the 3rd P? Yes, because he previously paid.
iii. (b) Agee is NOT liable because he disclosed he was agent.
iv. Would Agee be liable to Prop? Agents owes liabilities and duties to P
just like P owes the same to A. A has obligation to listen to P. P could
sue A for breach of fiduciary duty.
3. Problem 3
i. (a) No actual authority. No apparent authority because there is no
manifestation from P.
ii. (b) Would Agee be liable under K. Look for disclosure. Agee isn’t liable
because he disclosed he worked for Bubba’s Burritos.
iii. Agee will be liable in tort for fraud or misrepresentation, BUT NOT IN
n. Liability of Principal for Torts of Its Agent
i. A P can be liable for the torts of its agent in several capacities:
1. Direct Liability  P intended the conduct or the consequences.
2. Negligence  master was negligent or reckless (knew or should have known
but failed to stop the harmful conduct).
i. Example: Trucker had previous criminal record for sexual conduct w/
child. He was hired. Trucker rapes and kills girl. Parents sue parent
company. Was there an agency relationship? Yes. This is tort. Must
look at theories. Not direct liability. Intentional torts are generally not
w/in the scope of one’s work, not vicarious liability. This was negligent
hiring or background check.

3. Non-delegable duties  conduct violated a non-delegable duty of the master
(what are examples of non-delegable duties? Ultra-hazardous materials). This
will generally arise where the agent is an IC.
4. Vicarious Liability:
i. 3 Elements:
a)Where an agent acts on behalf of a principal that authorized it
to act;
b)The agent is acting w/in the scope of the agency; and
c) The agent is motivated by a desire to aid the P.
ii. Aided by the agency relationship (manager of hotel rapes patron)
iii. Servant purports to act or to speak on behalf of the P and there is
reliance upon apparent authority.
iv. Intentional Torts are generally OUTSIDE THE SCOPE of employment
a)EXCEPTION: Bouncer example – bouncer hired to bounce, if
they harm someone bouncing – Vicarious liability.
ii. Which theory would a 3P most want to use? Why? Direct liability. Because measure of
recovery would be greater. Under DL, P actually engaged in the harm versus under VL, P
didn’t really do anything wrong, A did.
iii. Tort Liability of Principal
1. Respondeat Superior  employer’s liability is NOT based upon or’s own wrong
doing but based of ee’s negligence. Thus, or’s liability is said to be vicarious or
secondary. This only applies in a master/servant relationship. This is a subset
of the A/P relationship.
iv. Employer liability for torts (Respondeat Superior)
1. Generally, employers are ONLY liable for the torts of their employees
committed w/in the scope of employment. An employer is NOT liable for the
intentional torts of its employees, unless the circumstances indicate otherwise
(where a bouncer injures a patron). Courts have historically looked to 3 factors
when determining if a tort falls w/in the scope of employment:
i. Whether the employee committed the tort w/in the general time and
place of his employment;
ii. Whether the employee was performing tasks he was employed to
perform when the tort occurred. (Frolic (no employer liability) versus
Detour (employer liability); and
iii. Whether the employee’s acts were motivated, at least in part, by the
employer’s interests when the tort occurred.
v. Employer Liability for Intentional Torts
1. Rule (General Rule) – intentional torts are outside scope of employment
agency UNLESS actions of the employee/agent are:
i. Specifically authorized;
ii. Natural from the nature of employment (e.g. bouncer);
iii. Motivated by a desire to serve the empoloyers or P’s interest (e.g.
employee apprehends shoplifter)
vi. Employer Liability for Torts Contd
1. An employee injures a 3P while driving the employee’s own car to or from
work? No liability from employer.
2. Employee injures several people while the employee was driving a company-
provided car to or from work? No liability from employer.
vii. Independent Contractors

1. Master is NOT liable generally liable for the torts of an IC because the control
and supervision found in an employer-employee or P-A relationship is lacking.
However, VL will be imposed in 3 circumstances (these are non-delegable
i. Where the contractor injures an invitee to the real property of the
a)NOT liable for injury to a Trespassor
ii. Contractor is involved in a Ultra Hazardous activity;
iii. Employer is estopped from denying liability because he has held out
the IC as if he were simply an employee or agent.
viii. Assume employee of investment bank is on phone w/ client:
1. Is there an agency relationship? Yes.
2. Tort or Contract? Tort.
3. 3P trying to hold P liable. Must look at theories. Not DL, no negligence (unless
bad driving history), no VL.
4. Employee would herself be negligent for her own actions.
ix. Agent IC versus Non Agent IC in K:
1. How can an IC be an agent (in K)? Assume hire IC to transport widgets from NC
to OH. Trucker gets in accident and 3P wants to sue employer. Employer has
no liability. Before trucker left, employer gave IC authority to buy zidgets to
protect the widgets. Zidget manufacturer can go after employer for payment
because IC has authority (whether actual or apparent).
x. IC versus Employees
1. Critical question is that of the right to control. To determine, consider these
i. Whether person performing services is engaged in an occupation or
business distinct from that of the principal;
ii. Whether or not the work is a part of the regular business of the
principal or alleged employer;
iii. Whether the principal or the worker supplies the instrumentalities,
tools, and the place for the person doing the work;
iv. The alleged employee’s investment in the equipment or materials
required by his or her task or his or her employment of helpers;
v. Whether the service rendered requires a special skill;
vi. The kind of occupation, w/ reference to whether, in the locality, the
work is usually done under the direction of the principal (employee) or
by a specialist w/out supervision (IC);
vii. The alleged employee’s opportunity for profit or loss depending on his
or her managerial skill;
viii. The length of time for which the services are to be performed;
ix. The degree of permanence of the working relationship;
x. The method of payment, whether by time or by the job (IC); and
xi. Whether or not the parties believe they are creating an employer-
employee relationship may have some bearing on the question, but is
not determinative since this is a question of law based on objective
xi. Questions on page 39:
1. #1  Is Servantes a servant? Yes. Are all agents also servants? No. Are all
servants also agents? Yes (depends upon what purpose).

2. #2  Is the CEO of GM a servant? Yes. He is an agent of GM. Is the pilot of a
Boening 747? Yes, they are an employee. Are you liable if your accountant
accidentally burns someone w/ cigar ash while doing your taxes? Is there an
agency relationship? (ABC). If Yes, next question is tort or K? This is a tort
situation. Was there DL, no negligence, no non-delegable duty, is there VL? No,
this is not w/in the scope of employment.
3. #3 Servants negligently spills scalding coffee on a customer. (a) Propp would be
liable because S is acting w/in the scope. (b) Propp is still liable because he
can’t remove a party, limit the rights, of a third party not a party to the
agreement (customer. (c) Is S also liable in tort to the customer? Yes.
4. #4 While driving to work, S negligently injuries a pedestrian. (a) Is P liable in
tort to the pedestrian? Yes. (b) Yes.
5. #5 P hires Agee to work as a cook. When A overhears a customer criticizing her
cooking, she hits the customer over the head w/ a skillet? (a) Yes, (b) No, (3
exceptions), (c) No. He’s not a principal.
o. Hayes v. National Service Industries, Inc.
i. Procedural History: TC enforced agreement negotiated by P’s attorney as to P’s action.
ii. Facts:
1. P sued National Linen Service and parent company, National Service Industries,
Inc. (D), alleging wrongful discharge from her employment as a sales
2. Attorneys for 2 parties settled case, but P rejected settlement, and D filed
motion to enforce settlement agreement.
3. Magistrate Judge issued report finding that P’s attorney (Rogers) had apparent
authority, and in fact believed he had actual authority, to settle case (2
independent grounds court validated settlement agreement). Report found
that terms of settlement are clear and P only contends that she didn’t consent,
but noted that such issue was IRRELEVANT so long as her attorney has apparent
authority to settle case.
iii. Issues: Whether P’s attorney had apparent or actual authority.
iv. Holdings: P’s attorney had apparent authority to enter into the settlement on P’s behalf
and that P therefore was bound by the agreement.
v. Rules: GA Law  An attorney of record is the client’s agent in pursuing a cause of
action and under GA law an act of an agent w/in the scope of his apparent authority
binds the principal. Also under GA law, an attorney has the apparent authority to enter
into a binding agreement on behalf of a client and such agreement is enforceable against
the client.
vi. Lecture:
1. Clark doesn’t believe there is actual authority. But there is apparent authority.
Court used GA law to settle the suit and find apparent authority.
2. If statute wasn’t present, would court have made same conclusion? Yes.
While P asserts that her attorney lacked authority to settle this matter, it’s
undisputed that P’s attorney, Rogers, spoke w/ counsel for D, Sharon Morgan,
and expressly told her that he had authority from P to settle the case for $15K.
i. Court is using this language to show apparent authority. Clark
believes this analysis is wrong. Must look at the manifestations of
the principal.

3. How could we re-write the opinion to show inherent authority which is an
extension of apparent authority? Fact that P hired an attorney, which would
be a manifestation by the P that the attorney acts on his behalf. Concerned w/
the principal’s manifestations to the 3P.
4. Inherent Authority  authority comes from the position.
p. Miller v. McDonald’s Corporation
i. Objectives: P sought damages from D for injuries that she suffered when she bit into a
heart-shaped sapphire stone while eating a Big Mac.
ii. Facts:
1. 3K owned and operated restaurant under License Agreement w/ D that
required it to operate in a manner consistent with the “McDonald’s System.”
Agreement described system as including proprietary rights in trade names,
service marks and trademarks, as well as designs and color schemes for
restaurant buildings, signs, equipment layouts, formulas and specifications for
certain food products, methods of inventory and operation control,
bookkeeping and accounting, and manuals covering business practices and
policies. Manuals promulgated by McDonald’s for franchisees contain detailed
information relating to operation of Restaurant, including food formulas and
specifications. 3K, as licensee, agreed to adopt and exclusively use the
formulas, methods ,and policies contained in the manuals.
2. Agreement described the way in which 3K was to operate the restaurant in
considerable detail. 3K could not make any changes in the basic design of the
building w/out D’s approval.
3. Agreement required 3K to keep restaurant open during hours that D prescribed.
3K also had to keep restaurant similar in appearance to all other McDonald’s
restaurants. 3K employees had to wear D’s uniform. 3K could only use
containers and other packaging that bore D’s trademarks.
4. For compliance purposes, D periodically sent field consultants to the restaurant
to inspect operations. Failure to comply w/ agreed standards could result in
loss of franchise.
5. Agreement also provided that 3K was NOT an agent of D for any purpose. But,
it was an independent contractor and was responsible for all obligations and
liabilities, including claims based on injury, illness, or death, directly or
indirectly resulting from restaurant operation.
6. P went to restaurant under assumption that D owned, controlled, and managed
it. P testified that she went to the Tigard McDonald’s because she relied on D’s
reputation and because she wanted to obtain the same quality of service,
standard of care in food prep, and general attention to detail that she had
previously enjoyed at other D restaurants.
iii. Issues: Whether there is evidence that would permit a jury to find D vicariously liable
for those injuries because of its relationship w/ 3K.
iv. Holdings: Court holds that there is sufficient evidence to raise a jury issue under both of
P’s theories: actual and apparent agency.
v. Rules:
1. In order to have actual agency the principal must have right to control agents
method of performance of obligation. (Right to Control Test)

2. Billops Rule: if, in practical effect, the franchise agreement goes beyond the
stage of setting standards, and allocates to the franchisor the right to exercise
control over the daily operations of the franchise, an agency relationship exists.
3. Restatement (Second) of Agency provides that one who represents that
another is his servant or other agent and thereby causes a 3rd person justifiably
to rely upon the care or skill of such apparent agent is subject to liability to the
3rd person for harm caused by the lack of care or skill of the one appearing to be
a servant or other agent as if he were such.
vi. Lecture:
1. What type of relationship did McDonald’s have w/ 3K? McDonald’s argued
that 3K was an IC and thus master would not be liable for tortious acts of
servant. Thus, only recourse is against 3K.
2. Is the agreement determinative of the final result? No.
3. 3P would have recourse against 3K.
4. Are all franchisees agents? No. In this case, franchisee was an agent. Depends
upon the level of control. The more control franchisor exercises over
franchisee, more likely franchisee will be considered an agent of franchisor.
5. Court determined that 3P could get to McDonald’s pockets. There were 2
independent arguments: (1) actual; and (2) apparent agency.
6. Actual Agency:
i. Whether McDonald’s have right to control? What evidenced was
used to show McDonald’s had control of 3K? Manual which showed
McDonald’s had specific control.
ii. Kind of AA relationship that would make defendant vicariously liable
for 3K’s negligence requires that defendant have right to control the
method by which 3K performed its obligations under the Agreement.
iii. Wood Case: AL court held that the agreement did not establish AA
because it did not control how the dealer complied with the
requirements. General instructions provided.
iv. Billops Case: DE SC held that the facts created a jury issue of whether
an AA relationship existed. Specific manual.
v. Distinction between Wood & Billops: extent to which the franchisor
retained control over the details of the franchisee’s performance. The
agreement in Wood, could ONLY be read as providing standards that
the franchisee had to meet, while the agreement in Billops could be
read as retaining the right to exercise control over the franchisee’s
daily operations.
vi. COA finds facts of Billops analogous to present case. Therefore, court
believes that jury could find that D retained sufficient control over 3K’s
daily operations that an actual agency relationship existed. Agreement
didn’t simply set standards that 3K had to meet, it required 3K to use
the precise methods that defendant established, both in the
Agreement and in the detailed manuals that the Agreement
vii. Evidence would support finding that D had right to control way in
which 3K performed at least food handling and preparation. In her
complaint, P alleges that 3K’s deficiencies in those functions resulted in
the sapphire being in the Big Mac and thereby caused her injuries.

Thus, there is evidence that D had right to control 3K in precise part of
its business that allegedly resulted in P’s injuries.
7. Apparent Agency:
i. What is apparent agency? Restatement (Second) of Agency provides
that one who represents that another is his servant or other agent and
thereby causes a 3rd person justifiably to rely upon the care or skill of
such apparent agent is subject to liability to the 3rd person for harm
caused by the lack of care or skill of the one appearing to be a servant
or other agent as if he were such.
ii. ******There is a distinction between apparent authority and
apparent agency*******Apparent agency creates an agency
relationship which does not otherwise exist. In an apparent agency,
the ABCs are not satisfied. In apparent authority, the ABCs are
iii. Why did the Court say let’s assume there was no agency relationship,
there is still is liability due to apparent agency? Due to the
agreement between McDonald’s and 3K because the agreement said
that 3K was not an agent and was thus an IC. Apparent agency arises
when there is in fact not an agency.
iv. What were the facts that the Court used to show that apparent
agency was met? Why should McDonald’s be estopped from arguing
there is not an agency relationship?
a)This McDonald’s operated like every other McDonald’s.
b)Appearance and operation of the Tigard McDonald’s.
c) Signs, uniforms, common menus, common appearance, and
common standards.
d)It looked like a McDonald’s.
v. What was McDonald’s argument:
a)There was a sign that said this was an independently owned
McDonald’s. This was an issue of fact and therefore sent to
a jury.
8. P asserts that D is VL for 3K’s alleged negligence because 3K was D’s apparent
9. Key issue is whether the putative principal held the 3 rd party out as an agent
and whether the P relied on that holding out.
q. Hypo:
i. Patient, 51-year-old diabetic, entered the hospital on Sept. 22, 2003, for surgery to
install a catheter. Dr. Z, an employee of the Anesthesia Group under K w/ the hospital,
was assigned to provide services during the procedure. P had never met him before. He
wore no ID and introduced himself to her simply as the anesthesiologist, not disclosing
his catheter was inserted w/out incident, P’s blood pressure and heart rate dropped
precipitously and Dr. Z was unable to stabilize her. She was resuscitated but suffered
brain damage and never regained consciousness and she remained in a vegetative state
until her death 3 ½ years later. In the wrongful death suit, P’s estate sued Dr. Z, the
Anesthesia Group and the Hospital.
1. Is Dr. Z liable? If so, on what basis? Yes, negligence.
2. Is the Anesthesia Group liable? If so, on what basis?
i. Is there agency? ABC’s, Yes.

ii. Is this tort or K? Tort.
iii. Direct liability? No. Negligence? No. (What fact would show
negligence: if hired him even after having butchered others). Non-
delegable duty? No. Vicarious liability? Yes, he was working w/in the
scope of his duty.
3. The hospital? If so, on what basis?
i. Apparent agency, arises even when there is no agency. Hospital
should be estopped from denying agency. There was nothing hospital
did to show that he was separate from the hospital.
r. How Does a SP Grow:
i. What are 4 ways that SP can grow?
1. Funding by owner;
2. Taking on debt and equity;
3. Borrowing money; and
4. Sharing profits w/ a lender.
s. Debt and Equity
i. What is debt? Money that is borrowed.
ii. What is equity? Giving ownership in exchange for some sort of consideration (cash or
iii. What risk does an individual assume if they decide to loan money to the business
versus a decision to take an equity position?
1. With debt, want principal and interest.
2. With equity, could potentially get nothing back (but could get more back).
3. Debt gets paid first. Creditors are paid first. (1) outside creditors; (2) inside
creditors; then (3) owners (equity position)
iv. Which one is more risky to the business, debt or equity? Why?
1. Debt. If go south still have to pay fixed amount. If decided to just get equity,
would relinquish control.
v. What is leverage? What is the problem w/ becoming over leveraged? Use of debt to
finance a business. Problem is as you borrow more money, have to pay more. If borrow
too much, may make it too much. If over-leveraged, and have a dip in an economy, want
have enough to pay bills.
t. Borrowing Money
i. What decision will a bank make if it deems a loan to be risky? It will require that the
lendee pay a higher interest rate.
ii. What can a business do to increase the likelihood of securing a loan?
1. Pledge personal or corporate assets. Collateral.
2. Promise to pay the money back in a short time. Makes lender feel more
3. Give creditor some measure of control over the business. Lender can make
sure they are getting paid back and make sure company remains profitable.
u. In Re Estate of Fenimore
i. Objectives: Donald Fenimore is insolvent, and creditors, known as Villabona, have
judgment against Fenimore for $32K. Creditors are seeking to recover a part of that
judgment from approximately $20K of property Fenimore recently inherited. Mrs. Serge
is also seeking to recover that $20K from Fenimore, contending that she is also a creditor
of Fenimore and that his debt to her should be paid first.
ii. Issues: Whether Mrs. Serge provided Donald Fenimore with debt or equity financing.
iii. Holdings:
1. A partnership existed between S and DF as of November 6, 1989.

2. Once S is determined to have been her brother’s partner, her right to collect
under the agreement from him as to his inheritance, which Is not partnership
property, is subordinate to the claims of his “separate creditors”, that is,
Villabona. If they are creditors of the partnership, even then her interests
would be subordinate to theirs.
iv. Lecture:
1. How is Ms. Serge involved? She gave her brother $15K for his business and she
wanted her money back. She argued she provided a loan. Brother
accumulated debt w/ another creditor and they want their money as well. Not
enough money to pay both of them.
2. People owed $32K are creditors.
3. Must look at agreement to determine whether Mrs. Serge provided Donald
Fenimore with debt or equity financing.
4. What was the key language?
i. DF agrees to divide the profits from each vehicle sold.
ii. If decide to share profits and losses, default is a partnership.
iii. Looks more like a partnership than a loan agreement. If loan
agreement, she would be paid first because her agreement was made
first. If partnership agreement, she would be paid second. Creditors
would be paid first.
5. Court made analysis that pursuant to this agreement looks like P because
splitting profits and losses.
6. Why would the standard of proof for proving the existence of P be stricter in a
dispute between 2 partners than in a situation where a 3P claims the
existence of a P?
i. Partners have ability to contract w/ one another and 3P does not have
ability to contract w/ the partners.
ii. Look back at Hospital Hypo. Is there another way, as a 3P, could hold
hospital liable? There is a partnership, if splitting profits. GP will arise
if have 2 or more people that share profits and losses. If they are a GP,
make Hospital joint and severally liable.
III. Chapter 3 – What is a Partnership and How Does it Work?
a. Partnership: An association of 2 or more persons to carry on as co-owners in a business for
profit (UPA 6(1)). Cannot have one person.
b. Partnerships (follow UPA in NC)
i. UPA is a set of default rules for partnerships when not provided in the PA.
ii. If the PA is silent, go to UPA.
iii. A business cannot operate as more than one type of entity. Can’t be a corporation and a
partnership. Want to open business and nothing formal is done, would be a general
partnership. In order to transition from GP to some limited entity, must file paperwork
with the State. Why is that it’s important to file w/ state? For 3rd parties, places them
on notice that organization has limited liability.
iv. Can a corporation serve as a partner in a P? Yes.
v. Could a partnership be a partner in a P? Yes. For example, can have a LLP that is a
partner in a GP.
vi. Members of P can be individuals or entities.
vii. Should individual partners hire their own lawyers? Yes. 2 individuals form a P, there
are 3 divergent interests. P is considered to be a separate entity from the partners.

viii. RUPA  entity, UPA  aggregate. But sometimes these theories don’t hold. Clark skips
these theories.
ix. Could a PA indicate that the P will NOT be liable for injuries to the public? Trying to
restrict rights of public. Can’t do this. 3Ps aren’t parties to the agreement.
x. Problems on p. 65 and 66. In terms of drafting PAs, as lawyers must be careful of
language used. Page 66, see Provision b  withdrawals of net profits by the partners
shall be in such amounts and at such times as the partners shall determine by mutual
agreement. What does mutually agree mean? What would constitute mutual
agreement? This is an ambiguous term.
c. Partnership Agreement (PA)
i. The PA shall control matters regarding the P.
ii. PA does NOT have to be in writing.
iii. If there is NO PA, the partners MUST vote unanimously to do any of the following: THE
1. Add a new partner;
2. Do something outside of the PA;
3. Change the PA;
4. For anything else, not including the aforementioned, a majority vote is all that
is needed.
iv. Why do you think that the UPA requires a unanimous vote to do any of the BIG THREE?
Have an effect on P, and affect P in a MAJOR WAY.
d. Property Ownership in a P
i. What is a partner’s sole asset in a P? His right to receive profits and losses from the P.
UPA 26.
ii. How can a P acquire property? By either buying or one partner can donate, or transfer
property to P.
e. Questions on page 67:
i. (1) BB can buy property. One of the partners can transfer property into the P
ii. (2) No. Why? What would have to happen for equipment to be P property? He would
have to transfer property to P.
iii. (3) Yes, property was accumulated by the P.
iv. (4) Yes.
v. (5) Yes, P property. BB bought the land through partner’s funds. If deeded to Capel, still
BB’s property. Not solely determinative.
f. Liability in/for a P:
i. What are the 2 typical disputes that occur in a P? Partner v. partner, or 3Ps v. P.
ii. What laws or rules help us to determine whether a P will be liable to 3Ps for acts or
omissions of a partner? Agency.
iii. What laws or rules help us to determine whether the P will have recourse against a
partner for the partner’s acts or omissions? Where do we look 1 st? PA 2nd? UPA 3rd?
Statutes or case law (?).
iv. General Rule: Every partner is an agent of P if he/she is acting w/in the scope of the P.
v. Is a partner an agent of the P? Yes, only when acting w/in the scope of the P.
vi. Is this true for all purposes? No, if acting outside scope of P.
vii. Under the UPA, is a P liable if a partner is not acting w/in the scope of the P? No.
viii. Can a P limit or restrict the rights of a partner? Yes. Can a P limit the power of an
agent to K? Yes. If so, how? Provision in PA. Even if partner is not allowed to enter into
Ks, if K is made and something is done w/in scope of PA, then P is liable to 3P. P should
put 3Ps on notice.
ix. Can the P limit or restrict the rights of a 3P? No.

x. Could a P recover from a partner who acts improperly? If breach duty of care, P can
recover from partner, even though 3P can enforce K against P that partner made w/ 3P.
g. P Decision Makings (P. 68 -69)
i. (1) There’s an equal right to management. Look to the BIG THREE + ONE. Not adding a
partner, outside scope of P, or change PA need unanimous. This is not one of these
three, only need a majority vote, he is powerless.
ii. (2) Need a unanimous vote.
iii. (3) Yes, they are legally obligated, because provided for in PA.
iv. (4) P is legally obligated but P can sue Capel. Does an agreement between partners
affects rights and obligations of 3PS? Capel is acting as an agent here as he’s acting w/in
his scope. In a GP, partners are jointly and severally liable therefore they are each liable
in this case.
v. (5) Clark question: Capel enters into agreement for Ferrari. Capel is not acting w/in
scope of his P and thus not an agent. P wouldn’t be liable.
1. When dealing w/ partners in a P. Idea is that every partner has power to act on
behalf on P (w/out authority under PA) as long as acting under his scope? But
in this case, outside the scope of the P.
h. Meinhard v. Salmon
i. Facts:
1. Walter Salmon, real estate developer, leased 7-story building (the Bristol) from
building’s owner, Elbridge Gerry for a term of 20 years. S also entered into
separate agreement w/ Morton Meinhard, a wool merchant. Under
agreement, M provided money for renovations to the building in exchange for
share of the profits from building over course of 20-year lease. Agreement also
provided that S and M were to share any losses equally but that S had sole
power to manage building.
2. Shortly before 20-year lease expired, G approached S w/ proposal. G owned 5
adjacent buildings, wanted someone to lease all of them, destroy them and put
up new, single, larger building. S accepted G’s proposal and entered into a lease
and development agreement w/ G. The new lease, to the Midpoint Realty
Company (owned and controlled by S), covered the whole tract. The rental,
which under the Bristol was only $55K, was to be from $350K to $475K for the
combined properties. S personally guaranteed the covenants of the new lease.
3. M was not a party to this new agreement and did not even know of agreement.
When M learned of the deal, he initiated this litigation, suing for an interest in
the new, expanded development.
ii. Issues: Whether S had a duty to disclose the opportunity to M.
iii. Holdings: S owed M a duty to disclose the opportunity to a sign a new lease.
iv. Rules: Joint adventurers, like co-partners, owe to one another, while the enterprise
continues, the duty of the finest loyalty.
v. Lecture:
1. What was the linchpin in the 2nd agreement/new project? Building for 1st
2. 4 months was left on 1st lease when 2nd lease was created.
3. What is a joint venture? JV is more a function of K law. Extremely similar to a
P. JV is for a limited purpose and a limited amount of time. Since the JV is a
function of K law, have a lot more control of what you have to do and what
you don’t have to do (different from a P).

4. Today, under UPA, this case would be a P.
5. What was S’s obligation according to Cardozo? Disclose offer to M, didn’t have
to allow him to join.
6. Meinhard wanted deal placed in a constructive trust.
7. Court found in favor of Meinhard because Salmon had duty to disclose.
8. M and S were partners, and S was the managing partner. Key fact because S
could exercise all of the power. M was more of a silent partner. Significant fact
that S was a managing partner.
9. What was dissent’s opinion? New deal was supposed to take place at
expiration of current deal.
10. Why does court place heightened level of responsibility in a P? Idea of the P is
based upon the idea of trust.
11. What would have happened if this was a P rather than a JV? Same thing
would have happened.
12. What would you have advised S? Tell S to wait until end of current lease, or he
has to disclose new deal to M.
i. Questions p. 74:
i. 1.2  Same result. However, because in actual case S was a MP, he had duty to disclose.
But maybe different result because he found out not because he was a MP.
ii. 1.3  Same result. Still related to this transaction in which began their transaction.
j. Why would a party want to form a JV as opposed to a P?
i. With a JV, have a little more control. In P owe certain duties to P. Some of these duties
(duty of care) could be eliminated if had a JV, because a JV is based on K. However, 99%
of courts treat JVs and Ps as the same.
k. How would you form a JV? Contractual agreement.
l. Joint Ventures (Will be posted)
i. Main difference between a JVC and a P is that a JV is normally temporary or project
based. A JV is a contractual arrangement between 2 parties that is undertaken to
complete a specific task whereas; a P is an agreement between 2 parties wherein both
the parties agree to share profits and losses of the activity undertaken. Thus in a JV, a
separate entity is formed that ceases to exist on completion of the task agreed whereas,
a P continues operations until dissolved and formation of a separate entity is NOT
m. Joint Ventures (Will be posted)
i. Each member of the JV retains ownership of his or her property.
ii. One common characteristic used to assert the proposition that a JV exists instead of a P
is the “two-tiered structure” under which JV assets are usually leased from one of the
venturers to the JV, when then uses those assets in the operation of the JV business.
iii. The absence of legislative rules for JVs allows the venturers significant freedom of K to
create their own rules of conduct for the internal running of the business. This is unlike
Ps where there are some things that a party cannot K out of.
iv. Joint venturers are NOT jointly and severally liable for the business venture’s debts,
unlike a P.
v. Key Point: given the current application of the UPA, if you want to create a JV, you MUST
EXPRESSLY contract for it.
n. Partner Duties:
i. Duty of loyalty:
1. Corporate Opportunity Doctrine: partners of a P owe it a fiduciary duty, and
may NOT use the information acquired in their official capacity for personal gain

(There is an opportunity presented to the P and partner misappropriates it for
themselves). P property usurped by a partner including the misappropriation
of a P opportunity is held in trust for the P. Under a constructive trust theory,
the P can recover any money or property misappropriated by the intransigent
2. A partner must refrain from dealing w/ the P as or on behalf of a party having
an interest adverse to the P. Self-dealing. Interested partner/director
3. Refrain from competing w/ the P in the conduct of its business.
ii. Duty of care – refrain from gross negligence, tri-part duty. Partner has to exercise GF,
fairly, and be informed. Can make stupid decisions as long as they are informed.
iii. Obligation of Good Faith and Fair Dealing
o. Questions (p. 75)
i. #5  Would have still found Salmon in breach of his fiduciary duty? There is certain
things you can’t contract out of. You can contract out of a breach of loyalty. Can’t
contract out of gross negligence. If determine this is a P, can’t contract out of this
p. Who is liable for what to whom?
i. Under the NCPA:
1. Partners are jointly and severally in Ks and tort.
2. Under UPA, you have J and S liability for K and tort.
q. Joint and Several Liability
i. Questions 1-5, p. 77
1. 1.1  Yes. Partners are considered agents of the P when acting w/in scope of P.
A is a partner.
2. 1.2  Yes. Individuals are liable for their own torts.
3. 1.3  Yes due to joint and several liability.
4. 3, but Clark changed question and asked if successful, can see collect from E?
5. J & S applies. E is J & S liable, but P CANNOT collect from E.
6. 5  Yes. A could seek contribution or indemnification.
r. How does the P grow? There are 4 sources of money for a P:
i. Existing owners;
1. What is a contribution agreement?
i. Requires that partners at some point contribute money.
2. Why might partners draft a contribution agreement?
i. Business needs money and CA will provide circumstances under which
money will be provided.
3. What four things will you want CA to have?
i. State the vote or events that trigger the obligation to contribute;
ii. The amount of each partner’s contribution obligation;
iii. The time in which to make the additional contribution; and
iv. The consequences of a failure to contribute.
4. CA will be mentioned in the PA.
5. There is no statutory requirement that partners make initial or additional
capital contributions.
6. If one partner decides to treat the contribution as a capital contribution, does
that decrease the other partners profit interest under the UPA? Contingent
upon how CC is constructed.
7. Can partners contribute things other than money? Yes.
8. Consider the provision on page 79. How does it affect the additional
contributions made by partners?

i. Treating CC as loans.
ii. Profits are usually split equal absent an agreement.
iii. If own 25% of company, your distributive interest is 25%.
iv. Might have to make contribution congruent to your ownership
percentage in company.
ii. Outside lenders;
1. What is a personal guarantee?
i. In event that P or business cannot pay, I am on the hook.
2. Why would you ever want to make a personal guarantee?
i. If the business isn’t credit worthy, make creditor more comfortable.
ii. Look at B/S, IS, and CFS.
3. How would you advise Capel, p. 79?
i. Advantage of signing a PG  business gets the money.
ii. Disadvantage  on the hook.
iii. To protect himself, Capel should make an agreement to get paid by the
iii. New investors (Additional Owners); and
1. What is one way that a partner can measure their ROI? Look to the ROE,
return on equity.
i. What percentage are you making on what you put in.
2. One common way of measuring return on investment is by comparing the
amount of cash flow (i.e. cash from business operations that could be paid to
the business’s owners) with the amount of the owner’s investment in a
i. Return on Equity = Cash Flow/Investment
3. An owner’s risk and return on equity are affected not only by the business’s
cash flow but also by the business’s financial structure. The higher the amount
of debt a business has, the higher the risk to the owner, and the higher the rate
of return that the investor will look for.
i. The use of debt to finance a business is sometimes called “leverage.”
a)Debt, in essence, levers up the return on equity.
b)Although leverage helps when times are good, it can kill when
times are bad.
iv. Earnings from business operations.
1. Existing partners fund the growth of their business NOT only by deciding to put
new money into the P, but also by deciding not to take money out of the P.
2. In deciding whether to retain earnings, the P should evaluate whether the P can
earn a higher return than the partners could earn individually if the money
were distributed to them.
3. Earnings should be distributed UNLESS the P has some lucrative use for the
s. Who is Liable For What To Whom? (SKIPPED IN LECTURE, NOT PURPOSELY)
i. Liability of the Partnership
1. Under RUPA Section 201, a partnership is a legal person – an entity. A
partnership can be held liable and can sue or be sued. Same is also true under
UPA, even UPA does NOT expressly adopt the entity theory.
2. A 3P can sue the partnership for the Ks entered by its agents and for the torts
committed by its agents.

3. Under RUPA, a partner can sue the partnership to enforce her rights under the
Act or under the partnership agreement. There is no similar provision in UPA;
Act limits partners’ ability to sue to seeking the dissolution of the partnership.
ii. Liability of the Partners
1. Under RUPA, partners are jointly AND severally liable for all obligations of the P.
2. Under UPA Section 15, partners are jointly BUT NOT SEVERALLY liable in K BUT
jointly AND severally liable in tort.***CLARK SAID DON’T WORRY ABOUT
3. Under joint liability, the plaintiff must sue ALL of the partners together in a
single suit.
4. Under joint and several liability, the plaintiff is free to sue one or more of the
iii. Note About Limited Liability Partnerships (LLP)
1. One drawback of a P is that the partners are generally liable for the P’s debts.
2. RUPA provisions bring significant protection from the traditional rule of liability
by protecting the assets of vicariously liable partners from collection by a
judgment creditor; generally a successful plaintiff cannot collect her judgment
from partners’ individual assets until exhausting partnership assets.
3. One common element in an LLP is the public filing of a document that serves as
notice that partners will not be personally liable for what the P does.
4. Section 306(c) of RUPA is broad. It provides that an obligation of a P while the P is a
LLP, whether arising in K, tort, or otherwise, is SOLELY the obligation of the P. A
partner is NOT personally liable, directly, or indirectly, by way of contribution or
otherwise, for such an obligation solely by reason of being or so acting as a partner.
t. How Do The Owners Of A Partnership Make Money? Generally an owner of a business makes
money by (1) being paid a salary by that business; or (2) receiving all or part of the profits from
that business; or (3) selling her interest in the business (a and b)
i. Salary  RUPA provisions are easy to understand and easy to apply.
1. If you work for a P, do you have to be paid a salary? No. Instead, will receive a
piece of the profits.
2. Can one partner prevent another from receiving salary? Yes.
3. Can one partner prevent another from increasing salary? Yes.
4. In order to change PA, in regards to salary, need unanimous vote, but if not
provided for in PA, just need majority vote.
5. Problems p. 82:
i. Yes if partners agree by majority vote.
ii. Yes. Partners are trying to increase, any time trying to change P
agreement, must get UNANIMOUS agreement.
iii. Suppose there is no agreement about salary, and one receives $30K
and $25K, only NEED MAJORITY VOTE to increase salary.
iv. #4  Yes. The other partners would care because the salary is
decreasing the profit. The P creditors care because affects Ps ability
to pay its debts. IRS cares because can get credit for paying salaries
and thus taxable income would decrease.
ii. Profits
1. Law w/ respect to P profits, like the law w/ respect to P salaries, is found
primarily in PA and other Ks and laws – not in the P statute or P case law.
2. Only RUPA provision that expressly deals w/ partners’ rights to P profits is
Section 401(b): “Each partner is entitled to an equal share of the P profits and is

chargeable w/ a share of the P losses in proportion to the partner’s share of the
3. Default Rule: If not provided for in PA, profits will be split evenly between
4. Problems, p. 82:
i. Each partners gets an equal share and thus $33K a piece.
ii. Yes.
iii. #4, can’t make distribution unless pay creditors first.
iii. Sale of Ownership Interest to a Third Party (WILL BE TESTED)
1. There are business and legal problems that a P encounters when one tries to
sell new P interests to new investors:
i. Finding a buyer;
ii. Gaining any necessary approval from existing partners; and
iii. Dealing w/ the question of pre-existing obligations.
2. An additional, unavoidable, statutory problem comes from RUPA Section 502:
“The only transferable interest of a partner in the P is the partner’s share of
profits and losses of the P and the partner’s right to receive distributions.”
3. Partners have right (only) to transfer right to distribution. Partner still retains
ability to participate in P decisions.
4. Why would law treat it differently if you purchase interest from P versus an
individual partner? All of the partners in P would have to agree to the sale
(unanimous decision), if coming from the P.
5. Problems, p. 83:
i. Partners have right to receive distributions/profits. Robert doesn’t
have right to participate in P decision, only right to receive
ii. Yes but no longer has right to distribution of profits.
iii. Yes, only have right to transfer interest in P.
iv. Yes, have the right to participate in management and distribution.
Generally all partners agree in bringing in a new partner.
iv. Sale of Ownership Interest Back to the Partnership
1. Buy-Sell Agreements
i. It’s common for the PA or some separate agreement among partners
to provide for sale of partnership interests back to the P or to other
partners. (Right of 1st refusal  at some point when partner wants to
sell interest, shall offer to P to purchase first).
ii. Such agreements are commonly referred to as “buy-sell agreements.”
iii. Special attention should also be given to the tax effects of the payout.
iv. Even if there is no buy-sell agreement, a partner has the power to
compel the P to pay for her P interest by withdrawing from the P. How
much and when a withdrawing partner is paid by the P is covered by (i)
PAs, (ii) P statutes, and (iii) the next chapter.
v. Why is buy-sell agreement important?
a)When have valid B-S agreement, helps determine how will
generate money to buy interest.
b)Affects relationships of parties when one party wants to
vi. If PA says the P will purchase the asset, P must have the money to buy
the interest.
2. Withdrawal of a Partner

i. First thing that happens when a partner w/draws from a P is that you
have to master a new vocabulary.
ii. If UPA controls, look to UPA Sections 29, 30, and 31: (only care about
UPA, don’t worry about RUPA and dissociation)
1. Does not mean that the P ceases to exist. It is not the
end of the P. It’s simply the beginning of the end.
b)Winding up; and
1. Liquidation of the business.
c) Termination.
1. P actually terminates.
iii. If RUPA controls the w/drawal of the partner, need to know: (DON’T
a)Dissociation as discussed in RUPA Section 601;
b)Dissolution as covered in RUPA Section 801;
c) Winding up; and
iv. Whichever statute and set of terms apply, you will be using them to
answer the questions of (i) what happens to the w/drawing partner if
there is no dissolution of the P and (ii) what happens to the P and to its
partners if there is dissolution.
v. Unless the P agreement says otherwise, a partner in a “partnership
at will” (a P w/ neither a specified end date nor a specific
undertaking to complete) can quit at any time w/out its being
u. Reviewed p. 83 and #3 again: Capel can compel, because a unanimous vote is need.
v. Withdrawal of a Partner
i. First thing that happens when a partner w/draws from a P is that you have to master a
new vocabulary.
ii. If UPA controls, look to UPA Sections 29, 30, and 31:
1. Dissolution;
i. Does not mean that the P ceases to exist. It is not the end of the P. It’s
simply the beginning of the end.
2. Winding up; and
i. Liquidation of the business.
ii. Selling of its assets to pay creditors and distribute whatever is left.
3. Termination.
i. P actually terminates.
w. When a partner withdraws from a P, a lawyer must answer 3 questions:
i. What happens to the withdrawing partner?
ii. If a partner withdraws, is the P terminated?
iii. What happens to the P and to its partners if there is a dissolution?
x. Dissolution
i. Where must you look to determine whether dissolution occurs?
1. UPA, Section 31.
2. If no particular term set for P, this is a P-at-will. One that can be terminated at
anytime for no reason at all.
y. UPA § 31. Causes of Dissolution.
i. Dissolution is caused:
1. Without violation of the agreement between the partners,

i. By the termination of the definite term or particular undertaking
specified in the agreement,
ii. By the express will of any partner when no definite term or particular
undertaking is specified (P at will),
iii. By the express will of all the partners who have not assigned their
interests or suffered them to be charged for their separate debts,
either before or after the termination of any specified term or
particular undertaking,
iv. By the expulsion of any partner from the business bona fide in
accordance with such a power conferred by the agreement between
the partners;
2. In contravention of the agreement between the partners, where the
circumstances do not permit a dissolution under any other provision of this
section, by the express will of any partner at any time;
i. Will cause dissolution, unless UPA allows P to continue.
3. By any event which makes it unlawful for the business of the partnership to
be carried on or for the members to carry it on in partnership; (highly tested)
i. A had degree and was allowed to provide medical services for P. If A
leaves, and B cannot provide medical services legally, then P ends.
ii. Statute passed.
4. By the death of any partner; (highly tested)
5. By the bankruptcy of any partner or the partnership; (highly tested)
6. By decree of court under section 32. (highly tested)
ii. Does death of a partner cause dissolution? Yes. Only if there is no PA that doesn’t
provide for the contingency. Even if one of the 10 partners dies, if there is no PA, then P
must wind up and terminate.
iii. What if a partner’s spouse is murdered? No dissolution.
iv. Under the UPA, what must happen when an event triggering dissolution occurs? Wind
up and then terminate.
v. If P has 10 year term, partner dies, under UPA, have to dissolve? Scenario # 1,
dissolution occurs.
z. Three Scenarios when a partner withdraws: (UPA Section 38) (3 scenarios which determine
what partners and P receive when P ends) Certain acts cause dissolution, when have acts that
cause dissolution, then have to look into what scenario this falls in.
i. Dissolution is NOT caused by an act in contravention of the PA.
1. Examples  This is when you have a P-at-will or death.
2. P could not continue. Dissolution  Winding Up  Termination and this must
3. Dissolution must occur.
ii. Dissolution caused by expulsion of a partner?
1. Must have dissolution  winding up  termination.
2. Sometimes courts will allow P to continue.
iii. Dissolution caused by an act in contravention of the PA?
1. Partners have the option of continuing the P.
2. Example  Have a PA and leaves in violation of the PA. PA  we have P for 5
years, and then leave in 4.
aa. Dissolution is NOT caused by an act in contravention of the PA (#1):
i. P property applied to discharge the P liabilities. (All the assets will be sold to pay

ii. Any surplus applied to pay in CASH the “net amount owing to the respective partners.”
(Paid what you contributed, if anything left over after that, profits will be divided equally
(unless PA says otherwise))
bb. Dissolution caused by expulsion (#2)
i. Expelled partner is entitled to:
1. Only the “net amount due him from the P.”
i. Contribution and share of the profits, must take liabilities into account.
ii. When expelling a partner, remaining partners have option to continue
P, so only have to pay what the partner is owed.
2. Default rule is that remaining partners can continue the P.
cc. Dissolution caused by act in contravention (liable for any damage caused) (#3)
i. Partners that did not cause the dissolution in cont. of PSA have 2 options:
1. Terminate the P: (takes into consideration of GW)
i. P property applied to discharge the Ps liabilities;
ii. Any surplus applied to pay in CASH the “net amount owing to the
respective partners”
iii. The right to sue the partner that caused the dissolution in
contravention of the P. (Should be able to reduce the net amount
owed to them based on damage?)
2. Continue the P:
i. Continue the business in the same name, if they obtain bond OR to
pay the partner that wrongfully caused the dissolution the value of his
or her interest, less any damages they be able to obtain against such
partner for the wrongful dissolution.
ii. In essence, what does this allow the remaining partners to do, do
they have to pay the wrongfully w/drawing partner now? Partner
that chose to continue must indemnify the wrongfully w/drawing
partner from all present and future P liabilities.
iii. Can pay now or later. If don’t have money to provide w/drawing
partner, must post bond to assure payment of w/drawing partner,
and w/drawing partner can still be sued. If pay later, there is no
restriction on the good-will.
iv. If pay w/drawing partner now, must determine value of the partners
interest. Can sue for any damages? Yes, for value of damages. In
determining the value owed to partner, goodwill will NOT be
included. UPA Section 38 (c) A partner who has caused the dissolution
wrongfully shall have: II. If the business is continued under paragraph
(2b) of this section the right as against his co-partners and all claiming
through them in respect of their interests in the partnership, to have the
value of his interest in the partnership, less any damages caused to
his co-partners by the dissolution, ascertained and paid to him in
cash, or the payment secured by bond approved by the court, and to
be released from all existing liabilities of the partnership; but in
ascertaining the value of the partner's interest the value of the good-will
of the business shall not be considered.
v. Business pays right now  value interest (don’t take into
consideration good will) – damages caused.

vi. Business pays later  post a bond, and pay partner at end of P. His
interest will be calculated at time he leaves, include good will (valued
at time he leaves), but still subtract damages (time he withdrew).
3. Example Mr. C’s watch is $500 and Rolex is $5K (due to good will).
ii. Partner that caused the dissolution in contravention of PSA:
1. P NOT continued:
i. P property applied to discharge the Ps liabilities.
ii. Any surplus applied to pay in CASH the “net amount owing to the
respective partners”
iii. Reduced by any harm done to the P.
2. P continued:
i. Is entitled to payment in cash for the value of this interest in the P
MINUS any damages caused by the dissolution. However, in
determining the value of such partners interests there shall be no
consideration of good will (if pay now, see above for full discussion).
dd. Withdrawal Questions Contd.:
i. What if there is no PA and a partner withdraw? PA at will (scenario #1). What type of P
is this? What happens? P assets will be sold to pay off liabilities and anything else will
go to P.
ii. If a P is for a term, a w/drawal of one partner cannot force the P to liquidate. Why
not? Because this is P for a term. Remaining partners have a chance to continue P.
iii. Any member of an AT WILL P has the right to force liquidation and ultimately
termination. Why? In an at will P, you can leave at any time, and can receive your
ee. Questions p. 85:
i. #1  P for a term. Propp CAN WITHDRAW from P w/in P’s 3 rd term. This puts us in
scenario #3, act that is in contravention. Rights determined upon whether partners
terminate (assets sold to pay liabilities and what’s left over will go P and he will liable for
any damages) or continue P (can be paid now or later, if later, post bond, can be reduced
by damages caused, if want to pay now, determine value of interest reduced by damages
and doesn’t include good will).
ff. Creel v. Lilly
i. Lecture:
1. Go to PA, no mention, go to UPA. Death, go to scenario #1. Must have
dissolution, winding up and termination.
2. Why does Mrs. Creel wants P to wind up and terminate? Partners based his
interest on “book value.”
3. BV doesn’t take into consideration good will.
4. If pay $1M for asset. No liabilities. Equity is $1M. If have 4 partners, each
receive $250K. This is the BV. Let’s assume you have an old business that has
generated a ton of good will. Good will is not placed on B/S (?).
5. Why did the court throw her argument out? Business didn’t have good will, so
BV was a good consideration of MV in this case.
6. Issue regarding around calculation of certain values, book versus market.
7. Creel wants UPA to apply.
i. Death of a partner causes dissolution (beginning of the end).
ii. Must wind up, assets must be sold, and that will determine true MV of
8. P wants ability to continue P.

9. Even if UPA applies, only way get to it is if PA doesn’t provide for it.
10. In this case, there was a PA. Under PA, even at death, could continue the P,
therefore, didn’t result in “death-penalty” for P.
11. Book Value = Assets of business – Liabilities + Equity (Partner Contributions)
i. Under BV, and principle of conservatism, appreciation of assets won’t
be taken into account. Doesn’t take into account good will.
12. Market Value = Value of such intangibles as goodwill, the value of the business
as an ongoing concern, and established vendor and supplier lines.
13. Court says there is no good will here.
14. If Joe’s Racing had been in business for 10 years, there would have been a
better argument for good will.
15. Assume that this case was decided under the UPA and that the partner
w/drew instead of dying, and that there was an agreement that the P would
last 10 years, but no other relevant provisions, how would this case have been
decided? What scenario would apply? Contravention of PA. Remaining
partners would have two options: (1) End P; (2) Continue P. If Continue, can
pay now or later. If pay right now, assets – liabilities to determine interest
reduced by any damage, but doesn’t take into account goodwill. If pay later,
must post a bond, assets – liabilities – damages + goodwill.
ii. Facts:
1. June 1, 1993, Joseph Creel began retail business selling NASCAR racing
memorabilia. Started business in section of his wife’s (Anne) florist shop. 1 and
½ years later he raised capital from partners so that he could expand and move
into his own space.
2. September 20, 1994, Creel entered into a P agreement (w/out assistance of
counsel) w/ Arnold Lilly and Roy Altizer to form a GP called “Joe’s Racing.”
3. MD, along w/ 18 other states, adopted the RUPA, effective July 1, 1998, w/ a
phase-in period during which the 2 Acts will co-exist. As of January 1, 2003,
RUPA will govern all MD Ps.
iii. Issues: Whether MD’s Uniform Partnership Act (UPA) permits the estate of a deceased
partner to demand liquidation of P assets in order to arrive at the true value of the
iv. Holdings:
1. When subsections (a) and (d) of paragraph 7 are read in conjunction, it is
apparent that the partners did NOT intend for there to be a liquidation of all P
assets upon the death of a partner.
2. Subsections (a) and (d) of paragraph 7 should be interpreted as outlining an
alternative method of winding-up Joe’s Racing and arriving at its true value
other than a “fire sale” of all its assets.
3. Where the surviving partners have in good faith wound up the business and the
deceased partner’s estate is provided w/ an accurate accounting allowing for
payment of a proportionate share of the business, then a forced all of all P
assets is unwarranted.
v. Rules:
1. UPA  partners may avoid the automatic dissolution of the business upon the
death of a partner by providing for its continuation in their P agreement or if
the estate of the deceased partner consents to continuation. If no mention of

continuation in agreement or no consent, the result was a forced sale of all P
assets (liquidation).
2. Book Value = Assets of business – Liabilities + Equity (Partner Contributions)
3. Market Value = Value of such intangibles as goodwill, the value of the business
as an ongoing concern, and established vendor and supplier lines.
vi. Reasoning:
1. COA turns to the “true value of the P” issue and whether liquidation is only
way to obtain it:
i. Creel’s Argument:
a)Accountant’s valuation is improper as it considers only the
book value and not the market value of the business.
ii. COA concurred w/ the TC’s findings as to the valuation of Joe’s Racing
in that there was NO value for goodwill. Company was too new.
gg. Liability Upon Withdrawal
i. Once a party withdraws from the P they are no longer liable for subsequent P liabilities
and obligations.
ii. A partner is liable for the existing obligations of the P accumulated during the course of
the partners association w/ the P. However, a partner can be excused from these
obligations if there is an agreement to that affect w/ the P and the P creditor (called a
iii. Questions p. 93:
1. A. Yes.
2. B. No (Ask Laura?)
3. C. Yes. 3P didn’t have notice that Capel had left P.
4. D. Yes. Capel has “lingering apparent authority.” Partner is in the dissolution
process. To eliminate lingering authority, provide notice in newspaper
(“Business” Section?)
hh. Winding Up
i. Upon winding up, who gets paid 1st:
1. Creditors other than partners (outside creditors)
2. Partner creditors
3. Partner capital contributions
4. Partner profits
i. If there is no agreement how will the profits be divided? Evenly.
ii. What if there is an agreement? Then it applies.
ii. If there are NO assets to pay the creditors can a creditor sue the partners? Yes, under
the idea of joint and several liability (GP).
ii. Partnership Accounts:
i. What is a partnership account?
1. How much partner has put in and how much they have received back from P.
In-flow and out-flow.
ii. Do partners need to agree on the partnership account? Should but don’t have to.
iii. Upon dissolution, the P is legally obligated to pay each partner the amount set forth in
the PA.
iv. Questions, p. 94:
1. #1, NO, this is dissolution and must wind-up and terminate.
2. #2 NO
3. #3 P must dissolve because this was a P at will.
4. #4 Yes or end.
v. Questions, p. 95:

1. #1, The debt owed to Capel (inside paid 2nd)should be treated differently from
the debt owed to other creditor (outside gets paid first).
2. #2, Yes.
vi. Questions, p. 96: (HEAVILY TESTED)
1. #1
i. Capel  $250K; P  $150K; A  $2K.
ii. Don’t have to agree to P accounts but should.
2. #2
i. C owed $100K; P owed $8K; A owed $2K
ii. $200K leftover in P.
iii. All partners get what they are owed. Out of $200K, $90K is leftover
and is split evenly.
iv. C  $130K; P  $38K; A  $32K
v. Equals the money the P had leftover.
vi. Clark’s example:
a)Instead of telling us how much they had left over, Clark will
tell us the P’s assets and liabilities. Subtract liabilities from
assets and this gives you what’s leftover.
3. #3
i. Same as above except that $20K is only leftover.
ii. Total amount owed is $110K as above.
iii. 20 -110 = -90.
iv. Divide profits and losses evenly, each party must take a loss of $30K.
v. C  $70K; P  -$22K; A  -$28K

jj. Kovacik v. Reed

i. Lecture:
1. Kovacik put in $10K in cash (asset).
2. At end of P, all assets were sold to pay debt. Assets were sufficient that was
owed to the creditors.
3. Reed only contributed services.
4. When K wanted his capital contribution back, his argument was that Reed owed
him for his capital contribution.
5. Court said that K was owed his capital but that Reed was owed for his services.
6. Assume that Hazel and Ralph decided to go into business for the purpose of
operating a taxi cab company. They file nothing w/ the State. Hazel contributes
nothing but her services to the P and Ralph contributed the taxi cab. If R
w/draws would H be liable if the P owed money to Cheryl for $5K worth of
massage services she provided? Idea is that this case sounds that Kovacik.
What’s the difference? In Kovacik, creditors were satisfied it was partner v.
partner. But here, outside creditors can collect from any partner because they
are jointly and severally liable. Outside creditor should should K, R, and the P.
ii. Facts:
1. November, 1952, Kovacik (Plaintiff) told Reed (D) that K had an opportunity to
do kitchen remodeling work for Sears Roebuck Company in SF and asked D to
become job super and estimator.
2. K said he had about $10K to invest and that if D would be super and estimator,
K would share the profits w/ D on a 50-50 basis.

3. K DID NOT to agree to share any loss that might result and D did not offer to
share any such loss. Subject of a possible loss wasn’t discussed in inception of
4. Venture was terminated on August 31, 1953 and K instituted this proceeding,
seeking an accounting of the affairs of the venture and to recover from D ½ of
iii. Issues: Whether the D is liable for ½ of the monetary losses of the JV.
iv. Holdings:
1. D is correct in is contention that the TC erred in holding him liable for ½ the
monetary losses, and that the judgment should therefore be reversed.
2. The conclusion of law upon which the judgment in favor of plaintiff for recovery
from D of ½ the monetary losses depends is untenable, and the judgment
should be reversed.
v. Rules:
1. General rule that in the absence of an agreement to the contrary the law
presumes that partners and joint adventurers intended to participate equally in
the profits and losses of the common enterprise, irrespective of any inequality
in the amounts each contributed to the capital employed in the venture, with
the losses being shared by them in the same proportions as they share the
2. Where one partner or joint adventurer contributes the money capital as against
the other’s skill and labor, neither party is liable to the other for contribution
for any loss sustained. Thus, upon loss of the money the party who contributed
it is NOT entitled to recover any part of it from the party who contributed only
kk. Notes:
i. There is a difference between the questions of (i) who is liable to 3Ps for unpaid
obligations of the P and (ii) who must bear the P’s losses. The questions arise at
different times and have different answers. Question of liability to 3Ps for unpaid
obligations of the P can arise at any time during the existence of a P.
ll. Bohatch v. Butler & Binion
i. Lecture:
1. PA provided for the procedures of expelling someone but not what they could
be expelled for.
2. TC rendered judgment for plaintiff/Bohatch on her breach of fiduciary duty
claim against D.
3. Why did the COA determine that the partner could not recover for breach of
fiduciary duty? P is a sacred relationship. Exception, bad faith. It’s an
affirmative obligation to whistle blow. Court thought this was a compelling
argument but not strong enough. Court was concerned about undermining
trust in Ps.
4. What could have partner done to protect herself in this case? In PA, could
have put in PA that partner could whistle blow and not have ability to kick her
5. What if Bohatch’s accusation would have been correct, same result? It would
not have mattered. Even if right, court would have still been in position to put
partner back in P.

6. Bohatch argued for a limited duty to remain a partner. Not that partners should
never be allowed to be expelled from P.
7. Bohatch argued she acted in good faith and she had an affirmative duty, in
compliance with State Bar, to report possible violations.
8. Court did not agree with Bohatch. Court said must have trust in P. Someone
you don’t trust should be able to be expelled. Such expulsion must be made in
good faith which is owed to the partners.
9. Could have Court made argument that other partners acted in bad faith? No
problem until she blew the whistle. Possible liable for damages in tort.
10. Would Court have reached different conclusion had accusations actually been
valid? No. But, she would have had a stronger argument for bad faith.
ii. Facts:
1. B was made partner in 1990. She then began receiving internal firm reports
showing number of hours each attorney worked, billed, and collected. From
her review of these reports, B became concerned that McDonald was
overbilling Pennzoil.
2. July 15, 1990, B met w/ Louis Paine (firm’s managing partner) to report her
concern that McDonald was overbilling Pennzoil. Paine said he would
3. In August, Paine met w/ B and told her that the firm’s investigation revealed no
basis for her contentions. He also said that she should begin looking for other
employment, but that the firm would continue to provide her a monthly draw,
insurance coverage, office space, and a secretary. After this meeting, B received
no further work assignments.
iii. Issues:
1. Whether a P has a duty NOT to expel a partner for reporting suspected
overbilling by another partner.
2. Whether the fiduciary relationship between and among partners creates an
exception to the at-will nature of Ps.
iv. Holdings:
1. SC affirmed COA’s judgment that the firm did NOT owe B a duty not to expel her
for reporting suspected overbilling by another partner. Thus, couldn’t collect
mental anguish and punitive damages.
2. SC affirmed COA’s judgment that the firm had breached its K w/ B, which
permitted her to recover K damages and AFs.
v. Rules:
1. Ps exist by the agreement of the partners and partners have NO duty to remain
2. The relationship between partners is fiduciary in character, and imposes upon
all the participants the obligation of loyalty to the joint concern and of the
utmost good faith, fairness, and honesty in their dealings w/ each other w/
respect to matters pertaining to the enterprise. Yet partners have no obligation
to remain partners, at the heart of the P concept is the principle that partners
may choose w/ whom they wish to be associated.

mm. Freeze-Out As An Endgame For A Partner- In a freeze out, the holders of the majority
interest force a minority owner to sell or otherwise give up her interest.
nn. Page v. Page

i. Lecture:
1. Why is the plaintiff bringing an action? To determine whether the P was for a
term rather than at-will. P wants a declaratory judgment that the P was at-will.
Puts us in Scenario #1, which automatically starts dissolution process. Part of
winding up involves paying P who is a creditor.
2. D’s position argues that this is a P for a term or purpose. D’s argument was
that purpose was to be profitable.
3. Court didn’t agree w/ D, this was not a specific enough purpose to be a
contravention of the PA. Every business is in the business of making a profit,
then there would no such thing as an at-will P, because each P would be for a
purpose (to make a profit).
4. In deciding whether partner would be liable for leaving in bad faith: As a
partner, owe fiduciary duty to other partners. If act in contravention against
such a duty can be sued.
5. This is a freeze-out the holders of the majority interest force a minority
owner to sell or otherwise give up her interest.
oo. Freeze Out
i. A partner at will is not bound to remain in a P, regardless of whether the business is
profitable or non-profitable. A partner may not, however, by use of adverse pressure
freeze out a co-partner and appropriate the business to his own use.
pp. End Games for a P Interest
i. Freeze out
ii. Expulsion (Bohatch) (scenario #2)
iii. Withdrawal from the P followed by either the P’s purchase of her P interests or
dissolution of the P.
iv. Sale to the P or an existing partner pursuant to an agreement.
v. Sales to a 3P of her transferable interest in the P (right to distributions/profits).
vi. Sale of the entire P.
vii. Conversion of the P to some other entity.
qq. Hypo:
i. Suppose A, B, and C agree to run night club in Durham. A and B hire D, a local real estate
agent, to locate and enter into a rental agreement for space to run the nightclub. After
internet researching a few listings, D learns that Lawson is leasing a building on the north
side of Durham. D calls Lawson and they orally enter into a K to rent the space;
however, D never informs Lawson that he is working for the ABC P. Who is liable?
1. ABC Partnership? ABC’s satisfied, there was actual authority, can get to ABC P.
2. C? Yes. P and jointly severally liable in K and tort.
3. A & B? Yes. P and jointly severally liable in K and tort.
4. D? Yes, agent that failed to disclose (non-disclosure)
IV. Chapter 4 – What is a Corporation and How Does a Business Become a Corporation?
a. Corporations:
i. What lead to the rise of corporations? Individuals wanted to make money. Could pool
funds from others and those parties won’t be personally liable. Social context that led to
rise of corporations? Why were they centralized and treated as Ps? Harder to get from
place to place. Industrial Revolution.
ii. Is a corporation and its owners one in the same or is a corporation a separate legal
entity? Corporation is a separate legal entity and can be a partner in a P.

iii. Are the owners of a corporation personally liable for the debts of the corporation? No.
Shareholders have limited liability. Shareholders provide capital for ownership interest,
and the BODs are the major decision-makers. BODs are elected by the shareholders.
iv. What is the extent of a shareholders liability? Limited to how much capital you invest.
Value of their shares.
v. What is the important of limited liability to a shareholder?
vi. How does the corporation facilitate wealth creation?
b. What is a closely held corporation? Public can buy shares but there is no public market for
facilitating the sale of those shares. Small corporations are called “close” or “closely-held.” They
have relatively few shareholders and there is NO public market for buying or selling interests in
them. Large corporations are called “public,” because they have shareholders and the interests in
them are publicly traded.
c. What are the 4 primary sources of corporate law?
i. State statutes; (NC follows the MBCA)
ii. Articles of incorporation, bylaws and other agreements;
1. AOI  Birth Certificate of the Corporation, corporation doesn’t come into
existence until the AOI are filed w/ secretary of State.
2. Bylaws are NOT filed w/ secretary of State. Gap-fillers of what’s not provided in
AOI in defining relationship between corporation and shareholders
iii. Case law; and
1. Interprets and applies the provisions in a corporation’s AOI and Bylaws.
2. Gap fills provisions not included in the AOI and Bylaws. For example, the extent
and nature of fiduciary duties.
iv. Federal statutes.
d. How does a corporation come into existence? Filing of AOI.
e. Difference between a corporation’s bylaws and its AOI? AOI (Birth Certificate) filed w/ State.
Bylaws are NOT filed w/ State and are GAP FILLERS.
f. What if the AOI contrast w/ Bylaws? AOI prevail because they are filed with the state.
g. How do you decide what goes in the articles of organization? (Chapter 55 of NCGS, See 2.02(a))
h. Also will study Delaware law. The state of incorporation controls the relationships within the
corporation. (Internal affairs doctrine)
i. ***The AOI establish a K w/ the corporation and its shareholders and between the corporation
and the State.***
j. What is a de jure corporation? A legal corporation.
k. Bylaws:
i. A K between the corporation and the shareholders.
ii. Generally provide the bulk of corporate rules and are easier to change since they are
NOT filed w/ the state.
iii. A company cannot change a bylaw in a manner that will conflict w/ the AOI.
iv. Bylaws are effective from the moment they are approved.
v. How do we determine to make a modification to bylaws? Look to the bylaws.
l. Promoters (Discuss this section in depth w/ Laura)
i. What is a promoter? Act on behalf of corporation before it’s formed.
ii. Why are they appointed to act in that capacity?
iii. What is the liability of a promoter where a corporation is never formed? Promoter will
be liable. What if tell you corporation has been formed even though it hasn’t?
Promoter will be liable.
iv. What are the 2 ways a corporation can be liable for the pre-incorporation K:
1. Corporation itself might expressly adopt the K. Corporation usually acts
through its board of directors, so if the BOD of Bubba’s passes a resolution

formally adopting the lease, corporation will be liable on lease from that
2. Corporation might impliedly adopt the lease. Suppose the BOD does NOT take
such a formal action, BUT a corporate official causes the corporation to use the
premises that are subject to the lease. By using the premises, the corporation
has adopted the lease, and is liable from that point.
v. What is the liability of a promoter if the corporation is formed? Promoter is still liable.
vi. How can the promoter get out of liability? Novation. K between (1)Corporation; (2)
Promoter; AND (3) 3P (all need to sign).
vii. ****ASK CLARK****
viii. Problems p. 117:
1. 1. (a) Yes.
2. 1. (b) Yes.
3. 1. (c) No. To get to them, would have to claim that individuals formed a P.
ix. Unless otherwise agreed, a person who, in dealing w/ another purports to act as agent
for a P whom both known to be non-existent or wholly incompetent, becomes a party to
such a K. Therefore, faced w/ a non-existent corporation the promoter becomes fully
liable for any Ks entered. Remember under our agency rule, an agent is NOT liable when
he’s acting pursuant to actual or apparent authority….
m. De Facto Corporation:
i. Persons acting on behalf of (or with) a business that they think is a corporation but, in
fact, the corporation was not actually formed.
ii. Problems p. 119:
1. P, A, C want to incorporate business as Bubba’s. Go to F, an attorney, who
prepares necessary papers. F tells them that he will deliver documents and
filing fee to state agency on March 1 and that they can start doing business as
corporation on that day. But, F moved away and never delivered documents to
state agency.
2. March 2, P, A, and C meet as directors and elect P as president. March 3, P,
acting on behalf of corporation, signs lease between Bubba’s and L&L. P and
people at L&L all think that Bubba’s is a corporation.
3. Who is liable?
4. (a) P is similar to a promoter. The principal is NOT disclosed here because it
doesn’t exist. P is liable.
5. (b) A and C are liable if they are a partnership. But, A and C, would say you
can’t treat us as a partnership, but as a de facto corporation (not a de jure
corporation). If there is a corporation, A and C’s liability is limited.
6. How does MBCA treat a de facto corporation? They recognize it.
7. Starting point is that P, A, and C are all personally liable for the acts purportedly
taken by the corporation. Courts developed the doctrine of “de facto
corporation.” Concluded that if the proprietors were acting in GF and came
very close to forming a legal corporation, there was a de facto corporation. As
a result, the proprietors would NOT be personally liable.
8. De facto corporation was a broad doctrine that applied in K and tort. It
applied in ALL cases EXCEPT action brought by state against proprietors.
9. De facto corporation is an equitable doctrine, so one seeking to use it MUST
act in GF. Thus, she must be unaware of failure to form legal corporation.

10. Many states today have abolished the de facto corporation doctrine. In these
states, if you fail to form a legal corporation, the proprietors are liable for
whatever they purported to do on the “corporation’s” behalf.
11. Continuing fact pattern from above, on March 3, E enters a K w/ the
corporation, by which E sells supplies to the business and treats the business as
though it was a corporation. Can he recover from each proprietor individually?
12. What two arguments would owners make? De facto corporation and
corporation by estoppel (acted as if the individuals had a corporation).
13. Starting point, is that again, there is no legal corporation, so proprietors will be
liable personally. However, P, A, and C may be able to argue de facto
corporation. But might also argue corporation by estoppel.
14. Argument is that E dealt w/ the business as a corporation and treated it as such,
and thus should be estopped from denying that it is.
15. *****Corporation by estoppel is a narrower doctrine than DFC because it
generally applies ONLY in K cases, NOT tort***. Because prior to entering into
K, 3P could have performed due diligence to determine there was a
corporation. Look to the Secretary of State to find the AOIs.
n. Promoter Liability for Secret Profits (WILL BE POSTED) (anything sold to corporation)
i. This is merely an obligation to disclose the promoters expected profit. There is no
fiduciary duty to a corporation that has yet to be formed, however, once it’s formed the
fiduciary duty retroactively attaches (duty from promoter to corporation because he
knows so much information about the corporation): (When did promoter acquire
property that he intends to sell?)
1. For property acquired before the promoter becomes a promoter, the test for
profit is the price paid by the corporation minus the FMV (fair market value) of
the property. This is known as the secret-profit (don’t want promoter to get a
secret-profit). Thus, what the promoter paid is IRRELEVANT. In short, there is
only a problem if the corporation paid more than the FMV?
2. For property acquired while he was a promoter, the test for profit is the price
paid by the corporation minus the price paid by the promoter.
ii. What is the basis behind this rule? Prevent secret profits earned by promoter.
iii. What must the promoter do to avoid liability under this rule? Disclose the specifics
about the property.
o. Issuing Stock Options:
i. What number of shares must be identified in the AOI? Authorized shares. Number of
shares the corporation can issue or sell.
ii. What is it called when a corporation sells its own shares? Issuance.
iii. Once a corporation sells its own shares to a shareholder, those shares are now
considered? Issued and Outstanding
iv. Fill in the blank, the number of shares authorized will always be equal to or greater than
the number of shares issued and outstanding.
v. What happens if a company buys back its own shares? Those shares are now called?
Treasury stock/shares. Why might a company want to do this? Company wants to buy
them and sell them when stock goes up.
vi. Can a company issue more shares than it has authorized? No. To change, must make
an amendment to the AOI.
vii. Assume have 1K shares are authorized. Sell them all to 4 shareholders, each has 250
shares. Now corporation needs to generate new money, wants to sell shares, issue

stock. Capped out under AOI. Put in AOI, put pre-emptive rights provision which
requires that if company wants to issue more shares, must offer shares to current
owners to make sure they can obtain/maintain their same amount of ownership.
p. Stock Related Terms:
i. Preferred Stock – what is preferred stock? If the AOI provide that a class of stock is to
be treated more favorably than the other class of stock, then it’s preferred stock.
ii. Common Stock – anything not preferred
iii. Par Value - PV is the minimum price for which a C can issue its shares. PV is just a
minimum issuance price, not a fixed price.
q. Preferred stock slides will be posted.
r. Preferred Stock:
i. PS is created by the AOI. Thus, if the AOI indicate that one class of stock is to be treated
differently than another class that such stock will be considered preferred stock. PS does
NOT offer the same potential for capital appreciation, but it’s more stable than common
stock and generally offers one of 3 benefits
1. Dividend rights;
i. Right to collect specific amount at specific period of time.
2. Liquidation rights; OR
i. Sell it, will be paid first.
3. Redemption rights (some sort of buy back preference stock)
i. Preferred shareholders get paid before common shareholders.
ii. If there was only one type of stock, it would be common stock.
ii. Generally, PS owners do NOT get voting rights in the business.
iii. However, PS stock can either be voting, non-voting, or voting only upon certain issues, or
upon the happening of certain events. Companies can issue voting rights w/ PS holders
under the MCBA as long as there is at least one class w/ unlimited voting rights.
iv. Unlike, CS, PS pays a fixed dividend that does NOT fluctuate, although the company
does NOT have to pay this divided if it lacks the financial ability to do so. The main
benefit to owning PS is that you have greater claim on the company’s assets than
common stockholders. PS always receive their dividends first and in the event the
company goes bankrupt preferred shareholders are paid off before common
v. CS and PS shareholders can receive dividend (money for owning a share). Why pay a
s. Types of Preferred Stock:
i. Participating PS (versus non-participating)
1. Which entitles holders to dividend increases if, during a given year, CS dividends
exceed those of preferred stock dividends.
2. 10 PS and 10 CS shareholders. Pursuant to agree, PS can receive $10/share
($100). Company has $200. Pursuant to PS agreement, have to pay PS
shareholders. Have $100 leftover. Could go to CS shareholders. If PS
shareholders hold participating PS shares, can jump into the left over $100. The
$100 leftover, would be split by 20 people, $5/share.
ii. Cumulative preferred (versus non-cumulative)
1. Stock. If a dividend on a cumulative preferred is missed, it’s not forgotten.
Instead, it accumulates and must be paid off before any dividend payments are
made to the CS.
2. If the company doesn’t have money can’t pay dividend at end of year. If don’t
get one in Year 1 or 2, in Year 3, must pay 1, 2, and 3 before any others.

iii. Convertible PS (versus non-preferred)
1. Which has a conversion price named at its issuance so that it can be converted
to a company’s CS at the set rate.
2. Why would you want to convert PS to CS? In order to get market appreciation.
iv. Prior PS (versus preference preferred)
1. Many companies have different issues of PS outstanding at the same time and
one of them is usually designated to be the one w/ the highest priority. If the
company has only enough money to meet the dividend schedule on one of the
preferred issues, it makes the dividend payments on the prior preferred.
Therefore, prior preferred have less credit risk than the other preferred stocks
but it usually offers a lower yield than the others.
t. You can have a class that is participating, cumulative preferred, convertible, prior PS. To
determine what type of stock the PS is, must look at the AOI. Generally, preferred shareholders
are NOT entitled to vote. Under the MBCA, the corporation can give PS shareholders ability to
vote as long as there is one class that has unlimited voting rights.
u. Common Stock
i. Three benefits:
1. Capital (Market) appreciation – (Market) capital appreciation occurs when a
stock’s value increases over the amount initially paid for it. The stockholder
makes a profit when he or she sells the stock at its current market value after
capital appreciation.
2. Dividends – paid out of retained earnings or current earnings. Can be made in
cash, property, or stock.
3. Owners of Common stock can vote on company issues and elect directors.
Also may have pre-emptive rights (ability to purchase new shares of stock first
in order to maintain same percentage of ownership)
ii. Disadvantages:
1. Last in line to get paid.
v. Why might a corporation issue more shares? Raise capital for operations. Make money off of
issuance. Only time corporation will make money off of shares is when it issues the shares.
w. Par Value
i. What is PV? Minimum price for which shares can be issued.
ii. How can it be determined? Figure out how much someone would pay for the stock. PV
may not match up with what someone will want to pay in the open market.
iii. 2 jurisdictions:
1. One has PV;
2. One does NOT have PV (most states follow this: NC. However there are
certain disclosure requirements that must be made.)
1. Neither the MBCA nor Delaware law requires that corporation set a par value.
2. NC requires a par value
3. Water Stock: Selling stock below the par value
4. The par value is$10 per share - you sell the stock for $1= $9 in water stock
5. The person who bought the stock (for a $1) would be sued to pay the value up
to the par value
6. States requiring par value require keeping 2 separate accounts

v. Stated Capital – the amount generated from the issuance of stock at par. This cannot be
distributed to shareholders, this money is merely a way of ensuring that the company
retains at least some money to pay its bills. Security to creditors.

1. Example: 10 shares, PV = $1/share. SC = $10.
vi. Capital Surplus – the amount generated from the issuance of stock sold in excess of par.
1. Can sell shares in excess of par. CANNOT sell below par, this is called watered
stock. BOD will get in trouble for amount that is sold below par.
2. Example:
i. PV = $1/share, 10 shares, Sell shares for $10/share or $100. SC = $10,
CS = $90. If want to give money back to shareholders, can’t pay a
distribution out of the SC account, because it provides protection for
the creditors. Can make a distribution out of CS. Anytime you give
money back to a shareholder, Clark calls this a distribution. A special
type of distribution is a dividend (See Retained Earnings)
vii. Retained Earnings – refers to the profits generated from operations that are retained by
the corporation rather than distributed to its owners as dividends.
1. When getting money back, prefer to get it from RE, because they are making
money and then turning it back out.
viii. SC, CS, and RE will be listed under Equity in a B/S.
ix. PV was originally created as a means to value the stock. However, it was rather
x. High PV increases liability for investors. Why? Because if par is high, they can’t receive
that money back. Although liability was increased for investors, who might be more
comfortable w/ a high PV? Creditors. If you are the creditor, want PV to be high.
xi. Companies began setting PV low. If represent creditors, what would you do? Have the
owners sign a personal guaranty, or provisions in loan document that in event funds
drop below certain figure, your loan repayment schedule will be accelerated.
xii. What happens when you sale stock for less than par? This is known as watered stock.
xiii. Problems, p. 124:
1. 1. (a) Yes. (b) Yes. (c) Yes. (d) Yes. (e) Yes.
2. 2. Technically can do it, but will be liable, and this is watered stock. BOD are
3. 3. YES.
4. 5. YES. Why would a shareholder sell her stock for less than its PV?
x. State of Incorporation
i. Majority of corporations incorporate under the laws of DE because have so much case
law and rulings are predictable which corporations like. Also, DE law is corporate
ii. Internal affairs doctrine – the state of incorporation govern the procedures for
corporate actions and the rights and duties of directors, shareholders and officers.
****Does NOT have to do w/ where suit will be held, but what law will apply.***
1. Question on Exam:
i. Company doing business in NC (principal place of business),
incorporate under laws of DE. 3P driving down street and is hit by an
employee of the company in NC. Tort occurred in NC, thus NC law
would apply. DE law only controls internal affairs of the corporation.
ii. Same as above, but shareholder wants to contest policy of
corporation, DE law will be applied. DE law governs relationships
between company and the shareholders.
V. Chapter 5 – How Does a Corporation Operate?
a. Who is Liable to the Corporation’s Creditors?

i. A corporation is an “entity” and a “person.” It can sue and be sued for the actions of its
ii. The corporation can be held liable to 3Ps for Ks, torts, violations of statutes, etc.
iii. There are contractual and judicial exceptions to the rule that shareholders are NOT
personally liable for the acts or debts of the corporation:
1. Contractual Exception: 3Ps often refuse to extend credit to a corporation w/
limited assets unless that corporation’s shareholders agree to be personally
responsible (i.e. personal guarantee payment).
2. Judicial Exception: not an easy or obvious exception.
iv. In K, how might a corporations SHs be liable w/out a 3P having to pierce the corporate
veil (PCV)?
1. SHs have limited liability in a corporation.
2. Reason that SHs have LL is because there is a veil placed on corporation that
exists to protect the SHs.
3. Answer: Contractual Exception: 3Ps often refuse to extend credit to a
corporation w/ limited assets unless that corporation’s shareholders agree to be
personally responsible (i.e. personal guarantee payment).
b. Dewitt Truck Brokers, Inc. v. W. Ray Flemming Fruit Company
i. Lecture:
1. P’s first argument is that there is no reason to PCV, because there is a
contractual exception. P doesn’t want to go after company because company is
broke. Is going after D because he provided the P a PG.
2. SOF was discussed because the PG was orally made, and have to have a writing
signed by party against whom enforcement is sought.
3. Therefore, had to show a judicial exception.
4. Who carries the BOP in PCV claim? Plaintiff, person bringing the PCV claim.
5. Is it necessary to prove the SH engaged in fraudulent conduct? No. Court’s
would require fraud in a K claim because 3P can research company to
determine if they can be paid back or not.
6. What is undercapitalization? When do you measure undercapitalization?
Inability of the corporation to pay its debts and obligation as they come due. At
time the company begins. Whether there is enough money in the company to
pay off debts when they come due. Did the SH’s put enough into the business?
7. What is the alter ego theory? Individual SH is treating the company as one in
the same. Have one bank account, have same meetings, one telephone.
Corporation starts to look like shareholders. No delineation between SH and
corporation. Factors:
i. One fact which all the authorities consider significant in the inquiry,
and particularly so in the case of the one-man or closely-held
corporation, is whether the corporation was grossly undercapitalized
for the purposes of the corporate undertaking;
ii. Failure to observe corporate formalities;
a)Meetings, for example.
iii. Non-payment of dividends;
a)Failure to pay dividends to other SH in order to keep money
to pay yourself a salary. It’s not that corporation is not
paying dividends to keep money inside of corporation.
iv. Insolvency of the debtor corporation at the time;
v. Siphoning of funds of the corporation by the dominant stockholder;

vi. Non-functioning of other officers or directors;
vii. Absence of corporate records; or
viii. Fact that the corporation is merely a façade for the operations of the
dominant stockholder or stockholders.
8. While the SOF prevented the P from suing on the PG was the SHs promise
wholly irrelevant in PCV? No. Wasn’t used as an independent basis, but was
still relevant to determine whether they can PCV.
ii. Facts:
1. W. Ray Flemming Fruit Company (“corporation”) sold fruit for growers on
commission. When the fruit was sold, the corporation would pay the growers
the sales price less (i) the corporation’s commissions and (ii) the corporation’s
transportation costs. The corporation contracted w/ Dewitt Truck Brokers, Inc.
(plaintiff) to transport the fruit.
2. Corporation owes P approximately $15K.
3. W. Ray Flemming, corporation’s principal shareholder, orally assured P that he
would personally pay for the fruit transportation if the corporation did not. This
oral promise to answer for the debts of another was NOT legally enforceable
because of the SOF.
iii. Issues: Whether W. Ray Fleming “pierced the corporate veil” and is thus liable.
iv. Holdings:
1. US COA affirmed DC’s judgment in favor of the P.
2. Finding of the DC that the corporate entity should be disregarded was NOT
clearly erroneous.
c. Ways to PCV (Getting a PG does NOT PCV, it is another way to get to a SH)
i. Fraud – some courts require a showing of fraud in a K case. Why would some courts
require a showing of fraud in a K case? This makes sense b/c in these types of cases the
parties entering into the K have the ability to thoroughly evaluate the corporation. As
such, they transact at their own peril. In a tort case, fraud is NOT a key consideration
b/c the harmed party did NOT consent to the harm and doesn’t have a way of
investigating the fraud before the cause of action arose.
ii. Under Capitalization – less likely in a K case b/c the 3P can inspect the corporate records
whereas a tort claimant cannot. Generally, courts are only concerned about
undercapitalization at the birth of the corporation.
iii. Alter Ego – disregard of corporate formalities, reality not form:
1. Failure to observe corporate formalities;
2. Non-payment of dividends;
3. Insolvency of the debtor corporation at the time;
4. Siphoning of funds of the corporation by the dominant stockholder;
5. Non-functioning of other officers or directors;
6. Absence of corporate records; or
7. In a single owned corporation who else is receiving a salary.
d. Corporation/Subsidiary Liability
i. ****Remember that a parent corporation is NOT liable for the Ks, torts, and other
obligations of its subsidiary corporation UNLESS there is a contractual or judicial
exception to the rule that a SH is NOT liable for the acts or debts of the corporation.****
ii. A corporation can be a shareholder of another corporation.
iii. A corporation whose stock is owned by another corporation is commonly referred to as
a “subsidiary.”

iv. A “subsidiary” is a corporation, a majority or all of the outstanding stock of which is
owned by another corporation, called the parent corporation.
v. Every corporation is an entity (a legal person), with its own assets separate from those
who own and run it.
e. In Re Silicone Gel Breast Implants Liability Litigation
i. Lecture:
1. Bristol’s name was listed on MEC’s products due to certain goodwill for Bristol.
2. Who are the claimants in this case? Those who got breast implants and
weren’t satisfied.
3. Why not get money from MEC? They closed up shop in 1991 and sold off
assets and then gave left over money to Bristol. Bristol gave MEC a demand
note in return (have to pay MEC at some point).
4. What are two ways of liability Ps are using to get to Bristol:
i. Direct Liability; and
ii. Corporate Control Theory (PCV).
5. Was there sufficient evidence to establish that they could PCV? Yes.
6. Factors that show substantial domination:
i. Parent (P) and Subsidiary (S) have common directors/officers
ii. P and S have common business departments
iii. P and S file consolidated F/S and tax returns
iv. P finances the subsidiary
v. P caused incorporation of subsidiary
vi. S operates w/ grossly inadequate capital
vii. P pays salaries and other expenses of S
viii. S receives no business except that give to it by the P
ix. P uses the S’s property as its own
x. Daily operations of the 2 corporations are NOT kept separate
xi. S does NOT observe basic corporate formalities (separate books,
shareholder/board meetings)
7. Analyzing factors, strong case for PCV, and could thus get into parent’s pockets.
If this didn’t work, would look to direct liability.
8. What factors go towards direct liability?
i. Apparent authority. Arises when there is in fact no actual agency
relationship, but such agency should not be denied.
ii. What manifestations was Bristol making? Branding themselves on
MEC’s products.
9. More likely that smaller corporation will have corporate veil pierced versus a
larger company.
ii. Issues: Whether the evidence supports a finding that SJ is appropriate.
iii. Holdings:
1. US DC (AL) held that D is NOT entitled to a SJ.
2. Because the evidence available at TC could support a finding that the corporate
veil should be pierced, D is NOT entitled through SJ to dismissal of the claims
against it.
iv. Rules:
1. 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.
2. The totality of circumstances must be evaluated in determining whether a
subsidiary may be found to be the alter ego or mere instrumentality of the

parent corporation. All jurisdictions require a showing of substantial
3. DE courts do NOT necessarily require a showing of fraud if a subsidiary is found
to be the mere instrumentality or alter ego of its sole stockholder.
f. Parent Liability (Situations) (Bristol Case)
i. PCV:
1. Establish liability on behalf of shareholders.
2. Theories to PCV:
i. Fraud
a)Need fraud in a K case because 3P can investigate prior to
entering the K
ii. Undercapitalization
a)Measured at time business begins. Whether have sufficient
capital in company to pay debts when come due.
iii. Alter Ego
1. Not paying dividends (keeping money in company to
pay salaries)
2. Failure to observe corporate formalities (SHs and
BODs meetings)
ii. Direct liability – a parent can be directly liable where its own actions in operating the
subsidiary cause harm. However, it must be proved that the alleged wrong can
seemingly be traced to the parent through the conduct of its own personnel and
management and that the parent is directly a participant in the wrong complained of. If
so, the parent is directly liable for its own actions.
1. SH (parent) is liable for its own actions.
2. Strict products liability, negligence, negligent failure to warn, negligence per se
for not applying w/ FDA regulations, misrepresentation, fraud, and
iii. Apparent Agency – unlikely because it would undermine the whole purpose of the CV.
1. Arises when in fact there is no agency relationship (ABCs are NOT satisfied)
2. Vicarious Liability
3. Bristol case where placing name on products.
g. Enterprise Liability
i. EL is a legal doctrine under which individual entities (for example, otherwise legally
unrelated corporations or people) can be held jointly liable for some action on the basis
of being part of a shared enterprise. EL is a form of secondary liability.
ii. Theory under which corporations that (although technically separate) are commonly-
owned and engage in one enterprise should be treated as a single legal entity for
purposes of liability.
iii. Example  Walkovszky v. Carlton
1. P was injured when hit by taxi.
2. Cab was operated by a corporation owned by Carlton. Corporation’s assets
consisted of 2 cabs.
3. Carlton also owned 9 other corporations, each set up the same way.
4. All 10 taxicab companies were operated out of a single garage, w/ a single
dispatching system. All 10 were operated as a single business.

5. P alleged C continually drained all profits out of the companies, leaving them w/
little in the way of assets.
6. P’s theory of “piercing the corporate veil”  if successful, would have pierced
through the one corporation that operated the cab that hit him and recovered
from Carlton.
7. P’s theory of “enterprise liability”  if successful, court would have treated all
10 companies as one. P would have been able to recover from the combined
assets of all 10 companies.
iv. How is it different from PCV/Agency Liability/Direct Liability? PCV allows you to go
vertically, whereas EL allows you to go vertically AND horizontally, suing every entity
involved (?).
v. Get owner of all of the companies and all of the companies under the owner’s
umbrellas. Look at what are consistent/share between the same companies: BODs, SHs,
meetings, bank accounts.
vi. Look to see if EL applies if limiting liability so much that it looks like a sham.
vii. Enterprise liability pierces the walls of one corporation NOT to go after the assets of a
shareholder, but to go after the assets of related companies.
h. Shareholders/Directors/Officers – system of checks and balances
i. SH  owners of the corporation. SH’s elect the BODs and can fire them.
ii. Ds  set the long term strategic plan of the corporation and appoint/hire the officers.
Also decisions to give dividends.
iii. Os  carry out day-to-day operations of the corporation.
iv. In a publically traded corporation, who makes the decisions regarding the operation of
the business? BOD. (day to day decisions – Officers)
v. What checks do the SHs have over the BODs? Removal power.
vi. What checks do the BOD’s have over the officers? Removal power.
vii. Are SHs agents of the corporation? No. SHs give BODs power who give officers power.
Officers are the actual agents of the corporation. What about individual directors?
No. What about the entire BOD? No. What about the officers? Yes.
viii. Could a director acting alone bind a corporation in K to a 3P? NO. Officers would have
to do it. No agency.
ix. How is the authority of the officers created? Provided by BODs: actual; apparent; and
inherent authority.
x. Under corporation statutes of all states, it’s the BOD that is entitled to make the
corporation’s most important decisions.
xi. Neither the BOD nor an individual director of a business is an agent of the corporation
or its members shareholders.
xii. Duties of an officer of a corporation are affected not only by state corporation law and
that corporation’s bylaws but also by agency law. While a member of the BODs of a
corporation is NOT an agent of the corporation, an officer is.
xiii. What is an insider director? A person who works for the company(employee) and that
is on the BODs.
xiv. What’s an outside director? Someone that doesn’t work for the company, but is on the
xv. Why have an outside director on the board? Unbiased opinion. A different perspective.
xvi. MASTER-BLASTER: BODs are individuals are masters. Officers are blaster.
xvii. Problems on p. 153:

1. 1. Want to bind the principal. Want to determine if we have the ABCs met?
ABCs are satisfied here. Does this arise in K or tort? K. Is there authority? May
have inherent authority in VP but not in Senior Attorney
2. 2. A. NO, not an agent. B. NO, not an agent. C. YES, officers are agents.
Ideally, who signatures do you want? Everyone. Could argue for a PG.
i. McQuade v. Stoneham
i. Lecture:
1. 7 members of the BOD.
2. BOD breached the voting agreement.
3. SH Agreement:
i. Elect each other as directors and once we are directors we will appoint
ourselves as officers.
4. Is it okay for SHs to elect each other as directors? Yes. At this point, no
general fiduciary duty to one SH to another or the corporation.
i. Once you are a director, have a fiduciary to the corporation. Frown
upon making decisions as what to do once you are directors because it
may go against the interest of the corporation for which the directors
owe a fiduciary duty.
5. Court invalidated agreement.
6. Was the corporation injured by the breach of the agreement? No.
7. What if the agreement was between the corporation and McQuade for 5
years? Agreement would be more likely to be enforced. If K between
corporation and McQuade, was person who gave McQuade K had the authority
to bind the corporation.
8. How would this case have been resolved if the court would have applied the
MBCA today? Different result.
9. This is an example of a closely held corporation. Under the MBCA (Section
7.32(a)(3)), establishes who should be directors….Modernly can do now what
happened in this class.
10. In a closely-held corporation can enter into an agreement as a shareholder as
to who is a director and obligations once they are directors. Can’t do this as a
public company.****WILL BE TESTED****
i. This is because in a closely-held corporation, the SHs are likely to be
the directors and the directors are likely to be the officers. In a
publicly traded corporation, much greater delineation of duties.
ii. Objectives: Action brought to compel specific performance of an agreement between
the parties, entered into to secure the control of National Exhibition Company (Baseball
Club/New York Nationals or “Giants”)
iii. Issues: Whether the agreement between the plaintiff and defendants was a legal K of
which the plaintiff should be provided specific performance.
iv. Holdings: NY COA reversed the judgment of the Appellate Division and that of the Trial
Term. The Court dismissed the complaint w/ costs in all courts.
v. Rules:
1. Directors may not by agreements entered into as stockholders abrogate their
independent judgment.
2. The power of the stockholders to unite is limited to the election of directors
and is NOT extended to Ks whereby limitations are placed on the power of
directors to manage the business of the corporation by the selection of agents
at defined salaries.

3. A K is illegal and void so far as it precludes the BOD at the risk of incurring
legal liability from changing officers, salaries, or policies of retaining
individuals in office, except by consent of the contracting parties.
j. Voting Agreements
i. Director Voting Agreements (Ds)
1. Generally, in publicly traded corporations, D’s are NOT allowed to enter in to
VAs as such agreements abrogate the independent judgment of the D’s. Ds
owe a fiduciary obligation to the company. Under the more modern view, SH’s
in closely held corps can enter into agreements controlling board decisions.
Moreover, the MBCA 7.32(b)(1) permits SH agreements…
k. Shareholders’ Decisions Instead of Directors’ Decisions
i. In NY today, the broad statements in McQuade would NOT even be applicable to the
facts there. NY has adopted a statute that permits shareholders of corporations w/
relatively few shareholders (“close” or “closely held” corporations) to enter into
agreements controlling board decisions.
ii. Now many states have such statutes, including Delaware and all states that have
adopted the MBCA.
l. Villar v. Kernan
i. Lecture:
1. Distribution – any time have a pay-out.
2. Dividend (special type of distribution) – comes from earnings and profits of the
3. Can have the first type of agreement in this case, agreement not to pay salaries.
4. Pursuant to the statute, and 7.32, does the new SH have to agree to the
agreement in order for it to be effective? No. Just have to have notice of the
5. K wants the original agreement to be invalidated.
6. Why is V so upset that K is being paid a salary? He is losing possible profits
from future distributions.
7. What was the holding of the court? SC of ME held that ME law precludes an
action for breach of an oral K between shareholders of a closely held
corporation prohibiting their receipt of salaries from the corporation. Thus,
there is no need to answer the second issue.
8. Agreement that parties made can be made, but MUST BE IN WRITING w/
respect to the applicable statute.
9. Under DE law and MBCA, agreements MUST BE IN WRITING.
ii. Objectives: P filed a breach of K claim against the D.
iii. Facts:
1. Frederick Villar (P) and Peter Kernan (D) incorporated business as Ricetta’s, Inc,
and P took 49% and D took 51%. Parties agreed that there would NEVER be
salaries. As owners, they would never receive salaries, just distribution.
2. Ronald Stephan became manager and 2% shareholder as he took 1% from P
and D each.
3. P and Stephan unsuccessfully attempted to buy out D and ultimately Stephan
became aligned w/ D.
4. March 1994, D entered into a consulting agreement w/ Ricetta’s. Agreement
provided for automatic payments to him of $2K/week. Agreement ratified at
shareholders’/BODs’ meeting at which P wasn’t present. D’s obligations
pursuant to the agreement weren’t specified, but the corporation’s rights were

restricted. D’s compensation could be increased but NOT decreased by a
majority vote of BODs and his services could be terminated ONLY for criminal
violation involving dishonesty, fraud, breach of trust, or for willful engagement
in misconduct in performance of his duties.
iv. Issues:
1. Whether Maine law precludes an action for breach of an oral K between
shareholders of a closely held corporation prohibiting their receipt of salaries
from the corporation.
2. If the answer to 1st issue is “no,” what factors are to be considered in
determining whether specific performance is available to take an oral K outside
the SOF provision for Ks not to be performed w/in one year?
v. Rules:
1. Section 618 of ME Code:
i. Written agreements between shareholders are enforceable even if
they (1) relate to a phase of affairs of the corporation, such as the
management of the corporation, payment of dividends, or
employment of shareholders, (2) restrict director discretion, or (3)
transfer management duties to shareholders, as long as such
agreements satisfy certain conditions.
ii. The agreement must be included in the AOI or expressly assented to
by all shareholders, and after the agreement is made anyone who
acquires shares must have notice or actual knowledge of the
iii. Even if the above requirements are NOT met, the agreement may still
be enforceable between the parties to the agreement if the rights of
any 3Ps who intervene and object to the enforcement of the
agreement are NOT prejudiced.
m. Shareholder Voting: Straight-Line Voting
i. Single D elections where majority SH will always prevail. Protects MSH’s (majority SH)
voting rights. Based upon issued shares that are outstanding.
1. If have 5 seats, will have 5 elections.
2. If C = 50 shares, A = 30, and P = 10.
3. In all 5 elections, C’s candidate will win.
ii. MBCA 7.28(a): Directors are elected by a plurality of the votes cast by the shares
entitled to vote in the election at a meeting at which a quorum is present.
iii. What is a quorum? More than ½. (7.25(a)).
iv. Plurality: The excess of the votes cast for 1 candidate over those cast for any other.
1. Al, Beth and Carol compete for 1 seat on Acme’s BOD. In the SH meeting, Al
receives 35% of the votes, Beth receives 40%, and Carol receives 25%. (A
majority percent is more than 50%)
i. Beth has the plurality (more votes), but not the majority.
n. Shareholder Voting: Cumulative Voting
i. To allow for more representative boards, corporations may adopt CV in electing
directors. Favors minority SHs.
ii. In CV, each SH’s number of votes is multiplied by the number of directors up for election.
iii. SHs are then allowed to split their votes on any number of candidates (or use all votes
on a single candidate).
iv. One election
v. Plurality needed. The candidates w/ the most votes are elected.

vi. Each shareholder gets to multiply the number of shares she owns times the number of
directors to be elected.
vii. Each shareholder can allocate her votes as she sees fit.
viii. CV does NOT apply to all shareholder votes. It applies ONLY to shareholders’ election
of or removal of directors. Not all corporations use CV even for such matters.
ix. Strategy behind CV
1. Minority SHS concentrate all of their votes on one or a small number of
directors, ensuring that those candidates get elected.
2. Majority SHs to spread his votes over more directors.
o. Cumulative Voting Formula
i. The following formula calculates the number of SHARES needed to elect a specific
number of directors. Thus, if you want to know how many votes a SH will need to
select the desired number of directors, multiply the number of shares times by the
number of board members to be elected. (ASK LAURA)
ii. [(N x S)/(D + 1)] +1
1. N = # of Ds the SH wants to elect
2. S = # of shares voting
3. D = total number of Ds to be chosen at the election
iii. Can stagger the board.
iv. Problems, p. 164:
1. 3.1  N = 1, S = 1K (it is possible for shares to be outstanding that can’t vote,
preferred and treasury), D = 9
i. 101 shares are needed to elect one board member.
iii. Number of shares X Number of directors to be elected = Number of
votes needed to elect the number of directors to be elected.
iv. Total number of shares voted in this election = 1K
v. Total number of votes in this election = 9K (# outstanding shares X
number of directors to be voted in)
2. Change: N =2 and everything else is the same. 201 shares are needed to elect
two board members. Needed 1809 votes to elect 2 people.
3. Clark’s Change: D = 3, staggered voting. N = 1, S = 1K
i. 251 shares are needed to elect one board member. Dilutes power of
minority SH. Staggering dilutes power, benefits majority SH. For
p. Cumulative Voting Problem
i. Under DE and MBCA, can remove a director w/out cause. If CV is in effect and can
remove board member w/ majority vote, what could happen? Majority could remove
him and take away power or undermine power of minority SH and take away power of
ii. If CV in effect can remove w/ or w/out cause, if try to remove him, if same number of
people who voted to elect him vote to keep him, he can stay.
q. Voting Hypo:
i. A corporation has 400 outstanding shares of stock, Latrice owns 101 shares of preferred
stock and Todd owns 299 shares of common stock. The AOI for the corporation stipulate
cumulative voting for the election of directors. Latrice wants to elect A, B, and C as
directors while Todd wants X, Y, and Z.
ii. What would happen under SL voting?

1. X, Y, and Z would be elected, because Todd has the majority and there are
separate elections.
iii. What would happen under CV?
1. S = 400, only common stock SHs can vote, N = 3, D = 6
iv. Same as above, but AOI for the corporation stipulate CV for the election of director and
provides that the holders of the PS can vote in the election of directors.
1. What would happen under straight line voting?
i. Same as above.
2. What would happen under CV?
i. 1*400/ (3+1) +1 = 101 shares. Could elect 1 board member.
ii. Todd could elect other two.
iii. Need 101 shares to elect 1 board member, or 303 votes.
iv. 1200 votes will be cast (400 X 3).
r. SH Approval
i. In addition to the election and removal of Ds, SHs may vote on the following
fundamental corporate changes (approved by MBCA and other corporation statutes):
1. Amendment of the AOI;
2. Dissolution;
3. Merger w/ another corporation (normally only the SHs of the disappearing
corporation have to approve the merger, not the SHs of the surviving
4. Sales of all or substantially all of the assets.
ii. CV does NOT apply to these SH votes, but apply to removal/election of directors.
iii. There may be a supermajority requirement, which isn’t present in CV or straight-line.
iv. Votes on FCC are reactive rather than active. What does this mean? Reacting to
decisions of the BODs. Whose actions are the SHs often reacting to? BODs.
(BOD do not have to go to the SH for everything except these fundamental changes.)
s. Review:
i. SHs have a very limited voice in corporate affairs:
1. They elect and remove directors and they have to approve fundamental
corporate changes.
ii. On other management decisions, the power lies in the board.
t. SH’s vote
i. Annual Meeting – meeting held once a year (annually).
ii. Special Meeting – any meeting other than the annual meeting.
iii. Record Owner – person who has the legal right to vote those particular shares at an
annual or special meeting of SHs. Meaning of RO is that a corporation keeps records
showing who owns its stock (ROs).
iv. What person is entitled to receive information about the meeting and the vote?
Record Owner. A corporation is required to send notice of annual and special meetings
to its record SHs.
v. Record date (set by corporation) – Corporation can fix a “record date” before the
meeting and ONLY the record owners as of that date are entitled to notice of and a vote
at the meeting.
vi. Why is it important to set a record date? Determines who record owner is and thus
who has power to vote. The record owner at the “record date” receives the notice of
the meeting and gets to vote at the meeting.
vii. Often the person listed as owner on the corporation’s records (“record owner”) is NOT
the real owner (“beneficial owner”).

viii. Street Name – An investor buying shares of a publicly traded corporation usually buys
her shares through a broker, NOT from the issuing corporation. She does NOT receive a
stock certificate; she is NOT shown as the owner in the corporation’s records. Instead, a
depository company, maintained by a group of brokerage firms, holds the certificate
and is shown as the owner in the brokerage firm’s records. This is commonly referred
to as “street name ownership.”
1. Example: Stock certificate from IBM will show broker (Goldman Sachs) as
record owner and in brokerage account will list Bob as the real owner
(“beneficial owner”) in their records.
ix. When stock is held in “street name,” the beneficial owner is informed about SH votes,
and the shares are voted as instructed by the beneficial shareholder.
x. What is the difference between providing the SH w/ notice and setting the record
date? Record date determines what SHs can vote at meeting. Notice just informs us of
date of meeting.
1. MBCA:
i. § 7.05. Notice of Meeting.—
a)(a) A corporation shall notify shareholders of the date, time,
and place of each annual and special shareholders' meeting
no fewer than 10 nor more than 60 days before the meeting
date. Unless this Act or the articles of incorporation require
otherwise, the corporation is required to give notice only to
shareholders entitled to vote at the meeting.
ii. § 7.07. Record Date.—
a)(b) A record date fixed under this section may not be more
than 70 days before the meeting or action requiring a
determination of shareholders.
2. Delaware Code:
i. 10 – 60 Rule for BOTH Notice of Meeting (8 Del.C. § 222) and Record
Date ( 8 Del.C. § 213)
ii. ***ASK CLARK***
u. Problems, p. 167: LOOK AT DEL SECTION 213 (a) AND MBCA SECTION 7.07(b)
i. Problem 1.1. BB’s will hold its annual SH meeting on June 30. What is the latest date
the corporation can use as its record date under the 2 states? What is the earliest date?
1. 7.07(b) record date can’t be set more than 70 days from the meeting, but not
less than 10.
2. Corporation can’t give notice of meeting more than 60 but not less than 10 days
before meeting.
ii. Problem 1.2. Capel
iii. 1.3 – Shepherd.
iv. 2. SHs do NOT have to approve this change in the corporation’s basic business. Look to
the 4 reasons to need SH approval.
v. SH Meeting (proxies)
i. What is a proxy? Give right to vote to someone else. (Clark - timing could be a good
ii. Under the MBCA, if no time is stated, how long is the proxy valid? 11 months.
1. Under DE law  3 years.
iii. Can the proxy be revoked prior to the expiration of the above referenced time? Yes.
iv. Under case law, a proxy can often be revoked even if it states that it’s irrevocable.
v. How can you make a proxy irrevocable? States that it’s irrevocable and coupled w/
some interest in stock (consideration). Then irrevocable for as long as parties specify.

vi. Why might a creditor require an irrevocable proxy in exchange for using the debtors
stock as collateral? Gives them right to have say-so in the company to make sure have
enough money to get paid. Protect collateral.
vii. A SH does NOT have to be present at the annual or special meeting to vote her shares.
viii. State corporation statutes provide for SH voting by “proxy.”
ix. Voting by proxy simply means that the person who is entitled to vote authorizes another
person to vote for her.
x. Form of Agency: owner is the principal and authorizes the proxy-holder to be her agent
for voting.
w. Proxy Statement
i. Definition: A document which the SEC requires a company to send to its SHs that
provides material facts concerning matters on which the SHs will vote. Think about the
PS as a news letter from the corporation. The firm needs to file a proxy statement (14a)
w/ the SESC.
ii. What is a proxy statement? Document that corporation is required to send to SHs.
Purpose is to educate SHs about items that are happening in the newsletter.
iii. Who sends it? Corporation.
iv. Who is it sent to? SHs (“record owners”), because RO is person that receives
information about meeting because they are eligible to vote. If RO isn’t actual owners
and have BO, RO will send information to BO as well.
v. What matters are reflected in the proxy statement? Whatever is going to be discussed
at the actual meeting.
vi. What federal laws regulate the solicitation of proxy statements? What does each law
cover? SEC and 17 C.F.R. Section 14(a)(8) and (9).
x. Virginia Bankshares, Inc. v. Sandberg (False or Misleading Statements of Fact)
i. Lecture:
ii. VBI is the majority SH of 1st American; 85%. Other SHs own the other 15%.
iii. VBI controls the BODs for 1st American. VBI made decision that 1st should merge w/ VBI.
iv. Did the BODs of both companies have to approve this transaction? Yes.
v. Did the SHs of both companies have to approve this transaction? No.
vi. Whose approval would be least necessary? VBI because 1st is going to cease to exist
after this merger.
vii. ***For surviving company, there is no need to get SH approval for a merger. This is a
general rule.***
viii. ***Generally, you must get SH approval for disappearing company to merge. This is a
significant event.***
ix. In this case, it was NOT necessary to get approval of SHS for merger of those from
disappearing corporation because VBI had 85% of 1 st stock.
x. What were 2 issues before the court?
1. Whether a statement couched in conclusory or qualitative terms purporting to
explain directors’ reasons for recommending certain corporate action can be
materially misleading w/in the meaning of Rule 14a-9; and
2. Whether causation of damages compensable under Section 14(a) can be shown
by a member of a class of minority SHs whose votes are NOT required by law or
corporate bylaw to authorize the corporate action subject to the proxy
i. Did this misstatement cause the minority SHs harm.
xi. *****Court relied upon TSC Industries, Inc. v. Northway, Inc.: When is fact material? A
fact is material if there is a substantial likelihood that a reasonable SH would consider it

important in deciding how to vote. A statement of belief by corporate directors about a
recommended course of action, or an explanation of their reasons for recommending it,
can take on the just that importance.*****
xii. Here the fact was material according to the Court.
xiii. Distinction between fact and opinion. Defendant said this was an opinion and less fact.
Court did NOT agree. Generally at C/L, opinions were NOT actionable (caveator
emptor/buying beware). Modern view, opinion can be actionable if person
misrepresents their state of mind. Said $42 high value, but it wasn’t ($60).
xiv. How was high value determined ($42)? Above both BV and market price. Fact that
didn’t take into account the gain from real estate was giant.
xv. What was the director’s possible motivation for lying about the value of the shares?
Self-interest and incentive. Interested director transaction.
xvi. We already know that if this would have gone to vote, merger would have gone
through. Why did they still try to get support from minority SHs? To prevent future
xvii. What were the P’s two causation theories?
1. Argue first that a link existed and was essential simply because VBI would have
been unwilling to proceed w/ the merge w/out the approval manifested by the
minority SH’s proxies, which wouldn’t have been obtained w/out solicitation’s
express misstatements and misleading omissions.
2. In alternative, the proxy statement was an essential link between the director’s
proposal and the merger because it was the means to satisfy a state statutory
requirement of minority SH approval, as a condition for saving the merger from
void-ability resulting from a conflict of interest on part of one of Bank’s
directors, Jack Beddow, who voted in favor of merger while also serving as a
director of FABI.
xviii. Court didn’t agree because at end of day because merger would have went through
xix. Court held that knowingly false statements of reasons may be actionable even though
conclusory in form, BUT Ps have failed to demonstrate the equitable basis required to
extend the Section 14(a) private action to such SHs when any indication of congressional
intent to do so is lacking.
y. Problems, p. 176:
i. #1: Board must disbelieve their opinion and most show that the opinion is NOT factually
supported. Standard to determine materiality, whether a reasonable investor would find
information important to decide to participate or NOT participate in the transaction.
ii. #3: What is scienter? Some sort of bad or malicious intent. Anytime someone gives
false or misleading statement, can give it intentionally or unintentionally. Sometimes
just negligence is needed, no malicious conduct.
z. Notes:
i. There is NO required state of mind for a violation of section 14(a); a proxy solicitation
that contains a misleading misrepresentation or omission violates the section even if the
issuer believed in perfect GF that there was nothing misleading in the proxy materials.
Section 14(a) requires proof ONLY that the proxy solicitation was misleading, implying at
worst negligence by the issuer.
aa. SH Proposal
i. The SH wants the SH proposal to be put in the proxy statement.

ii. Who drafts SH proposal? SH. SHs own agenda about what they want to discuss. Way
to persuade other SHs to vote in a certain way.
iii. What does SH proposal do? Frames information in SH’s POV to be placed in the proxy
iv. A SH eligible to submit a proposal must have: (Eligibility Requirement)
1. Continuously held at least $2K in MV, or 1% of the company’s voting stock, for
at least one year prior to the date of proposal submission. What is the purpose
of this requirement? Person has enough stake in company to justify inclusion of
2. Must continue to hold the stock through the meeting date.
3. Each SH may tender only one proposal for a particular meeting.
4. Proposals may NOT exceed 500 words and must be submitted by a specified
bb. SH Proposal Exclusion
i. Submission of a proposal does NOT guarantee its inclusion in the company’s proxy
statement. Companies may exclude SH proposals if:
1. The sponsor does NOT meet eligibility requirements (previous slide); or
2. Does not follow the correct procedures;
3. Violates proxy rules;
4. Relates to operations accounting for less than 5% of a company’s total assets;
5. Relates to the company’s ordinary business operations;
6. Relates to an election for membership on the company’s board of directors, or
specify amounts of cash or stock dividends;
7. In addition, proposal may be excluded if they violate the state law;
8. If a company wants to exclude proposals for other procedural….
cc. Kortum v. Webasto Sunroofs, Inc. (SH Inspection Rights)
i. Lecture:
1. WAG and Magna own 50% each of WSI. WSI has 6 board members. WAG
places 3 and Magna places 3. Kortum is CEO of WAG and sits on board of WSI.
2. Kortum brought the suit.
3. Who are they suing?
i. Suing WSI/Magna. Magna didn’t want WAG to access to the books.
4. If WAG equally owns WSI w/ Magna, why is WAG having difficulties in getting
access to books? Magna is in charge of the records/books due to the
Management Agreement, control of day-to-day operations.
5. What prompted relationship to deteriorate?
i. Mr. Kortum’s ascendancy as CEO of WAG and his insistence upon more
adequate reporting of information to WAG.
ii. WSI’s 1998 year end reported profits of only $2.1M, a 90% downward
variance from the $21M in profits that WSI had previously budgeted.
a)Concerned about the above, Horst Winter, Executive
President of WAG and a director of WSI, wrote WSI letter
requesting detailed explanations for downward variance.
b)Magna representatives responded that he books of WSI were
open to WAG at any time and agreed to let WAG conduct an
audit of WSI. Shortly thereafter, while WAG was arranging w/
Magana to conduct the audit, WAG was told that Magna
wouldn’t allow the audit to take place.
6. Magna thought WAG’s real reason for information request was they were trying
to compete w/ WSI. Magna points to five facts. The 5th is the most important in

that on May 19, 1999, WAG filed an action (Section 273) to discontinue WSI, in
which WAG proposed a plan of discontinuance and a distribution of WSI’s
7. What is a 273 action? Bring company to an end and have assets sold off.
8. On what 2 basis did Kortum request his right to inspect the records? As a
Officer (Agent) of WAG and a director of WSI.
9. What was the proffered reason for both basis? To see value of interest.
10. What limitation did WSI (Magna) attempt to impose on Kortum as a director?
WSI placed 5 conditions on Kortum’s inspection. What about on WAG as a SH?
Wouldn’t allow it.
11. There is a presumption in favor of a director that he is entitled to inspect the
records unless parties can show there is no reason to inspect.
12. Look at Kortum’s Director Inspection Claim and Court’s discussion:
i. Whatever he discovered as director, he could disclose to WAG because
he is the CEO of WAG and has a fiduciary duty (?). Magna’s claim that
WAG is engaged in a campaign to compete w/, and thereby harm, WSI,
is undercut by the fact that WAG’s 50% stock interest in WSI represents
20% of WAG’s revenues and 25% of its profits.
ii. Only condition was not to disclose information to Hollandia.
iii. Right to inspect records as director is unlimited. As member of BOD,
owe a fiduciary duty to the corporation.
13. Look at Shareholder’s Inspection Rights (Section 220 (c)):
i. Court said form of demand was met.
ii. WAG had a legitimate purpose. Needed to know value of their
iii. Was the scope of the inspection reasonable? Yes.
iv. When a SH “makes demand” who has the burden of proving proper
purpose? SH. When a director “makes demand” who has the burden
of proving improper purpose? Corporation.
14. In making demand to inspect, would prefer to make it as a director to the
presumption of entitlement.
15. How would this case been decided under MBCA? Would have been the same.
Under 16.01, when SH makes request to review bylaws (others), presumption
that SH can see those. If want to see financials, have to show there is a
proper purpose. If director makes request, still have presumption that
request is proper.
16. How is this case different from Meinhard? Shouldn’t the court have
prevented WAG from competing w/ the business (WAG)? In Meinhard, the
new acquisition derived directly from relationship that Meinhard and Salmon
had. In WAG case, Hollandia was not derived directly from relationship that
had been formed.
ii. Rules:
1. Director’s Inspection Rights (Section 220(d)):
i. Any director shall have the right to examine the corporation’s stock
ledger, a list of its SHs and its other books and records for a purposes
reasonably related to the director’s position as a director.
ii. Once director makes a Section 220 demand that is refused, a prima
facie showing of entitlement to the documents has been made and the

burden shifts to the corporation to show why inspection should be
denied or conditioned.
iii. There is a presumption that a sitting director is entitled to unfettered
access to the books and records of the corporation for which he sits
and certainly is entitled to receive what the other directors are given.
2. Shareholder’s Inspection Rights (Section 220 (c)):
i. Where the SH seeks to inspect the corporation’s books and records,
other than the stock ledge or list of SHs, such SH shall first establish (1)
that such SH has complied w/ this section regarding the form and
manner of making demand for inspection of such documents; and (2)
that the inspection such SH seeks is for a proper purpose.
ii. A SH must prove by a preponderance of the evidence:
a)(a) its compliance w/ the form and manner of making a
demand specified in the statute; and
b)(b) the propriety of its purpose for seeking inspection
(purpose is reasonably related to its interest as a SH).
iii. Once SH demonstrates its entitlement to inspection, it must also show
that the scope of the requested inspection is proper (books and
records sought are “essential and sufficient” to the SH’s stated
iv. A SH’s status as a competitor may limit the scope of, or require
imposing conditions upon, inspection relief, but that status does NOT
defeat the SH’s legal entitlement to relief.
v. So long as the statutory requirements for inspection relief are satisfied,
the mere pendency of another proceeding does NOT disqualify a party
involved in the other lawsuit from inspecting the corporation’s books
and records.
iii. Notes: The MBCA, like DE, provides readier access to books/records for directors than
for SHs.
dd. Director Inspection (Corp Records)
i. Once a director makes a demand that is refused a prima facie showing of entitlement of
the documents has been made and the burden shifts to the corporation to show why
inspection should be denied or condition. The legislature places such a high burden on
the corporation because the D’s responsibility is to act as a fiduciary and such
responsibility is impaired if he cannot evaluate what he is responsible for managing. SHs
are different, because allowing them the right to always inspect would tie the company
up and prevent it from conducting business.
ii. D’s right to inspection is NOT unlimited, Corporations may impose limitation.
iii. If D’s agents have a conflict of interest – a mere possible of confrontation want make a
difference (?)
iv. Can inspect but can’t disclose if contravenes fiduciary duty.
ee. Voting Agreements (SH)
i. Can SHs in a CHC enter into agreements regarding how they will act once they become
directors? Yes. Can decide what we will do as SHs and directors. Case said no but was
later overturned.
ii. What about in a PTC? Can enter into agreements as to how will vote as SHs but NOT as

iii. Proxy? If not mentioned in agreement, under MBCA, lasts for 11 months, under DE law,
lasts 3 years. Can be revoked at anytime, unless agreement provides that proxy is
irrevocable AND is coupled w/some sort of consideration.
iv. Proxy is a little different than a VT. Proxy arises when give one person right to vote. VT,
SHs who want to vote in a certain way give right to vote to a trust.
v. Generally, publicly traded corporations, SHs can agree to a VA, however, the power is
limited to the election of directors and is NOT extended to Ks whereby limitations are
placed on the power of directors.
vi. A voting agreement among directors is contrary to public policy and void. Next case
illustrates that courts will uphold voting agreements among SHs.
ff. Ringling Bros.-Barnum & Bailey Combined Shows, Inc. v. Ringling
i. Lecture:
1. (N x S)/(D+1) +1
2. Why did Ringling and Haley won’t to vote director? They could have elected 5
out of 7 directors if pulled votes together.
3. Took 126 to elect 1 board member. (1*1000)/(7+1) + 1 = 126 shares to elect 1
director. Takes 882 votes to elect 1 board member. 126 * 7 = 882.
4. Ringling = 315 shares, Haley = 315 shares. By themselves, could each vote 2
board members on and would have 63 shares left over.
5. Haley didn’t vote in accordance w/ voting agreement (VA).
6. What is the difference between a voting trust and voting agreement?
i. VT, stock is transferred to a trust which then votes. Another exercises
right to vote. Transferor loses right to vote. Trustee has right to vote.
ii. VA, may agreement to vote in a certain way, still exercise control of
7. A proxy votes on behalf of another party. Is a proxy revocable? Yes.
8. Here we have a VA. C/L rule is that the courts will not specifically enforce the
VA. If the VA was specifically enforced in this case, a new election would be
held. But didn’t want to harm Mr. North. Mr. North and Mrs. Ringley both got
their three. Filled 6 of 7 positions.
9. Pooling agreements = VA.
10. Can tell the trustee how to vote? Yes, have to. Key function in right to vote is
that other party has right to vote.
11. VT = trustee will be told how to vote, but party who transferred shares to vote
can’t actually vote.
12. Pooling agreement/VA, make agreement to vote but still have ability to exercise
own vote. Contractual agreement to vote in a certain way.
13. Modern view, strictly enforce PA/VA, and thus new election. Different from
C/L view.
gg. Duty of Care  Breach of Duty of Care by Board Action
hh. Shlensky v. Wrigley
i. Lecture:
1. What was the reason that the board members and directors didn’t want to
install lights? Would hurt the surrounding neighborhood. SHs argument was
that it would be in best interest of corporation to put lights in. Arguing that
breached duty of care.
2. Who elects BODs? SHs. To make decisions for the corporation. Directors are
supposed to act in best interest of organization.

3. Are directors allowed to make dumb decisions? Yes, as long as director is
acting in good faith, not wasting assets of corporation, and is informed, such a
decision will be upheld. Called the BUSINESS JUDGMENT RULE. Decision must
be in best interest of the corporation.
4. Directors made a decision that was in the best interest of the corporation.
5. Suppose it’s determined that placing in lights would increase revenue. Would
directors have breached duty of care not to place lights? No, if determine in
long run it would hurt the corporation. If there is a POSSIBLE increase, then no.
ii. Duty of Care (Action/Inaction)
i. A duty of care is a legal obligation imposed on an individual requiring that they adhere
to a reasonable standard of care while performing acts or not acting on behalf of their
fiduciary. As long as a director does each of the following they are protected by the BJR
(Tri-Part Duty):
1. Acts in good faith;
2. Are informed;
3. Honestly believed that their actions are in the best interest of the corporation.
ii. Action: BOD decision that results in a loss b/c that decision was ill advised or negligent.
Evaluation: whether the BOD is wrong or stupid is NOT the question, the question is
whether the PROCESS is valid.
jj. Inaction: BOD fails to act. THIS IS MORE DIFFICULT TO PROVE. Unconsidered failure of the BOD
to act in circumstances which due attention would arguably have prevented the loss. In short,
directors cannot blindly turn away from things that they should reasonably investigate, as this
would undermine their duties as directors. 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 w/ applicable legal
i. 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 will
establish the lack of good faith that is a necessary condition to liability. (Caremark)
kk. SH Derivative Suit:
i. Generally, the director makes a decision, decision not to install lights, and SH is upset.
SH is trying to protect the corporation. According to the SH, BODs made a bad decision,
and thus need the corporation to sue the BODs. Who is empowered with making
important decisions in the corporation? The BOD. Thus must get approval from BOD to
sue the corporation based on BODs decision. This is called “MAKING A DEMAND.” BOD
has to answer the question: yes or no. Most of time, the answer is no. If the answer is
no, the BOD has actual made a decision and anytime BOD makes a decision, if three
items above are satisfied, the decision is protected by the BJR.
ll. Business Judgment Rule (BJR)
i. What is the importance of having a BJR? Protects directors who meet the tri-part duty:
(1) informed; (2) good faith; and (3) act in best interest of corporation. – D’s get full
protection under this rule
ii. Whose decisions does it protect? Under the MBCA only the Directors.
iii. Does the BJR protect officers? No, not under the MBCA.
iv. What happens if the BODs or a D breached the duty of care? Are they personally
liable? Yes. Even if there is breach, what else must be proven? Causation. Is this
difficult to prove? Yes.

mm. Joy v. North
i. Lecture:
1. What was the problem w/ providing such a low interest rate? Didn’t
compensate for the risk. This was a no-win situation. If high risk, should charge
a high interest rate to compensate for the risk.
2. What is a special litigation committee? Board delegates power to a committee
who will decide whether the corporation can sue the BODs.
3. Why didn’t the BOD make the decision themselves and instead delegate
authority to the litigation committee? BOD might have a conflict of interest.
Attempt to “cleanse the taint” of the decision by giving authority to SLC.
4. Committee made a decision that suit should be dismissed as to the “outside
directors.” ODs don’t have any internal positions in the corporation besides
being members of the BODs.
5. What is the rational basis behind the BJR? Allows directors to make risky
decisions. Court said business people are in best place to make business
decisions. Hindsight is not relevant.
6. BODs make decision to authorize corporation to bring the lawsuit against
7. Does the BJR rule apply to a special litigation committee decision? Yes.
8. In this case, did the BODs exercise their applicable duty of care? No. Placed
bank in a no-win situation. Circumstance where member of the BOD can lose
protection of BJR.
9. If the BJR protected the directors in the Wrigley case, why not this case?
BODs in Wrigley made decision in favor of corporation. Here, made decision
that wasn’t in best interest of the corporation.
ii. Rules:
1. Business Judgment Rule: liability will not be imposed upon corporate directors
or officers simply for bad judgment or unsuccessful business decisions.
However, the BJR extends only as far as the reasons which justify its existence.
It does NOT apply in cases in which the corporate decision lacks a business
purpose, is tainted by conflict of interest, is so egregious as to amount to a no-
win decision, or results from obvious and prolonged failure to exercise oversight
or supervision.
2. SH Derivative Suit:
i. Involves 2 actions brought by an individual SH:
a)an action against the corporation for failing to bring a
specified suit; and
b)an action on behalf of the corporation for harm to it identical
to the one which the corporation failed to bring.
ii. A judgment in a DS runs to the corporation and thus SH plaintiffs
realize an appreciation in the value of their shares.
nn. Business Judgment Rule (BJR)
i. BJR doesn’t apply when:
1. Fraud
2. Illegality
3. Conflict of interest (self interest/self dealing)
4. Business decision is so egregious as to amount to a “no-win situation”
5. Obvious and prolonged failure to exercise oversight or supervision.
6. Directors are wasteful

ii. BJR protects directors from simple negligence NOT gross negligence. In short, if you
get the benefit of the BJR GAME OVER, the Board will win.
oo. Special Litigation Committee
i. As a general proposition, the decision whether a corporation should proceed w/ any
litigation matter is a business decision for the corporation’s board. What protection is
this statement entitled? Who makes this decision? What if they are interested? What
happens to the protection of the BJR?
ii. Accordingly, since a derivative action purports to be and, if pressed, is in fact brought on
behalf of the corporation, at least in certain instances and as an initial matter, it’s the
corporation’s full board of directors that is entitled to make the decision whether it’s in
the best interests of the corporation to pursue the derivative claims. As a result, the
requirement has been established that, in certain circumstances, a SH who wishes to
bring a derivative suit must first make a formal demand upon the BODs that may, as
matter of business judgment, determine that it’s not in the best interests of the
corporation to bring a suit against the BODs.
pp. Smith v. Van Gorkom
i. Lecture:
1. SHs wanted a rescission of the merger because felt price received was
2. What is a cash-out merger? Have a surviving corporation that purchases in
cash all of the shares that they merging into (disappearing company). Surviving
corporation owns all stock of the disappearing corporation.
3. TC granted judgment for defendant directors, holding that they were protected
by the BJR.
4. What was the defective decision by the BODs? Uninformed decision.
5. This was an enormous decision: sell the corporation ($700M deal).
6. 20 minute presentation by Van Gorkum to BODs who had no idea about deal.
7. As a member of the BODs you are allowed to rely upon manifestations by
officers. Officers run day-to-day operations of business, assume he/she
understands what’s going on. Delaware code also provides for such reliance.
8. However, Court found that this was not a “report” under Delaware law. To
qualify as a “report,” his presentation had to be based upon objective facts.
“Report” does NOT have to be in writing. “Report” must just be informed
based on a sound basis.
9. Was it relevant to the majority that none of the BODs were investment
bankers or analysts? Yes. BODs should have taken some time to make an
informed decision: bring in entity to do independent valuation of corporation.
10. Court did NOT attack substance of the decision that $55/share was correct. The
procedure was incorrect. If BODs took a week to make a decision and made
decision against that $55 was a fair price, there would not have been a breach
of duty of care. BODs can make bad decisions as long as are informed.
Decisions should be mutually exclusive (only look at procedure of making a
decision NOT substance of decision), unless the result is absurd.
11. If this BOD would survive and merge into new corporation, any decisions could
be breach of loyalty. DIDN’T OCCUR IN THIS CASE.
12. If you were a SH and didn’t want to sell your stock, what could you do? Have
to cash it out. Should also argue for rescission or damages for inadequate value
of stock (derivative suits).

13. Dissent argued that BODs were so intelligent that wouldn’t make a hasty
decision. Still didn’t matter to the majority.
ii. Rules:
1. The party attacking a board decision as uninformed MUST REBUT the
PRESUMPTOIN that its business judgment was an informed one.
2. The determination of whether a business judgment is an informed one turns on
whether the directors have informed themselves “prior to making a business
decision, of all material information reasonably available to them.”
3. Gross negligence is the proper standard for determining whether a business
judgment reached by a BODs was an informed one.
4. 8 Del.C. Seciton 141(e): Directors are fully protected in relying in good faith on
reports made by officers. “Report” has been liberally construed to include
reports of informal personal investigations by corporate officers. At a
minimum, for a report to enjoy status conferred by Section 141(e), it must be
pertinent to subject matter upon which a board is called to act, and otherwise
be entitled to good faith, not blind, reliance.
iii. Notes:
1. 8 Del. C. Section 102(b)(7): AOIs drafting according to the statutes cannot
protect directors from all liability. Such corporate articles can limit director’s
liability to the corporation and its SHs, but NOT to outside 3Ps. In addition, the
provisions can eliminate liability only for violations of the duty of care, NOT
for violations of the duty of loyalty or conduct that is in bad faith.
qq. Barnes v. Andrews (Breach of Duty of Care by Board Inaction)
i. Lecture:
1. There was one majority SH that sat on the BODs. He was sued for a breach of
his duty of care due to his inaction.
2. He attempted to be informed by speaking to his best friend, the President of
the corporation. In DE, can rely upon the reports of officers, as long as the
reports meet the tri-part test.
3. Could he protected as a SH? Yes, limited liability, unless could pierce corporate
4. However could get to him as a director? Through a breach of the duty of care.
5. Failure in this case was due to inability to show causation.
6. Breach of Duty of Care is similar to a tort: (1) Duty; (2) Breach; (3) Causation;
and (4)Damages.
7. What constituted his failure to be informed?
i. Duty of Care WAS BREACHED because there was inaction.
ii. A director can rely upon the “reports” of a CEO, however this was not a
“report” under applicable law. It was NOT grounded in objective fact.
He asked general questions and got general response.
a)In Van Gorkum, the information was not a “report” because
the officer’s report was not grounded in objective fact.
8. However, there was NO CAUSATION. Losses still might have resulted.
Proximate cause argument.
ii. Court in Barnes v. Andrews places the burden of proof on the P to show causation. The
P must show not only that the D breached the duty of care, BUT that this breach caused
a loss to the corporation.
iii. Barnes reflects the MAJORITY VIEW but this isn’t the only view. Delaware courts do
NOT make the P show causation. Rather, lack of causation is an affirmative defense to

be pleaded by the D. After P shows D breached duty of care, burden SHIFTS to D to
satisfy the “entire fairness test.” This requires the D to show BOTH that:
1. The process used to approve the deal was fair; and
2. That the terms of the deal were fair.
iv. Thus, Ds have a tough time satisfying the entire fairness test.
rr. Francis v. United Jersey Bank
i. Lecture:
1. Husband warned plaintiff (wife) that his sons would take the shirt off his back.
When husband died, 2 boys (who owned rest of stock) took over, and allegedly
helped themselves to vast sums of company’s clients’ money.
2. D and sons were directors. Lillian knew nothing about the reinsurance business
and did nothing to inform herself even of its rudiments. She never read
corporate documents. D simply did nothing to fulfill the duties of being a
3. Why did trustee sue Mrs. Pritchard? She was a director. If she was only a SH,
she would have been protected under the corporate veil. Sued as a director
because she owes a duty of care.
4. This an inaction case.
5. Why was there causation here, unlike in Barnes?
i. Specific warning by husband.
ii. Clark’s hypothesis, company here was smaller than in Barnes. Much
easier to find out what’s going on in a smaller corporation.
ss. Graham v. Allis-Chalmers Mfg. Co.
i. Objectives: SH derivative suit.
ii. Facts:
1. Several mid-level employees of a large corporation were indicted and pleaded
guilty to violating federal antitrust laws by engaging in price fixing.
2. SH in this case argued that the directors of the corporation breached the duty
of care by failing to monitor the employees sufficiently to uncover the problem.
iii. Issues: Whether the directors of the corporation breached the duty of care by failing to
monitor the employees sufficiently.
iv. Holdings: DE SC held that the directors had NOT breached their duty.
v. Rules: Directors are NOT required to set up a monitoring system until they have some
reason to suspect that the employees are not being honest.
tt. Duty of Care (Causation)
i. Once claimant has proved a breach of the DOC the following approaches apply
determine director liability:
1. MBCA Approach: (P must show, DOC, Breach of DOC, and Causation.)
i. Duty of care requires directors/officers to be apprised of the conduct
of corporate affairs. Once it’s proven that D no longer gets protection
of BJR, claimant must also prove causation (proximate cause):
a)Claimant must prove that the preponderance of directors
REQUIRED duties (duties the D should have been exercised)
would have avoided loss,
b)And what loss it would have avoided.
ii. Court could have placed burden on directors but do so would have
placed an extremely large burden on directors and no one would want
the job.
2. Delaware Approach: (P must still show DOC and Breach of DOC.)

i. DE rejects this approach. Once the P proves a breach of the DOC, the
BJR does NOT apply and the burden falls on the defendant to show
that their actions were fair to the corporation.
uu. In Re Caremark Int’l, Inc., Derivative Litigation
i. Lecture:
1. $250M was paid to those who had claims against the corporation.
2. In this suit, if the P’s win, the judgment goes to the corporation. Boosts up
3. Rule from Graham:
i. “Absent cause for suspicion there is NO duty upon the directors to
install and operate a corporate system of espionage to ferret out
wrongdoing which they have no reason to suspect exists.”
ii. Reasonable suspicion that illegal activities are taking place.
4. This Court did NOT agree totally with Graham. Adopted a NEW STANDARD.
Narrower standard.
i. Must, in good faith, create a monitoring system.
ii. If do have reasonable suspicion have to implement monitoring system.
5. Is it a breach of duty for the BODs to assume that its employees act w/
integrity? No.
6. When a BOD makes a decision as to the appropriate level of detail to place in
an information system, will it be difficult to challenge such decisions? Yes.
7. Citigroup Hypo: Court said BODs decision fell squarely under BJR. Exceptions
to get around the BJR are: (1) fraud; (2) no-win situation; and (3) conflict of
interest, etc.
8. Under Caremark, are the BODs required to implement a system that catches
bad behavior? No. If system implemented in GF and doesn’t catch bad
behavior, will not give cause for a breach of DOC.
ii. Issues: Whether D’s failure to monitor should result in a breach of duty of care.
iii. Holdings: Given the weakness of the P’s claims the proposed settlement appears to be
an adequate, reasonable, and beneficial outcome for all of the parties.
iv. Rules:
1. Compliance w/ a director’s duty of care can never appropriately be judicially
determined by reference to the content of the board decision that leads to a
corporate loss, apart from consideration of the good faith or rationality of the
process employed.
2. The BJR is process oriented and informed by a deep respect for all good faith
board decisions.
3. Where a director in fact exercises a good faith effort to be informed and to
exercise appropriate judgment, he or she should be deemed to satisfy fully the
duty of attention.
4. 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 w/
applicable legal standards.
vv. McCall v. Scott
i. Lecture:
1. Demand Futility (Sidebar):

i. “At the same time, we caution that this conclusion involves only the
sufficiency of the pleadings w/ respect to demand futility and reflects
no opinion as to the truth of the allegations or the outcome of the
claims on the merits.” P. 232.
ii. Generally, whenever SH wants to bring a lawsuit, must make a demand
upon the Board. Board can say yes or no. Yes, corporation can sue
BODs. If no, SHs will still sue saying demand shouldn’t be rejected.
BOD would respond and say that it should be rejected because the BJR
applies and this was a decision.
iii. Under DE never want to make demand. Only want make a demand if
know BODs will say yes, or if say no, decision will be made in good
faith and in best interests of company.
iv. In DE, if “make demand” then that’s an admission that BOD’s decision
will be in good faith, and thus BODs decision will be protected by BJR.
v. Therefore, in DE, should automatically go TC and argue that making
demand is futile. DEMAND FUTILITY.
2. What is this case really about?
i. Waiver of liability of director.
ii. Idea was that could limit liability of director but couldn’t eliminate
breach of duty of loyalty.
iii. But could limit liability for a breach of DOC, as long as conduct which
created breach of DOC was not intentional. If you were negligent,
wouldn’t be liable under this provision.
3. In order to have liability under Caremark, directors had to act intentionally but
can also do it w/ something else, but didn’t explain further (more than
negligence, less than intentional).
4. Court said reckless conduct might be enough to show liability for director’s
breach of a DOC. Even if reckless might work, defendant’s fall back provision
was waiver in the AOIs. Court punted this issue.
5. ***TAKE AWAY***Negligence will NOT establish a breach of the DOC, have to
be gross negligence. Difference between reckless and gross. Can include a
provision that limits DOC (won’t be liable for gross negligence, for example),
but can’t eliminate duty of care for intentional conduct.****
6. ***Breach of DOC if have gross negligence, reckless conduct, or intentional
conduct. Can limit liability up to intentional conduct in AOIs.***
7. If board acting in good faith to monitor but does not weed out bad behavior,
BODs will be protected by the BJR.
ww. Duty of Loyalty:
i. Question of a director’s duty of loyalty generally arise when the director:
1. Competes w/ the company;
2. Takes for herself a “corporate opportunity”; or
3. Has some personal pecuniary interest in a corporation’s decision.
ii. How are DOL cases different from DOC cases?
1. Breach of a Duty of Care  directors or officers were lazy or dumb.
2. Breach of a Duty of Loyalty  directors or officers were greedy and put their
own financial interests ahead of the interests of the corporation and its SHs.
iii. Can have a breach of DOL w/ director or officer.
xx. Jones Co., Inc. v. Frank Burke, Jr. (Competing With the Corporation):
i. Lecture:

1. Why did parties want to leave the P agency? Upset w/ president’s
inappropriate conduct and asked P agency’s customers to see if would come w/
2. Officers spoke w/ President and said will buy him out or will leave. Never
reached an agreement.
3. D agency took employees and officers from P agency and filed AOIs. After that,
entered into lease for agency.
4. P then sued those who left and worked for D agency, under breach of DOL.
5. Was there a breach of the DOL? Competing w/ the corporation.
6. How did they compete w/ the corporation? Buy starting another agency’s
7. Do lower level employees have a DOL (janitor)? Yes. Not to same extent as
higher up employees or executives.
8. Did their leaving constitute a breach of a DOL? Depends. Lower level
employees have a different level of DOL. Janitor, no breach. Higher up in
organization, have access to more confidential information, and your DOL will
increase as more confidential information you receive.
9. What about a member of the BOD? Member works for BB&T and wants to
start own bank. Wouldn’t have a breach of DOL. Board members have other
10. Officers are of a different situation.
11. If the officers had reached a formal agreement w/ the P before leaving but
after signing the lease for the new space, who would be liable on the lease
agreement? On what basis? 3P that owns building wants to enforce lease
agreement. Whoever signed the lease will be responsible as a promoter, agent
for company that didn’t exist. Can get to other officers who left under GP,
jointly and severally liable.
12. One of officers comes to me and asks what to do because they want to leave.
How would I advise? Disclose actions to disinterested board members.
13. At what point did they breach their DOL? Clark does NOT know. Answer could
be, even if started when talking w/ client, this might be a breach, but still would
be difficult to show damages. ***ASK CLARK ABOUT THIS***
14. Similar duty of loyalty seen in Meinhard v. Salmon.
15. Can a board member serve on multiple boards w/out breaching DOL? Yes.
Serving in interests of that organization or public, NOT necessarily a BOL (unless
misappropriate information or obtain competitive advantage). Can have
liability as a director on the board.
16. Expect directors to engage in other activities. More problematic when officer
acts as way party did in Jones.
17. A little bit easier for director to compete w/ corporation than an officer.
ii. Issues: Whether Ds breached their fiduciary duty to P agency.
iii. Holdings: The inferences reasonably to be drawn from the record justify the conclusion
(reached by jury and by a majority of Appellate Division) that the individual defendants-
appellants, while employees of P corporation, determined upon a course of conduct
which, when subsequently carried out, resulted in benefit to themselves through
destruction of P’s business, in violation of the fiduciary duties imposed on Ds by their
close relationship w/ P corporation.

iv. Rules: Agents/employees are prohibited from acting in any manner inconsistent w/ his
agency or trust and is at all times bound to exercise the utmost good faith and loyalty in
the performance of his/her duties.
v. Reasoning: Court said that upon this record the jury might have found that the
conspiracy originated in June or July WHILE a fiduciary duty existed, and that the
benefits realized when D agency commenced operation in September were merely the
results of a predetermined course of action.
vi. Does a corporation’s officer or director improperly compete if she also serves as a
director for another corporation?
1. Comment c to Section 5.06 of ALI’s Principles says no because the person is NOT
pursuing his self interest by serving on the other board.
yy. Competition w/ Corporation
i. If a director or officer wants to compete w/ a corporation must disclose.
ii. 3 ways for director or officer to get approval to compete w/ the corporation:
1. Argue that any reasonably foreseeable harm to the corporation is outweighed
by any benefit corporation will reasonably receive from allowing competition
to take place, or there is no reasonably foreseeable harm to corporation from
2. Competition is authorized in advance or ratified, following disclosure
concerning conflict of interest and competition, by disinterested directors (or
disinterested superior); or
3. Competition is authorized in advance or ratified, following disclosure
concerning conflict of interest and competition, by disinterested SHs, and SHs’
action is NOT equivalent to a waste of corporate assets.
zz. Quick Review
i. Who owes the DOC and DOL? Directors, officers, SHs (Not so much), and partners.
ii. We are sure Directors will receive protection of the BJR under the MBCA, however would
make argument for protection of officers.
iii. Corporate veil protects SHs.
iv. Tri-part duty of BJR, and if do satisfy all parts, decision will be protected by the BJR.
Claimant can try to remove BJR by showing fraud, wasting assets of corporation, breach
of DOL, etc.
aaa.Northeast Harbor Golf Club, Inc. v. Harris (“Usurping” a Corporate Opportunity):
i. Lecture:
1. Maine law applies because that is where corporation is incorporated (internal
affairs doctrine).
2. Gilpin property  delayed disclosure.
3. Smallidge property  delayed disclosure.
4. What was determination of TC? No breach of fiduciary duty. Reasoning of TC
was that corporation didn’t have the funds to purchase the properties and thus
was NOT a corporate opportunity. Also in regards to development, the
corporation was not in business to developing property.
5. TC applied the “line-of-business” test from Guth.
6. COA disagreed w/ the TC, applied the ALI Corporate Opportunity Test.
7. D was approached in capacity as President of corporation in purchasing the
Gilpin property, but D decided to take the opportunity for herself.
8. Why did the SHs ultimately decide to take action? New board members. D
also was attempting to develop the properties she purchased.
9. Even if new board hired new president, could still have gone after D.

10. ALI Section 5.05, Taking of Corporate Opportunities by Directors or Senior
Executives. PUT THIS IN OUTLINE. PAGE 241-242.
11. COA determined this was a corporate opportunity. Next question is whether
the opportunity was disclosed. Once disclosed, board must decide whether to
accept or reject opportunity. If board rejects the opportunity, she is not home
free, possible to make disclosure to interested board members. Must disclose
to disinterested board members.
12. Only way for director to meet their obligation is to disclose to disinterested
directors or SHS. Disinterested directors must act w/ the DOC. If disinterested
directors or SHs reject, then director can go after the property.
13. ALI Approach, Smallidge Property:
i. First step, is this a corporate opportunity (definition in 5.05 (b))? YES.
Harris was approached in her individual capacity. However, even
though not approached in business capacity, you could argue 5.05 (b)
ii. Second Step, did she disclose? After.
a)Can make a delay disclose, but show that had a GF belief that
it was not a corporate opportunity and then must get
approval by disinterested board members or SHs.
b)Won’t work in this case.
ii. Objectives: P sought an injunction to prevent development and also sought to impose a
constructive trust on the property in question for benefit of the Club.
iii. Procedural History: TC found in favor of defendant and plaintiff appealed.
iv. Issues: Whether the defendant had usurped a corporate opportunity of the
v. Holdings: SC of ME vacated the judgment of TC and remanded the case for further
bbb. ALI Approach 5.05
i. Step 1: Is there a corporate opportunity? Look to 5.05(b). This is the BURDEN the
CHALLENGER must prove that there was a CO.
1. Engage in a business activity of which a D or O becomes aware in connection w/
the performance of functions as a D or O or under circumstances that should
reasonably lead the D or O to believe that the person offering the opportunity
expects it to be offered to the corporation.
2. Engage in a business activity of which a D or O becomes aware through the use
of corporate information or property, if the resulting opportunity is one that the
D or O should reasonably be expected to believe would be of interest to the
3. To engage in business activity of which a D or O becomes aware and knows is
closely related to a business in which the corporation is engaged or expects to
ii. Step 2: Did the D offer the opportunity to the corporation AND disclose the conflict or
corporate opportunity? ALI 5.05(a). If there is NO DISCLOSURE GAME OVER. The D is
LIABLE for breach of the DOL.
1. Mandatory disclosure required (FULL DISCLOSURE). (If don’t have full
disclosure, have defective disclosure which can still remedy, see below)
2. CO rejected by corporation.

iii. Step 3: Who has the BOP? 5.05(c). (If D discloses to disinterested Ds or SH’s, D’s
burden, if not, SH’s burden (?) ASK LAURA AND CLARK)
1. D’s Burden: if the D discloses he will have the burden to prove that the
transaction was fair to the corporation unless D got:
i. Approval by DISINTERESTED directors/executives applying the BJR OR
ii. Approval by DISINTERESTED SHs w/out evidence of waste. (This
shows that get SH approval but there is evidence of waste, then
burden shifts to D)
2. SH Burden: The SH that challenges the taking of a corporate opportunity will
carry the BOP to prove that the transaction was unfair to the corporation if the
director got:
i. Approval by DISINTERESTED directors/executives applying the BJR OR
ii. Approval by DISINTERESTED SHs w/out evidence of waste.
ccc. ALI Approach 5.05 Defective Disclosure
i. If a D or O in GF makes a defective disclosure (for example innocently fails in include all
of the specifics regarding the transaction) the D or O can cure, if the cure is made w/in a
reasonable time after the suit is filed challenging the taking of the CO, if the original
rejection of the opportunity by the corporation is ratified by the BODs, SHs or the
person that originally approved the rejection of the opportunity.
ddd. ALI Approach 5.05 Delayed Disclosure
i. A D or O may make a LATE disclosure if:
1. They believed in GF that the opportunity was NOT a CO AND
2. The opportunity is rejected by disinterested BODs or SHs.
eee. Broz v. Cellular Information Systems, Inc.
i. Lecture:
1. CIS was not acquiring new assets, they were selling everything off. Mack
approached Broz in his capacity of RFBC, NOT CIS.
2. Pricellular throws wrench into situation. Pricellular was attempting to purchase
CIS and would eventually have money and assets. They would ultimately be
able to take advantage of the opportunity.
3. TC did NOT believe that CIS had the funds to acquire/purchase the opportunity,
however, the fact they were going to be acquired, they would eventually have
the money to acquire MI-2.
4. Did Broz have duty to Pricellular? NO. He owes a fiduciary duty to CIS and
5. SC applied the “line-of- business” test (Guff Test).
6. Guth v. Loft; “Line of Business” Test:
a. If there’s presented to a corporate officer or director a business
opportunity which the corporation is financially able to undertake, is
from its nature, in the line of the corporation’s business and is of
practical advantage to it, is one in which the corporation has an
interest or a reasonable expectancy, and, by embracing the
opportunity, the self-interest of the officer or director will be brought
into conflict w/ that of his corporation, the law will not permit him to
seize the opportunity for himself.
7. Guth Test (Broken Down): a corporate officer or director may not take a
business opportunity for his own if: (FACTORS)
a. Corporation is financially able to exploit the opportunity;
b. Opportunity is w/in corporation’s line of business;

c. Corporation has an interest or expectancy in opportunity; and
d. By taking opportunity for his own, corporate fiduciary will thereby be
placed in a position inimical to his duties to the corporation.
8. SC said CSI didn’t have the money to take this opportunity, this opportunity
wasn’t in line of business
9. TC focused that Broz failed to disclose first. ****Under the DE, Guth test, DO
However, under DE, you should still disclose to prevent liability under DE law.
10. What if ALI test applied? Must first determine if this a corporate opportunity.
FINANCIAL ABILITY HAS NO FACTOR IN ALI TEST, then maybe might be able to
show a CO under Step 1 (3). Then Broz must disclose and corporation must
reject. Broz didn’t disclose and thus will be in breach of fiduciary approach
under ALI (but not under Guth test).
11. Directors can serve on conflicting boards. Advise client to disclose to each
board and to abstain from voting (he would be considered interested).
12. Assume CO situation similar to this case:
a. 1st sentence is the most important, determines jurisdiction.
b. Director does disclose, corporation does reject, but doesn’t conduct
research, argument is that members weren’t informed and thus didn’t
uphold their duty of care.
c. Action against director for duty of loyalty for usurping CO. She would
say I disclosed to the board, but the board didn’t utilize DOC.
d. Director has burden to show decision was in fairness.
e. Can still go after board members for a breach of duty of care.
f. Under MBCA jurisdiction, P has burden to show duty, breach, and
causation (damages).
13. DE = line of business test
14. ALI = Guth Test
15. Another Example:
a. Harris example. H presents opportunity to board. Those on board, H’s
husband, nephew and two kids. Other 4 are unrelated.
b. 5 members reject and 3 accept opportunity.
c. What would I advise the board? Create a special litigation committee
composed of disinterested directors. If don’t do that, board will be
interested, and thus if CO rejected, H will have BOP to show fairness.
d. Argument also that if no SLC, interested directors could be sued for
breach of DOL.
e. Will add concept of derivative suit to this example.
16. Know difference between competing w/ corporation and usurpation of
corporate opportunity.
17. Example of gross negligence case: Van Gorkum.
ii. Procedural History: Court of Chancery held that D (corporate director) breached his
fiduciary duty by not formally presenting to the corporation an opportunity which had
come to the director individually and independent of the director’s relationship w/ the
iii. Issues: Whether defendant, Broz, usurped corporate opportunity from P.
iv. Holdings:
1. SC of DE reversed the judgment of the Court of Chancery.

2. Court of Chancery erred as a matter of law in concluding that Broz had a duty
formally to present the MI-2 opportunity to the CIS board.
3. The TC erred in its application of the corporate opportunity doctrine under the
unusual facts of this case, where CIS had no interest or financial ability to
acquire the opportunity, but the impending acquisition of CIS by PriCellular
would or could have caused a change in those circumstances.
4. Broz did NOT breach his fiduciary duties to CIS.
fff. Interested/Conflict of Interest/Both Side of the Transaction
i. This is a special type of DOL. In these types of cases the D or O is on both sides of the
ggg.HMG/Courtland Properties, Inc. v. Gray (Being on Both Sides of a Deal With The Corporation
(“Interested Director Transactions”))
i. Lecture:
1. Gray was HMG’s principal negotiator.
2. Why did the SHs wait so long to bring the lawsuit? No one knew of Grey’s
3. Issue of DOL was brought about by self-dealing. Grey stood on both sides of
the transaction.
4. In a self-dealing case, BOP is on defendant, under DE law, what are the 3 ways
that a director can attempt to escape breach of DOL under “self-dealing”
5. In a self-dealing case, BOP is on the defendant/director. He was prove 1 of 3
i. Disclosure to disinterested BODs;
ii. Disclosure to disinterested SHs;
iii. Entire fairness Test.
6. EFT made up of Fair Dealing and Fair Price: (ELEMENTS)
i. Fair Dealing:
a)Embraces questions of when the transaction was timed, how
it was initiated, structured, negotiated, disclosed to the
directors, and how the approvals of the directors and the SHs
were obtained.
ii. Fair Price:
a)Relates to economic and financial considerations of the
proposed merger, including all relevant factors: assets, market
value, earnings, future prospects, and any other elements
that affect intrinsic or inherent value of a company’s stock.
7. There was NO fair dealing NOR fair price in this case. In regards to fair price,
maybe price was okay, however, if directors would have known of Grey’s
interest he would not have been selected as lead negotiator, and thus price
more than likely would have been different.
8. What if Grey and Feiber would have disclosed to either disinterested board
members or SHs, do they still have burden to show entire fairness test? No.
9. Even if there was disclosure, however, doesn’t automatically mean director is
protected? This standard goes to the BJR rule.
10. ****Under DE law, even if able to establish disclosure, court could still go in
and challenge the decision under BJR (more favorable for director).****
11. Duty to Disclose  obligation to disclose material facts that will affect
obligation to the BOD.

ii. Issues: Whether Fieber and Gray breached their fiduciary duties of loyalty and care and
defrauded the company.
iii. Holdings: DE Chancery Court held that Fieber and Gray breached their fiduciary duties
of loyalty and care and defrauded the company. HMG was rewarded relief to remedy
the harm caused by their misconduct.
hhh. Notes:
i. What is the difference between “interested director transactions” and “corporate
1. A director transacting business w/ the corporation as contrasted w/ a director
taking business transactions away from the corporation.
iii. Cookies Food Products, Inc. v. Lakes Warehouse Distributing, Inc.
i. Lecture:
1. Reacquired Shares = Treasury Stock.
2. Changes in corporation under H’s leadership formed basis for lawsuit:
i. First, C’s board extended term of exclusive DA w/ Lakes and expanded
scope of services. April 1982, when sales increased, Cs needed
additional short-term storage and board accepted H’s proposal to
compensate Lakes at “going rate.” It would have been more
expensive to store product somewhere else.;
ii. Second, H moved from role as director and distributor to product
development. He invented taco sauce recipe, for which C’s board
approved a royalty fee to be paid to H. H’s rate was equivalent to sales
%tage slightly higher than what LD receives, but the taco recipe yields
greater profit to C because new product line is cheaper to produce;
iii. Third, since 1982, C’s board twice approved additional compensation
for H. January 1983, board authorized payment of “consultant fee.” Cs
board amended exclusive DA to allow Lakes additional 2% of gross
sales to expand outside of IA and result was Cs regularly shipped
products to several states throughout country;
3. ***Cs growth and success didn’t please all SHs. Discontent is motivated by 2
factors that have precluded SHs from sharing in C’s financial success:***
i. Cs is a closely-held corporation; and
ii. Cs has NOT paid a dividend.
a)Cs hasn’t improperly refused to pay dividends. Cs would have
violated terms of its loan w/ the Small Business
Administration had it declared dividends before repaying that
debt. SBA loan was NOT repaid until month before Ps filed
4. Ps argued that through the exclusive DA, taco sauce royalty, warehousing
fees, and consultant fees, H breached his fiduciary duties to corporation and
SHs because he allegedly negotiated for these arrangements w/out fully
disclosing benefit he would gain.
5. Ps are essentially arguing this is a freeze-out.
6. KEY POINT: W/ respect to interested directors transactions, the MBCA and the
DE approaches are the same. This case merely indicates that some courts may
add that a D/O/MajSH in a CHC prove that they acted w/ GF, honesty, and
7. Who had the BOP in this case?

8. Burden of Proof:
i. Duty of Care: BOP is on Ps because to the BJR which affords directors
presumption that their decisions are informed, made in good faith,
and honestly believed by them to be in best interests of the company.
ii. Duty of Loyalty: BOP is on director challenged in a self-dealing suit to
establish his good faith, honesty, and fairness.
a)Disclosure to disinterested SH or Directors, or EFT.
b)Additional requirement that IA and many MBCA jurisdictions
include is that directors who engage in self-dealing MUST
establish the additional element that they have acted in
good faith, honesty, and fairness.
9. General Rule  MBCA: if disclose to disinterested board members or SHs,
then court can’t challenge.
10. As a SH, do you owe a fiduciary duty? No. As a majority SH? Yes (in this
particular case, because it’s a CHC, similar to a P.)
ii. Procedural History: TC rendered judgment for defendants finding that Herrig’s action
benefitted, rather than harmed, Cookies.
iii. Issues: Whether defendant breached his fiduciary duty to company and fraudulently
misappropriated and converted corporate funds.
iv. Holdings: IA SC affirmed TC’s judgment to dismiss Ps’ claims.
jjj. Interested Transactions MBCA
i. Where there’s an interested director, he can satisfy the MBCA in 1 of 3 ways:
1. Disclosure and approval by BODs.
2. Disclose and approval by majority of disinterested SH.
3. Entire Fairness.
ii. In essence, meeting 1 of the 3 establishes a SAFE HARBOR and there will be no
additional review by the court unlike DE interested director transactions (DE TEST p.
250, footnote 24: If the D does gets ratification of their actions under (1) or (2), he will
be protected as fairness will be determined by the BJR. If NOT he must prove the more
difficult standard of Entire Fairness and will also be a part of BJR challenge). However,
some MBCA jurisdictions (IA court in Cookies) requires that D’s must also prove that he
acted in GF, honesty, and fairly. This additional requirement is different than the DE
kkk. The Requirement of Good Faith
i. In addition to DOC and DOL, there is also a requirement to act in good faith.
ii. After Van Gorkum, state legislatures, including DE’s, began to permit companies
incorporated in their states to place provisions in the AOI that eliminated directors’
liability for violations of the DOC.
iii. Unlike the DOC, new statutes did NOT permit liability for failure to act in good faith to
be eliminated in the AOI.
iv. Delaware courts currently define bad faith as an intentional dereliction of duty, a
conscious disregard for one’s responsibilities.
lll. Executive Compensation:
i. Who sets the salaries of executives? BODs.
ii. How is it determined? How much other CEOs make working for similarly situated
companies and how well company is doing. There are other factors as well.
iii. Is this decision protected? Yes, under the BJR.
iv. Suppose a CEO has demanded that his BODs grant him a big pay raise. To avoid conflict
if officer-directors were to vote on their own pay, most boards delegate compensation

decisions to a “compensation committee.” The CC often in turn then hires an outside
consultant to advise it.
v. SHs may sometimes sue derivatively, asserting that directors’ approval of massive
compensation violated their fiduciary duties.
mmm. In Re The Walt Disney Company Derivative Litigation
i. Lecture:
1. What is downside protection? In event company X does poorly, I want to make
sure I made same that I made at other company.
2. SHs argued breach of DOC in failing to recognize were O to leave, he would
have to be paid all of this money. How did Court treat this issue?
i. This was not a breach of this duty.
ii. They did not USE “best practice.”
iii. What would have been the “best practice”?
a)In a BPS, all CC members would have received, before or at
the CC’s first meeting on September 26, 1995, a spreadsheet
or similar document prepared by a compensation expert.
That spreadsheet, would form the basis of the CC’s
deliberations and decision
iv. There was enough information to approximate how much O would
walk away with. The BOD was informed.
a)CC members derived information about potential magnitude
of an NFT payment from 2 sources:
1. Value of “benchmark” options previously granted to
Eisner and Wells and valuations by Watson of
proposed O options; and
2. Amount of “downside protection” that O was
3. SHs next argued that there was breach of DOC to hire O. Court said no. They
were informed about whether or not to hire O.
4. Court only concerned w/ procedure, not result.
5. In the AOIs probably had provision that eliminated liability for breach of DOC.
However, SH still argued that BOD acted in bad faith which liability for can’t be
eliminated in the AOI.
6. Could the claimant have argued that this was a “no-win” situation? No.
ii. Issues: Whether the director’s approvals violated their DOC because they were
insufficiently informed, and whether the directors were liable because they had acted in
bad faith.
iii. Holdings:
1. DE SC affirmed TC’s judgment: no breach of DOC nor breach of GF.
2. Court of Chancery had a sufficient evidentiary basis in record from which to find
that, at time they approved the OEA, the CC members were adequately
informed of the potential magnitude of an early NFT severance payout.
3. Court upheld Chancellor’s conclusion, that when electing O to Disney
presidency the remaining Disney directors were fully informed of all material
facts, and that the Ps failed to establish any lack of due care on the director’s
nnn. Demand:
i. In a derivative suit (DS), whose right is the SH suing to vindicate? Suing to enforce right
of corporation.

ii.Where does this right come from? SHs are owners of the corporation.
iii.Who would you expect to bring a suit on behalf of a corporation? BODs.
iv. Why might they decide not to do so? Not in best interest of the corporation.
v. Interested director situation because party sits on BODs on Bubbas and has an interest
in Eggplant Company. Would the situation on p. 271, dealing w/ Edith’s Eggplant Co.,
satisfy the DE Test for interested transactions?
1. Must disclose.
2. Disclose to disinterested board members applying exercising their DOC, OR
disinterested SHs that aren’t wasting assets of corporation. If don’t do either of
these, must satisfy Entire Fairness Test.
3. Entire Fairness Test is the hardest to prove.
4. No disclosure in this case and thus EF must be satisfied. Whatever decision is
made BJR must still be applied.
5. The MBCA test for interested transactions? Same three scenarios, however,
once disclose, stop right there, no further inquiry.
6. DOC and DOL against Capel, and DOC against Propp and Agee.
vi. Why might courts be reluctant to allow SHs to bring derivative suits? To protect
against frivolous suits.
vii. How have courts attempted to balance this concern? Impose procedural requirements
in bringing DS. In NY, for example, must post a bond. Own certain percentage of stock.
viii. What are strike suits? Frivolous lawsuit and it’s unlikely to be any monetary damage.
ix. What are direct suits? SH is individually injured as opposed to corporation. This is
normal litigation. How are they different than derivative suits? Injury is to corporation.
x. One hint that a direct suit is appropriate is that the defendant’s conduct injured only
SOME SHs, rather than all of them. In contrast, suits that injure ALL SHs tend to be
derivative, although they can also sometimes be direct.
xi. Why might a corporation prefer that a suit be classified as derivative rather than
direct? If C, prefer that lawsuit would be structured as a DS. Might have a requirement
to make a demand, or even a bond requirement (procedural requirements that must be
met before get sued). If individual SH would rather file a direct suit.
ooo.Eisenberg v. Flying Tiger Line, Inc.
i. Lecture:
1. Plaintiff, Eisenberg, owned stock in Flying Tiger Line, Inc. (“Flying Tiger”), which
operated freight and charter airline.
2. Flying Tiger formed wholly-owned subsidiary called Flying Tiger Corporation
(“FTC”) (thus Flying Tiger is the only SH in FTC).
3. FTC formed wholly-owned subsidiary called FTL Air Freight Corporation (“FTL”).
4. Flying Tiger merged into FTL. Flying Tiger ceased to exist as separate entity
(disappearing corporation), and FTL survived (surviving corporation). FTL took
over running airline.
5. SHs of Flying Tiger got stock NOT in FTL but in FTC. Therefore, P and those who
used to own stock in Flying Tiger, now owned stock in a holding company (FTC),
a subsidiary of which (FTL) runs the airline.
6. Rather than the minority owner of a corporation that RAN an airline, P was
now minority owner of a corporation that owned ANOTHER corporation that
RAN an airline.
7. TC determined that suit was derivative. Thus SH was required to post $35K

8. What is importance of posting bond? Legal fees and expenses. Probably
amount of money corporation would have to spend to have lawsuit.
9. How do you determine whether a suit is direct or derivative? A claim that is
personal or to a few SHs versus a claim for the corporation.
10. Gordon v. Elliman was a derivative suit, but this decision was later overturned.
11. Today, a suit to compel a corporation to declare a dividend is direct. A suit to
dissolve a corporation would be a direct suit.
12. Court in this case determined that the suit was direct versus derivative. SHs
weren’t allowed to vote. Individual right to vote.
ii. Procedural History: TC agreed w/ D and required P to post bond of $35K. P refused and
TC dismissed case.
iii. Issues: Whether P should have been required to post security for costs as a condition to
prosecuting his action.
iv. Holdings: US COA reversed TC’s dismissal. COA held that P’s case was a direct suit.
Therefore, P did NOT have to satisfy a derivative suit’s procedural requirements,
including posting a bond.
ppp. Problems, p. 276:
i. #2 Was relevant. Courts are concerned w/ frivolous suits. Idea that this might be a
strike suit is diminished.
ii. #5:
1. 5.1  direct
2. 5.2  derivative (enforcing right of corporation)
3. 5.3  derivative (corporation’s assets are being used to pay bonuses)
4. 5.4  derivative
5. 5.5  derivative (corporation’s assets are being wasted)
6. 5.6  direct
7. 5.7  direct. Can sue Freer (liable for his own tort). He can also sue
corporation. Because of nature of position, scope of employment, could sue
corporation. HOWEVER, could NOT get to other SHs. Protected by CV.
qqq. Procedural Requirements of a Derivative Suit
rrr. Stock Ownership and Other Standing Requirements (Read MBCA 7.41)
i. Notes: (BOOK)
1. Some courts have strained to uphold SH standing under “continuing wrong”
theory. Reasoning behind this theory is that some D’s breach of duty do not
occur simply at single moment, but over time. If the SH owned stock at ANY
point during this “continuing wrong,” such a court will uphold the P’s right to
ii. Problems p. 277:
1. #1 Didn’t own a share, but bought stock after hearing of suit. Can’t bring a
derivative suit. ***Must hold stock at time action arose.***
2. Clark’s Question: Is there another way that one could get shares through
operation of law? (In other words, didn’t own stock when wrong occurred, but
by operation of law would have standing to sue.) Will, if inherited stock, divorce
iii. Does the MBCA make it that you have to be a SH at the time litigation is filed? (Have
wrongdoing then litigation). Yes, must be a SH throughout wrongdoing and litigation.
1. #4. No particular value
sss. Security-for-Expenses
i. MBCA and most states do NOT have security-for-expenses provisions.
ii. DON’T HAVE TO KNOW NY LAW (bond posting).

ttt. Demand on Directors
i. Basis for demand requirements:
1. To avoid frivolous lawsuits
2. To deter SS
3. Preserve role of directors in decision making
1. MUST MAKE WRITTEN DEMAND and wait 90 days, unless: (1) demand rejected
w/in 90 days; or (2) waiting 90 days would cause irreparable harm to
2. SH must allege w/ particularized facts which creates a reasonable doubt that:
i. The directors are disinterested and independent and (really an or)
ii. The challenged transaction was otherwise product of a valid exercise
of BJR. Thus the court must look into the substantive nature of the
challenged transaction and the board’s approval thereof.
3. Reasoning behind this. If make a demand in DE, assuming board is
disinterested and thus removes ability to argue against BJR.
iv. Problems, p. 279:
1. #1  demand would be excused. All board members are interested. CAN’T DO
2. #2  majority of the board is interested. Demand would be excused.
3. #3  not a majority. Less likely to futile to make demand.
4. #4  strong argument that demand should be excused but not as strong as #1.
5. #5  pretty far removed that demand would be futile.
uuu. Mark v. Akers (SH DS)
i. Lecture:
1. SH derivative action against IBM and IBM’s BODs w/out 1 st demanding that
board initiate a lawsuit. Complaint alleged that board wasted corporate assets
by awarding excessive compensation to IBM’s executives and outside directors.
Ds moved to dismiss complaint.
2. Excessive compensation paid to inside and outside directors.
3. Issue is whether demand is futile. If this was an MBCA case, this wouldn’t be
the issue because you HAVE to make demand.
4. DE Test:
i. In DA by 1 or more SHs the complaint shall allege w/ particularity the
efforts, if any, made by P to obtain action the P desires from directors
or comparable authority and reasons for P’s failure to obtain action or
for not making the effort.
ii. ***Aronson v. Lewis 2-prong Test to Determine Demand Futility: P’s
must alleged particularized facts which create a reasonable doubt
a)Directors are disinterested and independent, and
b)Challenged transaction was otherwise product of valid
exercise of BJ.
iii. Two branches of Aronson test are disjunctive:

a)Once director interest has been established, BJR becomes
inapplicable and demand is excused.
b)Director whose independence is compromised by UI exerted
by interested party cannot utilize BJR and demand is excused.
c) Whether board has validly exercised its BJ must be evaluated
by determining whether directors exercised procedural
(informed decision) and substantive (terms of transaction)
due care.
5. NY Test: (essentially the same as DE, except that in DE has a lower standard,
reasonable doubt)
i. Demand is futile if a complaint alleges w/ particularity that (Barr):
a)A majority of directors are interested in transaction; or
1. Director interest may either be self-interest in
transaction at issue, or a loss of independence
because director w/ no direct interest in transaction
is “controlled by self-interested director.
b)Directors failed to inform themselves to degree reasonably
necessary about transaction; or
1. A director does NOT exempt himself from liability by
failing to do more than passively rubber-stamp
decisions of active managers.
c) Directors failed to exercise their BJ in approving the
1. Egregious on its face and couldn’t be produce of
sound BJ.
ii. It is NOT sufficient merely to name a majority of the directors as
parties defendant w/ conclusory allegations of wrongdoing or control
by wrongdoer to justify failure to make a demand. The complaint shall
set for w/ particularity the reasons for not making such effort.
6. Why did court in Barr say demand was futile in regards to inside directors?
Interested directors. There was an offer on table to receive $24/share and took
offer for $20/share. Interested because got new jobs by accepting $20/share.
7. What about outside directors? Question of breach of DOC. Generally, don’t
look at substantive result, however if it’s absurd, look to result and might be
lack of due care.
8. In present case there are 2 categories: (1) Demand was excused w/ respect to
compensation of outside directors because setting own salaries (15 out of 18
board members, INTERESTED TRANSACTION). (2) But, demand was NOT
excused w/ respect to inside directors compensation (Majority of board is
disinterested, demand NOT excused. 3 out of 18 are interested).
ii. Inside Ds: Court held that demand was NOT futile because only 3 BODs were interested
while 15 made a disinterested decision to increase the salaries of the 3 inside executive
boards members.
iii. Outside Ds: Demand was futile because decision was interested because 15 Ds voted to
increase their own salary (this involved a majority of the board). (Still had to look at
substantive merits of the case) While demand was futile, there was no COA because the
directors did not:

1. Increase their collective salaries so as to use up nearly the entire earnings of a
2. Appropriate the income so as to deprive SH’s of reasonable dividends; or
3. So reduce the assets as to threaten the corporation w/ insolvency.
iv. Thus the salary increase was okay. ***First question is whether demand is futile but is
not a determination upon the substantive merits of the claim.***
v. Procedural History: NY SC (TC) dismissed P’s complaint (failed establish demand futility
and didn’t touch COA issue).AD affirmed dismissal (failed to establish demand futility)
vi. Holdings:
1. NY COA affirmed AD judgment.
2. P was NOT excused from making a demand w/ respect to the executive
compensation claim and P has failed to state a cause of action for corporate
waste in connection w/ the allegations concerning payments to IBM’s outside
vvv. Director Salaries
i. Historically, Ds didn’t receive compensation. However, most jurisdictions now provide
that Ds can have a salary unless corporation AOI or Bylaws provide otherwise. As such,
courts will generally NOT inquire into director salaries unless:
1. Ds increase their collective salaries so to use up nearly entire earnings of
2. Ds or Os appropriate income so as to deprive SH of reasonable dividends;
3. Ds or Os so reduce assets as to threaten the corporation w/ insolvency.
ii. In regards to Mark v. Akers, does the above, help to answer ultimate question,
whether or not demand is futile? No. (ASK LAURA)Won’t prevail on substantive
elements of the claim. However, demand is still futile.
www. Special Litigation Committees – put disinterested persons on here
i. Can a board move to dismiss a suit against a director by arguing that the suit is NOT in
the best interests of the corporation? Yes.
ii. If so, what issue might we possibly have in recognizing such a decision? Board
members might be interested. How have BODs dealt w/ this problem? Created SLC.
xxx.Auerbach v. Bennett
i. Lecture
1. 1st approach to SLC. MBCA APPROACH
2. Sidebar: Suit brought in NY. If MBCA jurisdiction, have to make a demand and
can’t sue w/in 90 days unless board rejects w/in 90 days or there would be
irreparable harm to corporation if waited 90 days. If DE controls, do NOT make
3. Under current law, can board delegate power to SLC? Yes.
4. 3 Step Process for Creating a SLC and SLC Decision Making:
i. Procedures for Selecting Members to SLC
a)Select members to participate on SLC. Want to select
disinterested and independent members. Sometimes they
are newly-appointed board members to lessen the likelihood
of the taint.
b)Can attack. But presumption is that protected by BJR,
complaint thus has BOP.
ii. Procedures and Methodologies That SLC Will Utilize in Decision-

a)Selection of procedures appropriate to pursuit of its charge,
1. As to methodologies and procedures best suited to
the conduct of an investigation of facts and
determination of legal liability, the courts are well
equipped to make determinations and attack.
2. The determinations to be made in adoption of
procedures do not partake of the nuances or special
perceptions or comprehensions of BJ or corporate
activities or interests.
b)Can attack. But presumption is that protected by BJR,
complaint thus has BOP.
iii. Substantive Decision Made By SLC – look at tri-part duty
a)Ultimate substantive decision, predicated on procedures
chosen and data produced thereby. Here decision is NOT to
pursue claims advanced in SH’s DA.
1. Those responsible for procedures by which BJ
reached may reasonably be required to show that
they have pursued their chosen investigative
methods in GF.
2. Will only look at substance of decision if members of
SLC are interested.
b)CANNOT ATTACK. Conclusion reached by SLC is outside
scope of court’s review.
5. In this case: Court does not find either insufficiency or infirmity as to the
procedures and methodologies chosen and pursued by the SLC: (1) committee
promptly engaged special counsel to guide its deliberations and advise it; (2)
committee reviewed prior work of audit committee; (3)conducted individual
interviews w/ directors found to have participated in any way in questioned
payments, and w/ Arthur Anderson reps.; (4)Questionnaires sent to and
answered by each of corporation’s non-management directors; and (5) at
conclusion of investigation SLC sought and obtained pertinent legal advice from
its special counsel.
6. Not all courts have adopted the Auerbach approach.
ii. Facts: Board is made up of 15 members, and the DS was brought against 4 of the
directors. Other directors had been members of the board in the period during which
the transactions occurred. Each of the 3 director members of the special litigation
committee (SLC) joined board thereafter. None of the 3 had any prior affiliation w/ the
iii. Issues:
1. Whether the BJR applies to shield from judicial scrutiny the decision of a 3-
person minority committee of the board acting on behalf of full board not to
prosecute a SH’s DA.
2. Whether P, on D’s motions for SJ predicated on the investigation and
determination of the SLC, has shown facts sufficient to require a trial of any
material issue of fact as to the adequacy or appropriateness of the modus

operandi of that committee or has demonstrated acceptable excuse for failure
to make such tender.
iv. Holdings:
1. The requisite showing has not been made on this record and thus D’s motion
for SJ should be upheld.
2. Court found nothing in the record that requires a trial of any material issue of
fact concerning sufficiency or appropriateness of procedures chosen by the SLC.
Nor is there anything in the record to raise triable issue of fact as to GF pursuit
of its examination by that committee.
yyy. Zapata Corporation v. Maldonado
i. Lecture:
1. Zapata approach is the 2nd approach to SLC. DELAWARE APPROACH.
2. If a SH doesn’t make demand, will go to court and decide whether demand is
futile. At that time, board can make a motion to dismiss as to the suit not being
in the best interest of the corporation.
3. Here board is interested and creates a SLC, and the SLC makes the MTD arguing
that the suit is not in the best interests of the corporation.
4. This Court rejects Auerbach approach.
5. 3 Step Process in Zapata SLC Committee Standard (See Rules Section Below)
(Same Steps As In Auerbach, just different BOPs and Court Involvement)
i. Whether or not procedure for selecting individuals to serve on SLC is
a)BOP is on defendant/director (different than Auerbach)
b)Show procedures to select members of the SLC.
ii. What is the process SLC use to make their decisions.
a)BOD must show they acted in GF and such.
b)BOP is on the defendant/director/board. (different than
1. Under Auerbach, presumption is that decision is
informed and in good faith and in best interests of
the corporation, and the claimant must remove this
protection. Not the same thing here.
iii. As to substantive decision, court will apply its own BJ.
a)Different from Auerbach because there, Court will not touch
substantive decision.
6. What are the differences between Auerbach and Zapata?
i. Auerbach more differential to board as won’t look to substance of
ii. In Zapata, D must show they acted in GF and Court will look into
substance of the decision.
7. ***OVERALL: With respect to SLC, court will look to procedure AND
substance, but with respect to BOD will ONLY look to procedure and NOT
8. MBCA = Auerbach; DE = Zapata
ii. Facts:
1. William Maldonado, SH of Zapata, instituted DA in Court of Chancery on behalf
of Zapata against 10 officers and/or directors of Z, alleging breaches of fiduciary

2. P DID NOT 1st demand that board bring action, stating instead such demand’s
futility because all directors were named as Ds and allegedly participated in the
acts specified.
3. By June, 1979, 4 of D-directors were no longer on the board, and remaining
directors appointed 2 new outside directors to the board.
4. Board then created an “Independent Investigation Committee”, composed
solely of the 2 new directors.
5. Committee concluded in September, 1979 ,that action should be dismissed as
its continued maintenance would not be in Company’s best interests.
iii. Issues: Whether the Committee has power to cause present action to be dismissed.
iv. Holdings:
1. The SH does NOT have an absolute independent, individual right to continue a
DS for breaches of fiduciary duty over objection by corporation.
2. SC held that the committee can properly act for the corporation to move to
dismiss derivative litigation that is believed to be detrimental to the
corporation’s best interests.
3. SC reversed CC’s order and remanded the cause for further proceedings.
zzz. Court Approval of Settlement or Dismissal
i. In a DS and a class action, the procedural rules thrust the judge into an unconventional
position. She’s required to police terms of the proposed settlement or dismissal to
ensure that they are fair to everyone before the court, and to those who are NOT
present but who may be affected by the action.
ii. As w/ class actions, the court may give notice to those who may be affected. The court
can thus solicit their input on the wisdom of the proposed settlement or dismissal.
Court retains discretion to determine whether to allow either of these, and on what
aaaa. Recovery in Derivative Suits
i. Because a DS vindicates the corporation’s claim, recovery in a successful DS goes to the
ii. Most courts will allow the successful SH to recover her costs from the losing litigant and
her attorney’s fees from the corporation.
iii. What if SH loses the DS? She cannot look to corporation or defendants to recover her
costs or attorney’s fees. Under some statutes, the defendants may be able to recover
their attorney’s fees from the SH if court finds that she sued “w/out reasonable cause.”
iv. SH’s loss is res judicata for other SHs – they cannot sue to try to vindicate the
corporation’s claim a 2nd time.
bbbb. Director Liability Limitation By Statute
i. MBCA 2.02 (b)(4) allows corporation to LIMIT or eliminate D liability to the corporation
of its SHs for breach of the DOC: (in AOI themselves)
1. This limitation only affects claims against Ds by the corporation or the SHs,
NOT 3Ps;
i. Why? Similar to P case. If P agrees to not be liable to any 3P, not
enforceable because 3P isn’t party to K. SHs and directors are all in
agreement and have contracted together.
2. Does NOT apply in DOL cases OR in cases where the D acts intentionally;
3. Intentional criminal misconduct.
cccc. Indemnification
i. Do Ds have a C/L right to indemnification? NO.
ii. What about an agent? Yes.

iii. If an agent has such right, why isn’t a director also entitled to such right? Directors are
NOT agents.
iv. If there is no C/L right to indemnification, where does such right to indemnification
come from? Statutes.
dddd. Indemnification 8.51 and 8.52 (Path: Look #2 first, then go to #3, then go to #1.)
i. The MBCA makes a distinction between permitted and required indemnification. If
indemnification is allowed, the D shall recover EXPENSES NOT FINES, DAMAGES, ETC.
does this provision apply to officers? (ASK LAURA)
1. Permitted – where the corporation MAY
i. In a case outside (2) and (3) where the D can establish that they met
the DOC.
2. Required – where the corporation MUST
i. Where the D is wholly successful on the merits or otherwise
3. Prohibited – where the corporation CAN NOT
i. Where there is a proceeding brought by the CORPORATION that
results in settlement or a judgment against the D.
ii. Where the director has received an improper financial benefit.
ii. Question 1, p. 304: Capel (D for BBs) sued for breach of DOC. She prevails. What
result? Is the corporation REQUIRED to indemnify Capel? See Comment to section
8.52. First question to ask is the whether the director is wholly successful on the merits
or otherwise. Here Capel was NOT liable, therefore corporation is REQUIRED to
indemnify Capel. Indemnificaiton ONLY APPLIES TO EXPENSES.
1. Would answer be different if Capel prevailed on technicality, such as the SOL?
Still required (or otherwise)
iii. Question 2, p.304. Does Agee have right to be indemnified by corporation for his
attorney’s fees? First question was whether the D was wholly successful. No, because D
lost. Next question is whether indemnification was prohibited? Did he lose to
corporation or someone else? He lost to SEC. Next, did D receive an improper benefit?
No. Therefore, Corporation is NOT prohibited from indemnification, but may indemnify
him if he met his DOC (GF, Informed, and In Best Interests of Corporation). However,
would not be compensated for fines or damages, just expenses.
iv. Above ONLY applies if don’t have provision in AOI providing otherwise.
v. If lose in two claims, but win one, D did not succeed.
eeee. Insurance
i. Why might a corporation decide to purchase D & O insurance?
1. They might not have the money to indemnify.
2. It might be available in situations where the D or O does not meet the DOC.
ii. What is the difference between side A and B D/O insurance?
1. Side A kicks in when can’t indemnify or corporation just doesn’t indemnify.
Direct coverage for directors and officers is often referred to as “Side A” or “last
resort” coverage. It’s usually much cheaper than traditional D & O insurance
because it only comes into play when the corporation cannot, or does not,
indemnify the directors and officers.
2. Side B kicks in whenever corporation has to pay (much more broad). Given
severity and expense of potential claims, many companies, especially public
corporations, purchase traditional D & O insurance to cover not only un-
indemnified claims made against the Ds and Os but also to reimburse the
company for its costs in providing indemnification. Under this corporate
reimbursement, or “Side B” coverage, the insurer agrees to “pay on behalf of”

or “reimburse” the corporation for amounts the corporation has paid or is
required to pay in indemnifying its Ds and Os.
iii. Side A only comes into play when? Corporation cannot indemnify the director.
iv. Most D & O policies generally provide “claims made” coverage. Coverage is triggered
and provided by the policy in effect when the claim is made, NOT when the allegedly
wrongful conduct took place. Therefore, the definition of “claim” is important.
Insureds negotiating coverage should seek a BROAD definition of “claim” that
encompasses written demands for relief, lawsuits, civil, criminal, administrative and
regulatory proceedings and investigations.
v. Payment of defense costs is charged against the limits of the policy. Defense costs are
incurred by the insureds and typically indemnified by the corporation, which then seeks
reimbursements from the carrier for the amounts paid.
VI. Chapter 6 – How Does a Business Structured As a Corporation Grow?
a. The basic choices about how a corporation receives money to grow is the same as other
structures: the proprietors can (1) borrow money, (2) sell interests in the corporation, or (3) use
earnings (can only use earnings if you have them; getting to that point may require (1) or (2)).
b. Borrowing Money:
i. What is the difference between ROE (return on equity) and ROC (return on capital)?
1. ROE = Cash Flow Generated/Equity Investment (Assets – Liabilities)
2. ROC = Cash Flow Generated/Equity + Debt Investment (Total Value of Assets)
ii. What is the COGS?
1. Cost of goods sold. How much money it costs to sell certain goods.
iii. Why would a company want to avoid borrowing substantial sums of money to increase
its ROE? Over-leveraging.
iv. How does debt affect your CFS? Increases CFS.
v. What are the 2 forces that prevent a corporation from accumulating a substantial
amount of debt? (p. 313)
1. Lenders work hard to lend only what they are sure will be paid back; and
2. Corporations fear bankruptcy.
vi. What is a contingent liability? How does it affect debt?
1. Potential liability. Risks that do not actually show up in financials (10k
Statement or footnote in B/S).
2. Example:
i. Pharmaceutical company may face a recall of its product, or may lose
its patent protection and be subject to competition from generics.
ii. BP Oil spill.
vii. What is a bond? What happens to a bond’s interest rate as the risk increases? How is
it different than preferred stock?
1. Form of debt. Company wants to raise additional money. Recognizes can’t go
to bank to get loan and make can’t issue shares. Sell $1M bond to Ms. Mack,
and Ms. Mack would give Clark $1M. Bond has maturity of 10 years. Get paid
back $1M at end of 10 years. Each year will pay interest, coupon, of 10%,
$100K. Mack is considered a creditor. In event that go bankrupt, creditors get
paid first.
2. When risk increases, the bond’s interest rate goes up. Same example as
above. $1M bond, that face value doesn’t change when market tanks. Mack
has ability to sell bond to Mr. Jenkins. If Jenkins sees volatility in market, only
want to pay $500K for bond. Still have 10% coupon. Jenkins will receive
coupon, 10% of $1M, from corporation. If bond matures, Marlin gets paid $1M.

3. Consider the McDonald bond example on p. 315. Why might the value of
McDonald bonds decrease? Due to shaken faith in public eye. What will
happen in the market place to account for this shaken faith? Require a raise in
the effective interest rate, and thus refuse to pay the face principal amount; will
pay a lower face principal amount. Can the face value of the bond change?
viii. How is a bond different from preferred stock?
1. PS = dividend, owner, equity position
2. Bond = coupon, NOT an owner, debt position
ix. What is hedging? How did banks try to hedge their “bets”? By owning mortgages.
1. Balance risk.
c. What is a sub-prime mortgage? Mortgage that is normally made out to borrowers with lower
credit ratings. Below credit score of 620. These loans will have a higher interest rate.
d. What’s fundamental presumption of real estate and land? Appreciates over time.
i. This presumption failed. Foreclosure occurred. Decreases value of land. Everything is
affected. Increases interest rates.
e. What is a mortgage backed security?
i. Packaged mortgages (sub-prime mortgage) that are sold to other banks.
f. Last person to buy loans is stuck w/ the problem.
g. Mortgage brokers – get cut of overall loan. Middle-man.
h. Credit Default Swap (Type of Insurance)
i. Investor buys a $10M, 5-year bond from CITI Bank, backed by subprime mortgages, that
gives Investor a 10% return ($1M per year).
ii. Because of the risk of default on the CITI bond, Investor purchases a CDS from AIG,
where the reference entity is CITI Bank.
iii. AIG charges 2% per annum on the CDS (2% of $100M).
iv. As a result, Investor must make regular annual payments to AIG ($200K/year for next 5
years), much like the premium payment you make every month to remain insured.
v. If CITI defaults on its debt (i.e., misses a coupon payment or does not repay it), the
Investor will receive a 1 time payment ($10M) from AIG and the CDS K is terminated.
vi. AIG didn’t hedge and get insurance. AIG thought no one ever had to pay out on CDS
and thus didn’t need to get insurance.
vii. Subprime market collapses. Corporation can’t pay investor. AIG can’t pay investor.
i. Issuing New Stock
i. Preemptive Rights – provide protection for dilution of a SH’s interest. SH w/ these rights
has the right to purchase that number of shares of any new issuance of shares that will
enable the SH to maintain her percentage ownership.
ii. Under MBCA/NC: if PR NOT provided for in AOI, they will NOT be provided.
iii. How to determine whether a SH has preemptive rights
1. State corporate laws;
2. AOI;
3. Purpose of the issuance
j. Preemptive Rights:
i. Who are they designed to keep out? Keep out NEW SHs. Keep in CURRENT PRs.
ii. PRs are more important in a CHC. Why? Fiduciary relationship.
iii. If AOI provide for PR, is a SH required to exercise their preemptive rights? No, at SH’s
iv. Question 3, p. 320: Shepherd can purchase 1K shares. (20% of 5K).
v. Question 4, p. 320: Shepherd does NOT have preemptive rights. PR attach where
consideration for stock is cash. This was not a cash transaction.

vi. Question 5, p. 320: NO. PR only attach when dealing w/ an issuance.
k. Preemptive Rights and the MBCA: MBCA Section 6.30
i. (a) The shareholders of a corporation do not have a preemptive right to acquire the
corporation's unissued shares except to the extent the articles of incorporation so
ii. (b) A statement included in the articles of incorporation that "the corporation elects to
have preemptive rights" (or words of similar import) means that the following principles
apply except to the extent the articles of incorporation expressly provide otherwise:
1. The shareholders of the corporation have a preemptive right, granted on
uniform terms and conditions prescribed by the board of directors, to provide a
fair and reasonable opportunity to exercise the right, to acquire proportional
amounts of the corporation's unissued shares upon the decision of the board of
directors to issue them.
2. A shareholder may waive his preemptive right. A waiver evidenced by a
writing is irrevocable even though it is not supported by consideration.
3. There is no preemptive right with respect to:
i. shares issued as compensation to directors, officers, agents, or
employees of the corporation, its subsidiaries or affiliates;
ii. shares issued to satisfy conversion or option rights created to provide
compensation to directors, officers, agents, or employees of the
corporation, its subsidiaries or affiliates;
iii. shares authorized in articles of incorporation that are issued within
six months from the effective date of incorporation;
iv. shares sold otherwise than for money.
4. Holders of shares of any class without general voting rights but with
preferential rights to distributions or assets have no preemptive rights with
respect to shares of any class.
5. Holders of shares of any class with general voting rights but without
preferential rights to distributions or assets have no preemptive rights with
respect to shares of any class with preferential rights to distributions or assets
unless the shares with preferential rights are convertible into or carry a right
to subscribe for or acquire shares without preferential rights.
6. Shares subject to preemptive rights that are not acquired by shareholders
may be issued to any person for a period of one year after being offered to
shareholders at a consideration set by the board of directors that is not lower
than the consideration set for the exercise of preemptive rights. An offer at a
lower consideration or after the expiration of one year is subject to the
shareholders' preemptive rights.
iii. (c) For purposes of this section, "shares" includes a security convertible into or carrying a
right to subscribe for or acquire shares.
l. Byelick v. Vivadelli
i. Plaintiff, Byelick, owned 10% of D corporation, VTIC. Defendant, Vivadellis, owned other
ii. November 1, 1996, VTIC’s BOD (comprised of D and his wife, Stephany Vivadelli)
eliminated SH’s preemptive rights which were provided for in company’s by-laws.
iii. December 30, 1996, D and his wife, as BOD, authorized VTIC’s issuance of an additional
50K shares to D (“December 1996 Stock Sale). This transaction reduced P’s ownership
interest in company from 10% to 1%.
iv. Issues:

1. Whether a minority SH of a closely-held corporation can sue a director/majority
SH for breach of fiduciary duty.
2. Whether Ds breached their fiduciary duty to P by removing his preemptive
rights and issuing new stock to D.
v. What was the nature of P’s claim? Breach of fiduciary duty. What FD was breached?
Duty of loyalty. Know that directors and officers owe FD to SHs and Corporation. Here
are expanding the duty of loyalty. SH to another SH.
vi. Because there isn’t a readily available market to sale shares in a CHC, these types of
decisions can result in oppression/”freeze out”/”squeeze out”.
vii. What was D’s argument? Lawfully removed PR. A BOD CAN do this. In a PHC, such
decision would be protected by BJR. But in a CHC, there can be a breach of FD due to
viii. What is the Director’s duty to issuance of shares? DOC and DOL.
ix. Case was NOT really about PR, but about breach of DOL.
x. This is an “interested director transaction.” First thing must show is disclosure to
disinterested BOD and SH. If not, must show EFT. No disclosure in this case, and could
not show EFT.
xi. Under MBCA, same result in this case. Under MBCA, articles provided for PR.
xii. ***In a CHC: Majority (as well as BOD and officers) SH has fiduciary DOL to minority
m. Venture Capitalist
i. What is a VC? Provide money. Businesses can get money from banks or other lenders,
or issue shares. Then why go to a VC? Become involved when ventures are highly risky.
ii. At what 3 points are you likely to see a VC?
1. When company initially starts;
2. Is alive but just making it; and
3. When company has failed.
iii. What is an “angel investor?” VC that saves the corporation.
iv. What is “second tier” or “mezzanine” financing? Later round financing.
v. Why do VCs demand high returns? To offset circumstances when VC may lose.
vi. VC are generally industry specific. I.e. Expertise in technology.
vii. When dealing w/ VCs, relationship between business and VC in K law.
1. Looking at VC in traditional business structure terms, a VC is a SH, but a SH w/
special rights including:
i. “Downside protection” such as a liquidation preference that requires
the VC to be paid 1st if company’s assets are sold off;
ii. “Upside opportunities” such as right to acquire additional stock at
predetermined price;
iii. Voting and veto rights; and
iv. “Exit opportunities,” such as a “redemption” right to sell the shares
back to the corporation.
n. Constraints on Issuing a Stock
i. Why might a company decide to go public? Raise money.
ii. How much money do companies generally try to rise through an IPO? Raise enough
money for 2 years. How does the greed versus fear consideration affect this
determination? Greed - C wants to issue as few shares as possible to generate buzz to
then take advantage of good will or market benefit later. Fear – C should have issued
more shares to take advantage of market, strike when iron is hot.

iii. How can you determine the MV of a company whose shares are publicly traded? Look
at price/share at which stock is currently traded and multiply by shares outstanding.
(Market Capitalization)
iv. How do you value a company whose shares are NOT publicly traded? Hint, 1 st
determine what the company is worth. Look at comparable companies. What earnings
will be relevant for this determination? How do you determine these earnings? Want
to determine future value, but to do so, must look at past value.
o. Initial Public Offerings (IPOs):
i. What is the purpose of an underwriter? Investigate value. Similar to a promoter.
Wants to drive up value of business. Maximize value of shares.
ii. How is the IPO price affected when a company goes public early in their life cycle?
Hard to value company and hard to figure out the IPO price.
iii. Why would a company be upset about soaring stock prices after an IPO? Company
upset that did not take advantage of the price. Want to set IPO value at last point
possible before issuing shares. Therefore, wait until get approval from registration.
iv. Why might an underwriter want the price to be undervalued? Think about the concept
of bargain shares. What is a bargain share? Share offered at a discount. If company
wants to initiate IPO, might provide shares to underwriter at a discounted price.
p. What is the difference between a “firm commitment” and a “best efforts” basis?
i. “Firm Commitment”
1. Money comes from underwriter.
2. Underwriter actually buys all of the shares in the PO from the issuing company
at the public offering price, less a negotiated discount. Underwriter then resells
shares to other investment bankers and public.
3. Underwriter thus bears the risk that the shares cannot be resold at the offering
4. Underwriter reduces this risk by ensuring that the offering price is NOT set until
very late in the offering process.
5. Risk is that if don’t sell them or sell them below what expected, might take a
loss. Therefore, will ask for a discount, and wait till last minute possible to set
IPO price, to make sure don’t have a loss.
ii. Best Efforts Underwriting:
1. Money comes from public, not the underwriter.
2. Rather than buying stock itself and then reselling it, underwriter instead uses its
best efforts to help the issuer to find buyers for the stock.
3. Corporation, NOT the underwriter, bears the risk that shares cannot be sold at
the offering price.
iii. How can an underwriter limit the risk associated w/ a firm commitment? Underwriter
will ask for a discount, and wait till last minute possible to set IPO price, to make sure
don’t have a loss.
q. Who gets the money from an IPO? Corporation can sell its own shares. Existing SHs (includes
board members and officers) can sale their own shares. Where can we look to find this
information? Prospectus must indicate who is actually selling the shares.
r. Why should a potential purchaser care who gets the money?
i. If C selling shares, money will go to C. C will try to make more money off of this money.
If C becomes more valuable, your share will become more valuable.
ii. If SHs/CEO are selling their shares, CEO will get the money. Looks like CEO doesn’t have
a lot of faith in the business.

s. Questions, p. 336:
i. #1: Does Roberts have a claim for 10b-5? Yes. Statement was untruthful. Must look to
see if he used the instrumentality of IC
1. Three types of misrepresentation: this is a fraudulent misrepresentation. So
could get punitive damages.
ii. #2: Does Roberts have claim for 10b-5? Yes; i(b).
iii. #3: Does Roberts have claim for 10b-5? Yes; applies to non-disclosure, i(b).
iv. #4: Does Roberts have claim for 10b-5? Yes; relates to buyer/investor as well.
t. Rule 10b-5 (1948):
i. It shall be unlawful for any person, directly or indirectly, by use of any means or
instrumentality of interstate commerce, or the mails or of any facility of any national
securities exchange,
1. To employ any device, scheme, or artifice to defraud,
2. 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
3. To engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person
ii. In connection w/ the purchase or sale of any security.
VII. Chapter 7 - How Do the Owners of a Corporation Make Money?
a. CHCs
i. How do SHs in CHC make money? Dividends or employment. If not, will not receive
money, unless company is dissolved.
ii. In a CHC, what other roles might a SH play? Officer, board member, general employee.
iii. What are squeeze outs or freeze outs? Majority SH puts pressure on minority SH
iv. How can SH in PHC escape freeze out or squeeze out? Can sell their shares.
b. Typical Freeze Outs
i. Termination of minority SH from employment
ii. Refusal to declare dividends
iii. Removal of minority SH from management
iv. Siphon off of corporate earnings
c. Oppression in CHC
i. Oppression in some states may allow SHs to dissolve the corporation.
ii. Because of the harsh consequences of dissolution, some states have adopted other
statutory and judicial COA for relief as a result of oppression.
iii. In states w/out an oppression triggered dissolution statue, some courts have imposed an
enhanced fiduciary duty between SHs and have allowed a direct cause of action for
breach of this duty.
iv. Really 2 approaches:
1. Oppression statutes;
2. DO NOT have oppression statutes:
i. Can file direct suit for breach of fiduciary duty.
d. Salary Issues
i. A salary is NOT a distribution under the MBCA.
ii. Who decides which SHS gets salaries? BOD.
iii. Are there any legal limitations, if any on such salary decision under MBCA? No.
iv. What happened in the Wilkes case described on page 446? Why did the SH have a
“right” to employment? Wilkes v. Springside Nursing Home, Inc:
1. Wilkes was 1 of 4 SHs of a corporation that owned/operated a nursing home.
Initially, all of the SHs worked at the nursing home and were paid salaries for
their work.

2. After a falling out w/ his fellow shareholders, Wilkes was forced out of his
nursing home job and salary by his fellow SHs. (suffered a freeze-out)
3. Wilkes sued other SHs, alleging a breach of the fiduciary duty owed to him by
the majority SHs.
4. MA court held for Wilkes because the majority had not shown a legitimate
business purpose for firing weeks.
5. Court provided that a “guaranty of employment may have been 1 of the basic
reasons why a minority owner has invested capital in the firm. The minority SH
typically depends on his salary as the principal return on his investment since
the earnings of a close corporation are distributed in major part in salaries,
bonus and retirement benefits.

e. Hollis v. Hill
i. Issues: Whether a duty of loyalty was breached by D and, if so, whether the DC erred in
granting a retroactive buy-out remedy.
ii. Holdings:
1. Court found that a fiduciary duty existed between P and D.
2. Court vacated the calculation of the value of P’s shares by the DC and
remanded for further proceedings to determine proper valuation of P’s shares.
Court also vacated award of attorney’s fees and the fees of expert witnesses,
and remand for reconsideration of those settings in light of relevant NV law. In
all other respects, the decision appealed is affirmed.
iii. Rules:
1. The duty existing between controlling and minority SHs in close corporations is
the same as the duty existing between partners.
2. SHs in CHC owe each other a duty of utmost GF and loyalty.
3. Fiduciary duty is not breached if the majority acted pursuant to a legitimate
business purpose.
4. When a legitimate business purpose exists, the minority SH must be given an
opportunity to demonstrate that the purpose could have been achieved
through means less disruptive to its SH interests.
5. A controlling SH cannot, consistent w/ his fiduciary duty, effectively deprive a
minority SH of his interest as a SH by terminating the latter’s employment or
6. SHs do NOT enjoy fiduciary-rooted entitlements to their jobs.
7. Minority SHs’ interest is NOT injured if the corporation redeems shares at a fair
price or a price determined by prior K or the SH is otherwise able to obtain a
fair price.
8. Presumptive valuation date for allowing buy-out remedies is the date of filing
unless exceptional circumstances exist which require an earlier or later date to
be chosen.
iv. What law applied in this case? NV (internal affairs doctrine). Case brought in federal
district court in TX.
v. P. 343 P asserted his rights as SH of FFUSA and limited partner of FFUI to inspect
books/records of 2 firms. Should have made his request as a director.
vi. P’s interest = 50%; D’s interest = 50%
vii. TC Ruled: Dan Hill (D), holder of other 50% interest, breached the fiduciary duty he
owed to P (D’s conduct was oppressive) and ordered a buy-out of P’s shares based on
corporation’s value ($667,950) more than 1 year prior to the date of judgment (February

28, 1998; when oppression began). (Add attorney’s and expert’s fees, total award to P =
viii. P did NOT actually want dissolution of business. Claimed Ds actions were a breach of
his fiduciary duty. Considered relationship such as partners, due to fact they had a
CHC, and thus leaves minority SHs open to oppression.
ix. Clark Case: oppression occurred when someone’s position was eliminated.
x. Why is a payment of dividends an important consideration of whether there’s
oppression? Less likely court would perceive this as oppressive.
xi. In this case, P is treated as a minority SH. How is that when he owns 50%? Based
upon way you are treated. Based upon relationship in case. Doesn’t matter if actual
50% SH.
f. Clarification: If are D, and fighting a derivative suit, D will file a 12(b)(6) motion, complaint fails to
state a claim upon which relief can be granted.
g. Salaries:
i. The MBCA does NOT set any limitation on salary.
i. The IRS DOES set limitations as to salaries paid to officers or directors. More
specifically, federal income tax law DOES limit the amount of salary payment that a
corporation can deduct as an ORDINARY and NECESSARY BUSINESS EXPENSE.
1. Why? Salaries can be a reasonable and necessary business expense, but
dividends and other distributions to SHs cannot be claimed as an ordinary and
necessary business expense tax deduction. Reasonable salaries can be written
off. If written off, the taxable income is reduced. If money given out in form of
dividend, it is taxed as ordinary income (unless a qualified dividend (capital
gains rate)).
ii. Why would a C want to set salaries to SHs as high as possible? Less taxable income.
h. Exacto Spring Corp. v. Commissioner of Internal Revenue
i. If salaries go up, the amount of taxable income goes down.
ii. 1993 and 1994, Exacto Spring Corporation, a CHC, engaged in manufacture of precision
springs, paid its co-founder, chief executive, and principal owner, William Heitz $1.3M
and $1.0M respectively, in salary.
iii. IRS thought amount was excessive, that Heitz should NOT have been paid more than
$381K in 1993 and $400K in 1994, w/ the difference added to the corporation’s income,
and it assessed a deficiency accordingly, which Exacto challenged in the Tax Court.
iv. Tax Court found that the maximum reasonable compensation for Heitz would have been
$900K in 1993 and $700K in 1994.
v. Issues: Whether the salary paid Heitz was reasonable, under 26 U.S.C. Section 162(a)(1).
vi. Holdings: US COA reversed Tax Court’s judgment and entered judgment for the
vii. Court must determine what is a reasonable salary.
viii. Tax Court applied a test that requires the consideration of 7 factors (none entitled to
any specified weight relative to another): (1) type and extent of services rendered; (2)
scarcity of qualified employees; (3) qualification and prior earning capacity of employee;
(4) contributions of employee to business venture; (5) net earnings of employer; (6)
prevailing compensation paid to employees w/ comparable jobs; and (7) peculiar
characteristics of employer’s business.
ix. US COA found that it’s apparent that the 7-factor test leaves much to be desired, as it’s
redundant, incomplete, and unclear. COA provided 6 reasons:
1. Test is non-directive. No indication is given of how factors are to be weighed in
event they don’t all line up on one side and many of the factors are vague;

2. Factors do NOT bear a clear relation either to each other or to primary
purpose of Section 162(a)(1), which is to prevent dividends, which are NOT
deductible from corporate income, from being disguised as salary;
3. 7-factor test invites Tax Court to set itself up as a superpersonnel department
for CHCs, a role unsuitable for courts;
4. Since test cannot itself determine outcome of a dispute because of its non-
directive character, it invites making of arbitrary decisions based on
uncanalized discretion or unprincipled rules;
5. Because reaction of Tax Court to challenge to deduction of executive
compensation is unpredictable, corporations run unavoidable legal risks in
determining a level of compensation that may be indispensable to the success
of their business;
6. Under factor (7) (“peculiar characteristics”), the court 1st and rightly brushed
aside the IRS’s argument that the low-level of dividends paid by Exacto was
evidence that the corporation was paying Heitz dividends in the form of
x. Court instead, applied the Indirect Market Test.
xi. Indirect Market Test:
1. A corporation can be conceptualized as a K in which the owner of assets hires a
person to manage them.
2. Owner pays the manager a salary and in exchange the manager works to
increase the value o the assets that have been entrusted to his management.
3. That increase can be expressed as a rate of return to the owner’s investment.
The higher the rate of return that a manager can generate, the greater the
salary he can command.
4. If the rate of return is extremely high, it will be difficult to prove that the
manager is being overpaid, for it will be implausible that if he quit if his salary
was cut, and he was replaced by a lower-paid manager, the owner would be
better off.
xii. Why might the SHs want the C to retain the earnings? Value of the C is going up. The
individual shares are going up as well.
xiii. What happens when you sell a share of stock? Must pay a capital gains tax. Capital
gains rate is 15% (don’t have to know this). When hold onto a share, multiple ways to
make money as a SH. Salary, dividend, or sell that share. If receive a dividend from C for
owning the share, receive $100 dividend, must pay ordinary income tax rate, ordinary
income. If one of the highest paid individuals and have a 40% rate, will pay $40. If sell
the share, capital gains tax applies which is 15%. Legislature could come in and make
adjustments. BODs decide to pay a dividend, but the individual SH decides to sell
his/her own share.
xiv. Why might a C decide to pay a dividend? Encourage investment.
xv. Why might a C decide NOT to pay a dividend? Re-invest money.
1. Either decision is protected by a BJR.
xvi. What’s the difference between fixing salaries in a PHC and a CHC? BOD set salaries in a
PHC. Less likely that the executive will control the BOD. But in a CHC, this is different.
Executive could be a director in a CHC.
xvii. Is it possible that value of C could increase but officer’s NOT be entitled to a high
salary? Yes. Company’s value appreciates/increases w/out the help/influence of a
certain officer or executive.

i. Executive Compensation
i. Salaries determined by independent BODs applying the BJR or approved by disinterested
SHs are presumptively reasonable UNLESS:
1. Executive is paid high salary and the increase in return is NOT attributable to
the executive.
2. The salary is really a form of dividend.
j. Gianotti v. Hamway
i. Asserting that they were unable to prevent continuing oppression, mismanagement,
waste and self-dealing practiced by Ds, Ps asked court to appoint a receiver pending the
suit, to require Ds, jointly and severally to restore to Libbie such funds as have been
misspent or lost by Libbie as a result of their oppressive acts/mismanagement/breach of
fiduciary duty/improper self-dealing, and to order liquidation of the assets and business
of Libbie.
ii. Ds were directors of Libbie holding. C was engaged in development and operation of
nursing homes.
iii. Ps asserted that Ds, either individually or through corporations they controlled, owned
or controlled majority of the 209,054 shares of the then outstanding Libbie C/S. Ps also
alleged that they were minority SHs owning a total of approximately 74.5k shares of
Libbie C/S.
iv. Ps charged Ds w/ authorizing and making payments from corporate funds to themselves
for directors’ fees and officers’ salaries grossly in excess of value of services they have
rendered to Libbie.
v. Ps also charged that Ds, acting in BF, had refused to declare dividends on Libbie C/S
which w/ due regard to the condition of the property and affairs of Libbile, should have
been declared.
vi. What does the statute provide on top of p. 357: (Corporate Death Penalty)
1. Section 13.1-747:
i. Any court of record, w/ general equity jurisdiction shall have full power
to liquidate the assets and business of a corporation:
a)(a) in an action by a SH when it’s established:
1. (2) that the acts of the directors or those in control
of the corporation are illegal, oppressive, or
fraudulent; or
2. (4) that the corporate assets are being misapplied or
vii. What is a receiver? Independent 3P who is in charge of selling off assets and pay off
viii. Ps also charged that Ds, acting in BF, had refused to declare dividends on Libbie C/S
which w/ due regard to the condition of the property and affairs of Libbile, should have
been declared.
ix. From June 1975 to September 30, 1985, Ds’ compensation totaled $2,799,006 while
during same period the Ps received $50K of $132K in C/S dividends. After-tax profits
during that period were $1,042,350 (thus for every dollar of profit, Ds received $2.67 in
compensation). However, this didn’t take into account an additional $1.4M attributable
to unnecessary loan and interests cots in order to enable those payments to be made to
Ds. Ps claimed that when profits are compared to total cost of compensation, the ratio
of compensation to profits is 4 to 1.

x. The nature, extent, and scope of Ds’ work in attending to corporate affairs were very
limited. From the standpoint of hours worked for Libbie, Ds were part-time employees
w/ significant outside business interests.
xi. The difficulties of the business can justify officers’ and directors’ compensation. But, the
complexities of nursing home operation were handled by the administrators of Libbie’s
xii. Why were these parties even in these positions? Individuals didn’t have experience to
run the nursing homes. However, they were selected by the BOD and the SHs appointed
the BOD. Ps also asserted that Ds, either individually or through corporations they
controlled, owned or controlled majority of the 209,054 shares of the then outstanding
Libbie C/S. Minority SHs had little control. If minority SHs had acquiesced to putting
parties on the BOD, they would have had a weaker argument.
xiii. This case is about SH oppressive. Doesn’t mean that acts of BOD are illegal.
xiv. What type of case is this? Breach of the duty of loyalty. Interested director transaction.
A transaction when director sits on both BODs. Director has duty to show that they
disclosed to disinterested SHs, w/out waste, or disinterested BOD who applied the BJR.
Did NOT disclose to either. Therefore, director had to show entire fairness. Could NOT
show that here.
xv. Did this court agree w/ TC? Agreed that salary was paid in excess. TC said that directors
didn’t have to restore the funds. SC said they will eventually have to restore funds,
however, the receiver can go after the funds.
xvi. Court only determined that the death penalty was appropriate remedy for the
oppression. C must dissolve, windup and liquidate, and terminate. Receiver takes
control during the windup. Claim of the C is an asset, of which the receiver has a right
to call.
xvii. According to dissent, what should have court done? All financial data increased. BV of
shares = (Assets – Liabilities)/# of shares outstanding (?). Dissent thought the death-
penalty should NOT have been invoked. Should have forced the corporation to pay a
dividend. Would have eliminated problem of oppression.
xviii. What happens to a C when there is oppression is state specific (statute specific).
k. Distributions
i. There are generally 3 types of distributions (means of giving money back to SHs):
1. Dividends (special type of distribution);
i. Special type of distribution paid out of current or retained earnings
2. Redemptions  SH has right to have their shares repurchased.
3. Repurchase  corporation request the right to repurchase shares.
ii. A C is NOT required to pay a dividend.
iii. Is it better for a C to pay or not to pay a dividend? Depends. Primary concerns:
whether C could earn bigger return by keeping money rather than giving it out.
iv. What is the MBCA/MODERN VIEW regarding dividends?
1. Corporation can pay dividend UNLESS corporation is insolvent or paying the
dividend will make the corporation insolvent.
2. Insolvency = Liabilities exceed assets.
3. Who would be concerned about excessive distributions to SHs? Creditors.
4. MBCA § 6.40(c) spells out when a C CANNOT declare a dividend § 8.33(b)
imposes liability on directors for making distributions in violation of § 6.40(c).
5. Does NOT require knowledge of the 3 accounts discussed in the “Traditional
v. Traditional View:

1. Any money generated from the sale of stock must go into 1 of 3 accounts:
i. Stated capital – money generated by sale of stock at par. A
corporation may never pay a distribution out of this account.
ii. Capital surplus – money generated in excess of par from a sale of
stock. A corporation can pay a DISTRIBUTION out of this account
(some states require notice). Remember that distributions made from
this account are only a return of capital NOT a dividend. A dividend is
a return of profit from operations.
a)Can pay a distribution out of CS.
b)Don’t like receiving money from here, because only getting
paid what you put in.
iii. Retained Earnings – money generated from operations. Distribution
paid out of RE is a dividend. SHs like to receive distributions/dividends
from RE.
2. Generally, in states like DE and NY that still follow the TV, if pay a distribution
out of CS, what might the state require you to do? Notice. SH would want
notice to know that the money is NOT coming from RE.
3. What about a “no-par” sale of stock by the corporation?
i. “No-par” = there’s NO minimum issuance price. BOD is free to
determine the appropriate amount of consideration for such an
ii. On a “no-par” issuance, the directors are usually free to allocate the
funds received between SC and CS.
iii. If the directors do nothing, the funds go into SC, NOT CS, and so they
are NOT available for distribution.
l. Zidell v. Zidell
i. Arnold Zidell, minority SH of 4 related, CHCs, brought 4 suits, seeking to compel the
directors of those corporations to declare dividends. P’s complaints alleged that Ds
arbitrarily, unreasonably, and in bad faith refused to declare more than a modest
dividend in 1973. P argued that there was SH oppression.
ii. P owned 3/8 of issued and outstanding stock of 4 affiliated different CHCs that bought
and sold scrap metal. Other 5/8 of stock of each CHC was owned by P’s brother, Emery
Zidell (3/8), and Emery’s son, Jay Ziddel (2/8 or ¼). Until 1973, all 3 men were the
directors of all 4 CHCs and all3 were employed by the 4 CHCs.
iii. May of 1973, board refused Arnold’s demand that his salary be raised from $30K to $50K
and thus P resigned and his salary ended. Prior to P’s resignation, customary practice
had been to retain all earnings in the business rather than distribute profits as dividends.
iv. Following his resignation, P demanded that the CHCs begin declaring reasonable
dividends. Thereafter, a dividend was declared and paid on the 1973 earnings of each
CHC. P contends that these dividends are unreasonably small and were not set in good
faith. He notes that at about the same time, corporate salaries and bonuses were
increased substantially.
v. TC ordered each of D corporations to declare additional dividends out of its earnings for
1973 and 1974.
vi. Facts would lead to show SH oppression, however the director voluntarily left AND
they had a longstanding policy that the C would NOT pay dividends.
vii. Ds introduced considerable amount of credible evidence to explain their conservative
dividend policy. Directors took into consideration: (1) future need for expensive physical

improvements (possible relocation of a major plant); (2) need for cash to pay for large
inventory orders; (3) need for renovation of a nearly obsolescent dock; and (4) need for
continued short-term financing through bank loans which could be “called” if the
corporations’ financial position became insecure.
viii. In decision to pay the dividend, NOT interested parties, thus this was a duty of care
case. Suppose majority SHs decided to pay all officers dividends except for P, then that
would be a duty of loyalty case. In DOL cases, the D has the burden of proof, but in
DOC the P has the burden. Under DE law, w/ respect to breach of DOC, P has burden
to show duty, breach, and if there was a breach, burden shifts to D to show EF. Under
the MBCA, the P ALWAYS has the burden of proof under the DOC.
ix. Issues: Whether the directors of the 4 CHCs acted in BF in not providing a larger
dividend to its SHs, and if they did act in BF, whether a distribution of additional
dividends is appropriate.
x. Holdings: The P has NOT carried his burden of proving a lack of good faith. Therefore,
the Court held that the TC erred in decreeing the distribution of additional dividends.
xi. Following facts are relevant to issue of BF and are admissible in evidence:
1. Intense hostility of the controlling faction against the minority;
2. Exclusion of the minority from employment by the corporation;
3. High salaries, or bonuses or corporate loans made to the officers in control;
4. Fact that the majority group may be subject to high personal income taxes if
substantial dividends are paid;
5. Existence of a desire by the controlling directors to acquire the minority stock
interests as cheaply as possible.
i. ***However, if the above facts are NOT MOTIVATING CAUSES they
do NOT constitute BF as a matter of law.***
m. Dodge v. Ford Motor Co. (Not Covered in Class, in Notes)
ii. Ford Motor Company had very few SHs. 2 of the SHs were the brothers Dodge (who
formed their out automobile manufacturing business). Ford Motor Company had paid
extraordinarily high dividends, which the Dodge Boys used to get their company rolling.
Henry Ford wasn’t pleased w/ this potential competition.
iii. Ford Motor Company then refused to pay dividends, and the Dodges sued.
iv. Ford had legitimate reasons to use earnings for purposes other than paying dividends.
He wanted to (1) expand production facilities of Ford Motor; and (2) Ford paid his
workers more than twice the going wage, and wanted to use some of the money to
continue that practice as well.
v. In Dodge’s brothers’ lawsuit, Ford could simply have testified at trial that he wanted to
use earnings to make cars less expensive and to pay the higher wages to improve his
workforce, both of which would increase his profits. Had he done so, no court would
have overruled his decision to plow the money into the new plant and NOT into
vi. Instead, Ford testified about how he wanted to make sure that everyone could afford a
car – that the goal of his company was NOT so much to make money as to provide the
public w/ cheap cars and his works w/ high wages.
vii. Michigan SC found his stated reasons so imprudent as NOT to be protected by the BJR.
In light of the huge cash surpluses and the history of declaring dividends, the Court
concluded that the directors had a duty to distribute a very large sum of money to SHs.
viii. Besides Dodge, there is no other reported decision in which a court required directors
to pay dividends because the corporation had a large surplus.
n. Sinclair Oil Corporation v. Levien

i. Sinclair had a subsidiary, Sinclair Venezuelan Oil Company {Sinven). Sinclair owned 97%
of Sinven’s stock. P owned 3K shares of 120K shares of Sinven stock. Sinclair nominates
all members of Sinven’s BOD. The directors were NOT independent of Sinclair. The
directors were officers, directors, or employees of corporations in the Sinclair complex.
By reason of Sinclair’s domination, it’s clear that Sinclair owed Sinven a fiduciary duty.
ii. Chancellor held that because of Sinclair’s fiduciary duty and its control over Sinven, its
relationship w/ Sinven MUST meet the test of intrinsic fairness. Under this standard
the burden is on Sinclair to prove, subject to careful judicial scrutiny, that its
transactions w/ Sinven were objectively fair.
iii. From 1960 through 1966, Sinven paid out $108M in dividends ($38M in excess of
Sinven’s earnings during the same period). Chancellor held that Sinclair caused these
dividends to be paid during a period when it had a need for large amounts of cash.
Although the dividends paid exceeded earnings, the P concedes that the payments were
made in compliance w/ 8 Del. C. Section 170, authorizing payment of dividends out of
surplus or net profits.
iv. Chancellor, applying the intrinsic fairness standard, held that Sinclair did NOT sustain its
burden of proving that these dividends were intrinsically fair to the minority SHs of
v. Issues: Whether the intrinsic fairness test or the business judgment standard should be
applied to the dividend payments in this case. If the BJ standard is to be applied,
whether the dividend payments complied w/ the BJ standard.
vi. Holdings: The Chancellor erred in applying the intrinsic fairness test as to these
dividend payments. The BJ standard should have been applied. The facts demonstrate
that the dividend payments complied w/ the BJ standard and w/ 8 Del. C. Section 170.
vii. Entire fairness = Intrinsic Fairness
viii. A parent owes a fiduciary duty to a subsidiary.
ix. When does EF apply? What type of transactions does EF apply to? Self-dealing,
interested director transactions, and…
x. According to P, how was Sinclair on both sides of the transaction? Sinclair received
dividends and controlled Sinven who declared dividends. This is self-interest case.
Argue that EF test should apply.
xi. With respect to dividends, how could they pay a dividend if it was in excess of their
earnings during a certain period? P. 371. Could have paid from earnings from previous
period. Even though dividend exceeded current earnings, the dividend came from
retained earnings.
xii. In DOL cases, when on both sides of transaction, must disclose, if DON’T DISCLOSE,
MUST SHOW EF. However, this was NOT the standard in this case. THE BJR WAS
xiii. ***Considered a DOC case because the minority SHs received dividends as well.
Nothing received by Sinclair was to exclusion of minority SHs.***
xiv. Treat overwhelming majority of these types of cases now as DOL cases.
xv. Sinclair case is limited to pure pro rata transactions to BJR. What does this mean?
What happened here, everyone received the benefit based on their pro rate shares.
Therefore, BJR will be applied.
xvi. Sinclair has been undermined by DE case law, even though there is little appreciation for
the shift.

xvii. If exact set of facts were provided, talk about both standards (DOC and DOL), P would
argue that EF applies (DOL), and that D would argue that BJR (DOC) would apply. If
exactly the same as case here, more apt to apply BJR, but if a little different, EF will
o. Types of Preferred Stock: (Remember slide regarding “Types of Preferred Stock”)
i. Difference between PS and CS?
1. PS gives preference to PS SHs.
ii. Although all of the shares in a particular class MUST have identical rights, one class can
have greater rights, or “preferences,” than another.
iii. A class w/ such a preference is generally referred to as “preferred.”
iv. The class w/out such a preference is generally referred to as “common.”
v. Typical preference for a class of stock is priority in the receipt of dividends. “Preferred”
means paid first.
vi. If just have simple “preferred” stock, just means you have priority as to payment, BUT
does NOT mean have priority as to amount.
vii. “Preferred Participating” stock not only gets paid 1st (because it’s “preferred”), but also
gets paid again. Double-dip.
viii. No statutory requirement that dividends be paid. There’s no right to a dividend until
the BOD declares one.
ix. Generally, dividends do NOT accrue from year to year, UNLESS the SH’s stock is
“cumulative.” “Cumulative” dividends DO ACCRUE – do carry over from year-to-year.
ALL omitted “cumulative” dividends MUST be paid BEFORE any dividend is paid on CS.
p. Problems, p. 373:
i. See book for delineation:
1. (a) Declare $4K dividend. PS SHs are entitled to dividend of $2.
i. There are 2K PS.
ii. There are 10K CS.
iii. If only $4K dividend, all goes to PS SHs.
2. (b) Declare $40K dividend. PS SHs are entitled to dividend of $2.
i. 2K PS and 10K CS.
ii. PS SH get $4K (2K X $2).
iii. CS SHs take the rest, $36K (Each CS SH gets $3.6/CS share).
iv. If lawyer for PS SHs, would want them to get PARTICIPATING PS.
3. (c) Declare $40K dividend. PS SHs are entitled to dividend of $2.
i. Have Participating PS SHs and CS SHs.
ii. 2K PS and 10K CS.
iii. PS SH get $4K (2K X $2).
iv. CS and Participating PS SHs split the $36K.
v. PS SH get total of $5/share and CS get $3/share.
4. (d) Declare $40K dividend. PS SHs are entitled to dividend of $2.
i. Have Cumulative PS SHs and CS SHs
ii. 2K PS and 10K CS.
iii. Dividend wasn’t paid for previous 3 years. Should have received
$2/year for 3 years. Including this year, should receive $8/share for PS
iv. Cumulative PS SHs will take $16K.
v. Remaining is $24K and will split by 10K CS SHs. This equals $2.40.
5. (e) This is Cumulative Participating PS SHs, same facts as in (d).
i. 2K PS and 10K CS.
ii. Take first $16K. Split remaining $24K by 12K, which equals $2/share.
iii. CS SHs take $2/share ($20K total) and PS SHs will take $10K/share
($20K total).

q. Buying and Selling Stock at a Profit
i. How Does Someone Know What Shares of a C’s Stock are Worth?
1. Major stock exchanges set prices for publicly-traded stocks each trading day.
2. For some smaller corporations, there may be something of a market, recorded
on what are called the “pink sheets.”
i. “Pink Sheets”:
a)Electronic system, published by Pink Sheets LLC, to display bid
and ask quotation prices. Mainly used by stock brokers
trading OTC (over-the-counter) securities. OTC securities are
those that are NOT traded on a public exchange.
b)Companies quoted in the PSs tend to be CH, extremely small
and/or thinly traded. Most do NOT meet the minimum listing
requirements for trading on a national securities exchange,
such as the NYSE or the Nasdaq Stock Market.
c) Many of the companies in the PSs do NOT file periodic reports
or audited financial statements w/ the SEC, making it VERY
difficult for investors to find reliable, unbiased information
about those companies. Not all CHCs are traded on the PSs.
d)Not considered same as NYSE or Nasdaq. But can find some
information on CHC in the Pink Sheets.
3. Reliability of Information – Common Law and 10b-5 Protection From Fraud
i. A C w/ books and records that are the product of manipulation and
fraud can be sued for C/L fraud. Less obvious examples of fraud
involve statements by Cs that are misleading or incomplete.
r. Basic Inc. v. Levinson
i. P’s brought class action against D and its directors, asserting that the Ds issued 3
false or misleading public statements and thereby were in violation of Section
10(b) of the 1934 Act and of Rule 10(b)-5.
ii. Issues:
1. Whether it was proper for the courts to apply a rebuttable presumption of
reliance, supported in part by the fraud-on-the-market theory.
2. Whether the appropriate standard of materiality applicable to preliminary
merger discussions was applied in this case.
iii. SHs hold shares of stock and when hear information from October 21, 1977 public
statement, SHs sold their shares. SHs say had they known the pending acquisition, they
would not have sold their shares.
iv. Issue around a breach of Rule 10(b)(5).
v. TC (DC) said the information about the merger negotiations was immaterial.
vi. Part of establishing a 10(b)(5) claim, must show reliance. How did TC treat reliance?
DC adopted a presumption of reliance by members of the P class upon D’s public
statements, and thus common questions of fact or law predominate over particular
questions pertaining to individual Ps.
1. This is the fraud-on-the-market theory.
vii. COA reasoned that while Ds were under no general duty to disclose their discussions w/
Combustion, any statement the company voluntarily released could NOT be so
incomplete as to mislead.
viii. COA rejected argument that preliminary merger discussions are immaterial as a matter
of law, and held that once a statement is made denying existence of any discussions,
even discussions that might not have been material in absence of the denial ARE
material because they make the statement made untrue.

ix. COA accepted the “fraud-on-the-market theory” which creates a rebuttable
presumption that Ps relied on D’s material misrepresentations (due to public
statements made by defendant).
x. Why did the SC disagree w/ TC as to materiality? How do we determine materiality?
1. Materiality in the merger context depends on the probability that the
transaction will be consummated, and its significance to the issuer of the
2. Materiality depends on the facts and thus is to be determined on a case-by-
case basis.
xi. In this case, it was possible that merger wouldn’t have occurred after preliminary
xii. TSC Industries Materiality Standard: To fulfill the materiality requirement there MUST
be a substantial likelihood that the disclosure of the omitted act would have been
viewed by the reasonable investor as having significantly altered the “total mix” of
information made available.
1. Event is certain to occur.
xiii. SEC v. Texas Gulf Sulphur (TGS) Materiality Standard: In regards to contingent or
speculative information or events, materiality will depend at any given time upon a
balancing of both the indicated probability that the event will occur and the
anticipated magnitude of the event in light of the totality of the company activity.
1. Event is speculative.
3. Applied in merger transactions.
xiv. How would you determine whether the event would occur (whether probability is
high)? In order to assess probability that event will occur, a fact-finder will need to look
to indicia of interest in the transaction at the highest corporate levels.
1. For Example: board resolutions; instructions to investment bankers; and actual
negotiations between principals or their intermediaries may serve as indicia of
xv. To assess magnitude of transaction to issuer of securities allegedly manipulated, a fact-
finder will need to consider such facts as the size of the 2 corporate entities and of the
potential premiums over MV.
xvi. No particular event or factor short of closing the transaction need be either necessary
or sufficient by itself to render merger discussions material.
xvii. The magnitude of a merger is high.
xviii. Did SC make a determination that the statements were material? Court remanded the
case to determine whether the statements were material.
xix. Clark believes the information is material in regards to magnitude, but still must
determine materiality under probability.
xx. How do you establish the reliance in this case? Each individual SH did NOT have to
submit an affidavit that we sold our shares due to the public statements. Therefore,
how was reliance showed in this case? Court applied the fraud-on-the-market theory
and thus placed a rebuttable presumption on fact that P relied on D’s
misrepresentation. Because most publicly available information is reflected in market
price, an investor’s reliance on any public material misrepresentations, therefore, may
be presumed for purposes of a Rule 10b-5 section.
xxi. Anytime dealing w/ a public statement there is a presumption of reliance. The market
price per share reflects all public information. Presumption is rebuttable.
1. How do you rebut the presumption?

i. Court acknowledged that Ps may rebut proof of the elements giving
rise to the presumption, or show that the misrepresentation in fact
did NOT lead to a distortion of price or that an individual P traded or
would have traded despite his knowing the statement was false.
ii. Any showing that severs the link between the alleged
misrepresentation and either the price received (or paid) by the P, or
his decision to trade at a fair market price, will be sufficient to rebut
the presumption of reliance.
iii. Ds also could rebut the presumption of reliance as to Ps who would
have divested themselves of their Basic shares w/out relying on the
integrity of the market.
xxii. Instead, CEO makes representation to a single SH. Don’t have a presumption of
reliance. The individual SH would have to prove they relied on the statement to his
detriment (I went out and bought or sold X number of shares due to the statement).
xxiii. Example:
1. Note #3, p. 383: Advise CEO note to make a comment.
s. Notes: Scienter  Having the requisite knowledge of the wrongness/illegality of an act or
conduct; guilty knowledge; knowing the impropriety/illegality associated with doing certain acts.
t. 10(b)(5) Claim
i. Misstatement or omission
ii. Material fact (a fact is material if there a sub likelihood that a reasonable SH would
consider it important in deciding how to act).
1. TSC Test – materiality – use when certain and clear
2. TGS Test (applied here) – materiality - use when uncertain and unclear –
speculative – balance probability vs. magnitude – if both high then material
(merger use this)
i. Probability
a)Look to negotiations, telephone records, any resolutions
passed by board, whether contacted investment bankers.
b)Magnitude (important)
iii. Plead scienter (scienter is a legal term that refers to intent or knowledge of wrongdoing.
This means that an offending party has knowledge of the “wrongness” of an act or event
prior to committing it.)
iv. Information was in connection w/ the purchase or sale of securities: Rule 10b-5
provides NO COA for a securities owner who decides NOT to sell based on false
information (NO COA for 10-5 claim, federal law). 10b-5 ONLY applies when there is a
purchase or sell of securities. Could have a fraudulent misrepresentation claim under
state law.
v. Reliance – Private versus Public Statement. If the statement is private have to
individually prove that you relied on such statement. If, however, the defendant publicly
makes a fraudulent statement, every investor could sue if it could be shown that the
statement affected the market as a whole – this is the “fraud on the market” theory
enunciated by the SC in Basic. This “fraud on the market” presumption of the plaintiff’s
reliance upon the deceit is only available in situations (like in Basic) where the security is
traded on a well organized market. If there’s a Private Statement a claimant must prove
reliance. (presumption of reliance on market so easier for plaintiff- reflects price of stock
on market – rebuttable presumption – can be rebutted by showing public was privy to
correct info or info to show statement wrong or prove person would have made
transaction anyway)
vi. Causation – claimant must prove actual cause (but for) AND proximate cause (loss
cause) – the loss has to be directly attributable to the statement.
vii. Federal Interstate commerce nexus. (Commerce Clause)

u. EP MedSystems, Inc. v. Echocath, Inc.
i. Rule 10b-5 claims: Claims of misrepresentation (and state law COAs) and insider
ii. According to P, reason for $1.4M investment was due to “imminent contracts.”
iii. What did D attach to their complaint?
1. Prospectus, (when make IPO, details specifics about the company)
2. Subscription Agreement (agreement to purchase shares for $1.4M)
3. 10K (Yearly filing w/ SEC)
4. 10Q (Quarterly filing w/ SEC)
iv. Purpose of attaching documents was to say that D informed P that value was
v. D moved to dismiss. Attached documents. Typically, motion to dismiss, based on the
pleadings not attached documents (not important point for this class).
vi. P purchased preferred stock.
vii. Issue: Whether the P proved that the D (1) made misstatements or omissions of
MATERIAL FACT; (2) with SCIENTER; (3) in connection w/ the PURCHASE or SALE of
securities; (4) upon which P RELIED; and (5) that P’s RELIANCE was the PROXIMATE
CAUSE of its injury.
viii. Had a misrepresentation, was it material?
1. TC said no. COA disagreed.
2. 2 different kinds of statements: (1) present or past; and (2) future (forward-
ix. “Bespeaks Caution” Doctrine (Defense):
1. Must proceed w/ caution.
2. Cautionary language, if sufficient, renders the alleged omissions or
misrepresentations immaterial as a matter of law.
3. Like safe harbor provision in the Reform Act, is directed ONLY to forward-
looking statements.
4. For BCD to apply, the cautionary language MUST be directly related to the
alleged misrepresentations or omissions.
x. What was the statement that was made?
1. Proposed Ks were “imminent.”
2. Imminent could mean that it was a present statement, not a future
statement, and thus the BSC Doctrine would NOT apply.
xi. Statements (misrepresentations) were PRIVATE NOT PUBLIC.
xii. Public Statement = if made statement to general public.
xiii. Regarding statements made to public, one does NOT have to prove RELIANCE. Market
price reflects all public statements. (Fraud on the Market Theory (?))
xiv. If private statement, MUST PROVE RELIANCE.
v. 10b-5 and Causation?
i. Proximate
1. “Loss Causation”
i. Requires P to show that the lie caused the P not only to buy the stock,
ii. Actual
1. “But-For” Causation
i. Requires that the P would NOT have entered the transaction if it were
NOT for the D’s fraudulent behavior.
ii. Easier to show than “loss causation.”
iii. Example:

1. A lies to B and says has product that turns wood into gold. B buys stock due to
statement. Statement is untrue, value of stock plummets because company
was poorly managed, not due to statement. Can’t show causation because
there is NO “loss causation.”
2. P. 393, Note #4:
i. CANNOT have causation.
ii. “But for” cause is present, but for lie would not have purchased
w. Birnbaum Rule (10b-5):
i. 10b-5 only applies when there’s a purchase or sale of securities.
ii. May have a state cause of action.
x. Materiality – two standards
i. TSC Standard (event certain) – 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.
ii. Sliding Scale (TGS) Approach (event uncertain – preliminary merger negotiations) -
probability versus the magnitude test. P. 502: Since a merger in which a C is bought
out is the most important event that can occur in a small corporation’s life, inside
y. Materiality of Mistatements or Omissions
i. Bespeaks Caution Application: (DEFENSE)
1. Statement that bespeaks caution or is cautionary is sufficient to absolve the
defendant of liability.
2. If the defendant had prefaced remarks about the health of the company w/ a
disclaimer that he might be wrong, then his subsequent statements cannot be
held against him.
3. Doctrine only applies to forward looking statements.
4. If someone uses this type of language regarding a present fact and the
statement is a lie, then the “bespeaks caution doctrine” will offer no
z. Rule 10b-5 COA:
i. (3) In connection w/ the purchase or sale of securities: Rule 10b-5 provides no COA for
a securities owner who decides not to sell based on false information. Rule specifically
requires that the act or omission occur in context of a purchase or sale, which simply
doesn’t encompass a failure to sell.
1. In Zanford, the Court held that a banker who stole money from client by
convincing client to buy stocks, then cashing the stocks in for himself was
liable under 10b-5 even though the banker’s fraud had nothing to do w/ the
value of the stock. It was enough that the fraud was connected to the
purchase of the stock by defrauded party.
ii. Broad standard.
aa. Rule 10b-5 COA:
i. (4) Reliance – private v. public statement. If the statement is private have to individually
prove that you relied on such statement. If, however, the defendant publicly makes a
fraudulent statement, every investor could sue if it could be shown that the statement
affected the market as a whole – this is the “fraud on the market” theory enunciated by
the SC in Basic. This “fraud on the market” presumption of the plaintiff’s reliance upon
the deceit is only available in situations (like in Basic) where the security is traded on a
well organized market. If there’s a Private Statement a claimant must prove reliance.

ii. Fraud on the market, rebuttable presumption. Ways to rebut presumption:
1. Showing that the market makers were in privy to the truth;
2. If news of the merger discussions made it to the market and corrected the
misstatement or untruth;
3. If the SHs sold their shares for reason other than the untruthful statement.
iii. Private statement – have to individually prove reliance.
bb. Malone v. Brincat
i. Objectives: Complaint alleged directors of Mercury, a DE C, breached their fiduciary
duty of disclosure.
ii. In 1997, Mercury’s accountants discovered that Mercury’s reports of earnings during
years of 1993-1996 were substantially overstated. Overstatement was significant.
iii. When corrected numbers were used, Mercury’s stock price plunged, reducing Mercury’s
market capitalization (# of shares X market price of each share) by more than $2B.
i. Why is this NOT a 10b-5 case?
1. This was NOT about a purchase or sale of securities.
2. Ps held onto shares.
ii. What was determination of TC regarding director’s duty to disclose? No duty in
absence of SH action.
iii. SH Action circumstances where BOD is asking SH to make a decision. Dealing w/
misrepresentations when there is a request for action. BOD will ask for SH action for a
fundamental corporate change, (i.e. selling assets, merger).
iv. This was NOT a case about SH action.
v. Is there a general duty to disclose? TC said there was (?). P. 396.
1. Whenever directors communicate publicly or directly w/ SHs about the
corporation’s affairs, w/ or w/out a request for SH action, directors have a
fiduciary duty to SHs to exercise due care, good faith, and loyalty.
2. Duty of disclosure obligates directors to provide the SHs w/ accurate and
complete information material to a transaction or other corporate event that is
being presented to them for action.
3. Issue in this case is NOT whether Mercury’s directors breached their duty of
disclosure. It’s whether D directors breached their more general fiduciary duty
of loyalty and good faith by knowingly disseminating to the SHs false
information about the financial condition of the company
vi. P is trying to create another duty for directors, duty to disclose. However, there is a
duty to disclose to uphold their duty of GF and loyalty.
vii. What are the 3 circumstances under which directors disseminate information?
1. Public statements made to the market, including SHs;
2. Statements informing SHs about the affairs of the C w/out a request for SH
action; and
3. Statements to SHs in conjunction w/ a request for SH action.
viii. Malone (Delaware)
1. Does state law require that directors disclose in the following circumstances:
i. Public statements made to the market.
i. NO, because federal law covers it. Covered by 10b-5.
ii. Informing SHs w/out a request for SH action.
i. YES. Duty is different than below. Less likely have to disclose
than #3. Might be in best interest of company to keep some
information confidential.
iii. Informing SHs in conjunction w/ a request for SH action.

i. YES. Duty is different than above. Duty to disclose more
information if information is material. More likely to have to
disclose than #2. Higher standard when request for SH
action. Why? MUST BE INFORMED. Directors are
cc. Rule 10(b)(5) Liability
i. Purchase or sale of securities - these types of cases involve some sort of
misrepresentation or non-disclosure. (Malone, EP MedSystems)
ii. Insider Trading – these types of case do NOT involve misrepresentation but occur when
someone an insider, when engage in transaction regarding material not made public.
dd. Dupuy v. Dupuy (didn’t go over in class)
i. Objectives: P’s lawsuit is grounded both on a Rule 10b-5 violation and a pendent fraud
claim under state law.
ii. Facts:
1. P, Milton Dupuy, and D, Clarence Dupuy are brothers living in same apartment
complex in NO.
2. Together w/ their mother, they engaged in number of joint commercial
ventures, including in 1971, formation of the Lori Corporation for purpose of
building, owning, and operating a hotel in the French Quarter of NO.
3. Initially, each brother owned 47% of the Lori Corporation shares, w/ their
mother owning remaining 6%.
4. P’s subsequent illness necessitated both his w/drawal from active participation
in management of corporation, and ultimately, the sale of his shares to D.
5. P alleged that during the negotiations for the sale of his shares, D
misrepresented certain material facts and concealed others in order to induce P
to part w/ his interest for only a small fraction of its true value.
6. P alleged that D told him the hotel project was stalled when in fact I was NOT,
and also that D failed to disclose that the corporation had entered into a
partnership agreement whereby its chief asset, ground lease for hotel site, had
been assigned to the partnership at valuation of $1M.
7. As basis of federal jurisdiction, P alleged that the sale negotiations had in large
measure been conducted through intrastate telephone conversations between
his brother and himself.
iii. Issues: Whether the making of intrastate telephone calls satisfies the jurisdictional
requirement of “use of any means or instrumentality of interstate commerce” found in
Section 10 of the Securities Exchange Act of 1934, and SEC Rule 10b-5.
iv. Rules: Intrastate use of the telephone may confer federal jurisdiction over a private
action alleging violation of Section 10 of the Securities Exchange Act of 1934 and SEC
Rule 10b-5.
ee. Goodwin v. Agassiz
i. Common Law Insider Trading
ii. Geologist had formulated a theory. Inside information because it was not known to the
public. Based upon information, company bought up land. Directors/Defendants
bought up shares of the company based on the inside information.
iii. SHs/Ps wanted to rescind their transaction of selling their stock. What was SHs/Ps
theory for rescission? Breach of duty.
iv. Issues: Whether on the facts found the defendants as directors had a right to buy stock
of the plaintiff, a SH.
v. Holdings: The P cannot prevail. Judgment of TC affirmed.

vi. Rules:
1. Circumstances may exist requiring that transactions between a director and a
SH as to stock in the C be set aside.
2. Knowledge naturally in possession of a director as to the condition of a C places
upon him a peculiar obligation to observe every requirement of fair dealing
when directly buying or selling its stock. Mere silence does NOT usually
amount to a breach of duty, but parties may stand in such relations to each
other that an equitable responsibility arises to communicate facts.
3. Where a director personally seeks a SH for the purpose of buying his shares
w/out making disclosure of material facts w/in his peculiar knowledge and not
w/in reach of the SH, the transaction will be closely scrutinized and relief may
be granted in appropriate instances.
vii. Shares were purchased on the public market.
viii. Assuming the inside information is material, it would NOT change fact that transaction
was made in a public market versus a purchase of the shares in a private face-to-face
transaction. There are no “special facts” present in this case. In a public market, buyer
and sellers do not know one another.
ix. Why didn’t this case fall under 10b-5? Rule 10b-5 had not been created (1948?).
x. No duty because transaction was made over public exchange.
xi. Was information material? Must look at the time of the non-disclosure, what
information was known by insiders? Geologist’s theory. Potential that land acquired
could have significant mineral deposit. At this point, idea was too nebulous to be
material for purposes of disclosing. Even if it was material, couldn’t show causation,
because sold shares on the public market.
xii. How is Goodwin different from Malone case? Both deal w/ state law COA. Goodwin
dealt w/ insider trading. Malone dealt w/ misrepresentation. Cases are consistent, just
deal w/ different theories of state law.
xiii. Questions in book:
1. What if suit was first brought by land owners that sold land to corporation?
Land owners would lose. Look at 10b(5) claim. Not in connection w/ purchase
or sale of securities.
2. Would 10b-5 have applied to present case? Don’t have to show an individual
duty. Must just show a duty to the public. Suit would be successful.
ff. What are special facts or special circumstances?
i. Want to look at how transaction was made, public exchange or face to face
transaction? Was director dealing w/ a SH or non-SH? Was information material?
1. In this case, public exchange and information was NOT material.
ii. For starters, a director or officer who has obtained non-public information by virtue of
her office is NOT generally under a C/L duty to disclose that information in buying or
selling stock.
iii. However, there are situations in which they will go beyond the starting point and
impose precisely such a duty. Usually do so under what is called the “special facts” or
“special circumstances” doctrine.
iv. Theory is that a fiduciary of the corporation has a duty to disclose “special facts” when
engaging in a stock transaction w/ a SH of the corporation.
v. “Special Facts”  an elastic concept, but generally covers any facts that a reasonable
investor would consider important in making a decision on whether to buy or sell

vi. Existence of geologist’s theory about the copper deposits in Goodwin would seem to be
a “special fact.” However, court concluded in Goodwin that the P could NOT recover for
2 reasons:
1. Court is NOT sure the “fact” was a fact at all – geologist’s theory was too
speculative to require disclosure.
2. Court seems to hold that there’s no C/L duty on directors or other insiders to
disclose inside information when trading on an exchange.
vii. Minority View (Kansas Rule):
1. A director who obtains inside information in his role as a director holds the
information in TRUST for SHs.
2. Such a director has a C/L duty to disclose the information before purchasing
from a SH.
3. Rejected in Goodwin.
gg. C/L COA
i. In short DE recognizes a COA beyond 10b5 for Directors/Officers that fail to disclose in
2 situations:
1. An insider has no general duty to disclose when trading on an exchange unless
there are special circumstances. Special circumstance might arise if the
transaction involves an insider and a SH of the C and the transaction is “face to
face.” In short, the closer the connection between the insider and the
purchaser/buyer, the more likely there will be special circumstances
2. Even though there is no general duty to disclose, failure to disclose may result
in a breach of the DOC or DOL.
ii. However, these claims arise only when a SH decides NOT to sale or purchase based on
D’s comments. If it’s based on the purchase or sale federal law applies. If you sale or
purchase, 10b5 applies, if you hold on to the stock, state law will apply based on one of
the two aforementioned theories.
hh. 10(b)(5) v. Common Law
i. 10b5 is broader than the C/L Approach in that under 10b5 you have an obligation to
the investing public. However, under the C/L Approach there must be a fiduciary
relationship.***KEY DISTINCTION***
ii. If there’s an obligation to disclose under 10b5 or C/L Approach MUST DISCLOSE OR
ii. Securities and Exchange Commission v. Texas Gulf Sulphur Co.:
i. Texas Gulf Sulphur Company (TGS) was looking for mineral sites in Canada. In October of
1963, aerial surveys indicated that the K-55 site near Timmons, Ontario was promising.
TGS drilled test hole in November and, when it appeared favorable, started buying land
in area. TGS decided to refrain from further drilling and to keep test results secret so it
could buy the land around the drill site as cheaply as possible.
ii. TGS did NOT issue a press release w/ facts about its major mineral discovery until April
iii. From October 1963 until April 1964, Francis G. Coates (a TGS director) and various TGS
insiders and their “tippees” purchased TGS stock in open market for as little as
iv. April 16, day of official announcement, price of TGS stock climbed to $37/share.
v. Issues: Whether all transactions in TGS stock or calls by individuals apprised of the
drilling results of K-55-1 were made in violation of Rule 10b-5.
vi. Holdings:

1. Court held that all transactions in TGS stock or calls by individuals apprised of
the drilling results of K-55-1 were made in violation of Rule 10b-5. Darke
violated Rule 10b-5(3) and Section 10(b) by “tipping” and the Court remanded.
vii. An insider’s duty to disclose information arises ONLY in those situations which are
essentially extraordinary in nature and which are reasonably certain to have a
substantial effect on the market of the security if (the extraordinary situation) disclosed.
viii. The only regulatory device is that access to material information be enjoyed equally, but
this objective requires nothing more than the disclosure of basic fats so that outsiders
may draw upon their own evaluative expertise in reaching their own investment
decisions w/ knowledge equal to that of the insiders.
ix. The basic test of materiality is whether a reasonable man would attach importance in
determining his choice of action in the transaction in question.
x. Whether facts are material w/in Rule 10b-5,when the facts relate to a particular event
and are undisclosed by those person who knowledgeable thereof will depend at any
given time upon a balancing of both the indicated probability that the event will occur
and the anticipated magnitude of the event in light of the totality of the company
xi. Where a corporate purpose is thus served by w/holding the news of a material fact,
those persons who are thus quite properly true to their corporate trust MUST NOT
during the period of non-disclosure deal personally in corporation’s securities or give to
outsiders confidential information not generally available to all the corporation’s SHs and
to the public at large.
xii. What are “tippees”? Those who receive tips regarding inside information from “tipper.”
xiii. Essence of Rule 10b-5 is that anyone who, trading for his own account in securities of a
corporation, has access, directly or indirectly, to information intended to be available
only for a corporate purpose and NOT for the personal benefit of anyone may NOT take
advantage of such information knowing it’s unavailable to those w/ whom he’s dealing.
xiv. Who must disclose? Insiders. Insiders, as directors or management officers are, of
course, by Rule 10b-5, precluded from so unfairly dealing, but 10b-5 is ALSO applicable
to one possessing the information who may NOT be strictly termed an “insider” w/in the
meaning of Sec. 16(b) of the Act.
xv. Anyone in possession of material inside information must either disclose it to the
investing public, or, if he’s disabled from disclosing it in order to protect a corporate
confidence, or he chooses not to do so, must abstain from trading in or recommending
the securities concerned while such inside information remains undisclosed.
xvi. Insiders can provide inside information if they disclose, wouldn’t be liable under 10b5,
but still have a state suit for a breach of DOL.
xvii. What would have happened in this case if there was disclosure? No 10b5 action, but
SHs would sue for a breach of DOL in a derivative action.
xviii. Under 10b5, have a duty to disclose to investing public, not true under C/L (state law).
xix. What if insider has a hunch that something good is going to happen? Do they have a
duty to disclose to investing public? No.
xx. What if insider does research and determines something good is going to happen?
NO. If do own research, that is available to everyone else, then such information or
theory would be available to the knowledge of the public. ***Only liable when insider
is trading on inside information that he only has.***
xxi. COA found liability on 10b5.
xxii. Were the “tippees” liable? No liability only because they weren’t defendants.

xxiii. Tippees liability is contingent upon tipper’s liability. If tipper liable, then tippee is
xxiv. Note #4, p.412:
1. Under 10b5, was there a duty to disclose to sellers of land? No because not in
connection of purchase and sale of securities. Couldn’t bring claim under state
law for failure to disclose, because party not a SH. Best cause of action would
be for non-disclosure, but still would fail because land owners know best what’s
going on w/ their land.
jj. Rule 10b5 Liability (Insiders)
i. Who are insiders?
1. Directors, officers, employees, and controlling SHs of the corporation.
2. CPAs, attorneys, and other professionals working for the corporation may also
be insiders, constructive insiders.
ii. Insiders and construction insiders owe a duty of trust and confidence to the C (and its
SHs), and such duty is breached by trading on inside material information.
kk. Rule 10b5 Liability (Misappropriators)
i. Government can prosecute a person under 10b5 for trading on market information if
there is a breach of duty owed to the source of the information.
ii. How is this liability different than insider liability? Under IL, duty is owed to C. Here,
the duty is owed to the source of information.
iii. There are 3 types of misappropriations:
1. When the person agrees to maintain information in confidence;
2. When the person communicating the information and the person w/ whom
it’s communicated have a history of sharing confidences so that the recipient
of the information should know that the person communicating the
information expects the recipient to maintain the confidence;
3. When the person receives the information from a spouse, child, parent, or
sibling (unless the recipient can prove that he had no reason to know the
information was confidential).
ll. Rule 10b5 Liability (Tippers/Tippees)
i. Both tippers and tippees may be liable under rule 10b5:
1. Tippers Liability: a tipper who passes along a tip violates rule 10b5 if she
passes on material information to tippee who trades in the stock even though
the tipper does NOT buy or sale anything. However, the tipper must have
received some personal benefit from passing along the tip.
2. Tippee Liability: the tippee’s liability is derivative and depends on the tipper
(derivative liability). A tippee will ONLY be liable when the tipper has
breached her duty and the tippee KNOWS, or SHOULD KNOW, that the breach
has occurred.
i. Money is a clear example of a benefit.
mm. Summary: 3 types of liability under Rule 10b5: (1) insider; (2) misappropriator; or (3)
nn. What is the distinction between the misappropriator and the tipper? Misappropriator is going
to misuse the information by trading on it. Tipper doesn’t necessarily trade on the information,
they just pass along the tip.
oo. Rule 10b5 Liability (Examples) (***CHECK W/ LAURA***)
i. Mr. Smith has a cousin that works at Steel Inc., a steel manufacturing company. Mr.
Smith’s cousin tells him that his company has just engineered the strongest steel ever
made and will be announcing the development in about a week. Mr. Smith’s cousin told

him NOT to tell anyone and Mr. Smith agreed. Mr. Smith did NOT tell anyone but he
purchased 1000 shares of Steel Inc. before the announcement. What is the likely result?
ii. ANSWER: Mr. Smith is liable because he told his cousin that he would not tell anyone.
(Not because he didn’t disclose, but that he also did NOT purchase). ***As part of
keeping information confidential, you cannot trade.***
iii. Mr. Smith is not liable as an insider, because he’s not an insider.
iv. Mr. Smith is a tippee, but he would not be liable, because the tipper, his cousin
wouldn’t be liable because he did not receive a benefit.
v. Mr. Smith was a misappropriator under (1).
vi. Is Mr. Smith an insider? No. Only liable if they actually trade. (?)
vii. Cousin was an insider, but there was no insider liability. He was also NOT a
misappropriator nor a tipper.
pp. Misrepresentation/Non-disclosure:
i. Contract claim for misrepresentation;
ii. Tort claim for fraud;
iii. 10b-5 – although NOT implicitly stated in the statute, this section imposes an obligation
to disclose material facts.
iv. State law breach of fiduciary duty.
1. Must be a fiduciary relationship between the parties. Duty must be owed.
qq. As insider, there is NO general duty to disclose, unless there is “special circumstances” (i.e.
fiduciary relationship (dealing w/ SH), face-to-face transaction, information is material).
rr. Remember TGS, if land owner sold land to C w/out C disclosing value of land, look to (3) NO (not
purchase or sale of securities), then (4) NO (no fiduciary relationship, unless landowner is a SH),
then move to (2) or (1). Is it likely that landowner will prevail? NO. Must be material information
they couldn’t discover through due diligence.
ss. Misrepresentation (K)
i. Fraudulent = rescission + tort action for fraud (must also show scienter)
ii. Negligent = rescission + possible tort action for fraud
iii. Innocent = rescission
tt. State Law Breach of FD
i. One who fails to disclose material information prior to the consummation of a
transaction commits fraud ONLY when he’s under a duty to disclose. Such duty only
arises when:
1. Special facts: SH/purchase directly in face to face transaction.
2. Failure to disclose results in a breach of the DOC or DOL.
ii. Is there a duty to disclose when an insider sells his shares over public exchange? Not
generally. Unless there’s special facts. (***ASK LAURA ABOUT THIS***)
iii. What about if transaction is face to face? Yes.
iv. What if the purchaser is NOT a SH? No.
v. Why would a court apply state law instead of 10b-5? No sell or purchase of securities.
uu. Chiarella v. United States
i. In 1975 and 1976, D worked as a “markup man” in NY composing room of Pandick Press,
a financial printer. Among documents D handled were 5 announcements of corporate
takeover bids. When these documents were delivered to printer, identities of the
acquiring and target corporations were concealed by blank spaces or false names. True
name were sent to printer on night of final printing.
ii. D was able to deduce names of target companies before final printing from other
information contained in the documents. W/out disclosing his knowledge, D purchased
stock in the target companies and sold the shares immediately after the takeover
attempts were made public.

iii. D realized gain of more than $30K in 14 months time.
iv. Was Chiarella liable for a violation of 10b-5 according to the US SC? No. SC reversed
COA’s judgment and held that a duty to disclose under Section 10(b) does NOT arise
from the mere possession of non-public market information.
v. Chiarella had no relationship w/ the C, he worked for the copy company. Therefore,
Chiarella is NOT an insider.
vi. Was Chiarella an agent of the target company? Possibly.
vii. Did Chiarella have a fiduciary duty to the target company? NO.
viii. Why didn’t the court bring Chiarella under liability even though his actions were
deceptive? No relationship.
ix. What did the dissent belief? Applied misappropriation theory. A person who has
misappropriated non-public information has an absolute duty to disclose that
information or to refrain from trading.
x. What would have happened if the misappropriation theory would have been applied?
Chiarella would have been liable. Owe a duty to the source of the information, the
printing company. Court didn’t apply due to a technicality in jury instructions.
xi. Court instead applied the traditional theory of insider trading:
1. Section 10b and 10b-5 are violated when a corporate insider trades in the
securities of his corporation on the basis of material, non-public information.
2. IT applies NOT only to officers, directors, and other permanent insiders of a
corporation, but also to attorneys, accountants, consultants, and others who
temporarily become fiduciaries of a corporation.
3. Targets a corporate insider’s breach of duty to SHs w/ whom the insider
xii. If Chiarelli had researched and found this, this would NOT be deceptive.
xiii. ***Any time you trade you trade on inside information, must either disclose or
abstain.*** If CEO has material non-public information, he must disclose before he
trades. If not, 10b-5 violation. If disclose to C and SHs, NO 10b-5 claim, but could still
have a state claim for a breach of DOL.
xiv. Rule 10b-5 Liability (Misappropriators)
2. 3 types of misappropriations.
xv. Traditional Insider Liability Rule: An insider owes fiduciary relationship to the
corporation and shareholders.
xvi. Problem #8, p. 420:
1. Chiarelli would be liable as a tippee if the tipper, director, would receive a
personal benefit.
2. Chiarelli is NOT an insider.
3. Misappropriation theory would not apply (nothing that indicates that Chiarelli
and director agreed that information is confidential).
vv. Notes:
i. Did it matter that the D purchased shares NOT in the acquiring company about which
he had inside information, but in the target company?
1. Section 14(e) of the ’34 Act is aimed at fraud in connection w/ tender offers.
Under this statute, the SEC promulgated Rule 14e-3(a), which makes it unlawful
to trade on material non-public information concerning a tender offer.

2. Under that Rule, the information might come from the acquiring company or
the target or insiders or other working for either the acquiring or target
company – just so the D knows or should know that the information is non-
3. Thus, a person in Mr. Chiarella’s position would violate 14e-3(a) even though he
did NOT violate Rule 10b-5.
ww. Dirks v. Securities & Exchange Commission
i. Dirks received information from Ronald Secrist, former officer of Equity Funding of
America. Secrist alleged that assets of Equity Funding were vastly overstated as result of
fraudulent corporate practices. Secrist also stated that various regulatory agencies had
failed to act on similar charges made by Equity Funding employees. Secrist urged Dirks
to verify the fraud and disclose it publicly.
ii. Secrest told Dirks about fraud occurring in Equity Funding. He investigated the fraud.
He had conversations w/ his clients who then sold the stock.
iii. Was this the issue of traditional insider liability? NO. Dirks was NOT an insider. He
didn’t owe a fiduciary duty to the C and its SHs. However, Dirks got information from
someone that was an insider.
iv. This is a tipper/tippee relationship case.
v. How are TT liability cases different than traditional insider trading cases? Must be a
personal benefit that runs to the tipper.
vi. Why does it make sense to have TT liability? Tipper doesn’t trade but passes along tip
to tippee who trades. Makes sense that such a transaction falls under 10b-5 claim,
because there is deception. Tippee is an active participant in this deceptive scheme.
vii. 10b-5 is designed to eliminate deceptive practices.
viii. Only way for tippee to be liable is if tipper is liable. Tipper must pass along confidential
information and must receive a personal benefit.
ix. What constitutes a personal benefit (p. 425)? Could be a reputational benefit that will
translate into future earnings.
x. Did Secrest receive any personal benefit? No. No reputational benefit that will
translate into future earnings. Secrest just wanted to expose fraud. Tipper isn’t liable,
therefore the tippee isn’t liable (derivative liability).
xi. Even if the tipper would be liable, the tippee is only liable if the tippee traded on the
information and he knew or should have known the information was confidential.
Information was NOT confidential in this case, because he was supposed to expose the
xii. To absolve himself of liability, who could have Dirks disclosed to?
xiii. Tipper/Tippee:
1. The tipper must personally benefit, directly or indirectly from the disclosure.
Absent some personal gain, there has been no breach of duty to SHs.
2. 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 issuer not to
disclose the information.
i. If tipper is an insider, owes duty to Corporation and SHs.
xiv. Notes
1. #6: p. 427
2. When the case was filed, Secrist was a former officer of Equity Funding, but this
fact could NOT help him under 10b-5, however, because he allegedly obtained
the information while serving as an officer.

3. Footnote #14:
i. 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 SHs.
ii. Basis for recognizing this fiduciary duty is NOT simply that such
persons acquired non-public corporate information, but rather that
they have entered into a special confidential relationship in the
conduct of the business of the enterprise and are given access to
information solely for corporate purposes.
iii. When such a person breaches his fiduciary relationship, he may be
treated more properly as a tipper than a tippee.
iv. For such a duty to be imposed, the corporation MUST expect the
outsider to keep the disclosed non-public information confidential,
and the relationship at least must imply such a duty.
v. “Temporary Insiders.”
4. Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.: there can
be NO LIABILITY – at least in civil cases – for aiding and abetting a violation of
Rule 10b-5.
i. 2 Reactions to this Holding:
a)Congress, in Private Securities Litigation Reform Act of 1995,
expressly embraced liability for “aiding and abetting”
violations of the securities laws (including, obviously 10b-5).
Provision does so, however, ONLY for cases brought by the
SEC; so aiding and abetting is NOT a viable theory in private
b)Enterprising P’s lawyers attempted to find ways around
1. One such effort was called “scheme liability,”
essentially arguing that secondary players are part of
the same scheme as the primary violator of Rule
2. SC rejected the effort and reaffirmed its holding from
Central Bank of Denver in Stoneridge Investment
Partners, LLC v. Scientific-Atlanta, Inc.:
a. Operator of a cable TV system agreed to pay
2 companies (Motorola and Scientific-
Atlanta) additional funds for cable boxes;
those companies then returned a portion of
the money to the cable operator, as part of
an effort to make its books look better, in
violation of Rule 10b-5.
b. SC held that Motorola and Scientific-Atlanta
could NOT be held liable because they had
neither made statements to investors NOR
participated in the cable operator’s
statements to investors.

c. Accordingly, investors in the cable operator
could NOT have relied upon anything
Motorola or Scientific-Atlanta said. W/out
reliance, there’s no Rule 10b-5 violation.
xx. United States v. O’Hagan
i. O’Hagan was partner in MN law firm, Dorsey & Whitney. In July 1988, English Company
(Grand Metropolitan PLC, or “Grand Met”) retained firm concerning potential tender
offer to acquire Pillsbury Company.
ii. Tender offer was announced publicly on October 4, 1988. Although O’Hagan wasn’t
working on Grand Met-Pillsbury transaction, he bought Pillsbury stock and options to
acquire Pillsbury stock. After tender offer was announced and price of Pillsbury stock
rose, O’Hagan sold stock for profit of $4.3M.
iii. O’Hagan used profits from alleged insider trading to replenish client trust funds from
which he had converted money.
iv. Issues: Whether O’Hagan violated Rule 10b-5.
v. Dorsey and Whitney was a constructive insider of Grand-Met. GM was acquiring
company, and Pillsbury was target company.
vi. Could we have gotten O’Hagan him as a constructive insider? Information was about
Pillsbury. He was NOT a constructive insider of Pillsbury. O’Hagan worked for law firm
that worked for Grand Met. Confidential information was about Pillsbury. Only
insiders would be directors /officers of Pillsbury.
vii. No TT liability because there’s no tipper.
viii. Only way to get to O’Hagan is through misappropriation theory. Duty owed to the
source of the information.
ix. If misappropriation theory was applied in Chiarella, D would have been liable under
O’Hagan. Would have owed duty to his employer.
x. MAT  duty owed to the source of the information.
xi. Source of information is NOT Grand Met, but is the employer of O’Hagan.
xii. Under dissent in Chiarella
xiii. MAT is based upon theory that Rule 10b5 attempts to ferret out deceptive conduct.
xiv. One thing not clear, does MAT apply in private causes of action? Don’t know.
xv. Could O’Hagan have been charged as a temporary (constructive) insider? No. He’s a
temporary insider of Grand Met, but he did not trade in stock on Pillsbury. Therefore, no
10b5 liability based on temporary insider idea.
xvi. What about if before purchasing stock, O’Hagan told his employer that he was buying
the stock? Wouldn’t be liable under 10b5.
xvii. A trustee cannot use property that has been entrusted to him UNLESS there is consent.
xviii. Could Grand Met have sued the law firm for misappropriation? Law firm owes a duty
to the source Grand Met. However, O’Hagan is an agent of the firm. Might have
vicarious liability (but not because O’Hagan is acting with criminal intent, not w/in scope
of his employment). Clark says no, 10b5 is out to get rid of deceptive conduct.
xix. Traditional or Classical Theory of Insider Training:
1. Section 10b and 10b-5 are violated when a corporate insider trades in the
securities of his corporation on the basis of material, non-public information.
2. CT applies NOT only to officers, directors, and other permanent insiders of a
corporation, but also to attorneys, accountants, consultants, and others who
temporarily become fiduciaries of a corporation.
3. Targets a corporate insider’s breach of duty to SHs w/ whom the insider

xx. Misappropriation Theory (Applied in this case):
1. A person commits fraud in connection w/ a securities transaction, and thereby
violates Section 10b and Rule 10b-5, when he misappropriates confidential
information for securities trading purposes, in breach of a duty owed to the
source of the information.
2. 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.
3. In lieu of premising liability on a fiduciary relationship between company insider
and purchaser or seller of the company’s stock, the misappropriation theory
premises liability on a fiduciary-turned-trader’s deception of those who
entrusted him w/ access to confidential information.
4. Outlaws trading on basis of non-public information by a corporate “outsider” in
breach of a duty owed NOT to a trading party, but to the source of the
xxi. Under any of the 3 theories discussed, one way to avoid liability under 10b-5 is to
disclose or abstain. Under misappropriation, partner would have needed to disclose to
Dorsey and Whitney. Dorsey and Whitney were the source. If had done this, would be
liable under 10b-5. O’Hagan still would have other liabilities.
yy. When thinking about 10b5 liability: (2 types)
i. Insider trading
1. If not in connection w/ purchase or sale of securities, no 10b5, can still have
state claim, but must show fiduciary relationship between the parties.
i. State law claim:
a)NOT a general duty to disclose unless can show special
b)Special circumstances: (1) relationship between the party;
(2) transactions is made face to face; or (3) information is
2. Insiders
3. Tipper/tippee
4. Misappropriator
ii. Don’t have insider trading
1. If not in connection w/ purchase or sale of securities, no 10b5, can still have
state claim, but must show fiduciary relationship between the parties.
i. State law:
a)Board making request for SH action
1. Highest obligation, duty to disclose.
b)Board NOT making request for SH action.
zz. Common Law Duty of Selling Shareholder
i. Someone who owns enough stock to exercise control over the corporation can her stock
for more than the sheer value of the stock. A buyer will be willing to pay an extra
amount – over the bare value of the stock – because ownership of this block of stock
carries w/ it the power to control the direction of the corporation. This extra amount is
usually called a “control premium."
ii. No court has imposed liability on a controlling SH for getting a control premium in selling
her stock.
aaa.Debaun v. First Western Bank & Trust Co.
i. Duty of controlling SH in selling the corporation.

ii. DeBaun and Stephens worked for corporation. 100 shares were issued: Johnson owned
70; DeBaun owned 20; and Stephens owned 10. Johnson died in 1965. First Western
Bank & Trust was executor and took title to Johnson’s 70 shares.
iii. Bank took over majority’s shares (70 shares). Bank looked for buyer.
iv. Bank ordered a Dun & Bradstreet report on Mattison and fund. Report noted pending
litigation, bankruptcies, and tax liens against corporate entities in which Mattison had
been a principal and suggested that SOF Fund no longer existed.
v. As of May 24, Earl Funk, a VP of Bank, had personal knowledge that:
1. On October 24, 1957, LA Superior Court had entered judgment against Mattison
in favor of Bank’s predecessor in interest for compensatory and punitive
damages as result of Mattison’ fraudulent misrepresentations and fraudulent
F/S to obtain a loan; and
2. Judgment remained unsatisfied in 1968 and was an asset of Bank acquired from
its predecessor in an acquisition of 65 branch banks.
vi. Buyer (Mattison) was going to provide $50K and remaining $200K, he would pay bank
from future revenues he received from running C.
vii. As of July 1, 1968, public records of LA County showed 38 unsatisfied judgments against
Mattison or his entities totaling $330K+ and 54 pending actions claiming total of $373.5K
from them. Record contained 22 recorded abstracts of judgments against Mattison or
his entities totaling $285.7K and 18 tax liens aggregating $20.3K.
viii. Why did Bank accept Buyer’s third proposal?
1. Partly because another Bank officer knew McCarrol as former trust officer of
Bank’s predecessor and partly because during luncheon w/ Mattison at
Johnthan Club where Mattison was warmly received by member of the Club,
Bank did NOT pursue its investigation into public records.
ix. Bank retained a security interest in the shares.
x. Bank was aware the C would not generate sufficient after-tax revenues to pay the $200K
back as scheduled. Buyer had to rely on future earnings that he received from
dividends. Bank knew that the only way they could have paid the Bank back was by
using money that the C had already earned.
xi. When Buyer took over C, the C was doing very well.
xii. When Buyer took over C:
1. Diverted corporate cash to himself and to MICO (shell company owned by
2. August 2, 1968, M caused C to assign to MICO all of C’s assets for fictitious
agreement for management services.
3. M diverted all corporate mail, opened it, and extracted all incoming checks to C;
4. M ceased paying trade creditors promptly;
5. M removed corporate books and records;
6. M collected payments from employees to pay health-insurance premiums;
7. M issued paychecks w/out sufficient funds.
xiii. What did Bank do when found out about Buyer’s conduct? Bank took no action until
April 25, 1969, when it filed an action in superior court seeking appointment of a
receiver. Federal IRS and CA State Board of Equalization filed liens upon corporate assets
and notices to w/out funds. July 10, 1969, Bank, pursuant to security agreement (part of
purchase agreement) sold all of C’s then remaining assets for $60K. $25K was paid to
release federal tax lien and $35K was retained by Bank. After sale, C had NO assets and
owed $218K+ to creditors.

xiv. DeBaun and Stephens filed 2 actions against Bank. 1 st asserted right to recover, as SHs,
for damage caused by Bank. 2nd was a SH’s derivative action brought on behalf of C.
xv. Bank demurred to both complaints. In demurrer to 1st, Bank contended that Ps, as SHs,
lacked capacity to pursue their claim. In demurrer to 2 nd complaint, Bank contended
that its liability did NOT run to C.
xvi. TC ruled in favor of C.
xvii. Bank was the majority SH, and owed a fiduciary duty to C and minority SHs. Bank failed
in upholding their fiduciary duty.
xviii. By selling to the Buyer (Mattison), Buyer became majority SH.
xix. Ps breached their DOC, but was no DOC lawsuit against the Ps because there are only 3
SHs and Board Members (Mattison, DeBaun and Stephens).
xx. Mattison took ownership of the shares, but they were still controlled by the Bank
xxi. Ultimate conclusion, court restored C to possession it was prior to Bank’s breach and
provided enough damages the C needed to place them in the position they would have
been in at this point considering they were a profitable company.
xxii. Who is going to receive money? C. Who owns the C? Mattison and the Ps. Seems
unfair. How would you have fixed this as a judge? Direct suit.
xxiii. Rules:
1. In any transaction where the control of the C is material, the controlling
majority SH must exercise GF and fairness from the viewpoint of the C and
those interested therein.
2. That duty of GF and fairness encompasses an obligation of the controlling SH 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 C of its assets to pay for
the shares purchased to conduct a reasonable and adequate investigation of
the buyer.
3. Total damage to Corporation is thus the SUM necessary to restore the negative
net worth, PLUS the value of its tangible assets, PLUS its going business value
determined w/ reference to its future profits reasonably estimated.
bbb. Perlman v. Feldman
i. MV of shares = $12
ii. Why did they sell for $20? Shares contained a “control premium.” 37% is NOT a
majority of shares, but is a controlling amount of the shares.
iii. How does “Feldman Plan” relate to this case?
1. Consisted of securing interest-free advances from prospective purchasers of
steel in return for firm commitments to them from future production. The
funds were thus acquired were used to finance improvements in existing plants
and to acquire new installations.
2. Receiving an interest-free advance for assurance of providing steel to buyers.
v. Feldman breached his duty by selling his shares for the control premium. Control
premium belonged to C. Therefore, C should be able to keep that benefit for itself.
When Wilport purchased “control premium,” eliminated “Feldman Plan.”
vi. Perlman: A controlling SH can sell shares UNLESS
1. Fraud;
2. Misuse of corporate assets
3. Looting;

i. If know Buyer loots but doesn’t loot in this certain case, then seller
doesn’t have liability.
4. When the sale results in a sacrifice of corporate good will and consequent
unusual profit to the fiduciary who has caused the sacrifice. “In a time of
market shortage where a call on a corporations’ product commands an
unusually large premium.”
i. Applies to facts of Feldman.
vii. Says this action was derivative, but really was a direct action. More willing to treat as
a direct, because if treated as derivative, C would recover, and thus Wilport would still
benefit. Becauose it was direct, award ran to SHs.
ccc. “Selling” Fiduciary Offices With the Controlling Interest
i. It’s not uncommon for the sale of a controlling block of stock to be accompanied by an
agreement that directors friendly to the seller will resign. This practice – sometimes
called delivering a “stacked” board to the buyer – allows the buyer, who is the new
controlling SH, to have her people take control of the BODs.
ii. What does it mean when a SH promises to deliver a stacked board? Allows the buyer,
who is the new controlling SH, to have her people take control of the BODs.
iii. Can a sale involving a true majority of a C’s stock legitimately carry w/ it a deal to
deliver a stacked board? Yes.
iv. What about a controlling interest? Can it carry w/ it a deal to deliver a stacked board?
Yes. There is a caveat. Question is whether or not party w/ controlling interest actually
has a controlling interest. Everyone seems to agree that a sale involving a true majority
of the C’s stock can legitimately carry w/ it a deal to deliver a stacked board to the buyer.
v. If receive a controlling share, does it automatically mean you can remove the majority
SHs? Removal may acquire a showing of cause, which may prevent you from providing a
stacked board.
ddd. Redemption and the “Equal Access” Rule
i. Corporate codes do NOT obligate a C to repurchase stock from its SHs.
ii. There is NO case law that imposes a general obligation on a C to buy stock back from any
of its SHs.
iii. There is, however, a line of cases that establishes an “equal access rule.”
iv. Equal Access Rule:
1. Requires a close corporation NOT to discriminate in repurchasing shares.
2. Such discrimination breaches a fiduciary obligation owed to the minority SHs.
3. EAR is NOT universally accepted. Where it’s accepted, as in MA, it is LIMITED
eee. Donahue v. Rodd Electrotype Company of New England, Inc.
i. Direct suit, SH alleges she has suffered a harm.
ii. What was determination of TC? Dismissed P’s bill on merits.
iii. Who made decision to buy back the stock? Children of Harry Rodd. Individually, P had
more shares than each brother. But if treat them as one controlling group, would have
more shares than P. Made a difference that decision makers were sons of Seller.
iv. Special board meeting was held on July 3, 1970. Harry Rodd resigned his directorship
and Frederick Rodd was elected to replace his father. 3 directors then authorized Rodd
Electrotype’s President, Charles Rodd, to execute an agreement between Harry Rodd
and company in which company would purchase 45 shares for $800/share, for a total of
v. Why did the BODs not execute the agreement and authorized President (he’s an agent
of the organization)? The agent is the only one that can bind the C.

vi. Can a minority SH in a C generally force dissolution? NO. Who can force dissolution,
or when can C dissolve? When C becomes dissolvent. In a CHC: Freeze-out, deadlock,
or oppression can cause dissolution (it’s not automatic, depends on state statute
“Corporate Death Penalty”). P. 458 show another situation, where SHs seeking
dissolution own more than 50% of the shares. What about a P: can leave which causes
dissolution. Can still leave if not a P at will, will get paid but might have to pay
damages. In P much easier to leave and get paid than in a CHC.
vii. Assume you are a minority SH of a CHC and want to get out for a freeze out or squeeze
out? Not likely that someone would buy my shares.
viii. ***Is there a difference between the standard that partners in a P have to exercise and
that of D/O’s in a C? Yes. Which one must be exercised in a CHC? P standard. Utmost
good faith and loyalty to other SHs. Must provide an equal opportunity (equal access
rule) to other SHs to sell back their interest to C. EAR is NOT applicable to a publicly
held corporation.***
ix. Did the controlling SH in this case force the C to buy its stock back? Didn’t have a
controlling SH, individually in this case, but if look at brothers in aggregate, could be
considered a controlling block. Children wouldn’t have done this but/for their
relationship w/ their father. Central to court’s conclusion. Controlling SH took
advantage of minority SH.
x. What is most difficult to dissolve, a P or a C? A C.
xi. What’s difference between BV and liquidating value? BV = Assets – Liabilities =
Equity/number of shares outstanding. Liquidating Value = amount of money you can
sell your share for.
xii. How would this case have been resolved if there a valid BSA? Wouldn’t have had
problems w/ this case. What is a BSA? Agreement for C to buy back stock from SHs.
xiii. The court in Donahue treated this case as a direct, rather than a derivative, action.
fff. Buy Sell Agreements
i. A contract that requires a C or majority SH to buy shares upon the occurrence of a
certain condition. Well drafted BSA will establish:
1. What triggers an obligation to sell and buy stock;
2. The purchase price; and
3. Where the money comes from
i. Sinking Fund – What is a sinking fund? When C or SHs periodically
put money into fund. What are the disadvantages? Don’t always
have money to put into sinking fund. Requires C to use its assets into
fund instead of reinvesting money it has made.
ii. Life Insurance – Who is the beneficiary of the policy? Have to have an
insurable interest. Why (policy)? Moral hazard.
ggg.Types of Buy-Sell Agreements:
i. One Way Agreements
1. A 3P who is someone other than C or SH purchases the deceased individual’s
2. Has two sources of income to purchase.
3. Allows a 3P to acquire a deceased or departing owner’s interest in the business.
4. BSA is usually used to provide a market for a CHC or individual ownership
5. In many instances, the 3Ps are key employees.
6. This BSA is simple to fund. The 3P can either establish a fund for the purchase
or buy a life insurance policy on the owner.

ii. Cross-Purchase Agreements
1. Other SHs are buying the shares. Money is coming from surviving SHs. Either
comes from sinking fund or life insurance (on one of the SHs that dies).
2. Usually obligates surviving owners of a business to purchase a deceased
owner’s interest directly from the decedent’s heirs.
3. If the owner becomes disabled or retires, the surviving owners also may be
obligated to purchase the interest of the departing owner directly.
4. The business is NOT a party to such an agreement.
5. Normally, each remaining owner purchases enough of the deceased or
departed owner’s interest to maintain his proportionate interest in the
business. Proportionate purchases are NOT required, however.
6. It’s critical to look at ownership implications when designing the BSA.
iii. Entity or Stock Redemption Agreements
1. C is buying the shares. Have two funds to purchase.
2. An entity or stock redemption agreement is entered into by both the owners
and the business entity itself.
3. Generally, each owner agrees to sell his/her interest in the business back to the
business entity upon a triggering event, and the business agrees to purchase
such interest.
i. This provides the deceased owner’s heirs w/ cash in lieu of an interest
in the business, or the departing owner w/ cash payments for disability
or retirement.
ii. Under the terms of this type of BSA, because the entity is obligated to
purchase the deceased or departing owner’s stock, each remaining
owner’s relative share of the business stays the same w/ respect to
each other owner.
iii. Because the obligation to purchase the departing owner’s interest
would rest w/ the business and NOT the remaining owners, any
funding vehicle used MUST be for the benefit of the business rather
than the owners.
iv. Wait and See Agreement
1. Right of 1st refusal. C holds the option to purchase.
2. Hybrid of the previous two BSA (Cross-Purchase Agreements and Entity or
Stock Redemption Agreements).
3. These BSAs are flexible, giving the business entity the option of redeeming any
ownership interest upon a triggering event.
4. Under these BSAs, the owner or his/her estate is obligated to sell, BUT the
business entity is NOT obligated to buy, the deceased or departing owner’s
5. Arrangement is usually established and funded immediately w/ appropriate
types and amounts of life insurance.
6. BSA provides the amount that is to be paid to any deceased SH but does NOT
identify the purchaser. The corporation has the 1st OPTION to purchase all or a
part of the decedent’s stock and, to the extent the corporation chooses not to
exercise its option, the surviving SHs are given an option to purchase.
i. If any stock remains after the corporation and the SHs have had the
opportunity to exercise their options, the corporation is REQUIRED to
purchase the remaining shares.
hhh. Valuing Business:

i. A properly structured and implemented BSA should include a means of establishing the
VALUE of the business which is acceptable to both the owners and the IRS.
ii. There are 6 generally accepted ways to value a business;
1. “Goodwill” multiplier;
2. Rate of return on assets;
3. Last 5 years’ average earnings;
4. Use of a capitalization factor; and
5. 2 versions of the BV Method:
i. Combination; and
a)MOST commonly used by taxing authorities.
b)Method establishes a value for the business based on its past
and present financial position, general economic conditions,
book value and earnings.
ii. Capitalization of Net Earnings
iii. Most reliable means of determining BV is to use the services of a
certified appraiser, particularly for CHCs, SPs, and Ps
iii. Tailoring Agreement to Entity
i. Closely Held Corporations or Sole Proprietorships:
1. “One-Way” Agreement may be appropriate.
i. Enables and obligates a key employee or some other person to buy the
business and providing the departing owner of his/her heirs w/ cash.
ii. Partnerships:
1. Cross-Purchase Agreement.
2. In absence of a BSA, the P may have to be liquidated or run in conjunction w/
the decedent’s heirs.
iii. Corporations:
1. Entity Redemption OR “Wait and See Agreement”, unless the number of SHs is
jjj. Jordan v. Duff & Phelps, Inc.
i. Rule 10(b)-5 issue. Centered around letter of resignation and when P resigned. There is
something not discussed in case. What was the policy about the stock restriction and
policy agreement? Once you leave we have right to purchase all your shares back
which coincides with preceding December 31 of year.
ii. Agreement had not consistently been applied due to the affair the mistress had w/ the
CEO. Did the board breach any fiduciary duties by allowing an exception to one
woman? Yes. Woman was able to make more money by selling shares later, thus Equity
of the company would be lower. Breach of DOC. Would you be upset about this? Yes.
Wouldn’t be likely that you prevail on this case. If satisfy tri-part duty (informed, acted
w/ GF, best interests of C), get BJR protection. BODs were informed. BODs acted w/ GF.
BODs acted w/ best interests of C (bad publicity). It would fail under the BJR.
iii. 11/16/83, resignation was submitted. He actually left at end of year to receive stock
value of December 31, 1983 instead of 1982. This is important in regards to 10b-5.
Depends on whether information is material. If date/sale based upon 1982, no merger
discussions had been held.
iv. Public announcement was January 10, 1983. Obvious that had merger discussions
prior to that (before December 31, 1983). Merger actually didn’t go through due to
Federal Reserve’s onerous condition.
v. Merger eventually went down and P would have made 20x more if he would have sold
his shares at that point.

vi. Issue was when the sale of stock went down.
vii. What was court’s ultimate determination? Reversed TC’s judgment of SJ and remanded
viii. Was there a duty to disclose the underlying material in this case? Yes. Court
concluded there was a duty to disclose to him as an employee even though he was an
at-will employee. Timing of sale and materiality of discussions was issue for the jury.
May have difficulty determining scienter.
ix. P. 472-472. Under special facts doctrine, applies when have fraud, misrepresentation,
and non-disclosure, when discussing cases insiders. No obligation to disclose unless
have special circumstances: Face-to-meeting, if information is material, if person they
are transacting with is actually a SH.
1. ****Applies to 10b-5 and state law cases.****
x. What about idea of at-will employment? At will employment usually contains illusory
xi. What should Duff and Phelps done differently in this case? Disclose merger
xii. Question 2.1Suppose in BSA, said purchase or sale or securities under the redemption
agreement would not violate 10b-5? CANNOT WAIVE 10b-5 liability.
xiii. Question 2.2: Can do this. This is NOT a direct restriction of 10b-5. Addressing
obligation to disclose which can be limited.
kkk. Berreman v. West Publishing Company
i. When did the merger agreement ultimately take place? February 25, 1996.
ii. P’s last day at D was May 31, 1995.
iii. P’s argument was that if he would have been informed about considering merger, he
would have stayed and made more money.
iv. Court had to determine whether information was material and there must also be a duty
to disclose.
v. Was the information material? NO.
1. Standards for determining materiality:
i. TSC  applied when event is certain
ii. TGS  applied when event is uncertain. Balancing test: probability
of event versus the anticipated magnitude.
a)Magnitude of event here would be high. A merger is one of
the largest events that a SH can go through.
b)Probability was low because event was speculative.
vi. Was there a (fiduciary) duty to disclose? Yes. It is a CHC and treat SHs in a CHC as
partners in a P (Meinhard v. Salmon).
vii. So while there is a duty, information was too speculative to warrant materiality.
viii. Why didn’t this case fall under 10b-5? Exclusive jurisdiction lies in the federal court for
a 10b-5 claim and this suit was in state court.
ix. Was West Publishing Company a PHC or CHC? In this case, there were arguments for
both sides. Important to determine whether there is a duty to disclose. Higher duty to
disclose in a CHC. But didn’t matter because information wasn’t material. Court didn’t
make a decision either way. For purposes of standard of review, Court considered C CH
because it was looking a motion for SJ, and thus look at facts in favor of non-moving
x. ***Most important characteristic to determine whether a C is PH or CH, is whether the
C is publicly traded over a public market (but not a determinative factor).***
xi. Privately held does NOT necessarily mean closely held.

xii. Who would want to treat it as a CHC? P/SH/minority SH. Applies a heightened duty.
xiii. Issues: Whether D breached a fiduciary duty to P by not disclosing merger discussions.
xiv. Holdings: D did NOT breach a fiduciary duty to P. MN COA affirmed DC’s holding.
xv. Rules:
1. Common Law Fiduciary Duty: SHS in a CHC owe one another a fiduciary duty.
2. Attributes of Close Corporation:
i. 3 characteristics generally identify close corporations under C/L:
a)Small number of SHs;
b)No ready market for corporate stock; and
1. Dominant characteristic of a C/L close corporation.
c) Active SH participation in the business.
3. Scope of Common Law Fiduciary Duty: The fiduciary duties of SHs in a CHC
include the duty to disclose material information about the C.
4. Application of Probability-Magnitude Test to Undisclosed Facts:
i. Tentative, speculative discussions about merger are NOT material.
VIII. Chapter 8 – What Are The Various “Endgames” For The Corporation, Its Shareholders, Its Managers?
a. Fundamental Corporate Changes – for each of the following, the BOD must obtain approval of
the SHS: (The Big 4)
i. Amend the AOI;
ii. Dissolution;
iii. Merger;
iv. Sale of Substantially all of the corporations assets
b. Why does the BODs have to approval from the SH? Substantially impacts the C and the SHs.
c. BODs first make the decision and then submit decision to SH (reactive).
d. FCC Process:
i. BODs must approve the fundamental change (majority vote, unless AOI provide
ii. BOD must notify the SHs of the recommendation that the fundamental change be
iii. A special meeting of the SHs must be held to vote on the deal;
iv. If the deal is approved the SHs that opposed the proposal might have a right to force the
C to buy them out (“dissenting SHs right of appraisal”).
v. The corporation must inform the state of the fundamental changing by filing a document
w/ the State.
e. What is a quorum? 51%.
f. Are SHs required to vote on FCC? Yes. NFC? No (but BODs can give decision to SH, but unlikely)
Election of BODs? Yes.
g. SH Voting:
i. BODS – plurality (CV (more power to minority SH) v. straight line)
ii. Non-fundamental changes:
1. MBCA: Modern View – (quorum) + (a majority of the votes cast). This view
ignores votes that abstain.
2. Delaware: Traditional View – (quorum) + (majority of the shares present at
the meeting). Essentially, people that abstain are treated as voting against
the proposition.
3. Example:
i. 6K shares outstanding.
ii. To conduct business, must show 3,001 shares (quorum requirement).
iii. 3,600 people show up.
iv. Of the 3.600, only 2,000 vote.

v. Under MBCA/Modern View, to approve NFC, must receive 1,001
vi. Under Delaware/Traditional View, must receive 1,801 votes.
vii. To effectuate NFC, more difficult under the Delaware/Traditional
iii. FCC
1. MBCA – see modern view (quorum + majority of votes cast)
2. Delaware – FCCs must be approved by (quorum + majority of shares entitled
to vote)
3. Traditional – Super Majority View – (quorum + 2/3 of the shares entitled to
4. Example: (Use same figures as above)
i. 6K shares outstanding.
ii. To conduct business, must show 3,001 shares (quorum requirement).
iii. 3,600 people show up.
iv. Of the 3.600, only 2,000 vote.
v. Under MBCA/Modern view, need 1,001 votes to effectuate a FCC.
vi. Under Delaware, need 3,001 votes to effectuate a FCC (can’t do this at
this meeting).
vii. Under Traditional/Super Majority View, need 4,000 votes to
effectuate a FCC (can’t do this at this meeting).
h. Dissolution
i. Two types of Dissolution:
1. Judicial dissolution – most state statutes provide that a SH must establish that
those in control of the corporation have acted in a manner that is illegal,
oppressive, or fraudulent.
2. Voluntary dissolution – BOD approves dissolution and then SH’s vote on the
proposal (think about necessary votes for FCC) (MBCA v. Delaware Approach to
ii. Questions, p. 483:
1. #1: Will they be personally liable for any beyond personal value? No.
Protected under limited liability of C, corporate veil. It will cost funds to
2. #2: Let’s assume Propp and Capel have more than 2/3 of the stock. DO NOT
DO THIS. Attempting to freeze Agee out by brining company to end.
Technically they have a power to initiate a voluntary dissolution, because they
control the BOD and they are the majority SHs. In a CHC, you owe a fiduciary
duty, and possibly violated their DOL. BOD would be interested and wouldn’t
be protected by BJR. Self-dealing (both sides) and usurptation of corporate
opportunity. In a CHC P, treat SH as partners in a P.
i. Merger
i. Surviving corporation:
1. This is the C that will survive the merger.
2. Both BODs have to approve transaction.
3. Under the MBCA do the SHs of the surviving C have to approve the merger?
No. See 11.04(g)(1). Why or why not? Not a FCC for the surviving SHs.
4. Under MBCA, only time SHs of surviving C have to vote, is if the surviving C is
issuing shares of the C of more than 20% of its own OUTSTANDING STOCK. See
6.21(f). Why? Might devalue their stock. What type of provision could SH put

in AOI, preemptive rights, but this wouldn’t apply here because not issuing
shares for cash, issuing shares for shares of disappearing C (preemptive rights
do NOT attach).
ii. Disappearing Corporation:
1. This is the C that will cease to exist.
2. Under both Delaware and MBCA, the SHs of the disappearing C will have to
approve the change because it’s a substantial change (FCC).
iii. Under Delaware law the BODS of the SC and DC AND SHs of the SC AND the DC have to
vote to approve the merger. (***DISTINCTION***)
iv. Chart:
1. MBCA:
i. Surviving Corporation (SC):
a)BOD: have to approve
b)SH: do NOT have to approve, because not a FCC, UNLESS the
SC issues more than 20% of its own OUTSTANDING shares
(this would devalue shares that SC SH’s own and wouldn’t
have ability to apply preemptive rights).
1. Why are they issuing shares?
a. Two things that SHs of DC can receive:
i. In cash-out merger, receive cash
and sell them to SC;
ii. Cash is a form of consideration, so
instead of giving cash, can provide
stock in SC. SHs of DC cease to be
SHs of DC and become SHs of SC.
SC now owns shares of DC.
ii. Disappearing Corporation (DC):
a)BOD: have to approve
b)SH: have to approve because it’s a FCC
v. Problems, p. 484:
1. #1: Capel would have to approve because he is a majority SH. If merger goest
through, S and U becomes creditors of McDonald’s. In a merger, creditors of DC
become creditors of the SC.
2. #2: “Triangular Merger”
i. SC and DC want to merge into new corporation (NC). Under the
MBCA, both BODs have to approve, then SHs of the DC have to
approve and NOT SHs of SC unless, exception. If in DE, BODs and SHs
of BOTH have to approve.
ii. If DC has a troubled B/S and I’m a SH of SC, will not want to acquire
DC (SH would say no). Instead, SC creates wholly owned subsidiary
called NC. SC gives NC shares of SC. NC assets are SC and NC gives SC
shares of NC. All NC shares are owned by SC. NC owns a few shares
of SC. NC and DC merge. In order to create a new company, don’t
need SH approval, not a FCC. Who is only owner of NC? SC. SC
causes NC to acquire DC. What will NC give to DC? Shares of SC. DC
walks away w/ shares of SC. NC then has shares of DC. Under new
format, have two entities, SC and NC. This gets around approval of
SHs of SC. SC has shares of NC and NC has shares of DC. Circumvents
process of having to go to SHs of SC. Liability still follows. When NC

acquires DC, also acquires assets and liabilities of DC. DC have shares
of SC.
j. Triangle Merger
i. Scenario is that a SC wants to merge w/ a DC.
ii. In a jurisdiction (DE) where both disappearing and surviving SH approval is needed a
triangle merger gets around the necessary approval from the surviving corporation SHs
for a merger
1. Steps
i. SC would create NC (NC would be a subsidiary corp of SC)
ii. SC and NC would each have their own shares of stock
iii. SC and NC would exchange shares of stock with each other
a)NC becomes a wholly owned subsidiary of SC because all of
NC’s shares are owned by SC
b)NC receives some of SC’s shares
iv. Then NC exchanges it’s SC shares with DC (corp want to acquire/merge
with) SC’s shares
v. DC gives NC all of its shares DC now disappears
a)DC’s SHs now own SC’s shares.

SC (Surviving Corporation)

NC subsidiary DC (want to acquire/ merge with)

iii. How is that not legal?

1. Idea is that if you don’t want your BODs to do this, DON’T elect them.
2. Example where triangle merger will be used under DE law (issue in DE because
SHs of SC have to approve).
k. Effects of a merger: MBCA 11.07
i. The surviving corporation or entity that is designated in the merger agreement
continues or comes into existence.
ii. The separate existence of the corporation and entities merged into the surviving entity
cease to exist.
iii. Property ownership merges into the surviving corporation.
iv. All liabilities of the corporations and entities merged into the survivor are vested in the
v. The name of the survivor may, but need not be, substituted in any pending proceeding
for the name of any party to the merger whose existence ceased in the merger.
vi. The articles of incorporation or bylaws of the survivor are amended to the extent
provided for in the merger agreement.
vii. Articles of incorporation of survivor that is created by the merger become effective.
viii. Former shareholder of the corporations merged into the survivor are entitled to the
rights provided to them in the merger agreement.
l. Shareholder Protection
i. Four potential forms of legal protection (applies to SHs of BOTH Cs)
1. Sue directors who approved merger alleging breach of common law or
statutory duty of care;
2. Vote against the merger;
3. Assert dissenting shareholders rights of appraisal (SHRA); or

4. Sue the directors who approved the merger alleging a breach of common law or
statutory duty of loyalty
ii. #1 Sue the directors who approved the merger alleging breach of common law or
statutory duty of care
1. “Merger Agreement” directors of each merging corporation will agree on a plan
of merger.
2. Shareholders who are dissatisfied with what they receive from a merger
sometimes sue the directors who approved the merger, alleging breach of the
duty of care in approving the merger.
iii. #2 Vote against the Merger
1. A merger requires not only approval by the board of directors of each of the
merging companies, but also the approval of the shareholders
iv. #3 Assert the dissenting shareholders rights of appraisal
1. An individual shareholder’s vote against a merger will NOT prevent the merger
from happening
2. SH rights of appraisal only come up during closely held corporations.
3. “Appraisal Rights” to shareholders who dissent from merger.
i. Fair value of shares as determined by a judicial appraisal process.
ii. There are no statutory provisions governing how a court is to
determine that fair value.
4. A shareholder who opposes a merger and complies with the detailed statutory
requirements has more than the right to have her shares appraised or valued.
5. Dissenters recovery during rights of appraisal cannot include a minority
discount because it would be harming the SH twice.
v. #4 Sue the Directors who approved the merger for breach of a duty of loyalty
m. Damages
i. SH Rights of Appraisal:
1. Value the shares of the company AT THE TIME of the MERGER.
2. Damages the SH would have incurred at the time of merger! What did SH
receive? What was the value they could have received at the time of the
3. SHs are NOT trying to undue the merger.
4. Questioning the value that they received from the merger.
ii. Recissory Damages:
1. Compare damages to value of stock TODAY and AT THE TIME of the MERGER.
Get the difference between the 2.
2. Designed to put you in the position had the merger not gone forward.
3. Look at the value the SH received at the time of the merger, and compare that
to the value of the stock TODAY, and you get the difference between the two.
n. Case: HMO-W Inc. V. SSM Health Care System (SH Appraisal Rights)
i. HMO contends that COA erred when it precluded application of minority discounts in
determining the fair value of dissenter’s shares. This court agreed with COA and
concluded minority discounts may not be applied to determine the fair value of
dissenters shares in an appraisal proceeding.
ii. 1983, SSM and number of other health care providers form HMO-W as a provider-
owned health care system. All SHs assumed minority status in this CHC. SSM and the
Neillsville Clinic together owned approximately 20% of HMO-W’s shares.
iii. By early 1990s, competitive pressures from w/in health care business led HMO-W to
explore possibility of merging w/ another health care system. SSM recommended
DeanCare Health Plan. HMO-W instead proposed JV w/ United Wisconsin Services.

iv. Before SH approval of merger, HMO-W retained Valuation Research Corporation (VR) to
value HMO-W’s net assets both prior to and upon merger. VR estimated company’s net
value to fall w/in range of $16.5 to $18M.
v. HMO-W’s BODs voted to approve proposed merger w/ United and to submit the merger
to a SH vote. Proxy materials sent to SHs informed them of their statutory right to
dissent to merger.
vi. At SH meeting, both SSM and Neillsville Clinic voted against proposed merger. Merger
was approved.
vii. Both SSM and Neillsville Clinic made demand for payment of their dissenting shares.
Abandoning the VR report, HMO-W hired new appraiser to value assets. Appraiser
arrived at valuation of approximately $7.4M and based upon this valuation, HMO-W sent
SSM a check for almost $1.5M as value of SSM’s shares. Disputing HMO-W’s valuation of
shares, SSM informed company that SSM’s fair value calculation of its shares yielded a
figure of approximately $4.7M.
viii. HMO-W instituted special proceeding to determine fair value of dissenting shares. SSM
asserted that HMO-W was estopped from claiming a company value that was lower than
the $16.5 to $18M value.
ix. At special proceeding, HMO-W’s expert said value immediately prior to merger was
$10.544M and SSM’s expert said the value was $19.250M. Circuit court applied a
minority discount of 30% to value of dissenting shares but refrained from applying a
lack of marketability discount. TC also ordered SSM and NC to repay w/ interest the
amount by which HMO-W’s initial payment exceeded the court’s fair value
x. COA held that WI statutes governing dissenters’ rights do NOT allow minority discounts
to be applied in determining the fair value of a dissenter’s shares. COA affirmed CC’s
determination as to HMO-W’s net asset value and held that SSM had failed to prove
harm in reliance on the VR report that initially value HMO-W’s net assets at $16.5 to
xi. Dissenters rights prevents freeze outs of minority shareholders.
xii. The purpose of dissenters rights statutes, the court concluded that the application of a
minority discount in determining the fair value of a dissenters shares frustrates the
equitable purpose to protect minority shareholders.
xiii. “Fair Value” – value of the shares immediately before the corporate action, the focus of
fair valuation is not the stock as a commodity but rather the stock only as it represents a
proportionate part of the enterprise as a whole.
xiv. Minority Discount – based upon the idea that your shares are worth less money
because your shares do not have a control factor
xv. There should not be a minority discount because it would be double punishment to
freeze out minority and then apply the 30% minority discount.
xvi. SSM argued that HMO engaged in unfair dealing because of the money differences. This
court saw no reason why they should rely solely on the value and methodology of the
first appraiser or to have accepted a valuation if deemed inaccurate because that would
have lead to more issues and lawsuits. It was important to have a new report done.
xvii. In a closely held corp. it is unfair to apply the minority discount.
xviii. There was no unfair dealing because the first report was defective. Therefore, the board
should not be stopped from giving another report because the first was defective and if
they had kept the first the SH would have sued for defective suit.

xix. ***Generally there will be one action for the SH appraisal rights, determining the
value of the shares and an action for the damages caused by the breach of fiduciary
1. However, in this case the court looked at all relevant factors in determining the
value of the shares and the breach of fiduciary duty was a factor affecting the
value of the shares.
xx. This case was about the standard of review – this court stated that it was not in the best
position and respected trial court.
1. Therefore the court did not decide if there was breach of duty or loyalty
xxi. This was a direct suit.
xxii. ***Cannot have shareholder rights of appraisal in a public company, because a SH’s
shares can be sold on the public market.***
xxiii. Issue #1 – whether minority discount should factor into appraisal of company? (Court
says NO)
1. Would be a double punishment to the minority shareholders, forced to sell and
forced to accept the discount, Court did not adopt the minority discount
i. Marketability – based on whether you can SELL your stock
ii. Minority Discount – idea that minority shares are worth less b/c they
do not come with controlling interest in the company
xxiv. Issue #2 – company says the value is high before the company, and after the merger, the
company says the company is worth much less  looks like unfair dealing
1. Unfair Dealing – breach of some sort of duty
2. This is a valuation for the SH’s interest, issue is – Can we analyze this duty in the
context of a suit for appraisal?
i. THIS COURT (ALI APPROACH) says yes, all relevant factors should be
ii. In Delaware, you would have to have a separate lawsuit for breach,
DE would not have considered this breach in the context of this case
about SH rights of appraisal.
3. Here – no breach, b/c first report of appraisal was defective
xxv. QUESTIONS p. 493
1. #2  Answer: Other SH would not have received anything b/c would have
become SH in the new entity

2. Was this suit DIRECT or DERIVATIVE?  DIRECT here, b/c minority SH sue on
their own behalf

3. #5  Answer: No with respect to minority discount b/c in publically held

corporation, could sell on public market, STILL could have an issue of unfair

4. Rights of SH appraisal generally only come up with CHC, not publically held

o. Weinberger v. UOP, Inc. (Sue the directors who approved the merger for breach of the duty of
i. Signal merged with UOP.
ii. Signal already was a 50.5% majority shareholder in UOP
iii. However, it sought to buy/ acquire the remaining 49.5%

iv. Signal conducted study about buying shares of UOP – study says should receive
$24/share – study was performed by two Signal directors who were ALSO directors of
UOP (dual representation), report used private UOP info to make report.
v. A price of $21/share was voted on and a merger ensued.
vi. This was a hurried and rushed decision – 4 days the decision was made.
vii. This was a breach of the duty because it failed to inform the SH’s of all the information
needed for a merger. Because it failed to be informed and because DE was applied, the
burden switched to the Defendant to prove entire fairness.
1. Fair Dealing – No
i. Four day decision
ii. People sat on both sides of the transaction
iii. Events that should have occurred did not
2. Fair Price – No
i. Plaintiff argued $24 dollars a share
ii. If this had been the value used it would have given the SHs an
additional $17 million.
viii. Court found that there was a breach of the duty and in determining the damages it
compared rescissory damages to SH rights of appraisal.
p. Merger, generally:
i. Under MBCA AND DE law, BODs of both companies must first approve the merger.
ii. Under DE law, the SHs of BOTH companies must approve merger.
iii. Under MBCA approach, the SHs of ONLY the disappearing corporation have to approve
merger, unless surviving corporation is providing more than 20% of its own stock.
q. Coggins v. New England Patriots Football Club, Inc.
i. Each of 10 investors received 10K shares of voting common stock in the corporation.
ii. July 1960, the corporation sold 120K shares of NON-VOTING common stock to the
public at $5/share.
iii. Sullivan had effective control of the C until 1974 when the other voting SHS ousted him
from the presidency and from operating control of the C.
iv. November 1975, Sullivan succeeded in obtaining ownership or control of all 100K voting
shares, at a price of approximately $102/share, of the C, by that time renamed the New
England Patriots Football Club, Inc. (Old Patriots).
1. (Owned all of voting shares of Old Patriots, 100K, but 120K shares of NON-
VOTING shares were outstanding).
v. In order to finance this coup, Sullivan borrowed approximately $5,348,000 from the
Rhode Island Hospital National Bank and the Lasalle National Bank of Chicago. As a
condition of loans, Sullivan was to use his best efforts to reorganize the Patriots so
that the income of the C could be devoted to the payment of these personal loans and
the assets of the C pledged to secure them. At this point, they were secured by all of
the voting shares held by Sullivan.
vi. ***In order to accomplish in effect the assumption by the C of Sullivan’s personal
obligations, it was necessary to eliminate the interest of the non-voting shares.***
vii. October 20, 1976, Sullivan organized a new corporation called the New Patriots Football
Club, Inc. (New Patriots). BODs of the Old Patriots and the BODs of the New Patriots
executed an agreement of merger of the 2 corporations providing that, after the
merger, the voting stock of the Old Patriots would be extinguished, the non-voting
stock would be exchanged for cash at the rate of $15/share, and the name of the New
Patriots would be changed to the Old Patriots. As part of plan, Sullivan gave the New

Patriots his 100K voting shares of the Old Patriots in return for 100S% of the New
Patriots stock.
1. Sullivan was making decisions on both ends.
viii. MA law required approval of the merger agreement by a majority vote of each class of
affected stock. Approval of the voting class, entirely controlled by Sullivan, was assured.
Merger was approved by the class of non-voting SHS at a special meeting on December
8, 1976. On January 31, 1977, the merger of the New Patriots and the Old Patriots
was consummated.
ix. David Coggins was owner of 10 shares of non-voting stock in the Old Patriots. He voted
against merger and commenced this suit on behalf of those SHs, who, like himself,
believed transaction to be unfair and illegal.
x. Coggins didn’t assert his SH appraisal rights, because he is actually contesting the
merger. Coggins requested rescission.
xi. TC didn’t agree to rescind the merger because it was 10 years after the merger.
However, TC allowed rescissory damages.
xii. What type of case is involved here involving Mr. Sullivan?
1. Sullivan was on both sides of the transaction. He didn’t disclose and thus had
to show total fairness.
2. Some cases require a legitimate business purpose.
i. ****DE doesn’t require this but other jurisdictions do. It’s required
in this case.****
a)Don’t know which approach the MBCA would select.
b)Mention both for essay purposes.
ii. According to Sullivan, the business purpose was: (1) to comply w/
NFL’s discouragement of public ownership; (2) difficulty in reconciling
management’s obligations to the NFL w/ its obligations to public SHs;
(3) and the cost and possible revelation of confidential information
resulting from the obligations of publicly owned corporations to file
reports w/ various public bodies.
3. Court did NOT believe Mr. Sullivan. He could comply w/ NFL’s policies w/out
eliminating their rights. TC believed they eliminated their rights because he
needed to pay back his loan. Clearly a breach of loyalty is present.
4. Rescission, generally, on these type of circumstances is appropriate, but
couldn’t do it here. 10 years later.
5. Didn’t even have to get to entire fairness because there wasn’t a legitimate
business purpose.
xiii. How to determine value of recissory damages: KNOW FOR TEST
1. Value Now – Value SH received at time of merger (difference is rescissory
xiv. How to determine value of SH appraisal rights: KNOW FOR TEST
1. What was received at time of merger and what they should have received.
xv. Can enter such a loan covenant as long as it’s for a legitimate business purpose and
there is total fairness.
xvi. Questions: (p. 508)
1. #2 There would have been a legitimate business purpose.
2. #3 This was a direct suit.
r. Problem: Cash Out Mergers (p. 508)
i. S is a SH of the disappearing corporation (T). A is the surviving corporation.
ii. What are the SHs options (4):

1. Sue directors that have approved merger that they have breached their DOC;
i. Act in best interest of C, act in GF, and are informed.
a)Van Gorkum.
2. Sue directors that have approved merger that they have breached their DOL;
3. Vote Against the Merger; or
i. Under both DE and MBCA, S has a right to vote. His vote will NOT
have any power; he can’t stop the merger.
ii. Under MBCA, to vote on FCC, need majority of shares of votes that
are cast.
4. Sue for SH rights of appraisal
i. Not suing to undue merger but suing to state that the amount of
money received is insufficient.
s. Cash Out Merger (MBCA)
i. MBCA – SHAR is exclusive remedy UNLESS the deal was NOT approved in accordance w/
the procedural requirements or was procured as a result of fraud or material
misrepresentation. High standard.
ii. This is a very HIGH threshold – assuming the deal was approved by the proper vote SH
would have to show fraud or misrepresentation to undo the merger.
t. DE
i. No consideration of business purpose. Instead, the burden is on the …..
u. Sale of Substantially All the Assets
i. Sale of substantially all the corporation’s assets is another possible endgame for a
corporation and is a fundamental corporate change, which requires approval by the
BODs AND by the SHs.
ii. Effect of Sale of Assets on the Creditors of the Selling Corporation
1. ***General C/L rule is that the buyer of a corporation’s assets is NOT liable
for the selling corporation’s debts.***
2. A corporation’s sale of assets does NOT automatically terminate its legal
existence. Often, however, sale of all of a corporation’s assets is followed by
that corporation’s dissolution, which DOES terminate its legal existence.
3. Any corporation that is considering dissolution and distribution to SHs will have
to pay off its creditors. A corporation’s failure to do so can make its SHs
personally liable to these creditors.
v. Franklin v. USX Corp.
i. 1996, Franklin was diagnosed w/ peritoneal mesothelioma, which she maintained was
caused by her childhood secondhand exposure to asbestos.
ii. December 1945, assets of WPS were purchased by Consolidated Steel Corporation of
California (Con Cal) for over $6.2M in cash. In connection w/ the sale, Con Cal agreed to
ASSUME all of the liabilities, obligations and commitments of WPS.
iii. August 31, 1948, Con Cal sold transfer assets to Con Del for approx. $8.3M in cash, plus
additional consideration that brought total purchase price to over $17M.
iv. After August 31, 1948, Con Cal changed its name to Consolidated Liquidating
Corporation, which dissolved on February 29, 1952. Alden G. Roach was Con Cal’s
president and chairman of the board at time of sale; after the sale he continued as
president of Con Del.
v. Con Del was later merged into U.S. Steel, which later changed its name to USX.
vi. TC found that the transaction between Con Cal and Con Del constituted a de facto
merger so Con Del assumed the liabilities of Con Cal, which USX then took over after Con
Del merged into it.

1. “Defacto Merger” – not an actual merger, but looks like a merger, TC relied
primarily on the fact that the CEO was same for both companies, was President
and Chairmen of Concal, and then became President of Condel  idea was
Condel was nothing more than an extension of Concal.
vii. TC also found that USX could be deemed to have assumed the liabilities of Con Cal/WPS
under the de facto merger AND under the theory that USX was a mere continuation of
Con Cal.
viii. Linchpen in this case was CONDEL – issue – whether it was a sale of assets to Condel or
a merger?
1. If merger, USX would have assumed Condel’s liabilities
2. If sale of substantially all of the assets, USX would NOT have assumed Condel’s
ix. COA – didn’t agree with TC, said the MOST important factor in determining if
something is a MERGER or SALE OF SUBSTANTIALLY all of the ASSETS is the EXTENT of
1. If you pay adequate consideration – looks more than substantially sale of
2. If you pay less consideration/inadequate consideration – looks more like a
defacto merger (b/c if it’s a merger, the debts and liabilities are passed on to
the acquiring corporation)
x. ASK – is this a defacto merger or is this sale of substantially all of assets?
xi. There was adequate consideration. Seller would have enough to pay off its creditors.
xii. P. 511, Adequate Cash Consideration v. Adequate Stock Consideration:
1. Adequate cash consideration is indicative of a sale of assets.
2. Adequate stock consideration is indicative of either a sale of assets or a
i. If CHC were to issue shares, stronger argument that a merger is
ii. As long as stock was fairly valued, stronger argument that it was a
sale of assets rather than a merger.
xiii. Mere continuation:
1. While those factors are important, the key factor is whether adequate
consideration is paid.
xiv. Adequate Compensation = Sale of Assets
xv. Inadequate Compensation = Merger
xvi. Rule from K Class: Court’s won’t inquire into adequacy of consideration, however, will
look into consideration if it looks like sham consideration.
w. Sale of Assets (DE)
i. Buying Corporation – SHs do NOT have to approve the transaction since the transaction
is NOT an FCC from the BC. Also, NO SHAR.
ii. Selling Corporation – SHs of SC MUST approve because it’s a FCC for the SHs of the SC.
No SHAR for the SHs.
x. Sale of Assets (MBCA)
i. Buying Corporation – SHs do NOT have to approve the transaction since the transaction
is NOT an FCC for the SC UNLESS the corporation is issuing more than 20% of the
corporation’s stock to facilitate the purchase of assets.
ii. Selling Corporation – SHs of SC MUST approve because it’s a FCC for the SHs of the SC.
SHAR for the SHs.
y. Under DE law:

i. Do SHs of the SC have to approve the sale of substantially all the assets? Yes.
1. Under MBCA? Yes.
2. However, under DE, SHs do NOT have SHRA, but under MBCA they do.
ii. Do SHs of the BC have to approve transaction in DE? No.
1. Under MBCA? No. Unless, 20% rule.
z. Hypothetical on p. 514 (CHECK W/ LAURA):
i. Under DE, should treat as a merger, because he could vote in that case.
ii. Can stop merger because has 50% of votes that are entitled to vote.
iii. Would have to argue a de facto merger, would have to show inadequate consideration,
stock consideration.
iv. Under MBCA. Could vote due to 20% rule in both merger and sale of substantially all
of the shares situation. What power does he have, quorum, plus majority of votes
cast? 20% rule also applies in merger situation allowing Capel to vote.
v. Place of incorporation will determine DE or MBCA. MBCA or DE? Merger or Sale of
Sub. All of Assets? Does party have opportunity to vote (due to jurisdiction or 20%

ADD voting part to this chart

Delaware MBCA
Selling Substantially All of Assets
Buying Corporation SHs NO NO (unless corporation is issuing
more than 20% of its own shares
outstanding that are voting)
Selling Corporation YES/No SHAR YES/Yes SHAR
Surviving Corporation SHs YES (THINK TRIANGLE MERGER) NO (unless corporation is issuing
more than 20% of its own shares)
Disappearing Corporation SHs YES/Yes SHAR YES/Yes SHAR
***Note: In DE, must bring a separate action apart from an action apart from a SHAR (ex. Breach of DOC/DOL).
Do NOT have to do this in other jurisdictions (ALI).***

aa. Review:
i. If a 3P is trying to hold a successor in interest liable, would they prefer that the
transaction be structured as a merger or sale of substantially all assets? Merger.
ii. If a SH is trying to stop a FCC, would they prefer that the transaction be structured as a
merger or sale of substantially all assets? Why? Think about the distinction between
DE and MBCA.
1. Depends on whether it’s a FCC for the party. Affected by whether the
jurisdiction and whether the jurisdiction is a surviving or disappearing
corporation or the buying or selling corporation.
2. If DE applies, and member of surviving or disappearing C, can vote. If MBCA,
and member of surviving corporation cannot vote unless 20% rule, but if
disappearing corporation can vote.
3. Then look to SHs in a transaction involving the sale of substantially all of the
bb. Hostile Takeover
i. What is a hostile takeover? Gaining control over a corporation over the objection of that
corporation’s BODs.

1. Also used to describe a proxy or consent solicitation of the targets company’s
SHs. Seeks their support of an effort to replace the incumbent directors.
ii. How is it different than a cash-out merger? In a cash-out merger, the BODs of BOTH
corporations have to approve the merger. In a hostile takeover, there is NO approval by
the BODs. Go directly to the SHs, because the BODs will not approve the takeover.
iii. Acquiring Company or Individual  “bidder,” “raider,” or “shark.”
iv. Company whose stock is targeted for acquisition  “target company.”
v. If target company is a public company, the usual process for acquiring the shares is a
“tender offer.”
vi. “Tender Offer”  bidder makes a public offer of cash or securities of the bidder (or
package of cash and securities) to the target SHs who tender their stock.
vii. Tender offer will usually be conditioned on a sufficient number of the target’s shares
being tendered to ensure that the bidder gains control of the target company.
viii. How does the Shark/Raider/Bidder have standing to sue? They are SHs of the “target
corporation,” and allege that BODs is breaching their fiduciary duty to not allow the
takeover. If NOT a SH, do NOT have standing.
cc. Unocal Corp. v. Mesa Petroleum Co. (Takeover Defenses)
i. Mesa is the shark/bidder.
ii. Unocal Corporation, D, was target of takeover bid by group of related Cs, Mesa, P,
controlled by T. Boone Pickens. P already owned 13% of D’s outstanding stock.
iii. Under P’s “two-tiered,” “front loaded” tender offer, it would (1) pay $54/share in cash
for 64M shares (37% of D’s outstanding stock) AND then (2) would buy remaining stock
of D w/ high risk debt securities described as “junk bonds” and valued at $54/share.
1. Bonds  if have strong company, bond rating will be high. Interest rate will be
low, because more assured of getting paid back.
2. Junk Bonds  high-risk debt securities, high interest rates, won’t necessarily
get money back.
iv. In response, D BODs made “self-tender” (to offer its SHs (or at least some of its SHs)
opportunity to exchange their stock of D for debt).
v. BOD’s decisions were made in reliance on advice of investment bankers. Directors
unanimously approved exchange offer. Resolution provided that if P acquired 64M
shares of D’s stock through its own offer (the Mesa Purchase Condition), D would buy
the remaining 49% outstanding for exchange of debt securities (IOUs) having
aggregate par value of $72/share. Board resolution also stated that the offer would be
subject to other conditions, including the exclusion of P from proposal (the Mesa
1. Unocal deal only kicked in when Mesa purchased 64M shares and thus
obtained 50% of company.
vi. Legal counsel for board advised that under DE law P could ONLY be excluded for what
directors reasonably believed to be a valid corporate purpose. Directors’ discussion
centered on objective of adequately compensating SHs at the “back-end” of P’s proposal
(“junk bonds”). To include P would defeat that goal, because under the proration aspect
of exchange offer (49%) every share of P accepted by D would displace one held by
another SH. Further, if P were permitted to tender to D, the latter would in effect e
financing P’s own inadequate proposal.
vii. What was Unocal’s motivation for excluding Mesa? Unocal would actually be giving
Mesa money they could use to continue their hostile takeover.

viii. D’s exchange offer was commenced on April 17, 1985, and P promptly challenged it by
filing this suit in Court of Chancery.
ix. Vice Chancellor temporarily restrained D from proceeding w/ the exchange offer UNLESS
it included P.
x. Vice Chancellor decided that in a selective purchase of the company’s stock, the
corporation bears the burden of showing: (1) a valid corporate purpose, AND (2) that
the transaction was fair to all of the SHs, including those excluded.
xi. Why did Mesa argue that the board was NOT entitled to BJR protection? Mesa argued
that directors are interested. Directors are allegedly interested because they would
benefit from the self tender offer because their shares would be purchased; to the
exclusion of Mesa.
1. Unocal’s Argument: Board made a decision in this case; self tender and
excluded Mesa. According to Board, decision was in best interests of Unocal.
xii. Can a board oppose a hostile takeover? Yes. Board is charged w/ protecting the
1. However, before can use defensive measures, must determine that there is a
2. To make this determination, MUST act in GF, best interests of corporation, and
be informed.
3. If there is a threat, then they can implement defensive measures, which are
designed to protect the company and to eliminate the threat/takeover.
4. However, the defensive measures MUST be reasonable.
xiii. How do we know if a defensive measure is reasonable?
1. Inadequacy of the price offered;
2. Nature and timing of offer;
3. Questions of illegality;
4. Impact on “constituencies” other than SHs (creditors, customers, employees,
and community);
5. Risk of non-consummation;
6. Quality of securities being offered in the exchange; and
7. Basic SH interests at stake.
xiv. Will a board’s decision to use a particular method to oppose a hostile takeover be
protected by the BJR? Yes, if it’s reasonable.
xv. What was the purpose of Unocal’s defensive measure? Prevent a takeover and
designed to get SHs of Unocal to wait and sell in the self-tender, instead of joining the 1 st
tier of the Mesa Plan.
xvi. “Greenmail”  practice of buying out a takeover bidder’s stock at a premium that is
NOT available to other SHs in order to prevent the takeover.
xvii. Was this defensive measure reasonably related to the threat?
1. P. 520.Factors listed above.
xviii. Did the BOD owe duties to Mesa? Yes because Mesa was a SH. Were they limited by
Mesa’s actions? Yes.
xix. A board’s decision will be protected by the BJR UNLESS decision that there’s a threat
was NOT informed, made in GF basis, or in best interests or C, OR if it was, decision
was unreasonable.
dd. Anti Take Over Provisions (Shark Repellants/Poison Pills)
i. Target adds to its charter a provision which gives the current SHs the right to sell their
shares to the acquirer at an increased price (usually 100% above recent average share
price), if the acquirer’s share of the company reaches a critical limit (usually 1/3). This

kind of poison pill cannot stop a determined acquirer but ensures a high price for the
ii. Target takes on large debts in an effort to make the debt load too high to be attractive –
the acquirer would eventually have to pay the debts.
iii. Company buys a number of smaller companies using a stock swap, diluting the value of
the target’s stock.
iv. Target grants its employees stock options that immediately vest if the company is
taken over. This is intended to give employees an incentive to continue working for the
target company at least until a merger is completed instead of looking for a new job as
soon as takeover discussions begin. However, w/ the release of the “golden handcuffs,”
many discontented employees may quit immediately after they’ve cashed in their stock
options. This poison pill may create an exodus of talent employees. In many high-tech
businesses, attrition of talented human resources often means an empty shell is left
behind for the new owner.
v. Golden Parachute – A clause in an executive’s employment contract specifying that
he/she will receive large benefits in the event that the company is acquired and the
executive’s employment is terminated. These benefits can take the form of severance
pay, a bonus, stock options, or a combination thereof.
ee. Unocal:
i. Before the BODs will receive BJR protection, the BODs must establish:
1. Reasonable grounds to believe that a danger to corporate policy and
effectiveness in making this determination (threat), the BODs must prove that
they (1) acted in GF, (2) on an informed basis and (3 )in the best interests of
the C. Following might meet this test:
i. If tender offer is coercive or inadequate, it meets this test;
ii. Nature and timing of offer;
iii. Questions of illegality;
iv. Impact on constituencies other than SHs;
v. Risk of non-consummation;
vi. Quality of securities being offered in exchange.
2. That the defensive measure was reasonable
ff. Notes:
i. SEC nullified ruling of Unocal. After Unocal decision, the SEC prohibited issuer tender
offers that are NOT made to all SHs.
gg. Chesapeake Corp. v. Shore
i. When Shorewood BOD learned of Chesapeake’s plans, it enacted bylaws to “better
enable the BOD to defend the Company against a hostile takeover.”
ii. Chesapeake made unsolicited tender offer for Shorewood stock. Shorewood board then
implemented a package of takeover defenses, including a supermajority bylaw provision
requiring a 2/3 SH vote to amend its bylaws.
iii. And when the target company’s BOD acts to prevent the takeover, the action is generally
challenged in the courts.
iv. Like Chesapeake, the bidder will already own some of the target’s outstanding shares.
As a SH of the target, the bidder can challenge the actions taken by the target’s board
“to defend the Company against a hostile takeover” as violative of the board’s fiduciary
duties to its SHs.”
v. Court held that the Shorewood directors breached their fiduciary duties in their
response to the Chesapeake takeover threat.
vi. Entity made attempt to make hostile takeover.

vii. Delaware Chancery Court relied in part on Unocal.
viii. Court stated that “a board’s unilateral decision to adopt a defensive measure is strongly
suspect under Unocal, and CANNOT be sustained w/out a compelling justification.
ix. After applying two-step Unocal test, court found that the supermajority bylaw( made
target company less attractive, once shark takes over would be hard to effectuate
goals) was a wholly inappropriate response to Chesapeake’s takeover attempt.
hh. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.
i. Pantry Pride (PP/SC) attempted to acquire Revlon (RV/DC) for a price in range of $40 to
$45/share. RV’s BODs met w/ company’s investment banker who advised them that
$45/share was a “grossly inadequate price” and the company’s special counsel
recommended that RV purchase stock in exchange for notes.
ii. August 23, 1985, PP made its tender offer. August 29, RV commenced its own tender
iii. During September, RV SHs had TOs from PP at $47.50/share in cash and from RV for
Senior Subordinated Notes (“Notes”) w/ face value of $47.50 and 1/10 th of a share of
PS (Total $57.50) w/ a stated value of $100/share for each share.
1. At this point, RV was attempting to protect the company from the shark/PP.
2. At this point, SHs would receive cash and an IOUs.
iv. Notes contained covenants restricting RV’s ability to incur additional debt, to sell
assets, or to pay dividends UNLESS approved by RV’s “independent directors.”
1. Why would the covenants prevent RV from incurring more debt? It would
affect parties ability to get (those who now have IOUs)
v. Other bidders were also making bids to the RV board. On October 3, RV agreed to
leveraged buyout w/ Forstmann Little & Co. (“FLC”) at $56/share in cash. Under terms
of buyout, FLC would assume RV’s debt incurred in the issuance of the Notes and RV
would WAIVE restrictive covenants in the Notes for FLC.
1. Initially, RV was making bids to its own SHs to protect itself from the shark.
However, now FLC jumped in, and it became OBVIOUS to RV’s board that they
were going TO SELL (board now auctioneers/sellers). Duties shift.
2. FLC was considered a white knight (savior of C).
3. Waiver of covenants upset the owners of the IOUs and threatened to sue.
4. Bidding continued.
vi. When RV announced leveraged buyout, it also announced that it would eliminate Note
covenants to facilitate the leveraged buyout and would do the same for any other offer
which provided more than $56/share to RV SHs. After this announcement, value of the
Notes plummeted and people who had tendered their RV stock to RV in exchange for
Notes threatened to sue RV and its board.
vii. FLC said it would w/draw new offer if it were NOT immediately accepted and imposed
1. “No-Shop Clause”;
i. RV wouldn’t shop around for more attractive deal.
2. “Break-Up Fee”; and
i. RV would pay FLC $25M if deal fell through.
3. “Lock Up” of the “Crown Jewels”
i. FLC had an option to buy 2 divisions of RV (Vision Care and National
Health Laboratories), exercisable for $525M when any other person or
group acquired 40% of RV’s shares.
viii. RV accepted FLC’s offer and PP sued.

ix. TC enjoined certain transactions designed to thwart efforts of PP to acquire RV. TC ruled
that such arrangements are NOT illegal per se under DE law, but that their use under the
circumstances here was impermissible.
x. What was the problem here? What is the “No-Shop Clause?” RV wouldn’t shop around
for more attractive deal. “Break-Up Fee?” RV would pay FLC $25M if deal fell through.
“Lock Up” of the “Crown Jewels?” FLC had an option to buy 2 divisions of RV (Vision
Care and National Health Laboratories), exercisable for $525M when any other person or
group acquired 40% of RV’s shares.
xi. At time recognized they were going to cease to exist, board of RV knew they were
auctioneers and should get best price. By agreeing to FLC’s terms, affectively stopped
the auctioning process. Can agree to 1 one of 3 as long as you are getting the best
xii. Unocal duties kick in when C is trying to protect itself.
xiii. Revlon duties kick in when C is attempting to sale.
xiv. Were the Unocal duties implicated at any point, and if so, when? Yes. During the 1st
initial offer by PP for $40-$45 because RV was trying to protect itself. Was there a
legitimate threat? Yes. Was that defensive threat proportionate to the threat? Yes. If
PP brought a suit at that point, RV board would have been protected under the Unocal
duty and the BJR.
ii. Revlon
i. Situations that implicate Revlon Duties:
1. When a corporation initiates an active bidding process seeking to sell itself or
to effect a business reorganization involving a clear break-up of the company.
2. Where in response to a bidder’s offer, a target abandons its long-term
strategy and seeks an alternative transaction involving the break-up of the
company or CHANGE OF CONTROL (company owned by the public then control
becomes centralized).
ii. However if a BOD’s reaction to a hostile tender offer is found to constitute only a
defensive response and not an abandonment of the corporation’s continued existence,
Revlon duties are NOT implicated.
jj. Paramount Communications, Inc. v. Time, Inc.
i. Paramount was able to sue because they are a SH of Time.
ii. Two plaintiffs in this case: Paramount and SHs of Time.
1. Principal grounds for reversal, asserted by ALL Ps, is that Paramount’s June 7,
1989 uninvited all-cash, all-shares, fully negotiable (though conditional) tender
offer for Time triggered duties under Unocal and that Time’s BODs, in
responding to Paramount’s offer, breached those duties. Ps argue that in DE
SC’s review of Time’s BOD’s decision of June 16, 1989 to enter into revised
merger agreement w/ Warner, Time is NOT entitled to benefit and protection of
2. SH Ps assert claim based on Revlon. Argue that original Time-Warner merger
agreement of March 4, 1989 resulted in change of control which effectively put
Time up for sale, thereby triggering Revlon duties. Those Ps argue that Time’s
board breached its Revlon duties by failing, in face of change of control, to
maximize SH value in immediate term. Base argument on 2 facts:
i. Ultimate TW exchange ratio of .465 favoring W, resulting in W SHs’
receipt of 62% of combined company; and

ii. Subjective intent of D’s directors saying that market might perceive TW
merger as putting D up “for sale” and their adoption of various
defensive measures.
iii. Paramount had offered $175/share and then $200/share (market value was $126/share).
iv. Why didn’t SHs just sell their shares to Paramount for $200/share? Purchase of shares
may have been conditioned upon a tender upon a certain number of shares.
v. 1st agreement: “confidence” letters, no-shop clause,
vi. However, Time was not going to cease to exist. Time wanted to keep control of Time-
Warner Corporation.
vii. Did the merger go through the first time? No because Paramount made their
announcement right after announcement of 1st merger. When Paramount made their
offer, Time investigated the offer and determined that the price was inadequate and
would pose threat to Time culture. SHs of Time wouldn’t understand the short-term
versus long-term benefit.
1. Would if Board was wrong? TW merger makes stock plummet. Just because
the Board made bad decision doesn’t mean they won’t get protection from BJR,
as long as decision was made in GF, decision-makers were informed, and acted
in best interest of corporation.
viii. Time went back to Warner and made new offer. D’s BODs decided to recast its
consolidation w/ W into an outright cash and securities acquisition of W by D. D would
now make an immediate all-cash offer for 51% of W’s outstanding stock at $70/share.
Remaining 49% would be purchased at some later date for mixture of cash and securities
worth $70/share. To provide funds required for its outright acquisition of W, D would
assume $7-$10B worth of debt, thus eliminating one of principal transaction-related
benefits of the original merger agreement. $9B of total PP would be allocated to
purchase of W’s goodwill.
ix. W agreed to new terms but sought control premium and guarantees that governance
provisions found in original merger agreement would remain intact. D was assured of
its ability to extend its efforts into production, all the while maintaining D identity and
x. Why did Time make this 2nd offer? Adopted a defensive measure to make themselves
less attractive.
xi. However, then Paramount made their $200/share offer. Time again rejected
Paramount’s offer due to long-term benefit of Warner deal and maintaining culture of
xii. Revlon situation: Court said Revlon duties were not initiated. Time was not going to
disappear. If Revlon duties were applicable, Time would become an auctioneer. If
Revlon duties had been implicated here, then there would be a violation here.
xiii. Paramount’s Argument: Breach of Unocal duties. Paramount arguing that Time is
trying to protect itself. Must first analyze if there is a threat. Must meet tri-part duty,
must be informed, act in GF, and act in best interests of C. Paramount said their offer
wasn’t a legitimate threat. Used 2-tier tender offer in Unocal to show a threat and that
pricing in Unocal wasn’t adequate. Paramount distinguished facts of Unocal by saying
their offer wasn’t two-tier or coercive, and was adequate. What did court determine
was the actual threat? Threat to Time’s culture. Time was informed, acted in GF, and
acted in a true belief that they were doing what was best for C. Therefore, the Time

BOD accurately determined a threat. Then must move to whether Time’s defensive
measures were reasonable based on the threat. Yes, it was reasonable.
kk. Paramount Communications Inc. v. QVC Network, Inc.
i. Action arose out of proposed acquisition of PC by V through a TO, followed by a 2 nd step
merger (PC-V transaction) and a competing unsolicited TO by QVC.
ii. Paramount initially was trying to purchase other entities such as Time.
iii. Paramount recognized that they needed to link w/ something, and that was Viacom.
iv. Original merger agreement w/ Viacom. Why wasn’t final at that point? Still must pass
by votes of SHs.
v. August 20, 1993, discussions between PC and V resumed. Parties negotiated in earnest
in early September, and performed due diligence w/ the assistance of their financial
advisors. September 12, 1983, PC BOD met and unanimously approved the Original
Merger Agreement:
1. Each share of PC C/S would be converted into .10 shares of V Class A voting
stock, .90 shares of V Class B non-voting stock, and $9.10 in cash;
2. PC BOD agreed to amend its “poison pill” Rights Agreement to exempt
proposed merger w/ V;
3. “No-Shop” Provision;
i. PC would NOT solicit, encourage, discuss, negotiate, or endorse any
competing transaction UNLESS:
a)3P makes unsolicited, bona-fide proposal, which isn’t subject
to any material contingencies relating to financing; and
b)PC BODs determines that discussions or negotiations w/ 3P
are necessary for PC BODs to comply w/ its fiduciary duties.
4. Termination Fee;
i. V would receive a $100M termination fee if:
a)PC terminated the OMA because of a competing transaction;
b)PC’s SHs did NOT approve the merger; or
c) PC BODs recommended a competing transaction.
5. Stock-Option Agreement
i. Granted V option to purchase approximately 19.9% (23.699M shares)
of PC’s outstanding C/S at $69.14/share if any of triggering events for
TF occurred.
ii. Two provisions:
a)Note Feature = V permitted to pay for shares w/ a senior
subordinated note of questionable marketability instead of
cash; and
b)Put Feature = V could elect to require PC to pay V in cash a
sum equal to difference between PP and MP of PC’s stock.
vi. Poison Pill: designed to make the target less attractive.
vii. Puts provisions in AOC and bylaws.
1. As part of agreement w/ Viacom. To make Viacom more comfortable,
paramount agreed to eliminate poison pills.
viii. QVC jumped into the scene and offered $80/share. Had to show they had financial
ability to finance offer and gave information to Paramount.
ix. Viacom came up w/ new offer.
x. QVC publicly announced offer. Wanted stock-option agreement invalidated.
xi. Viacom realized that it needed to modify its offer. Original agreement was in place
between Paramount and Viacom.

xii. QVC came in and puts offer on table and necessitates that Viacom up its offer. What
happened to original agreement, not in agreement. Did Viacom do anything about 3
previous positions? No.
xiii. QVC doesn’t have to agree to the other 3 provisions but Paramount didn’t leverage
this out of Viacom.
xiv. What duty was implicated here? Revlon or Unocal?
1. Revlon. It was clear that Paramount was going to cease to exist.
2. Under Revlon, BOD has a duty to maximize SH value. Didn’t do this here.
Instituted defensive measures.
3. Revlon duty was implicated because have a break-up and change of control.
xv. Only quantitative analysis of the consideration to be received by the SHs under each
proposal was based on then-current MPs of the securities involved, NOT on the
anticipated value of such securities at the time when the SHs would receive them.
ll. What do the Revlon duties require?
i. BOD are analogous to an auctioneer.
ii. Can still utilize defensive measures as long as designed to get best price.
mm. When do Unocal duties kick in?
i. Threat of takeover and want to continue existence of company.
ii. Can utilize defensive measures.
nn. Poison Pill: Example
i. Poison pill – the target company issues rights to existing SHs to acquire a large number
of new securities, usually CS or PS. The new rights typically allow holders (other than a
bidder) to convert the right into a large number of CS if anyone acquires more than a set
amount of the target’s stock (typically 10 to 20%). This dilutes the percentage of the
target owned by the bidder, and makes it more expensive to acquire control of the
target. This form of poison pill is sometimes called a SH rights plan because it provides
SHs (other than the bidder) w/ rights to buy more stock in the event of a control
oo. Lyondell Chemical Co. v. Ryan
i. Case: DOL and Breach of GF in breach of DOL context.
ii. Lyondell Chemical Company (LCC) was 3rd largest independent, publicly traded chemical
company in NA. Dan Smith (Smith) was LCC’s Chairman and CEO. LCC’s other 10
directors were independent.
iii. Basell AF (BAF) is privately held Luxembourg company owned by Leonard Blavatnik (B)
through his ownership of Access Industries. BAF is in business of polyolefin technology,
production and marketing.
iv. Initial offer:
1. April 2006, B told Smith that BAF was interested in acquiring LCC. BAF sent
letter to LCC’s board offering $26.50-$28.50/share. LCC determined that price
was inadequate.
v. What was important in May of 2007:
1. May 2007, Access affiliate filed a Schedule 13D w/ the SEC disclosing its rights
to acquire an 8.3% block of LCC stock owned by Occidental Petroleum
Corporation. Schedule 13D also disclosed B’s interest in possible transactions
w/ LCC.
vi. Section 13(d) of the Securities Exchange Act of 1934 requires anyone who acquires
more than 5% of a company’s stock to file a Schedule 13D that reveals the ownership
interest. Such a filing often causes the market price of the company’s stock to increase,

because the filing may indicate that someone may be considering an attempt to acquire
the company.
vii. In response to Schedule 13D, LCC BOD immediately convened “special meeting” where
it recognized that 13D signaled to market that company was “in play,” but directors
decided to take a “wait and see” approach (on day 13D was made public, LCC’s stock
went from $33 to $37/share).
viii. Apollo Management LP contacted Smith to suggest management-led LBO, but Smith
rejected proposal.
1. What’s an LBO? Leveraged buyout.
2. What’s a management leveraged buyout? Self tender (remember Unocal).
This would be a defensive measure.
ix. June 2007, BAF announced that it had entered into $9.6B merger agreement w/
Huntsman Corporation, specialty chemical company. Hexion Specialty Chemicals, Inc.
made topping bid for Huntsman.
x. July 9, 2007, B met w/ Smith to discuss all-cash deal at $40/share. Smith said that was
too low and B raised offer to $44-$45/share. Smith said he would go back to BOD w/
bid, but said was still too low. Later that day B and Smith talked and B offered to pay
$48/share. Under B’s proposal, BAF would require no financing contingency, but LCC
would have to agree to a $400M break-up fee and sign merger agreement by July 16,
1. Gave BODs 7 days.
xi. Smith called “special meeting” of LCC BOD on July 10, 2007. Meeting lasted an hour
and BOD reviewed valuation material that had been prepared by LCC management.
BOD discussed BAF’s offer, status of Huntsman merger, and likelihood that another party
might be interested in LCC. BOD instructed Smith to obtain written offer from BAF and
more details about BAF’s financing.
xii. B agreed to BODs request, but also made additional demand. BAF had until July 11 to
make higher bid for Huntsman, so B asked Smith to find out whether the LCC board
would provide a firm indication of interest in his proposal by the end of that day. LCC
board met on July 11 for less than 1 hour and decided that it was interested, authorized
retention of Deutsche Bank Securities, Inc., as its financial advisor, and instructed Smith
to negotiate w/ B.
xiii. Why would the directors be deemed interested? The directors’ alleged financial
interest is the fact that they would receive cash for their stock options.
xiv. From July 12-15, parties negotiated terms of LCC merger agreement; BAF conducted due
diligence; DB prepared a “fairness” opinion; and LCC conducted its regularly scheduled
board meeting. LCC BOD discussed BAF proposal again on July 12, and instructed Smith
to try to negotiate better terms. Specifically, BOD wanted higher price, go-shop
provision, and reduced break-up fee.
1. Go-Shop Provision benefits the target company.
2. Even though there was a no-shop provision, could still shop. Why? What was
in no-shop provision? Can shop unless it violates your fiduciary duties.
xv. B agreed to reduce break-up fee from $400M to $385M.
xvi. July 16, 2007, BOD met to consider BAF merger agreement. LCC’s management and
financial and legal advisers presented reports analyzing merits of deal. Advisors
explained that, notwithstanding no-shop provision in merger agreement, LCC would be
able to consider any superior proposals that might be made because of the “fiduciary
out” provision. DB said that the proposed merger price was fair (an absolute “home-

run”). LCC BOD voted to approve merger and recommended it to SHs. At special SHs
meeting held on November 20, 2007, merger was approved by more than 99% of the
voted shares.
xvii. LCC’s charter included an exculpatory provision protecting directors from personal
liability for breaches of the DOC.
xviii. Plaintiff was a SH who argued a breach of Revlon duties, and lists claims on bottom of
p.559. TC dismissed all claims except those directed at the process by which the
directors sold the company and the deal protection provision in the merger
xix. Were the Revlon duties implicated? Does fact that company is “in play” trigger the
Revlon duties? NO. When did the Revlon duties trigger? Time for action under Revlon
did NOT begin until July 10, 2007, when the directors began negotiating the sale of LCC.
xx. Were there facts to suggest that the BOD failed to meet their DOC, such that a
directors’ SJ would not be appropriate as there would be material facts at issue? Yes.
May of 2007, board members knew they were in play, but they decided to wait and see.
Could have done more. Directors only spent a few days in determining whether to
merge. However, board members were well informed, utilized DB, there was another
1. This court said they couldn’t find this way.
xxi. However, court said they didn’t have to discuss DOC issue because placed exculpatory
clause in AOI, protecting the directors from personal liability for breaches of the DOC.
xxii. Court discusses GF and DOL, but we have never discussed this.
xxiii. Why did the Ps characterize this as a breach of the DOL, specifically GF? Generally in
DOL, will be an argument that directors were interested. Court didn’t believe directors
were interested. Trying to circumvent DOC argument. Court didn’t accept this argument
and didn’t find a breach of DOL.
xxiv. Was there evidence that they acted in BF? No. Evidence was contrary to that. The
directors were active, sophisticated, and generally aware of value of company and
conditions of the markets in which company operated. They had reason to believe that
no other bidders would emerge, given price BAF had offered and the limited universe of
companies that might be interested in acquiring LCC’s unique assets. Smith negotiated
the price up from $40 to $48/share, a price that D B opined was fair. Finally, no other
acquirer expressed interest during the 4 months between merger announcement and
the SH vote.
xxv. When did Revlon Duty Kick-In:
1. When BAF sent letter to LCC asking for $26.50/share?
i. Revlon didn’t kick in. Said wasn’t for sale.
2. Schedule 13D submission and recognition that they were “in play?”
i. NO. Didn’t decide they were going to sell or break-up.
3. July 9, B met w/ Smith to talk about all-cash deal: $48/share?
i. NO. CEOs are discussing bids, doesn’t mean up for sale.
4. July 10, BOD meeting, asking for formal written offer?
i. NO. Can argue LCC was just investigating. Sale of business is NOT
5. July 11, BOD meeting?
i. NO. Still considering option of remaining independent. Only kick in
when change of control.
6. July 12, BOD wanted a higher price, reduced break-up fee, and go-shop

i. Getting closer for Revlon duty to kick in.
7. When it was clear company has ceased to exist, LCC had met their Revlon duty.
IX. Chapter Nine – What is a Limited Partnership and How Does it Work?
a. Entities are based on state laws. LLC is the best type of entity.
b. Limited Partnership:
i. What is a LP? P that has one or more general partner and the other partners are limited
ii. What is difference between a GP and LP? All partners in a GP are jointly and severally
liable in K and in tort. In a LP, the limited partners are only liable for their contributions.
However, the general partner is still jointly and severally liable in K and in tort.
iii. A general partnership (GP) has ONLY general partners.
iv. General partners in a LP have the same rights and duties as partners in a GP.
v. LPs have been said to be “linked” to P law.
vi. A LP is subject to federal securities laws such as 10b-5 and state securities laws.
vii. Even if the CLP meets requirements of state’s LP law, that document alone will NOT meet
the requirements of your clients. More important document to your clients is the
limited partnership agreement.
viii. What two laws govern LP? UPA bc gen partner) and RULPA (Know 1976 version)
ix. If PA is silent, look to the RULPA, if that is silent then look to ULPA.
x. 10(b)5 applies to P. When discussing concept of ownership, it can be read to include
xi. How does a LP come into existence? Must file w/ state, Certificate of Limited
Partnership. Why? Because have to put public on notice that there is limited liability.
xii. Limited partners in a LP are similar to a SH in a C. Limited liability. Liability as to what
they invested in C.
xiii. What document controls relationship between partners? Partnership Agreement.
c. Corporations v. Partnerships:
i. Generally, SHs are NOT personally liable for the debts of a business structured as a
corporation. However, partners are liable for the debts of a business structured as a P.
ii. Generally, there are NO statutory constraints on a corporation’s SHs selling to a 3P her
ownership interest. What is the exception to this rule? CHC. There are however
significant statutory constraints on a partner selling his partnership interest to a 3P.
iii. A partner is statutorily empowered to trigger the P buyout of his rights as a partner
through w/drawal. There is NO general C statute counterpart to w/drawal. Except for
the limited situations that trigger a dissenting SHAR, a SH is NOT statutorily empowered
to trigger the corporation’s buyout of her ownership interest. What exceptions to this
rule have we discussed?
d. Limited Partnership Statutory Requirements:
i. LP must have at least one general partner.
ii. The general partner in a LP is liable for the debts and obligations of the P.
iii. The name of the general partner MUST be included in the “Certificate of LP.”
iv. ALL PARTNERS WILL BE LIABLE. Limited partners are NOT personally liable. General
partners are PERSONALLY LIABLE. If you commit tort, still liable for intentional torts and
negligence (your own torts).
v. Although RULPA does NOT require that there be a written LPA, almost all LPs have
detailed written agreements. In particular, these agreements define relative roles of the
limited partners and the general partner(s).
vi. The LP statutes do NOT that the general partner be a natural, flesh-and-blood person.
e. LP General Partners:

i. Who would want to serve as a general partner given that the given partner is liable for
the debts and obligations of the P? General partner maintains the control.
1. Not entirely true anymore due to Safe-Harbor Provisions.
ii. What can the partner do to limit the liability of the general partner? (CANNOT enforce
agreement limiting rights of 3Ps.)
1. Create an LLP (limited liability partnership – no one has to be a general P)
(There the general partner may file w/ the secretary of state a certificate
telling the world that the general partner will NOT be personally liable for
what the business does);
2. Make a Corporation serve as the general partner in the LP.
f. LP/GP
i. Who makes decision in LP, absent agreement? General partner.
ii. Do limited partners in a LP generally have right to vote? No. But can add the ability to
vote. (302 and 303).
iii. What happens if a limited partner exercises too much control? Becomes like general
partner and becomes joint and severally liable.
iv. What are the control safe harbor provisions? 303
1. Allows a limited partner to do certain things w/out incurring joint and several
v. RULPA Section 303(b):
1. A limited partner does not participate in the control of the business within the
meaning of subsection (a) solely by doing one or more of the following:
i. being a contractor for or an agent or employee of the limited
partnership or of a general partner or being an officer, director, or
shareholder of a general partner that is a corporation;
ii. consulting with and advising a general partner with respect to the
business of the limited partnership;
iii. acting as surety for the limited partnership or guaranteeing or
assuming one or more specific obligations of the limited partnership;
iv. taking any action required or permitted by law to bring or pursue a
derivative action in the right of the limited partnership;
v. requesting or attending a meeting of partners;
vi. proposing, approving, or disapproving, by voting or otherwise, one or
more of the following matters:
a)the dissolution and winding up of the limited partnership;
b)the sale, exchange, lease, mortgage, pledge, or other transfer
of all or substantially all of the assets of the limited
c) the incurrence of indebtedness by the limited partnership
other than in the ordinary course of its business;
d)a change in the nature of the business;
e)the admission or removal of a general partner
f) the admission or removal of a limited partner;
g)a transaction involving an actual or potential conflict of
interest between a general partner and the limited
partnership or the limited partners;
h)an amendment to the partnership agreement or certificate of
limited partnership; or

i) matters related to the business of the limited partnership not
otherwise enumerated in this subsection (b), which the
partnership agreement states in writing may be subject to the
approval or disapproval of limited partners;
vii. winding up the limited partnership pursuant to Section 803; or
viii. exercising any right or power permitted to limited partners under this
[Act] and not specifically enumerated in this subsection (b).
vi. What if a limited partner is a director/officer/SH of a corporate general partner?
(303(b)(1)) Can be one of mentioned and NOT be subjected to joint and several liability.
vii. Can partners by agreement limit liability of a general to 3Ps? No.
viii. Can a limited partner ever be personally liable? Yes. Must satisfy two-prong test. See
g. LP 3P Liability:
i. Under RULPA, a limited partner participating in (1) control is ONLY liable to persons who
transact business w/ the limited partnership (2) reasonably believing, based upon the
limited partner’s conduct, that the limited partner is a general partner. RULPA 303(a).
Thus, limited partners may NOW participate in management w/ impunity so long as
they DISCLOSE to 3Ps their limited partner status.
ii. Also, can get to limited partner who commits a tort (intentional tort or negligence).
h. Questions, p. 581: #2 Yes. Might like DE law better.
i. Questions, p. 585:
i. #3: NO LIABILITY. Did the party exercise control. Look at Section 303. Can serve as an
agent and employee w/out deemed to exercise control. Clark can’t think of hypo where
a limited partner can do an act that doesn’t fall under 303.
j. When thinking about SHs in a C and limited partners in a LP, how does their liability compare?
Limited partners’ personal liability is more clearly defined, and more difficult to get to, than
piercing the corporate veil in a C.
k. Who Decides What?
i. Answer to this question is found in the LP statute and the LPA.
ii. Generally, the answer will be that the general partner decides.
1. RULPA establishes this as the default rule.
l. Zeiger v. Wilf
i. Who signed the K for property (PP of $3.84M for real estate, a liquor license, and
miscellaneous assets)? Trenton Inc.
ii. Parties agreed that P would receive a consulting fee of $27K/year, payable monthly for
16 years. P wasn’t expected to devote much time or effort to project. P was also to
receive from project 2 ½ percent of annual net cash flow after debt service.
iii. Closing was on March 4, 1986. Trenton, Inc., was purchaser and signed consultant
agreement w/ P. K documents authorized C to assign its property interests, as well as
consulting K, to another entity, and did that by assignment to a LP named Goldberger,
Moore & Novick, Trenton, L.P. (Trenton L.P.)
iv. LP began anticipated renovation and operation of hotel/office building.
v. Trenton L.P. consisted of 1 general partner – Trenton Inc. TI owned 4.9% of LP. It had 4
limited partners: entity known as Midnov (owned by Novick and Goldberger), which
held 42.7% interest; another entity called Capitol Plaza Associations (CPA), controlled by
Wilf and family and which owned 42.7%; George Albanese owned 5.1%; and P owned

vi. Stock of TI was owned 50% each by Midnov and CPA. Goldberger became was
president; Wilf was VP; Novick was secretary/treasurer; and Bernadette Lynch was
assistant secretary.
vii. TLP has duty to pay for property and P his consulting fee.
viii. Can’t get to M, CPA, and GA because they are limited partners.
ix. P’s 1st recourse would be against TLP. TLP went bankrupt (judgment proof). TIC went
bankrupt (judgment proof).
x. P is trying to get to M and CPA as SHs of TIC who is the general partner.
xi. P argued that because CPA controlled TIC, who was general partner, then he should have
joint and several liability.
xii. Two arguments here: (1) CPA was limited partner that exercised control (303 ruled this
out); and (2) CPA as SH of TIC, TIC was on hook as entity that formed initial K and was a
general partner of TLP (would have to PCV: undercapitalization or alter ego, K claim,
might have to show fraud), didn’t discuss this here.
xiii. Ownership doesn’t determine how profits and losses are split. Absent agreement,
profits and losses will be split evenly/equally. (CHECK W/ LAURA, THIS IS RULE FOR GP
m. To the Partnership and Partners
i. A general partner in a LP has liability exposure NOT only to 3Ps for obligations of the LP,
BUT ALSO to the LP AND to the limited partners for breach of fiduciary duties.
ii. The PA can alter a general partner’s liabilities to the P AND other partners.
n. Kahn v. Icahn
i. Ps, who are limited partners and minority SHs of a DE LP, allege the usurpation of a P
ii. Ps bring this action derivatively on behalf of American Real Estate Partners, L.P. (AREP)
against AREP’s general partner American Property Investors, Inc. (API), the general
partner’s sole SH and CEO, Carl Icahn (Icahn), and Bayswater Realty and Capital Corp.
(Bayswater), a C affiliated w/ Icahn, and API’s other directors.
iii. Ps are holders of “depository units” representing LP interests of AREP. AREP is DE LP,
whose business is conducted through a subsidiary. AREP is in business of acquiring and
managing real estate. AREP has 2 classes of depository units – “Depository Units” and
“Preferred Units.”
iv. AREP’s general partner, API, is a DE C. D Icahn is Chairman and CEO of API, and owns
100% of that company’s stock.
v. Icahn, through another DE P, High Coast LP, owned 54.1% of the Depository Units of
AREP and over 88% of the Preferred Units.
vi. Ps allege that D Bayswater is a real estate and investment company owned and
controlled by Icahn.
vii. Ps assert claim for usurpation of P opportunities, or opportunities that rightfully
belonged to the LP. Ps’ complaint alleges that Icahn breached his fiduciary duties to
AREP and usurped, for himself, a corporate opportunity of AREP by failing to make the
opportunities completely available to AREP and, instead, keeping a percentage of the
profits for Bayswater and other affiliates. Ps identify 2 specific transactions that they
claim qualify as AREP’s missed opportunities:
1. Investment in another real estate LP, Arvida. Investment was made through
number of entities, but AREP received 70% of potential AREP share of
investment and Bayswater received 30% of the investment.

2. Stratosphere, which owns and operates the Stratosphere Tower, Casino & Hotel
in Las Vegas, NV. AREP invested $42.8M to purchase certain mortgage notes of
Stratosphere, w/ face value of $55M. An affiliate of Icahn purchased $39M face
value of those notes. Ps have represented that Stratosphere has filed a
voluntary plan of reorganization and AREP and the Icahn affiliate have
submitted a proposal for the restructuring of Stratosphere that would entail
additional investments.
viii. Ds argue that the complaint fails to state a claim. Principal contention is that AREP’s
PA provides that API, the general partner, may “compete, directly or indirectly w/ the
business of the Partnership.”
1. Is this type of provision allowable in a P (LP or GP)? Yes.
2. Is this type of provision allowable in a Corporation? No.
ix. LPs give the partners more flexibility and control. P law is a function of K law and thus
can determine obligations and burdens of partners.
x. NOT necessarily a violation of Meinhard. It’s consistent w/ Meinhard. Only thing
different is that there is a provision allowing D to do what they want to do.
xi. In determining whether there was a corporate opportunity here, court applies the
line-of-business test in this case:
1. The opportunity is either essential to the C or is one in which it has an interest
or expectancy;
2. The corporation is financially able to take advantage of the opportunity itself,
3. The party charged w/ taking the opportunity did so in an official rather than
individual capacity.
xii. Court says that it’s NOT at issue whether there was a corporate opportunity here, didn’t
have to discuss this issue.
xiii. However, did this Court believe that a corporate opportunity was present here?
1. There are NO factual allegations from which the court might infer that any of
the Ds received the investment opportunities in an official capacity and then
used that information for individual gain.
2. Thus, there MAY NOT be a corporate opportunity.
xiv. ****TAKE-AWAY: In a P in general (both GP and LP, because Ps are a function of K law),
can modify the DOLs, CANNOT DO THIS IN A CORPORATION. Limitation must be in an
agreement, default rules will apply if not agreed to.****
xv. Ps respond by saying that there’s a legal distinction, cognizable in the present case,
between competing w/ the P and usurping the P’s opportunities. Court does NOT agree.
xvi. Notes: Notice that the Ps, limited partners, brought this action derivatively for the LP.
RULPA provides for such derivative actions in Article 10. Derivative actions by limited
partners have been recognized and required even in states w/out such provisions.
o. In Re USACafes, L.P.
i. October 1989, Metsa Acquisition Corp. purchased substantially all of the assets of
USACafes, L.P., a DE LP at cash price of $72.6M or $10.25/share.
ii. Review:
1. Whether or not debts/obligation/liabilities will be assumed by C that
purchased the assets? C would want this treated as sale of substantially all of
the assets because don’t assume debts/obligations/liabilities. P would want
this to be a merger.
2. Whether SH, whether a merger or sosaa, are the SH of DC or SC
3. DE or MBCA, SHRA.

ii. Merger
a)SHs of DC have SHRA under DE and MBCA. In DE, If also
alleging that there was another problem, must bring a
separate suit as to breach of DOC and DOL. In MBCA, bring
one suit.
4. Must have a quorum present. Voting.
iii. Ps are holders of LP units. Ps brought these cases as class actions on behalf of all LP unit-
holders except Ds.
iv. LP was formed in 1986 reorganization of the business of USACafes, Inc., a NV C. Also
formed as part of the of the reorganization was USACafes General Partners, Inc. (GP), a
DE C that acts as the general partner of the LP. Both the LP and GP are named as Ds in
this action. 2nd category of Ds is composed of Sam and Charles Wyly, brothers who
together own all of stock of the GP, sit on its board, and who also personally, directly
or indirectly, own 47% of the LP units of the LP. Sam Wyly chairs Board of the GP. 3rd
category of Ds are 4 individuals who sit on BODs of GP.
v. 2 Theories of the Amended Complaint:
1. Alleged breach of the DOL. Claims that the sale of the LP’s assets was at a low
price, favorable to Metsa, because the directors for the GP all received
substantial side payments ($15-$17M) that induced them to authorize the sale
of the LP assets for less than the price that a fair process would have yielded. It
alleged that in connection w/ the sale:
i. Wylys received from Metsa more than $11M in payments disguised as
consideration for personal covenants not to compete;
ii. GP received a $1.5M payment right in consideration of the release of a
claim that Ps asset was non-existent;
iii. D, Rogers, director of the GP and President of the LP was forgiven the
payment of a $956,169 loan from the LP and was given an
employment agreement w/ the LP that contemplated a $1M cash
payment in event, then imminent, of a “change in control”;
iv. D, Tuley, also director of GP, was forgiven repayment of a $229,701
loan; and
v. Other directors were given employment agreements providing for
$60K payment in event of a change in control.
2. GP was NOT sufficiently informed to make a valid BJ on the sale. Breach of the
vi. Wyly Ds and other director Ds moved under 12(b)(6) to dismiss the breach of fiduciary
duty claims in the amended complaint. Ds asserted that, while the general partner
admittedly did owe fiduciary duties to the limited partners, they as directors of the
general partner owe NO such duties to those partners.
vii. What is the critical issue in this case?
1. The general partner owes a DOC and DOL to the LP. Because they all of the
power and control.
2. ***Whether directors/majority(controlling) SHS of a corporate general
partner owe fiduciary duties to the LP and its limited partners.***
viii. Holdings:
1. The amended complaint DOES allege facts which if true establish that the
director Ds have breached fiduciary obligations imposed upon them as directors

of a DE C or have participated in a breach of such duties by the GP. The
amended complaint does state a claim upon which relief can be granted.
ix. Directors/majority(controlling) SHs of a corporate general partner OWE a fiduciary
duty to the LP.
1. Not sure about where general partner also owes duty to limited partners.
i. It makes sense that there should be a duty owed here. Court grounds their decision in
the law of corporate trust. The directors and officers of a corporate trustee are in a
fiduciary relation NOT merely to the corporation but to the beneficiaries of the trust
administered by the corporation. The theory underlying fiduciary duties is consistent w/
recognition that a director of a corporate general partner bears such a duty towards the
LP. That duty extends ONLY to dealings w/ the P’s property or affecting its business.
ii. The principle of fiduciary duty is to be that one who controls property of another may
NOT, w/out implied or express agreement, intentionally use that property in a way that
benefits the holder of the control to the detriment of the property or its beneficial
iii. Here the LP is analogous to the beneficiary in trust law.
iv. How far does the duty take us? Don’t know.
v. Here there were facts to determine a breach of the duty.
vi. Is this case consistent w/ Kahn? Yes. The difference was that there was an agreement
to limit the duties in Kahn.
vii. Questions, note 3, p. 604:
1. Hotel Inc is a general partner of Hotel LP. Shepherd is a director of Hotel Inc. As
an attorney, what would be my advice for Shepherd? Determine how he came
across the opportunity; whether approached as director or as a part of Hotel LP.
What if he just heard about it over dinner? Can give it to anyone w/out liability.
Clark really doesn’t know. Must look at more case law.
p. How do the Owners of a Business Structured as a Limited Partnership Make Money?
i. Partners in a LP make money in 3 ways:
1. Dividend (depends on Ks and K law)
2. Salary (depends on Ks and K law)
3. Sell of an interest (depends in part on whether buyer is the LP or a 3P and
whether the seller is a general partner or a limited partner)-remember that the
sale of an interest only carries w/ it a right to receive a dividend.
ii. In LP, file w/ state, in GP, no filing.
iii. In GP, absent agreement (default rule) = profit/losses are distributed equally to each
iv. In LP, absent agreement (default rule) = profit/losses are distributed in proportion to
the contributions of each partner.
q. Transfer of Ownership Interest to a Third Party
i. Sale of an ownership interest in a LP to a 3P by either a general or limited partner is
governed by RULPA.
ii. RULPA limits a limited partner’s ability to sell her LP interest to a 3P by limiting what
such a 3P will get – distribution rights, but NO MANAGEMENT or INFORMATION RIGHTS
UNLESS the LPA otherwise provides.
iv. In an LP, what interest will be conveyed when a limited partner or general sells their
interests? Right to receive a dividend.
v. No right to management, unless PA says can.

vi. In a GP, what interest will be conveyed when a general partner sells their interest? No
right to management, unless PA says can.
vii. Questions, p.606:
1. Dealing w/ LP. P is a general partner. P sells all of his interest to Roberts in LP.
Will Roberts have right to participate in management? NO. Only has right to
receive distributions/profits/losses. Will P continue to have power to
manage? NO. What if P sells a 50% share of his P interest to Roberts?
Roberts will NOT have right to participate in management (unless PA says
otherwise). What about P? Still has right to participate in management.
2. Conclusion: If P sells entire interest, he doesn’t retain interest and can’t
maintain management control. If sell 50% interest, still retains an interest and
maintains management control.
viii. In GP, if sell entire interest, still retain management control.
ix. Sale of Ownership (RULPA) Section 702. Assignment of P Interest:
1. Applies to LP.
2. Interest. Except as provided in the PA, a P interest is assignable in whole or in
part. An assignment of a P interest does NOT dissolve a LP or entitle the
assignee to become or to exercise any rights of a partner. An assignment
entitles the assignee to receive, to the extent assigned, only the distribution to
which the assignor would be entitled. Except as provided in the PA, a partner
CEASES to be a partner upon assignment of all his/her partnership interest.
x. Uniform Partnership Act 1914 Section 27
1. Applies to GP.
2. Even if sell entire interest, STILL will be able to participate in management.
i. (1) conveyance by a partner of his interest in the P does NOT of itself
dissolve the P, nor, as against the other partners in the absence of
agreement, entitle the assignee, during the continuance of the P, to
interfere in the management or administration of the P business or
affairs, or to require any information or account of P transactions, or to
inspect the P books; but it merely entitle the assignee to receive in
accordance w/ his K the profits to which the assigning partner would
otherwise be entitled;
ii. (2) in case of a dissolution of the P, the assignee is entitled to receive
his assignor’s interest and may require an account from the date only
of the last account agreed to by all the partners.
3. If assignor maintains control, still could be liable. Party should withdraw if no
longer wants to be held liable for P’s debts.
xi. IN BOTH LP AND GP, if a partner sells his/her interest, 3P will NOT get right to
management UNLESS PA provides otherwise.
xii. Hypo: Could have situation where have 3 partners, Clark sells interest to X. 1 st question.
Dealing w/ GP, X does NOT have right to participate in management. Clark will still have
right to participate in the management. Next day, P injures someone. Clark would still
be personally liable because he’s a partner. Clark should withdraw. If Clark withdraws,
must ask if it’s in contravention of PA. Possible discussion regarding dissolution, winding
up, liquidating, termination.
r. Transfers of Ownership Interest to Limited Partnership
i. RULPA, like RUPA, contains default rules regarding an owner’s right to force the business
to buy her ownership interest.

iii. RULPA speaks of “withdrawal” instead of “dissociation” (RUPA).
iv. RULPA default rules differ in Section 602 and 603, depending on whether the person
who is w/drawing is a general partner or a limited partner.
v. RULPA makes it clear that a general partner can w/draw AT WILL, while a limited partner
MUST give 6 months’ written notice (unless the PA said otherwise).
vi. ***Key w/ Ps, must 1st determine if it’s a GP or a LP. If a GP, must find out if it’s at will or
for a particular time or purpose.****
vii. Withdrawal:
1. In a LP, can a general partner withdrawal at will? Yes. Must still make
distinction whether the LP is at-will or NOT at-will.
i. Example:
a)Form LP and purpose is to sell t-shirts (EXPLAIN TO LAURA,
THIS SEEMS A LITTLE CONFUSING). It’s P to sell t-shirts. Can
leave and doesn’t necessarily mean you will cause harm to P
and be liable for damages.
ii. However, assume the LP says that the P will last for 5 years. General
partner leaves in year 2 but will liable for the damages he causes.
2. When can a limited partner? A limited partner can leave but there are
LIMITATIONS on a limited partners’ ability to leave. Must give notice. Do they
ever have to provide notice of withdrawal? Yes. If so, how much notice is
required? ***6 months.***
viii. Withdrawal:
1. General partner can w/draw at will. If she breaches the PA the LP can sue her.
RULPA 602.
2. Limited partner CAN w/draw according to the terms of the PA. If the PA is
silent the LP MUST give 6 month’s notice to each general partner before
withdrawing. RULPA 603. Why? Primary purpose of limited partner is to
provide money/funds. If can leave w/out notice, can frustrate the purpose of
the LP.
ix. If a LP w/ 1 general partner and he leaves, can the LP continue?
1. It depends. Someone has to step up and become the general partner AND the
limited partners HAVE TO ALL AGREE to continue the LP.
x. Questions: p. 606, Bottom Section of Questions and Notes:
1. #2:
i. (a) What options do A and C have if they want the business to
continue? One must step up as general partner and must
unanimously agree to continue the LP.
ii. (b)What options do A and C have if they want the business to end?
Don’t do one of the above.
2. #3 P is a limited partner AND a general partner. P withdraws as general
partner, but does NOT want the LP to continue. Remaining partners must make
unanimous agreement to continue, if P doesn’t want LP to continue he can
cause the LP NOT to continue.
3. #4 A can w/draw but must provide 6 months notice to each general partner.
i. Would the answer be different if the PA were for a term of years?

xi. ***If have 3 general partners in a LP, 1 general partner withdraws, the LP will continue
and no unanimous vote is needed.***

If in a Limited Partnership
Type of LP General Partner Limited Partner
Partnership at-will General partner can leave at-will. Limited partner can leave at-will after providing 6
months notice to the general partners.

Partnership for a General partner can leave at-will, but Limited partner CANNOT leave at-will, even if
Term of Years OR might be liable for damages. provide notice, CANNOT LEAVE until the term of
Particular Purpose: years ends or the particular purpose is fulfilled.

s. If a LP ends, limited partners don’t want to continue or don’t appoint a new general partner, then
must go through dissolution, winding up, liquidation, termination (same as for a GP).
t. Example: If a LP comes to an end. 5 partners. 1 partner contributed 80% and other 4
contributed 20%. Partner 1 will take away 80% and other 4 will take away 5%. Won’t be tested if
there’s a shortfall, but will likely be tested on a split from the profits.
u. Example: If a GP comes to an end. 5 partners. 1 partner contributed 80% and other 4
contributed 20%. Each partner will take away 20%.
X. Chapter 10 – What is a Limited Liability Company and How Does it Work?
a. What is the primary source of LLC law? Contract law.
b. What is the operating agreement? Sets out rules that govern the relationships of the members
of an LLC. Analogous to the bylaws in a C and the PA in a P.
c. What are the articles of organization? Document that is filed that brings company into
existence. Similar to AOI or Certificate of Incorporation.
d. How is an LLC formed? File the articles of organization (AO) w/ the State.
e. What are the benefits of operating a business as an LLC? Limited liability and pass through. As
an LLC can elect to be taxed as a C or a P. Default status is to be taxed as a P.
f. An LLC offers all of its owners, generally referred to as “members,” BOTH:
i. Protection from liability for the business’ debts similar to the liability protection of SHs
of a C; AND
ii. The same pass-through income tax characteristics of a P.
g. Must the name of the business reflect that it is being operated as an LLC? Yes. P. 610, question
#2. In NC, under the ULLCA, LC would be sufficient. In DE, LC would NOT work, MUST say LLC.
h. What is a member managed LLC? Members/owners manage the LLC. Members make all
decisions. It looks a lot like what other entity we have studied? Partnership.
i. What is a manager managed LLC? Managers manage the LLC. Managers are elected by the
members/owners. It looks a lot like what other entity we have studied? Corporation.
j. Does a manager have the ability to bind the LLC? Equivalent to the BOD or the officers.
Manager would have the ability to bind the LLC.
k. What about a member? Yes, even if have member-managed or manager-managed LLC. Because,
they are like partners and thus agents, as long as acting w/in scope.
l. Authority:
i. Each member of an LLC is an agent of the LLC for purposes of its business and an act of a
member, including the signing of an instrument in the company’s name for apparently
carrying on in the ordinary course of the company’s business binds the company UNLESS
(1) the member had NO authority from the company and (2) the person w/ whom the

member was dealing knew or had notice that the member lacked authority (DON’T
ii. General Rule, member can bind, UNLESS, see above.
m. Distinction between manager and member-managed LLCs:
i. In a member-managed company, the OA will answer such questions as: (1) how to
determine how many votes each member has and (2) how to determine what matters
require more than majority vote.
ii. In a manager-managed company, the OA will answer questions such as (1) how
members elect and remove managers and (2) what issues require a member vote.
n. Delaware Limited Liability Company Act has strong influence on LLC law a more LLC are organized
under DE law than under law of any other state. National Conference of Commissioners on
Uniform State Law (NCCUSL) issued a Uniform Limited Liability Company Act (ULLCA) in 1996.
o. ****Don’t have to know the DE LLC statute, just have to know the ULLCA. ****
p. ULLCA Section 103: Effect of operating agreement: non-waivable provisions
i. (b) All members of a LLC may enter into an operating agreement, which NEED NOT be in
writing, to regulate the affairs of the LLC and the conduct of the business, and to govern
relations among the members, managers, and company. To extent operating agreement
does NOT otherwise provide, this Act governs relations among the members, managers,
and company.
ii. Comment: (b) makes clear that the only matters an operating agreement may NOT
control are specified in subsection (b). An operating agreement may modify or eliminate
any rule specified in any section of this Act EXCEPT matters specified in (b).
q. The most important document in the business is the “Operating Agreement.”
r. Interests in GPs are NOT subject to federal securities laws, while the interest in LPs and Cs are.
What about LLCs? Still debatable.
s. Who is Liable to Whom for What?
i. Members’ Liability to Third Parties:
1. An LLC is an entity. It can carry on “any lawful business purpose or activity.”
2. An LLC can incur debts from the actions and inactions of its managers or its
3. Creditors of an LLC can collect their claims from the earnings and other assets
of the company.
4. LLC statutes protect the owners from personal liability for these claims against
the company.
5. Protection from liability for the company’s debts extends to ALL members.
6. Members are protected from liability ONLY for the company’s debts. Thus, a
member is PERSONALLY LIABLE for her OWN CONDUCT, even when she is acting
for the company.
t. Webber v. United States Sterling Securities, Inc.
i. Retail Relief, LLC is a LLC organized under laws of DE. Michelle Master Orr and her
husband Shawn are members. Orrs sent an unsolicited fax advertisement to P on behalf
of Retail Relief. Sending such a fax advertisement violated a federal law, and violations
of that law are treated as torts.
ii. P sued the Orrs individually. The Orrs, here referred to as Ds, moved for SJ, alleging that
they could NOT be held personally liable because they were acting on behalf of Retail
iii. Plaintiff wanted to hold the Orrs personally liable. Ds argued that we are members of
the LLC and thus should be protected from personal liability.

iv. ***This is a simple rule: Who committed the intentional act? The Orrs. You will be
liable for your own wrongdoing/tort.***
v. Suppose some other member had sent the transmission. Orrs would NOT be liable
due to the limited liability provided by the LLC.
vi. Was Retail Relief, the LLC, also liable here?
1. Intentional torts are ALWAYS outside the scope UNLESS (REMEMBER AGENCY
principles) they are specifically requested or w/in the scope (?).
2. Member WAS acting w/in their scope of employment. Basic agency principles.
3. Retail Relief WOULD BE LIABLE.
vii. Question #3, p. 614: Epstein would NOT be liable. Would be protected because it was
an LLC.
u. Notes: Under principles of C law, the limited liability of a SH of a CHC is limited by the concept of
piercing the corporate veil. Question of whether courts will similarly pierce the veil of an LLC is
the most frequently litigated question of LLC law. In some states, LLC statutes do NOT expressly
address this question. In other states, like WA, statute is clear: The members of an LLC shall be
personally liable for any act, debt, obligation, or liability of the LLC to the extent that SHs of a WA
business C would be liable in analogous circumstances.
v. In re Suhadolnik
i. Michael Suhadolnik filed for Chapter 7 bankruptcy relief. He’s what both the Bankruptcy
Code and this bankruptcy court call a “Debtor.” Before filing for bankruptcy, Debtor
allegedly owned and controlled a LLC, Chatham. Denmar Builders, Inc., claims that
Chatham is indebted to Denmar, and that the Debtor is personally liable for this debt
owed by Chatham to Denmar because the Debtor treated Chatham as his alter ego
and, thus, the court should pierce the veil of the LLC.
ii. Issue: Whether the members of an LLC receive protection of the corporate veil.
iii. Denmar could sue Chatham because they had a K. Chatham was probably insolvent.
iv. Denmar was trying to impose liability on Debtor because he argued that he and the LLC
were one in the same.
v. Debtor relied upon the Illinois Limited Liability Act which specifically provides that an
individual is NOT personally liable for the debts of an LLC solely because that individual is
a member or manager of the LLC or because the LLC has not observed required
vi. What was Debtor’s argument? Took Act a step further and contended that members in
an LLC will NEVER be liable.
vii. Court disagreed w/ Debtor’s argument. Creating a super business entity which would
shield all wrongdoing and bar all civil COAs against controlling owners of LLCs even for
the most egregious acts of fraud or other wrongdoing would serve no public purpose.
ix. An LLC is less formal than a corporation.
x. Holdings: Veil piercing is available w/ respect to members and managers of IL LLCs
under traditional veil piercing theories such as alter ego, fraud, or undercapitalization
(but NOT failure to follow corporate formalities (i.e. annual meetings)).
w. ULLCA § 404. Management of limited liability company:
i. (a) In a member-managed company:
1. each member has equal rights in the management and conduct of the
company's business; and
2. except as otherwise provided in subsection (c), any matter relating to the
business of the company may be decided by a majority of the members.

ii. (b) In a manager-managed company:
1. each manager has equal rights in the management and conduct of the
company's business;
2. except as otherwise provided in subsection (c), any matter relating to the
business of the company may be exclusively decided by the manager or, if there
is more than one manager, by a majority of the managers; and
3. a manager:
i. must be designated, appointed, elected, removed, or replaced by a
vote, approval, or consent of a majority of the members; and
ii. holds office until a successor has been elected and qualified, unless
the manager sooner resigns or is removed.
iii. (c) The only matters of a member or manager-managed company's business requiring
the consent of all of the members are:
1. the amendment of the operating agreement under Section 103;
2. the authorization or ratification of acts or transactions under Section 103(b)(2)
(ii) which would otherwise violate the duty of loyalty;
3. an amendment to the articles of organization under Section 204;
4. the compromise of an obligation to make a contribution under Section 402(b);
5. the compromise, as among members, of an obligation of a member to make a
contribution or return money or other property paid or distributed in violation
of this [Act];
6. the making of interim distributions under Section 405(a), including the
redemption of an interest;
7. the admission of a new member;
8. the use of the company's property to redeem an interest subject to a charging
9. the consent to dissolve the company under Section 801(b)(2);
10. a waiver of the right to have the company's business wound up and the
company terminated under Section 802(b);
11. the consent of members to merge with another entity under Section 904(c)(1);
12. the sale, lease, exchange, or other disposal of all, or substantially all, of the
company's property with or without goodwill.
iv. (d) Action requiring the consent of members or managers under this [Act] may be taken
without a meeting.
v. (e) A member or manager may appoint a proxy to vote or otherwise act for the member
or manager by signing an appointment instrument, either personally or by the member's
or manager's attorney-in-fact.
x. Questions, p.612: #2: In an LLC, who makes the decision?
i. First must determine whether you have a member or manager-managed LLC.
1. If manager-managed:
i. Generally, majority vote needed by managers, if more than one. If
just one, he/she can make the decision by himself/herself. There are
certain circumstances, 404(c), where a unanimous vote is required.
2. If member-managed:
i. Generally, majority vote needed by members. There are certain
circumstances, 404(c), where a unanimous vote is required.
ii. ULLCA Section 404:
1. Default rule: in a member-managed company, each member has equal rights
doesn’t depend on contribution.

2. Default rule: in a manager-managed company, each manager has equal rights
in the management and conduct of the company’s business.
i. Except as otherwise provided in subsection (c), any matter relating to
the business of the company may be exclusively decided by one
iii. Only need majority vote in this example.
y. LLC Fiduciary Duties:
i. Members in a member managed LLC OWE fiduciary duties.
ii. Managers in a manager managed LLC OWE fiduciary duties; however, members in a
manager managed LLC generally do NOT owe fiduciary duties. Why? Because
members in a manager-managed LLC are like SHs in a C.
z. Questions, p. 618:
i. #4: BB’s, a GP, enters a 5-year lease w/ L&L Realty for its restaurant location. After
one year, the business converts to an LLC.
1. A. Is the lease still enforceable? Yes. Against whom? The LLC AND the
members of the LLC. Under GP, partners were jointly and severally liable,
members in the LLC will now ALSO be jointly and severally liable.
2. B. Would my answer change if the GP had dissolved and the proprietors then
formed an LLC? Technically the LLC would NOT be liable because when the GP
was ended, all the creditors were paid off. Members of the LLC are obviously
not liable as well. GP ceased to exist after dissolution, winding up, and
i. However, if there was a deficiency in paying back creditors, a judgment
would be against the GP and partners of the GP. LLC and its members
would still not be liable.
aa. Lynch Multimedia Corporation v. Carson Communications, LLC
i. Manager-managed LLC:
1. Members in a manager-managed LLC do NOT owe fiduciary duties, but the
managers might.
ii. Parties were involved in JV LLC (CLR Video). One of companies (Lynch Multimedia) sued
1 of other member companies, its owners, and its agent, alleging that they breached the
operating agreement and various fiduciary duties when they independently acquired
other cable franchise, rather than securing them for CLR Video.
iii. Here, Carson is a President and just a manager.
iv. Carson is NOT liable in this case.
v. Under Operating Agreement (OA) of November, 1995, CLR has 3 owners: (1) Lynch
Multimedia; (2) Rainbow Communications and Electronics; and (3) the Robert C. Carson
vi. CLR has a Board of Managers which manages its business.
vii. Under the OA, Lynch names 3 managers, and Rainbow and Carson Trust each name 1.
viii. Robert C. Carson was president of CLR. OA gives President general and active
management of CLR’s business, and carries out orders and resolutions of the Board of
ix. Two Important Provisions of the OA:
1. Section 11.4 – Other Cable Systems:
i. Any opportunity which comes to the attention of a Member to
purchase cable television systems (i) in Kansas from Cablevision of TX,
Tristar Cable, Inc. or Falcon Cablevision; and (ii) in Atchison, Brown,
Clay, Cloud, Doniphan, Jackson, Jefferson, Nemaha, Leavenworth,

Marshall, Ottawa, Pottawatomie, Republic, Riley and Washington
counties in KS shall be 1st offered to the Company.
2. Section 11.2 – Other Interests:
i. Any Member of Manager may engage independently or w/ others in
other business ventures of every nature and description. Neither the
Company nor any Member shall have any right by virtue of the
Agreement or the relationship created hereby in or to any other
ventures or activities in which any Member of Manager is involved or
to the income or proceeds derived therefrom. The pursuit of other
ventures and activities by Members or Managers is hereby consented
to by the Members and shall NOT be deemed wrongful or improper.
x. Carson learned in 1996 that Falcon might be for sale. According to P, at subsequent
meeting of members in fall of 1996, members approved possible acquisition of Falcon,
along w/ potential purchase of 2 other cable systems (Galaxy and Tristar). After 1996
meeting, Carson learned that cable systems owned by Westcom (successor of Tristar)
and Galaxy might become available for purchase.
xi. August or September of 1997, Carson informed Lynch reps of Westcom and Galaxy
opportunities at meeting at Lynch Corporation headquarters. Also discussed at October
26 and 27 meeting.
xii. According to Lynch, it encouraged Carson to acquire these companies. Carson objects
that “encouragement” is too strong a term, they merely suggested continued study of
target companies.
xiii. Carson and P reps met on April 4, 1998. Members discussed acquisition of Falcon,
Westcom, and Galaxy. By end of meeting, no agreement had yet been reached w/ F, W,
or G about buying their cable systems.
xiv. October 7, 1998, Carson wrote to Dolan, proposing 2 plans for acquiring F and W.
November 11, he sent term sheet to Gabelli (Lynch rep), proposing to acquire F and W.
He submitted another term sheet to Dolan on December 30, 1998, which proposed
acquisition of F and W properties BUT which attached terms NOT contained in the CLR
OA, and which would require changes in the OA. Among the proposed changes was an
increase in his salary, continuation as President of CLR, and an increase in the value of
his equity interest upon the sale of his interest to other members.
xv. March or April of 1999, Carson purchased the F and W cable systems for HIMSELF.
xvi. Issues: Whether the D violated the OA and any fiduciary duties.
xvii. Holdings: The SJ motion of the defendants MUST be granted, and the court found,
under the facts presented here, there was NO violation of the operating
agreement/fiduciary duties.
xviii. Rules: Under KS law, the members of a LLC may EXPAND or RESTRICT their duties and
liabilities by the terms of their agreement.
xix. Defendant’s Contention:
1. Any duty under Section 11.4 was met when he notified or told other members
of the CLR Video that certain opportunities existed.
xx. Plaintiff’s Contention:
1. Carson could NOT fulfill the duty created by Section 11.4 UNLESS he presented
the other members w/ a no-strings-attached purchase offer at a properly called
special meeting of the members. Carson violated this obligation, according to
Lynch, because he sought to add terms to any acquisition of the target

companies and because there was NO formal meeting informing Carson that he
could acquire the companies for his own.
xxi. Court didn’t agree w/ P’s contention. Court read 11.4 and 11.2 together and only duty
Carson had was to tell CLR the opportunity was there.
xxii. What if 11.2 and 11.4 were NOT implicated here? Possible violation of Carson’s
fiduciary duties.
1. Here, this was a usurpation of a corporate opportunity . Under ALI, must
disclose or abstain. Once disclosed, company must reject the offer for Carson
to be able to take opportunity.
xxiii. Questions, p. 621: #3
1. A. 1st step. This is a manager-managed LLC. E is a member and doesn’t owe
any fiduciary duties. E doesn’t have a duty to disclose. He can take the
2. B. Stronger argument that E is considered a manager, and if so, he would have
a fiduciary duty to the LLC and must disclose or abstain.
bb. How do the Owners of a Business Structured as a Limited Liability Company Make Money?
i. Usually, the operating agreement provides how and when a LLC’s earnings are to be
distributed to its members. Statutory provisions on distributions are only default rules.
ULLCA Section 405 provides that any interim distributions must be in equal shares and
approved by all members.
ii. Most important limitation on a member’s making money by selling her interest for more
than she paid for it is imposed by the market. It’s usually difficult to find a buyer for an
interest in a small business or even large business that has relatively few owners.
iii. Even if a member of a LLC is able to find a buyer for her interest, her ability to sell may
be limited by statute or by the operating agreement or by both. Statutory provisions
relating to a member’s sale of her ownership interest are likely to be a default rule.
iv. Making Money in an LLC:
1. How are distributions made and approved absent agreement?
i. Any interim distributions must be in equal shares and approved by all
members (P.622, ULLCA Section 405).
cc. Lieberman v. Wyoming.Com LLC
i. September 30, 1994, Steven Mossbrook, Sandra Mossbrook, and Lieberman created LLC by filing Articles of Organization.
ii. Initial capital contributions were valued at $50K: (1) Lieberman invested $20K, to consist
of services rendered and to be rendered, Lieberman had a 40% ownership interest; (2)
and (3) Mossbrooks were vested w/ remaining $30K capital contribution and 60%
ownership interest.
iii. August of 1995, Articles of Organization were amended to reflect increase in
capitalization to $100K. Increase in capitalization was result of addition of 2 members,
each of whom was vested w/ capital contribution of $25K, representing a 2.5%
ownership interest for each new member.
iv. Despite increase in capitalization, Lieberman’s ownership interest, as well as his stated
capital contribution, remained the same.
v. February 27, 1998, Liebermann was terminated as VP of Other members
met same day and approved and ratified the termination.
vi. March 13, 1998, Lieberman served and its members w/ document titled
“Notice of Withdrawal of Member Upon Expulsion: Demand for Return of Contributions
to Capital.” Lieberman’s notice demanded the IMMEDIATE RETURN of his share of the

current value of the company, estimating the value of his share at $40K, based on recent
offer from Majority SH.
vii. Members of held special meeting on March 17, 1998, and accepted
Lieberman’s withdrawal. Members also elected to continue, rather than dissolve, Members approved return of Lieberman’s $20K capital contribution.
viii. Lieberman refused to accept the $20K when it was offered.
ix. DC ruled that, because the remaining members of LLC agreed to continue
the business under a right to do so in the Articles of Organization, the company was NOT
in a state of dissolution.
x. Paragraph 9 of the AO of LLC permits continuation:
1. 9. Continuity. The remaining members of the LLC, providing they are 2 or more
in number, will have right to continue business on death, retirement,
resignation, expulsion, bankruptcy or dissolution of a member or occurrence
of any other event which terminates the continued membership of a member
in this LLC, in accordance w/ the voting provisions of the OA of the Company.
xi. 1st issue about capital contribution (CC): But this wasn’t before the court because the
LLC agreed to give him back his initial CC. Wyo. Stat. Ann. Section 17-15-120 specifically
says “withdrawal or reduction of members’ contributions to capital.”
xii. Idea that even if member w/draws his CC, he might still be a member.
xiii. Distinction is made:
1. Member w/draws CC and does NOT necessarily mean w/drawing from LLC,
still wants to be a member; or
2. Member w/draws from LLC, and this is a dissociation.
xiv. Court determined that WY statute only deals w/drawal of the CC and NOT actual
membership. Clear that P is entitled to $20K.
xv. Does CC include the FMV? Court did not agree. Because it’s clear the statute is only
speaking about withdrawal of the contribution.
xvi. Court did say different jurisdictions treat this issue differently.
xvii. Example:
1. Create LLC. A and B each contributed $50K. LLC pays A and B back $50K each.
CC is no longer still in LLC, but both still are members in the LLC.
xviii. What is the rule under the ULLCA?
1. Provides for member dissociation and the LLC’s purchase of the dissociating
member’s distributional interest at fair market value, unless the operating
agreement otherwise provides.
xix. In this case, the P was trying to dissociate. If ULLCA controlled, he would have received
the FMV ($400K), UNLESS the OA provided otherwise.
xx. Holdings:
1. There was NO dissolution, and Lieberman is NOT entitled to distribution of
assets as he claimed.
2. Lieberman CANNOT compel dissolution under Section 17-15-120(d)(i).
3. SC of WY affirmed the DC’s determination that is NOT in a state
of dissolution and that Lieberman is entitled to the return of his CC, $20K.
However, questions remain regarding Lieberman’s equity interest, which was to
be represented by his membership certificate. This case is thus remanded for a
full resolution of the controversy between the parties.
xxi. Rules:
1. Wyo. Stat. Ann. Section 17-15-123(a)(iii): Requires that, upon w/drawal of a
member, the LLC must dissolve unless all the remaining members of the

company consent to continue under a right to do so stated in the articles of
2. Wyo. Stat. Ann. Section 17-15-120. Withdrawal or reduction of members’
contributions to capital.
i. (a) Member shall NOT receive out of LLC property any part of his or its
contribution to capital until:
a)(i) all liabilities of the LLC, except liabilities to members on
account of their contributions to capital, have been paid or
there remains property of the LLC sufficient to pay them;
b)(ii) the consent of all members is had, unless the return of the
contribution to capital may be rightfully demanded as
provided in this act;
c) (iii) the AO are cancelled or so amended as to set out the
w/drawal or reduction.
ii. (b) subject to provisions of (a) of this section, a member may rightfully
demand return of his or its contribution:
a)(ii) unless otherwise prohibited or restricted in the OA, after
the member has given all other members of the LLC prior
notice in writing in conformity w/ the OA. If the OA does NOT
prohibit or restrict the right to demand the return of capital
and NO notice period is specified, a member making the
demand MUST give 8 months prior notice in writing.
iii. (d) Member of a LLC may have the LLC dissolved and its affairs would
up when:
a)(i) Member rightfully but UNSUCCESSFULLY has demanded
the return of his or its contribution.
dd. Lieberman v. Mossbrook (Lieberman III)
i. Undisputed that L w/drew his membership from W and demanded return of his CC on
March 13, 1998. It’s now undisputed that in accordance w/ his demand, W wrote him
$20K check and cancelled his membership certificate on April 16, 1998. From that date,
L’s investment in the company as represented by his capital account was 0 and he was
NO longer a member. He did, however, retain his equity interest in the sense that he
remained entitled to his share of the company’s earnings while he was an investor.
ii. L’s situation is different from that of a transferee. Paragraph 4.3 of OA dealing w/
transfers of shares does NOT address the situation where a member’s CC has been
returned. In a transfer, the CC remains w/ the company and the transferee receives the
ownership interest commensurate w/ the CC.
iii. Article VI, paragraph 6.2, of the W OA provided that upon liquidation of any member’s
interest in the company, liquidating distributions were to be made in accordance w/ the
members’ positive capital balances.
iv. 6.2 provides that the members’ capital accounts were to be credited w/ the amount of
money the member had contributed, the fair MV of property the member contributed
and the member’s distributive share of company income and gain; the members’ capital
accounts were to be debited w/ the amount of money the company distributed to the
member, the fair MV of property distributed to the member and the member’s
distributive share of company loss and deduction.
v. In L’s notice of w/drawal, in March 1998, he demanded $400K in payment for his interest
in L’s demand stated the $400K was based on a recent offer from the

majority SH, but there was no evidence in record supporting that valuation of L’s
ownership interest. Other than his unsupported $400K demand, L presented no
evidence of the value of his equity interest as of the date he w/drew.
vi. Mossbrooks contend that a January 25, 1998, offer to purchase Mr. Mossbrook’s interest
represents best estimate of W’ value at time L w/drew. Based upon purchase offer, an
independent appraiser retained by Mossbrooks valued L’s equity interest on date of his
w/drawal at $100K. Subtracting from that amount the $20K returned tl L as his CC and
the $7,965 paid to him in September 1999, appraiser concluded L’s equity interest
amounted to $72,035. No evidence was presented refuting appraisal.
vii. Issues: Whether Lieberman’s equity interest was converted by LLC.
viii. Holdings:
1. The DC correctly concluded that L established the elements of conversion as a
matter of law.
2. The value of L’s interest MUST be measured by his share of the value of the
company at the time he WITHDREW and received his CC, together w/ interest
on that amount. In that manner he is made whole and placed in the same
financial position he would have been had the wrong NOT been committed.
3. The value of Lieberman’s interest at the time and place of the conversion was
$72,035 together w/ interest at the rate of 7%/year from the date of his
ix. Rules: The goal in awarding damages is to make the injured party whole to the extent
that it’s possible to measure an injury in terms of money. An injured party is made
whole when he is placed in the same financial position he would have been in had the
wrong not been committed.

Entity Duty of Care Duty of Loyalty

Corporation Can eliminate/limit (except for CANNOT ELIMINATE
intentional or grossly negligent acts)
Partnership (General or Limited) Can eliminate/limit Can eliminate/limit
Limited Liability Company Can eliminate/limit Can eliminate/limit