Marika Fain

Skeel, Corporations Fall 2016

Table of Contents
I. ENTERPRISE FORMS ........................................................................................................................................... 4
A. Types of Business Entities: .......................................................................................................................................... 4
B. Background on Attributes of a Corporation: ........................................................................................................ 8
C. Attributes of a Corporation: ........................................................................................................................................ 9
1. Separate, Perpetual Legal Personality/Entity ................................................................................................................... 9
2. Limited Liability for all participants: ..................................................................................................................................... 9
3. Transferability of Interest:...................................................................................................................................................... 10
4. Centralized Management: ....................................................................................................................................................... 10
5. Managers are Appointed by Equity: Shareholders appoints managers ............................................................... 11
II. INCORPORATION ............................................................................................................................................. 11
A. Corporation Foundational Documents: ................................................................................................................ 11
1. Articles of Incorporation: essential, core foundational document, very hard to change.............................. 11
2. Bylaws: the operating rule of the corporation DGCL §109 ....................................................................................... 11
3. Shareholder Agreements:........................................................................................................................................................ 11
B. Where to Incorporate ................................................................................................................................................. 12
Dodge v. Ford ............................................................................................................................................................................................................. 12
Hobby Lobby .............................................................................................................................................................................................................. 13
III. STOCK ISSUANCE, DIVIDENDS, & DEBT .................................................................................................. 14
A. Debt and Equity ............................................................................................................................................................. 14
B. Modigliani-Miller Irrelevance Theorem .............................................................................................................. 17
C. Dividends and Disclosure: General Background ............................................................................................... 18
D. Dividends Tests:............................................................................................................................................................ 20
E. Piercing the Corporate Veil ....................................................................................................................................... 22
Sea Land Services, Inc. v. The Pepper Source .............................................................................................................................................. 23
Kinney Shoe Corp v. Polan ................................................................................................................................................................................... 23
Walkovszky v. Carlton ........................................................................................................................................................................................... 24
IV. STRUCTURE OF/DECISION MAKING WITHIN CORPORATION ........................................................ 24
A. Background: ................................................................................................................................................................... 24
B. Authority of Officers .................................................................................................................................................... 24
White v. Thomas ....................................................................................................................................................................................................... 25
Gallant Ins. Co. v. Isaac ........................................................................................................................................................................................... 26
C. Shareholder Voting ...................................................................................................................................................... 27
D. Electing and Removing Directors ........................................................................................................................... 29
1. Annual election of directors is a shareholders’ foundational and mandatory voting right ........................... 29
2. Number of directors on board must be in bylaws, unless it is in certificate DGCL §141(b)......................... 29
4. Voting Methods: Straight Voting vs. Cumulative Voting: ........................................................................................... 29
5. Frequency of Voting for Directors: Unitary Board vs. Staggered Board .............................................................. 29
6. Newly Created Director Vacancies: DGCL §223: unless otherwise provided for by certificate or bylaws,
when there are director vacancies bc of newly created directorships: ........................................................................ 30
7. Removal of Directors: DGCL 141(k).................................................................................................................................... 30
8. HYPO: Un-Fireable CEO: .......................................................................................................................................................... 30
E. Director Voting .............................................................................................................................................................. 31
F. Proxy Voting.................................................................................................................................................................... 31
Rosenfeld v. Fairchild Engine & Airplane Corp .......................................................................................................................................... 32
G. Shareholder Information Rights ............................................................................................................................. 33
Pillsbury v. Honeywell, Inc. ................................................................................................................................................................................. 33
H. Techniques for Separating Control from Cash Flow Rights .......................................................................... 34
1. Circular Control Structures: DGCL §160(c) / Spieser.................................................................................................. 34

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 Speiser v. Baker ........................................................................................................................................................................................................ 34
2. Vote Buying ................................................................................................................................................................................... 35
Schreiber v. Carney ................................................................................................................................................................................................. 35
Perry Mylan ................................................................................................................................................................................................................ 36
3. Controlling Minority Structures ........................................................................................................................................... 36
I. Federal Proxy Regulation ........................................................................................................................................... 37
7. Rules 14a-1 – 141-7 ................................................................................................................................................................... 38
J. Proxy Access: ................................................................................................................................................................... 41
K. Proxy Fraud .................................................................................................................................................................... 42
Virginia Bankshares, Inc. v. Sandberg ............................................................................................................................................................. 44
V. FIDUCIARY DUTY ............................................................................................................................................. 44
A. Overview .......................................................................................................................................................................... 44
B. Duty of Care .................................................................................................................................................................... 45
1. Background: .................................................................................................................................................................................. 45
2. Duty of Care Generally:............................................................................................................................................................. 45
3. Business Judgment Rule: ......................................................................................................................................................... 47
Francis v. United Jersey Bank ............................................................................................................................................................................. 48
Kamin v. American Express Co. ......................................................................................................................................................................... 49
Smith v. Van Gorkum .............................................................................................................................................................................................. 49
4. Good Faith: Disney ...................................................................................................................................................................... 51
In re Walt Disney...................................................................................................................................................................................................... 51
5. Directors & Officers Indemnification and Insurance ................................................................................................... 52
Waltuch v. Conticommodity Services, Inc. .................................................................................................................................................... 54
6. Duty to Monitor ........................................................................................................................................................................... 55
Grahm v. Allis-Chalmers ....................................................................................................................................................................................... 55
In Re Caremark International Inc. Derivative Litigation ........................................................................................................................ 56
Re Citigroup Inc. Shareholder Derivative Litigation ................................................................................................................................ 57
7. Violations of the Law:................................................................................................................................................................ 57
Miller v. AT&T ........................................................................................................................................................................................................... 58
DUTY OF CARE CLAIM ........................................................................................................................................................................................... 58
C. Duty of Loyalty ............................................................................................................................................................... 59
1. Generally ........................................................................................................................................................................................ 59
2. Self-Dealing Transactions........................................................................................................................................................ 59
State Ex Rel Hayes Oyster Co. v. Keypoint Oyster Co. .............................................................................................................................. 61
Cookies Food v. Lakes Warehouse ................................................................................................................................................................... 62
Sinclair Oil Corp v. Levin....................................................................................................................................................................................... 63
Weinberger v. UOP, Inc. ........................................................................................................................................................................................ 64
3. Corporate Opportunity Doctrine .......................................................................................................................................... 65
Northeast Harbor Golf Club, Inc. v. Harris .................................................................................................................................................... 67
4. Compensation of Directors ..................................................................................................................................................... 68
Lewis v. Vogelstein .................................................................................................................................................................................................. 71
In re Goldman Sachs ............................................................................................................................................................................................... 71
D. Shareholder Litigation ............................................................................................................................................... 71
Levine v. Smith .......................................................................................................................................................................................................... 74
Rales v. Blasband ..................................................................................................................................................................................................... 74
Zapata Corp v. Maldonado ................................................................................................................................................................................... 76
VI. TRANSACTIONS IN CONTROL ..................................................................................................................... 77
A. Sales of Control .............................................................................................................................................................. 77
Zetlin v. Hanson Holdings .................................................................................................................................................................................... 79
Perlman v. Feldmann ............................................................................................................................................................................................. 79
In Re Delphi Financial Group SH Litigaiton .................................................................................................................................................. 80
B. Mergers and Acquisitions .......................................................................................................................................... 80
C. Appraisal Rights ............................................................................................................................................................ 82
D. Freezeouts....................................................................................................................................................................... 84
Standard of Review for Freezeouts after M&F ........................................................................................................................................... 85

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 Kahn v. Lynch Communications Systems ...................................................................................................................................................... 86
In Re CNX Gas Corporation .................................................................................................................................................................................. 88
M&F World Wide ..................................................................................................................................................................................................... 89
VII. INSIDER TRADING ........................................................................................................................................ 89
A. Securities Exchange Act §10b and Rule 10b-5 Generally ............................................................................... 89
B. 10b-5 Elements.............................................................................................................................................................. 90
SEC v. TX Gulf Sulfur ............................................................................................................................................................................................... 91
Santa Fe Industries v. Green ............................................................................................................................................................................... 91
C. Mis-disclosure: ............................................................................................................................................................... 92
Basic, Inc. v. Levinson ............................................................................................................................................................................................ 93
Erica P. John Fund, Inc. v. Halliburton, Co. .................................................................................................................................................... 93
D. Insider Trading & Misappropriation..................................................................................................................... 94
Insider Trading Checklist ..................................................................................................................................................................................... 94
14e-3 Checklist ......................................................................................................................................................................................................... 95
Chiarella v. US ............................................................................................................................................................................................................ 95
Dirks v. SEC ................................................................................................................................................................................................................. 96
Neuman ........................................................................................................................................................................................................................ 97
US v. O’Hagan ............................................................................................................................................................................................................. 97
VIII. TAKEOVERS and CONTROL CONTESTS .............................................................................................. 100
A. Takeover Background ............................................................................................................................................. 100
Take Over Duties ................................................................................................................................................................................................... 100
Unocal v. Mesa Petroleum ................................................................................................................................................................................. 101
Revlon, Inc. v. MacAndrews and Forbes Holding ................................................................................................................................... 102
Paramount Communications, Inc. v. Time, Inc. ....................................................................................................................................... 103
Paramount Communications, Inc. v. QVC Networks, Inc. .................................................................................................................... 104
B. Termination Fees: ATT Merger w/ Time Warner .......................................................................................... 105

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I. ENTERPRISE FORMS

A. Types of Business Entities:

1. Sole Proprietorship: simplest enterprise form, A starts a business
a. Formation: one person sets up a business, get whatever licenses are needed to set up that business
(like to start a food truck), and does nothing else—no other actions necessary automatic
b. Profits: sole proprietor gets all the profits of the enterprise.
c. Liability: sole proprietor is responsible for all obligations of the enterprise if he is unable to pay
operations (responsible for business debt)
d. Taxation: Pass-through taxation—all profits/loses are part of owner’s individual tax return
 Pass-through taxation: individual owners of businesses pay taxes on income derived from
that business on their personal income tax; business income “passes through” to the
business owners who must pay a tax on it; basically this is more desirable than double tax
2. General Partnership: A and B start a business together; more than one person.
a. Formation: arises automatically as long as there are two more people involved in the business.
Don’t need to fill out forms w the state, just need required licenses.
b. Duration: dissolves upon withdrawal of any partner, absent an agreement otherwise
c. Profits:
 Default Rule: profits of the business are distributed equally
 This can be altered by contract. Can divvy control and profits whichever way the partners
desire; can contract that one partner gets all profits.
d. Liability: each partner is personally responsible for all obligations of the partnership (jointly and
severally liable)
 Each partner is personally liable if the partnership fails
 Creditors can come after any owner’s personal assets for debt of partnership
 Creditors of the partnership have priority over creditors of the individual partners
 Cannot contract around personal liability—can’t say one partner is personally liable for
debt and other is not.
o But can make contract saying if partners found liable, one will pay all the debt (so both
still found formally liable, but only one pays the debt)
e. Transferability of ownership interest: not transferable unless other partners agree or
partnership permits it
f. Taxation: pass-through taxation. The owners of the entity pay tax on their share of the entity’s
taxable income, even if no funds are distributed by the partnership to the owners.
 Partnership is treated as a simple aggregate of individuals
g. Tenancy in Partnership: the partnership holds the property, not the individual partners, even
though they are jointly and severally liable.
 In case of bankruptcy of partnership, the property goes first to creditors of partnership and
second to creditors of individual partners
 Therefore, creditors don’t have to worry about what’s going on with the partners
themselves; only the partnership reduces transaction costs and uncertainty.
3. Limited Partnership: partnership that allows limited liability and profit sharing for passive investors
called “limited partners”
a. Formation: doesn’t automatically arise. Requires formal filing of certificate w/ the Secretary of
State in whichever state it is in and payment for their required fees.
b. Duration: lasts as long as parties agree, or absent agreement, until a general partner withdraws
c. Two Type of Partners: General and Limited
i. Limited Partners:
1. Not required to contribute anything other than initial investment
2. Have limited liability (as opposed to being jointly and severally liable), so they are not
responsible for the operations of the business
3. Prohibited from participating in management of business

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 4. Historically, if a limited partner gets involved in management, a court might treat them
as a general partner, and therefore as having full liability (but this is rare bc this rule has
eroded significantly)
ii. General Partners:
1. There must be at least one general partner (as LPs are prohibited from exercising control
and incurring full liability)
2. General Partnership manages Limited Partnership
3. Full unlimited liability (jointly and severally liable for obligations of limited partnership)
a. Can get around this by making the GP a corporation of an LLC or some other
enterprise form that has so form of limited liability, which has been permitted by
courts. If the GP is a corporation, then the individual running the corp is not
personally liable.
d. Transferability of Ownership Interest: not transferable unless other partners agree or
partnership agreement permits it
e. Profits/Loses: Partners share on proportional basis, absent a contrary agreement
f. Taxation: pass-through taxation. The owners of the entity pay tax on their share of the entity’s
taxable income, even if no funds are distributed by the partnership to the owners.
g. The LP form works pretty well for businesses because some of the partners are really investors and
the others are really running the business, so LP form is a formal way to recognize distinction
between managers and investors
h. Used mostly by hedge funds and real estate firms
4. Corporation: A and B form corp, shareholders provide capital, directors and officers manage the
business.
a. Formation: doesn’t arise automatically; arises when the “incorporator” files the articles of
incorporation with a state official
b. Duration: corporate existence is perpetual, regardless of what happens to shareholders, directors,
or officers.
c. Liability: all shareholders have limited liability for corporate obligations, also true for directors and
officers acting on behalf of/managing the corporation
d. Management: centralized management structure: business and affairs are under management and
supervision of the board of directors.
 Shareholders vote for  board of directors, who assign mangers
 Shareholders can be managers. Note that managers of a corporation are separate from
shareholders, so a shareholder that is managing is wearing two separate hats: shareholders
hat and a manger hat.
 One can be a shareholder, but not a manger, a manager but not a shareholder, or you can be
both
 In partnership you are a manager bc you are a partner, so there is no formal distinction bw
managing interest and partnership interest. In corporations, there is a formal distinction.
e. Tax:
 Unlike a partnership, a corporation is a separate tax-paying entity.
 General rule is that a corporation is subject to two levels of tax: double tax
1. Corporation itself is subject to a tax (so if a corporation earns profits, it is taxed on those
profits); and
2. If the corporation then distributes those profits to its owners (dividends to
shareholders), the shareholders are also taxed
3. If a corporation doesn’t distribute profits, it is taxed when it earns income, and tax on
shareholders is deferred until the income is distributed or when they sell their shares
(taxed on profits from selling shares) – double tax is unavoidable
 “Zeroing out” profits: small firms sometimes create business expenses (like pay salary to
shareholder managers). Bc those expenses are business expenses; those are deducted from
the corporation’s profits. Tax on corporate profits is therefore decreased.
 It is conceivable to have situation where double tax is better than single tax

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 f. Why isn’t every business a corporation?
 Cheaper to be a partnership: Can be a partnership w/o doing anything formal with the state
which requires less transaction costs
 Tax reasons: corporations have two levels of tax while partnerships have one level of tax
(pass-through taxation)
The following are New Entity Forms. They have the best of both corporate and LP worlds – they have pass
through taxation and limited liability (but if ownership interests are publicly traded, entity will be subject to
double taxation)
Attribute Corporation Limited Partnership
Limited Liability (Benefit) Yes (For all SHs) Yes (for Limited Partners); however,
General Partner has full (unlimited
liability)
Double Tax (Disadvantage) Yes No
Is investor traditionally prohibited No Yes
from participating in management
functions? (Disadvantage)
Bottom Line:
1) Corporation has the key benefit of a Limited Partnership, which is that investors can have limited liability, and
it does not have the key traditional limitation of a limited partnership, which is the inability of investors to
manage the limited partner.
2) Nevertheless, the corporation has the downside of double taxation that the Limited Partnership does not.

5. Limited Liability Partnership (LLP): greatest liability protection for professionals

a. Liability:
 All partners have limited liability, so not responsible for others’ malpractice, but cannot
eliminate own liability from malpractice.
o Not labile for: ordinary tort claims or malpractice committed by other partners/others.
o Liable for: committing malpractice or having supervisory authority over someone who
commits malpractice
b. Taxation: pass through
c. Examples: law firms, accounting firms
6. Limited Liability Limited Partnership (LLLP):
a. Same concept as limited partnership
b. Least common of the enterprise forms. When entity wants to distinguish roles of general partner
(managing) vs. limited partners (non-managing, just investing)
c. Liability: all have limited liability, (even GPs) but looks like LP
d. Management: main difference LPs do not participate in management, GPs do.
e. Taxation: Pass through
f. Main diff bw LP: While LPs do not participate in management and GPs do, both types of partners
have limited liability, while in limited partnership, only LPs have limited liability
7. Limited Liability Company (LLC):
a. Fastest growing entity form; same concept as corporation, very similar to one but is not. Good for
small businesses.
b. Formation: must file articles of regulation/organization (~charter) and have operating agreement
(which contains governance and financial provisions0
c. Liability: All members have limited liability, even when they exercise management control
d. Management: shareholders can manage if they want to.
e. Taxation: pass through taxation unless ownership interests are/on verge of being publicly traded
f. Terminological diffs bw corp:
 Investors of a LLC are known as “members” rather than shareholders
 Article of Organization rather than Certificate of Incorporation
 Operating Agreement rather than bylaws
g. Other Features:
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  Voting is per capita, pro rata
 Derivative actions usually allowed
 Distributions are pro rata
 Membership interests are assignable
h. Examples: Bain Capital; New Deck Tavern (wants limited liability for all partners bc exposure to
torts claims and pass through taxation)
8. S Corp: (closely held corporation)
a. Entity form of choice for many small businesses prior to establishment of LLCs
b. IS A CORPORATION
c. Reqs:
 No more than 100 shareholders
 1 class of stock
 SH can only be U.S. citizens, no institutional SH
d. Liability: limited liability
e. Centralized management
f. Taxation: pass through taxation
g. LLC vs. S-Corp:
 LLC has greater flexibility (can have more than 100 members). But some opt for S-Corp bc of
greater certainty of how S-Corp will be treated under the law (but less true now bc LLCs
have been around for a while)
 Better to be S-Corp if plan to become regular Corp
o But DE lets you change from LLC to Corp automatically
o If an LLC wants to become DE corp, it should create DE corporation, merge the two
entities, and make the corporation the surviving entity
 If expecting heavy loses, better to be LLC or partnership
Examples:
1. Wachtel Lipton: General Partnership.
 This is unusual bc the partners are exposing themselves to potential liability; should be an LLP
like most law firms but isn’t bc of their marketing strategy. Idea that “we’re not like the other law
firms, if we fail then our wallet is on the line. We’re not afraid to stand behind what we do.”
2. Facebook: Corporation
3. Baby Blues: LLC, which is good for small businesses
 One restaurant, one city, no current expectation that they will expand to other cities, so most
likely an LLC
 If you’re in multiple states/multiple locations, it is a big business that can likely sell stock to
investors, can if you can sell stock, suspect you are a corporation (also if its really old, it can be a
corporation)
 Want limited liability bc things can go wrong in a restaurant, which brings a tort risk
 If a bank if providing loan to place like Baby Blues, it could be worried that it won’t get paid back
so can ask for personal guarantee or use a big asset as collateral.
 If you are a small business, you will incorporate in home state bc will be more expensive to
incorporate elsewhere like DE (there may also be home field facto, where state incentivizes you to
incorporate there, or matters to business to be incorporated there). If you’re a corp that is on
verge of being publicly held, there is incentive to go to DE.
4. EY: LLP, as are big accounting firms.
 LLP form developed for professional firms, like law firms and accounting firms, and most are LLP.
 LLP statute protects partners from other partners’ malpractice, which is why they are more useful
from regular partnership.
5. Hedge Fund: LP—hedge funds and real estate firms are almost the only business that uses LP.
 Should it change to an LLLP? Benefit would be limited liability for both limited AND general
partners.
 Downside to LLLP: 1. its not necessary bc we have no risk in individual liability we’re making
investments, not issuing debt. HFs not worried about full liability that GPs have; 2. Can eliminate
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 GP’s unlimited liability w/ becoming an LLLP by making GP a corporation or LLC, etc. But, this is
more complicated and costly, while setting up LLLP is a “one-shot deal,” don’t have to set up two
different kinds of entities. 3. LLLP law might not be recognized in your state, as it is relatively
new.
 Why do HFs want to be LPs? HFs just want investors’ money, and don’t want limited partners to
be involved in the management. With a limited partnership a little risk (though very small) still
exists that if a limited partner gets involved in management, they will be re-characterized as a
general partner and get full liability. This dis-incentivizes limited partners to get involved, and this
reinforces what HF’s want, since they don’t want them involved in the management. But with
LLLP, the risk is gone, bc even if you get re-characterized as GP, still have limited liability. HFs
want sharp distinction bw investors and managers.

B. Background on Attributes of a Corporation:

1. Attributes can be contracted around
2. Even though there are other entity forms, like LP and LLC, that have general partnership,
corporation remains a superior structure of capitalizing large firms
a. Corporation’s legal characteristics have complementary qualities:
i. Limited liability makes free transferability more valuable by reducing costs associated w/
transfers of interest (bc value of shares is independent of assets of the owners)
ii. Free transferability permits development of large capital (equity of stock) markets, which are
also advanced by presence of centralized management
b. Corporation is especially useful when large aggregations of capita are required and complex
operates demand specialized management
3. Distinction bw Public Corp and Close Corp (few shareholders)
a. Public Corp:
i. Firms that incorporate bc they foresee a need to raise capital in the public capital markets
(aspiring “public firms”)
ii. Adopt all basic characteristics of the corporate form
b. Close/Closely Held Corp:
i. Incorporate for tax liability purposes rather than capital-raising purposes
ii. Shareholders tend to be their officers and directors and take investment return as tax-
deductible salary rather than as dividend
iii. Often drop features of corporate form if they conflict w/ their status as incorporated
partnerships by including in charters: 1) restrictions on transfers of shares; 2) buy/sell
agreements allowing any shareholder to name a price at which she is willing to buy out her
fellow shareholders or sell her own shares; 3) commitments to make further capital
contributions to the business
iv. Whether a particular close corp adopts the corporate form or another legal form depends on
tax objectives and transaction costs (organizing regular corp costs half as much as forming
partnership or LLC bc corp form supplies more elaborate set of default provisions and
requires less drafting)
4. Distinction bw Controlled Corporations and Lack of Controlled Shareholder
a. Ownership structure: controlled corps has single shareholder/ small group in control, while corps
w/ no controlling shareholders have managers that control corp’s affairs
b. If there is no controlling shareholder/group, then anyone can purchase control of corp by buying
enough stock
5. Attributes:
a. Separate, perpetual legal personality (separate entity)
b. Limited liability for all investors
c. Centralized management under board structure
d. Free transferability of share interests
e. Appointed by equity investors

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C. Attributes of a Corporation:
1. Separate, Perpetual Legal Personality/Entity
a. All but sole proprietorship have this
b. Allows entity to act as an entity, rather than a group of individuals. It is distinct from its
shareholders, creditors, directors, and officers. It can be taxed, hold property, sue and be sued, enter
into contracts
c. Advantages:
i. Reduces Costs for Contracting Credit:
1. Investors don’t have to execute transaction or agree to it so coordination costs of closing
transaction are small
2. Since corp owns the business assets, this determines pool of assets upon which creditors
can rely for repayment; don’t have to worry about shareholders’ creditors or partners’
creditors
3. Liquidation protection against unexpected liquidation: individual owners of corp can’t
withdraw their share of firm assets at will, effecting liquidation, nor can personal
creditors of an individual owner foreclose on owner’s share of firm assets
ii. Staying power: entity is not dismembered if one of its shareholders/partners dies or becomes
insolvent perpetual existence/unlimited duration
iii. Reduces Transaction costs: corporation can enter into transactions on behalf of all principals
d. Can contract around this
2. Limited Liability for all participants:
a. Shareholders cannot lose more than the amount they invest, unlike general partners, who is legally a
party to all partnership agreements and is liable under them default rule for corps
b. Corporations have unlimited liability for debts/obligations; shareholders have no liability for them
c. Benefits:
i. Attracts Investment:
1. Since investors are not personally responsible for debts/obligations
2. Shareholders don’t have to do extensive research or monitor/manage company they
invest in
3. Encourages risk-averse shareholders to invest in risky ventures and to have many
investments bc consequence of failed investment is limited; people more hesitant to buy
risky stock when full liability goes with it
ii. Allows shareholders to diversify their portfolios of assets. W/o LL an individual won’t
invest in different companies unless he’s willing to take on the risks, which prevents portfolio
diversification bc can’t take on a lot of different risk and then have to monitor each company;
w/ LL can invest in different companies and this will minimize individual risk bc if you invest a
little into a lot of different companies and one goes under, won’t lose too much like if had all
money in one investment.
iii. Increases ordinary people’s access to the market: w/o LL, there would be nothing for
ordinary people to invest in bc they can’t risk losing all their money; only wealthy people
would be able to invest. Also, wealthier people would be able to better monitor which
companies are safer to invest in, while this would be expensive for common people.
iv. It makes stock fungible (easier to price stock). W/o LL, stock would have different value in
different people’s hands. Stock of wealthier investors would be valued more to creditors bc
they would be able to comply w/ obligations if company fails, however someone who is
judgment proof would be a less attractive stockholder.
v. Decreases need to monitor managers. W/o LL, investors would want to manage to make
sure corp doesn’t take action that expose them to too much risk, but w/ limited risk, don’t
need to monitor.
vi. Decrease of need to monitor other shareholders: w/o LL, a shareholder would be on hook
for full extent of the corporation’s liability if the rest are judgment proof; w/ LL doesn’t matter
who is judgment proof and who isn’t

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 vii. Incentivizes managers to act efficiently: As long as shares are tied to votes, poorly run firms
will attract new investors who can install new managerial teams. Potential for displacement
gives manages inventive to operate efficiently in order to keep share prices high.
d. Benefits of not having Limited Liability:
i. Lenders are more likely to lend to corp bc there are more ways with will get repaid=higher
changes of repayment
e. Ways to Remove Limited Liability:
i. Personal guarantee: each shareholder would have to individually agree to this
ii. Can waive limited liability (put in certificate that all shareholders have unlimited liability)
3. Transferability of Interest:
a. Investors own a share; it is their legal property and can be transferred with all rights that it confers.
b. Benefits: Permits the firm to conduct business uninterruptedly as the identities of the owners
change
c. Partnership doesn’t have share transferability (can’t just give director role to someone else)
4. Centralized Management:
a. There are 3 separate positions in a corporation: Shareholders, Directors, Officers
i. Being a shareholder does not automatically make you a director or officer (although in most
corps shareholders are all 3 of those positions)
ii. Shareholders elect a board of directors (on a yearly basis) and accord them power to initiate
corporate transactions and manage day to day affairs of corporation
iii. Directors then choose the managers/officers of the company and delegate some power to
them (shareholders are not directly involved in choosing managers/officers)
iv. So in all corps there is a separation bw the shareholders and the management of the
company corps are manger-run businesses, not owner-run businesses
v. This is contrasted from partnerships where each of the partners is also running the business,
while in corps, no such assumption for shareholders
vi. Meaning of Manager: sometimes used to describe directors and officers, but most commonly
used to describe high-level officers, like CEO.
vii. Although fewer officers are directors than in past bc potential for conflicts of interest, it is very
common for CEOs and such to also be on Board of Directors
b. Idea of Separation of Control and Ownership and No Controlling Shareholder: Berle-Means Corp
i. In early 20th century in US, there was such a sharp separation bw control and ownership that
shareholders had very little control; in many corps there were no controlling shareholders and
shareholders owned less than 1% of a corporation.
ii. B&M recognized a problem and advocated for shareholders to reassert control of corps bc
managers were running the corporations and shareholders had no say
iii. This is why traditional US and UK corps have separation of ownership and control, while corps
in other parts of the world have group of controlling shareholders
c. B&M saw this as a problem because of Agency Costs:
i. Owners of a corporation are the shareholders = Principals
ii. Directors and officers of a corporation = agents of shareholders (loosely bc not accountable
directly to shareholders)
iii. In all agency relationships, there is a worry of a conflict of interest—that agents will engage in
activities that benefit the agents themselves, but not shareholders. When there are widely
scattered shareholders, as with separation of control and ownership, it becomes very difficult
for them to police the directors and officers, and concern is that agency costs will be severe.
iv. Ideally, shareholders would still police agents, eliminating agency costs, but monitoring is
undermined by a collective action problem which is combination of
1. Rational Apathy Problem: Monitoring directors/officers is not worth it to small
shareholders who only have one $50 share bc it isn’t rational to waste the time and
money when only $50 at stake unless problem is huge
2. Free Rider Problem: Even if small shareholders do have economic incentive to monitor,
if they know another shareholder will monitor, they have incentive to free-ride on their
monitoring
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 d. Changes in the Last 40 Years:
i. Rise of Institutional Investors: People are buying bigger stakes in companies and becoming
large shareholders (private equity, hedge funds). This might not create controlling
shareholders in most companies, but they are still sizeable enough and are thought to monitor
more than shareholders did in the past
ii. Technology Change: Cost of monitoring has gone down (Shareholder advisory firms,
institutional shareholder services, advisory services that study firms on behalf of shareholders
and even those that don’t have inventive to monitor get reports, which can affect their vote)
iii. This all reduces seriousness of agency cost problem
e. Today, it is not accurate to say that typical American corp looks like a Berne-Means corp
5. Managers are Appointed by Equity: Shareholders appoints managers

II. INCORPORATION
-Forming a corporation: process creates public record of incorporation, binds parties to corporate law of
incorporating state, documents optional terms parties may have chosen.

A. Corporation Foundational Documents:

1. Articles of Incorporation: essential, core foundational document, very hard to change
a. Corporate existence begins w/ preparing Charter/Certificate of Incorporation/Articles of
Incorporation. This must be signed by one or more of the incorporators and submitted to the state’s
secretary of state for filing.
b. Must include: DGCL §102
i. Corporation name
ii. Address
iii. Capital Structure: number and classes of authorized shares corp can issue to raise capital
iv. Nature/purpose of business
v. Names of incorporators
c. Can include customized features (like voting provisions, membership requirements, board size, etc).
2. Bylaws: the operating rule of the corporation DGCL §109
a. Bylaws must 1) conform to DE corp statute and 2) corp’s charter and 3) can’t interfere with core
director management functions
b. Can contain anything that is not in certificate, but that is needed to run the corp: existence and
responsibilities of corporate officers, annual meeting date, procedures for functioning of board,
empowerment for officer to call a stockholders’ meeting, rules for shareholders to call special
meeting, manner in which directors are elected, if certificate doesn’t mandate size of board or
manner in which board will be determined, can include that, etc.
c. In DE, shareholders have inalienable right to amend the bylaws DGCL §109(a) but some states
limit that power to board of directors.
i. Amending bylaws:
1. Before corp has received payment for stock, bylaws can be amended, adopted, repealed
by incorporators or initial directors
2. After corp has received payment for stock, shareholders can unilaterally adopt, amend,
or repeal bylaws. Corp can, in its certificate of incorporation, allow directors to
unilaterally adopt, amend, or repeal bylaws, but CANNOT take away shareholders’ rights
to amend bylaws.
3. Requires a vote of majority of shares present at meeting
d. Choosing to put info in certificate or bylaws:
i. It is must harder to change the certificate than the bylaws—to change certificate, directors
have to propose a change and shareholders must approve it (majority of shares at meeting).
However, since both directors and shareholders can change bylaws unilaterally, easier to
include certain provisions there.
3. Shareholder Agreements:
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 a. Address restrictions on disposition of shares, buy/sell agreements, voting agreements, payment of
dividends
b. Generally, corp is a party to these contracts, so courts will specifically enforce where all
shareholders are parties
c. Where some shareholders are not parties, enforcement turns on whether agreement is fair to
shareholders who were not signatories
B. Where to Incorporate
1. Main choice is bw home state and DE
a. For small business, its more convenient and cheaper from tax perspective to incorporate at home
i. Also, lawyer that will represent small corp will be more familiar w/ the local law than the out
of state law
b. Big corps that sell stock more widely usually incorporate in DE
2. Why DE:
a. Expertise of judges: corporate law is the major topic that DE judges deal with so they have a wide
range of experience and are efficient
b. Fast Court System: only two levels - chancery court and supreme court
c. Sympathetic to managers and directors: it is responsive and flexible to what managers want
d. Cachet of being DE Corp (corps think that’s where successful corps go)
3. Race to the Bottom v. Race to the Top - Two Views about Incorporation in DE:
a. Race to the Bottom: since managers decide where to incorporate, DE lets managers do what they
wan to attract them. Their laws make it hard to police manager’s misbehavior, and the focus is on
pleasing agents, not principals. This competition to attract corps will lead to more lenient and worse
corporate laws. – DE won the “race to the bottom”
i. This view wants more federal law/intervention/regulation, so to stop DE from doing this
b. Race to the Top: Even if managers chose where to incorporate, shareholders have a say. Corps can’t
afford to incorporate in a state with “bad” laws bc their products would be too expensive, their stock
would be valued less, and they would ultimately be driven out of the market. This causes companies
to consider the quality of corporate law, so DE will make “good” laws to attract corps. Likewise, DE
would be punished for having bad laws.
i. EX: PA enacted really strong anti-takeover provision and some firms left PA to another state
ii. This view is skeptical of federal law, because states are doing a good job on their own
4. DE is the Center of Corporate Law:
a. New Jersey initially had favorable charter laws: it allowed corps to own stock of other corporations.
b. Woodrow Wilson administration triggered firms to move to DE bc he passed antitrust laws
c. DE’s most serious competition comes not from other states but from DC—DE is very vulnerable to
federal intervention
d. SD and NV have competed w/ DE but haven’t attracted too many companies

Dodge v. Ford
MP: Directors’ primary responsibility is corp’s shareholders
Facts: Henry Ford stopped making 10 mil special dividends. Dodge brothers, who held 10% of shares in Ford
Motor Company, sued to force Ford’s board to declare a dividend out of a large pool of earnings that had been
retained to fund new projects and finance price reductions on Ford products. Ford, the controlling
shareholder, said he eliminated special dividends bc he had obligation to share his success with the public
through price reductions.
Issue 1: Capitalization Requirement:
 Rule in MI required Ford to have min $1,000 and max $50 mill of capital, but Ford had $50 mill.
 Ds argued that capital was all the corps assets, and F argued it was shareholders’ capital what they put
into the firm
 Ct said capital is the shareholders’ capital, not anything else, and Ford is under $50mil max
Issue 2: Ultra Vires: was F going beyond his powers?
 Ford manufacturers cars, which is not sufficiently connected to buying ships and iron mines (new
projects)

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 Ultimately not a problem bc F wasn’t actually doing that. Closer call was the smelting operation, which F
was doing, and court said it was closely enough related to making cars to its OK
Issue 3: Fiduciary Duty
 Expansion: court is not business expert, not its issue to resolve – cts don’t interfere w/ business
decisions
 Dividends: court agreed that F’s directors wrongfully subordinated shareholder interests to those of
consumers by holding back dividends. F cannot focus on the community at the expense of his company.
Business scope is organized and carried on for profit of stockholders, and directors must be employed to
that end. Directors’ primary responsibility is to shareholders.
Skeel:
 This is a unique case bc F announced that he was acting in interests of non-shareholders.
o Board’s decision would be justified if he said purpose of withholding dividends was to make money
o But cannot try to advance non-shareholder interests over those of shareholders.
 Why don’t Dodge Bros. sell their stock?
o There wasn’t a big market for their stock bc they owned 200/2,000 shares, so not a lot of trading
opportunities. Also, no one would buy stock of a company w/ a very controlling shareholder who
stopped special dividends bc means shareholders would never get anything beyond regular
dividends. If market is afraid there won’t be special dividends, the price of the stock would lower so it
would be undervalued.
o Dodge Bros. were potential competitors of F and needed money; D was trying to prevent D from
raising capital they needed to finance a competing car company.
 This case is standard citation of corporate law of directors’ responsibility to shareholders

Hobby Lobby
Facts: ACA requires employers’ health plans to cover contraceptives, including morning-after pills. HL
operates on Christian principles and believes that some of the pills cause abortions and violate their beliefs so
they don’t want to give health insurance that covers these drugs. Religious Freedom Restoration Act:
prohibits gov from substantially burdening person’s exercise of religion.
Issues: 1) Can for-profit corp have religious freedom rights?; 2) can a corp invoke RFRA?
Alito Holding: Congress intended RFRA to apply to corps bc they are composed of individuals (aggregation
theory). Denying religious liberty to corps impairs religious liberty of individuals.
RBG Dissent: 1) Corp isn’t a sum of shareholders but rather a distinct entity (real entity theory), and 2) for-
profit corps don’t have religious freedom rights, unlike religious/non-profit corps.
 RBG’s main point: Corporation can’t practice religion distinct from people who make up the
corp, unlike in non-profit/religious where they all have same cause/religion
 Alito’s Response:
o RFA protects “persons,” this includes all corps and partnerships
o It is agreed upon that RFRA applies to non-profits, why should for-profits be treated differently?
o Corps can be formed for any lawful purpose, no reason why it shouldn’t have religious freedom
rights.
o Distinction bw religious/non-profit and for-profit corps: true religious orgs are non-profit and
have a homogeneity of religious beliefs, while shareholders in for-profit orgs like HL have
heterogeneous religious beliefs
Skeel:
 TAKEAWAY: religiously-oriented, for-profit corps can exercise constitutional rights. Unclear about how
this can be applied to public corporation; in closely-held corps can reference your religious orientation in
your bylaws bc run by small amount of people, all the same. But this is more complicated for publicly held
corp bc majority would not want to exercise religious freedom rights bc want to attract as much business
as possible and wants to breach a broad constituency.
 Debate on nature of a corporation:
o Aggregate Theory: Corporation as an aggregate of contractually bound individuals; Alito majority
o Actual Entity Theory: Corporation as an unique, distinct thing, something metaphysical on its
own; Ginsburg dissent
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 o Concession Theory: Corp owes its existence to the state; was the standard theory but not anymore
o Note—In the U.S., there is little discourse concerning corporation as a person

III. STOCK ISSUANCE, DIVIDENDS, & DEBT

A. Debt and Equity
Corporate financing comes from 3 sources: equity financing (stock), debt financing, and corporate earnings.
1. Equity Financing: Corp can issue shares of stock (articles of incorporation prescribe how much
stock/what kind of class of stock each corp has and can sell). Shareholders pay the corp for their shares.
Each share represents an ownership interest in the corp and gives the shareholders some rights and
powers.
a. Common Stock:
i. Permanent stake in the corporation (but can contract around this: “callable stock”=stock that
directors have right buy back; “putable stock”=stock that directors have right to require
shareholder to put back into the company at predetermined price)
ii. Stock is forever, as long as the corporation exists
iii. Stockholders can profit in 2 ways:
1. Dividends: Corps can commit to make dividends (but not required to), but no
requirement of payback to common stock shareholders
2. Selling stock: to someone else in the marketplace or selling back to a corporation (can
make money if the stock price grows and shareholder sells it the stock)
iv. Dividends: Dividends on common stock is not guaranteed—if board doesn’t declare them in a
given year, there is no continuing right to receive them later. SH also have residual dividends –
can’t be paid dividends until preferred stock dividends have been paid.
v. Residual: common stockholders are the last to recover in case of liquidation, and are not
guaranteed dividends (payout order: creditors, preferred stock holders, common stock
holders)
1. Creditors get paid back first: if a firm loses money and can’t pay back a creditor, the
creditor loses money. If a firm makes a great investment, creditor still only gets whatever
it loaned to a corporation. Creditors therefore won’t loan if there is risk of not getting
that money back.
vi. Protections against vulnerability: Because stockowners are last to recover and their
investment is permanent, they are vulnerable bc no guarantee that they will get paid anything.
1. Voting rights: to elect directors, to change bylaws, to vote to approve significant corp
transactions. One vote per share.
2. Fiduciary duty: director’s duties are primarily owned to shareholders
3. Appraisal rights: under certain circs, shareholders have right to insist that company pay
for their shares at price set by the court
vii. Number of Shares:
1. Authorized: shares that the corporation can sell (must be in charter)
a. Most companies authorize more shares that they anticipate selling bc authorizing
more shares requires a charter amendment (director proposal + shareholder vote)
b. DE: corp franchise tax based on number of shares authorized – affects decision of
how many shares to authorize; prevents unlimited number
2. Issued: shares that the corporation has sold
3. Unissued: shares that are authorized but unsold
4. Outstanding: shares currently held by shareholders (in marketplace)
5. No longer outstanding: shares that the corporation bought back (treasury shares)
a. Directors can buy back stock and cancel it, treating it as no longer authorized.
b. If company is buying back a few shares can choose who to buy back from, but if it
makes a public offer to buy back, must offer to all shareholders and buy back all
shares

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 viii. Common stock must be in the certificate with its basic attributes (number of authorized
shares, classes like non-voting common stock)
b. Preferred Stock:
i. Dividend Preference: preferred stock gets fixed dividends (if directors choose to give
dividends) ($10 preferred = $10 payment per share each year)
1. Giving dividends at all is up to board discretion, but no dividend can be paid to
common stock until preferred stock dividend is paid
2. Cumulative Dividend Preference: Any missed dividend to the cumulative preferred share
has to be paid in full before dividends can be made to common stock (if no dividends
paid on $10 cumulative preferred in Years 1 or 2, no dividends to preferred or common
can be paid in Year 3 until corp pays accumulated $20 on the cumulative preferred)
ii. Liquidation Preference: if firm is liquidated, preferred stockholders have to get payout before
common stockholders.
iii. Protections against vulnerability:
1. Some fiduciary rights
2. Generally no voting rights, but a lot of corps have provision in place that if directors miss
a set number of dividends, usually 3, then preferred stockholders get voting rights. If
dividends are paid back, voting rights are taken away.
a. To protect their economic rights. Preferred stockholders will make better decisions
than common stockholders bc they have something to lose (higher priority on
dividend payout)
b. Series of skipped dividends is a sign that firm is in trouble so it needs more
decision makers.
iv. Preferred stock has to be in the certificate
1. DE allows blank check preferred stock (a class): stock issued for which terms are not set
in the certificate.  often used as poison pill defense: target issues preferred stock that is
convertible into large number of common shares to dilute the bidder’s ownership of the
target and make it more expensive to take over the target.
c. Stock Options
i. Contractual right given by corp to employees to buy share of stock at specified price for a
specified period of time or at a specified date.
ii. Incentivizes employees to work so that the market price of the corp’s shares rise above the
exercise price of their options. That way they can exercise option when the market price is
above the exercise price and get the shares for cheaper and make a profit by selling at the
market price.
iii. Warrant: type of stock option
d. Putable Stock: stock that SH can sell back of selling back to the corp at a predetermined price. Price
is usually low; so kind an insurance for SHs (if share price goes down below predetermined price,
corp has to buy it back at higher price)
e. Callable Stock: stock that directors have right buy back
i. Way to take advantage/protect corp’s future success: if stock price goes up, can buy back the
stock at the stock price and re-sell it at the higher price
ii. DE restricts ability to buy back: if a company is insolvent it cannot buy back its stock, it must
be solvent.
iii. Typically callable stock issued for subsidiary company by parent—parent reserves right to buy
back its stock from parent company should it become beneficial
iv. Common= subsidiary
f. Shorting Stock: sale of a stock that seller has made a contract to borrow and return, motivated by
the belief that the stock’s price will decline, enabling it to be bought back at a lower price to make a
profit.
i. Ex: shorting Wells Fargo stock: A enters into contract with B to borrow 100 shares of Wells
Fargo stock for $25/share for 3 months. A immediately sells the borrowed shares at
$25/share. When the contract is up and A has to give back the stock, he goes into the market
and buys 100 shares of Wells Fargo stock to give back to B. If at this time the Wells Fargo stock
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 dropped to $20/share, A will make $5 per share. However, if stock price goes up, A loses
money.
2. Debt Financing: Corp can borrow money to finance its operations. Debt obligations (debt securities)
are fixed by contract and can be issued to third persons or to shareholders. Debt obligates corporation
to repay principal and interest. Debt holders do not have rights to share in earnings.
a. Not Permanent (has maturity date): there is a legal obligation to repay the principal amount (what
the creditor lent) plus any interest by a stated date. Payout period for debt can range, depends on
payment schedule
i. short term: to be paid w/in year, usually loans/notes to finance day-to-day operations
ii. long term: usually bonds
b. corp must pay interest
c. Doesn’t have to be in certificate or bylaws: firms can decide to borrow money at any time; up to
board, don’t need shareholder input
d. Highest Priority: debt is the highest priority and gets paid off before anyone else. If firm liquidates,
pay senior creditors, then junior creditors, then any liquidation preference that preferred
stockholders get, then common stockholders
e. Less risk than equity:
i. Creditor has legal remedies for nonpayment of interest, like right to sue
ii. Liquidity priority over shareholders
f. tax treatment: interest that corp pays is deductible from taxable income (unless debt is convertible
security)
g. Types of Debt:
i. Bank Loans:
1. Small businesses: bank debtor likely to be major creditor
2. Large corps: can be single bank or lots of banks that get together and collectively lend
money to corp
ii. Bonds: today used interchangeably w/ debentures. In past, bonds had collateral attached, and
debentures were unsecure (no collateral attached)
1. When debt is raised publically rather than from bank, is it “issued” by the firm. Main kind
of firm-issued debt is a bond.
2. Debt publically issued and used long-term is a bond; debt that is publically issued and
used short term is a note/commercial paper
3. How bonds work: they are issued by corps and when one buys a bond they give the corp
a loan and corp agrees to pay loaner back the face value of the loan on a specific date and
to periodically pay interest.
4. Bonds give no ownership rights
5. Bonds have advantage over stocks bc investor faces less risk as creditor than stockholder
bc creditors have right to periodic interest payment and priority repayment if corp
defaults.
iii. Shorter Term Instruments: IOU; commercial paper: very short-term obligation of the firm (like
30 days)
iv. Leveraged Loan: investment bank makes loan to business, then will coordinate with number of
lenders will agree to put up with a piece of the loan. Lenders can be variety (hedge funds,
equity funds, etc).
h. Debt doesn’t have protections that stock has:
i. No voting rights:
1. debt holders have much more limited interest in firm than shareholders (but creditor
can contract around no voting rights, like if corp fails to pay interest payments, we get
voting rights)
2. Debt holders have their own protections in debt agreement
3. Usually, creditor takes stock of corporation as collateral
i. Convertible Securities: debt that is convertible into stock
i. Treats lender as if he holds the stock though he doesn’t

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 ii. Current debate is whether big banks should be required to hold convertible debt (coco’s:
contingent convertible securities). Idea is that if a bank is in trouble, its debt to a corp can
convert into corp’s stock, reducing pressure on the bank because it won’t have to make debt
payments anymore
iii. Corps that issue convertible debt do not get a deduction for interest payment on debt
iv. Seen in Silicon Valley VCs, and in Europe
3. Corporate Earnings: corp can use funds generated internally by its business
4. Creditor Protections:
a. Creditors face various risks:
i. Debtors can misrepresent their income or assets before they borrow
ii. After debtors borrow they can:
1. Dilute assets that secure their debt (by operating business badly or hiding assets so they
are out of reach of creditors)
2. Dilute claims of their unsecured creditors
3. Increase riskiness of their debt (by altering investment policy)
iii. Debtors can externalize costs to involuntary creditors like tort victims by incurring liabilities
that exceed the value of their assets
b. corp law provides creditors with additional protections in all jurs bc:
i. core corporate feature of limited liability exacerbates traditional problems of debtor-creditor
relationships:
1. presents opportunities for misrepresentation in transaction w/ voluntary creditors
(debtor can mislead others concerning assets in corp and can walk away from business if
it fails)
2. makes it possible to shift assets out of corporation after a creditor has extended credit to
the corporation (can distribute assets to self while leaving debts w/ corp)
c. 3 basic strategies to protect creditors:
i. impose extensive mandatory disclosure duty on corporate debtors (fed securities laws impose
mandatory disclosure obligations under Securities Act of 1933; state corp laws don’t really use
this)
ii. can promulgate rules regulating amount and disposition on corporate capital
iii. can impose duties on corporate participants to safeguard creditors (like directors owe duty to
corp when its insolvent, and creditors’ rights>shareholders rights in that situation)
B. Modigliani-Miller Irrelevance Theorem
Asks which security should corp use to raise money: common stock, preferred stock, or debt?
1. Traditional View: if you have two companies, A and B, that are otherwise identical (same employees,
same assets, same business) except Corp A raises its funds by selling all stock while Corp B sells half
stock, half debt, Corp A will be less valuable than Corp B.

Corporation A Corporation B

All Stock ½ Debt ($500); ½ Stock

$1,000 $1,100
Assume exactly identical corps except securities issued. Corp. B borrows $500 and sells all of its stock.
Debt worth $500 on market, and one might think that stock would also be worth $500. However, traditional
view says it would be worth more than that (e.g. $600). So, B worth more than A.

a. Why? Diverse Risk Preferences: investors have different risk preference, so if you’re financing a
firm, you want to provide a variety of options to different investors. By providing more options, you
can facilitate investing, which makes Corp B more valuable to investors than Corp A. Corp B is more

17
 attractive to investor who doesn’t want much risk bc of the debt option, and other investors will pay
for the privilege of having more risk options available to them (stock).
i. Debt can be more safe but lower returns (bc don’t have stock in company so no returns on
cor’s profits); stock could be less safe but higher returns
2. Modigliani-Miller Irrelevant Theorem
a. In a Cosean world (with no transaction costs, no taxes, no frictions), it doesn’t matter whether you
use debt or equity to raise capital; capital structures don’t impact the value of a company:
i. Process of arbitrage: prices of equity in the all-equity company and the half-equity company
will converge. If Corp A is really no different than Corp B and Corp A’s stock is cheaper, Corp A
is undervalued while Corp B is overvalued. There will then be pressure to sell Corp B stock and
buy Corp A stock because is just as good as B stock but cheaper.
ii. Homemade Leverage: if people have different preferences for risk, they can create a
portfolio that matches their risk profile
1. If investor wants a risky investment, can buy all stock of Corp A and buy half of it with
borrowed money (that mimics position of someone who holds stock in Corp B w/o
having need for Corp B at all)
2. Create safe security by lending to investor who’s going to buy stock (recreating debt of
company B)
3. Assumes: no transaction costs to find someone to lend money and non-recourse loan:
bank will typically ask for guaranty in other assets, so must assume bank can’t go after
any assets that they they’re not part of the equation
4. Takeaway: people won’t pay extra for company to create risk profile for them when they
can create it themselves
3. We don’t live in a Coasean world; Real World Effects on Capital Structure:
a. Push to Finance through Debt:
i. Tax: interest payments on debt are tax-deductible, but dividends are not-tax deductible 
encourages financing through debt (Corp B is more valuable through tax lens)
ii. Agency Costs: (free cash flow theory) issuing more debt limits agency costs because it limits
the managers’ cash flow.
1. When selling stock, the amount of cash in the company increases=more cash for
managers to play around with.
2. Managers can stop paying dividends, but have to make interest payments on debt or face
consequences, which imposes discipline on managers
b. Push to Finance through Equity:
i. Bankruptcy Costs: having too much debt creates a risk of bankruptcy and bankruptcy is
costly  encourages financing through stock
c. Clientele Effect (type of regulatory cost): certain types of investments are particularly attractive
to certain types of investors, and this shapes the firm’s decision about which capital structure to
adopt, depending on what kind of investors it wants to attract
4. Banks’ Capital Structure Debate: Current debate criticizing that banks have so much debt. But if banks
had less debt, they would have less tax benefits, and they want to take advantage of them. Additionally,
it is more expensive to sell stock than to issue debt.
C. Dividends and Disclosure: General Background
1. Par Value:
a. Historically: when corps authorized stock, they set a par value on the stock based on what they
thought the stock was worth at the time of corp formation, and had to receive that par value when
they sold the stock
b. Purpose: to protect shareholders and creditors bc supposed to have commitment that firm had at
least par value in capital
i. For shareholders: guarantees everyone else is paying same price you are for stock. If they
don’t, they could be dues or forced to make up the difference
ii. For creditors: par value thought to create a pot of money that sits in a corporation that could
not be messed with, assured creditors that corp had money
c. In practice, it was ineffectual:
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 i. People cheat: “watered stock”: stock for which the investor pays the set amount, but actually
pays less because pays with property (which is overvalued and more uncertain than cash
value)
1. If corp has $50/share par value, I wanted to buy 20 shares (total $1,000); rather than me
paying $1,000, directors say we’ll give you 20 shares for your corporations casebook 
selling stock for property that theoretically was worth as much as set par value, but in
reality worth a lot less
d. Today:
i. Courts have relaxed par value req. Most states now allow stock w/o par value (no par stock)
ii. Many firms do set a par value, and its typically pretty low. It is an artificial dollar amount
specified in the articles of incorporation and has no relationship to the market value of the
shares. Investor is obligated to pay at least par value for stock. Applies only when shares are
originally issued, not when they are later traded.
iii. Stock is valued by market value, or if newly formed corp, prices are determined by bank
iv. Par value might make sense when a corp is originally formed, but in following years the corp
may not be worth the same amount of money, and it would be problematic to insist that stock
is the same par value from the time the corp was formed; if corp isn’t doing well stock might
be worth lower than its par value.
v. In DE still matters: limits ability to make dividends under dividends test
2. Income Statements: Results of the business operation of the business over a specified period. It does
not reflect cash expenditures of the cash available to owners.
3. Balance Sheet: an accountant’s snapshot of a corp’s financial status at a given moment, on one day
a. It has historical valuations on it, not current market value, (which is what shareholders would
receive upon liquidation), so can’t tell what’s going on now (value on balance sheet might differ from
current economic value of asset). For that, look at income statement, which talks about what’s
happening on on-going basis.
b. Left Side: Assets: anything that can create future value
i. Working assets: cycle through firm’s production process, from raw materials to inventory to
receivables (cash, securities, accounts receivable, inventories, prepaid expenses)
ii. Fixed assets: not intended for sale and used for lengthy period in order to manufacture,
display, warehouse, and transport the product (property, plant, equipment, vehicles, etc.)
c. Right Side: Liabilities: value of corp’s short-term and long-term debt
i. Current liabilities: debt due w/in one year
ii. Long-term liabilities: debt due over period longer than one year
d. Right Bottom: Net Worth/ Shareholder Equity (how much SH are paying for shares): Assets -
liabilities which equals the corp’s net worth, which includes
i. Stated capital: par value amount x shares that are issued and outstanding
1. DGCL §154: if corp issues no par stock, board of directors must set aside some
discretionary portion of the sale price as the company’s stated capital
ii. Capital surplus: the price paid for stock in excess of the par value price of stock
iii. Earned surplus (retained earnings): profits over time minus any dividends distributed (if
any); will be 0 if brand new business
1. GAAP: general acceptable accounting principles: allows companies to write up assets
based on a fair estimate of economic value, as long as it is disclosed
e. Whenever an item is changed on one side of the ledger, an equal amount must be entered on
the other side—always a balanced sheet

Balance Sheet Hypo:

-corp issues 10 shares of common stock with a par value of $80 for $1000
Assets Liabilities
Add $1000 cash --
Net Worth
Add $800 stated capital
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 Add $200 capital surplus

-Now corp spends $400 on equipment

Assets Liabilities
$1000 cash (working asset) --
Add $400 equipment to assets Net Worth
(fixed asset)
Decrease cash by $400 $800 stated capital
$200 capital surplus

-Now you spend $200 at Staples on the Staples Credit Account

*becomes liability bc you now owe Staples $200 when you pay off the credit
Assets Liabilities
Add $1000 cash Add $200 liability to Staples
Add $400 equipment to assets Net Worth
Decrease cash by $400 Add $800 stated capital
Add $200 office supplies (fixed Add $200 capital surplus
asset)

-Next corp adds class of preferred stock at $40/share par value and sells 10 shares for $500
-you earn another $100 in capital surplus (500-400 (10x40))
-you create another $400 in stated capital
-you have $500 cash
-must account for new form of stock in balance sheet

Assets Liabilities
Add $1000 cash $200 liability to Staples
Add $400 equipment to assets Net Worth
Decrease cash by $400 Add $800 stated capital (add title “common”)
Add $200 office supplies Add $200 capital surplus (add title “common”)
Add $500 cash Add $400 stated capital (preferred)
Add $100 capital surplus (preferred)
Total: $1700 Total: 200 (equity) + 1500 (liability) = $1700

-sides are equal because if you subtracted liabilities from assets you would have net worth

D. Dividends Tests:
1. Dividends: a corporation can distribute assets to shareholders through dividends. They are periodic
payments by the corporation to shareholders in proportion to their share ownership. They are usually
made in relation to past or current corporate earnings.
2. Reason for Tests Creditors’ Vulnerability: When corp distributes dividends, it transfers assets to
shareholders, thus jeopardizing creditor claims. Creditors are vulnerable since the power to declare
dividends resides with board of directors that are elected by and accountable to shareholders (who obvi
want dividends).
3. 4 Dividends Tests: To protect creditors, corporate law specifies when distributions are legally
authorized and then up to BoD to decide whether to give them
a. Insolvency Tests:
i. Equity Insolvency Test (main): forbids dividends if it would prevent the corp from paying its
debts as they become due.
ii. Bankruptcy Insolvency Test (used only w/ MCBA §6.40(c): can make a dividend on any
difference between assets and liabilities (requires assets > liabilities)

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 1. $1,700 (assets) – $200 (liabilities) = $1,500 max dividend
b. Balance Sheet Insolvency Test: dividends allowed as long as after the distribution, corp’s
assets>liabilities + stated capital
i. can also do it backwards by looking at balance sheet and adding up all surplus accounts
ii. this is the traditional test
c. Earned Surplus Test: dividends can only be made out of earned surplus that is above 0 (corp
profits overtime that are not distributed to shareholders)
i. Assets > liabilities + stated capital + capital surplus
ii. most restrictive test
d. Nimble Dividends Test: directors can make dividends out of current profits, even if no other
dividends test would allow dividends (look at income statement)
i. Current earnings are applied to dividends rather than repaying debts – corp in debt that
earned profits can distribute dividends to shareholders before repaying its outstanding debt
ii. Offers little protection to creditors
4. DGCL §170: DE uses the balance sheet test and the nimble dividends test (two-prong)
a. Step 1: Balance Sheet Test: under the balance sheet test, can you make a dividend?
i. Note that DE defines surplus as everything after assets exceed stated capital; assets- (liabilities
+ stated capital) = surplus
ii. Yes maximum dividend (only go to step 2 if you can’t make a dividend under Step 1)
iii. No Step 2
b. Step 2: Nimble Dividend Test: look at the profits from this year and last year – can make a
dividend payment out of profits from either year, or both (whichever is higher). Look at income
statement
i. if one of the profits is negative (corp lost money) can chose the positive profit year
c. Hypos:
i. Suppose under balance sheet test cotp can make $5k dividend, and under nimble dividends
test corp can make $20k dividend under DGCL §170, maximum dividend if $5k bc you only
get to use the nimble dividend test if you cant make a dividend under balance sheet test
ii. Suppose you can’t make a dividend using the balance sheet test. But last year, you lost $15k
and this year your profits are $25k you can make a dividend of $25k.
5. MCBA §6.40(c): Two tests:
a. Equity insolvency test: no dividends if now/after distribution corp can’t pay its debts as they come
due  takes into account ability to pay liabilities
b. Bankruptcy insolvency test: no dividends if after distribution assets < liabilities + amount that
would have to be paid on liquidation to any preferred shareholders  takes into account ability to
pay preferred shareholders their liquidation rights
c. Combine the two tests: basically, corps may not pay out dividends if in doing so: 1) They can’t
pay their debts as they come due; or 2) assets < liabilities + preferential claims to preferred
shareholders
6. Applying tests to textbook hypos
Assets Liabilities
$1,172,200 $537,200

Net Worth
Stated Capital (Preferred): $6,000
Stated Capital (Common): $75,000
Capital Surplus (preferred + common): $27,000
Accumulated Retained Earnings: $527,000

Total: $1,172,200 Total: $537,200 (Liab.) + $635,000 (NW) =

$1,172,200

a. DCGL §170
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 i. Balance Sheet Test: Assets > liabilities + stated capital? $1,172,200 > ($537,200 + $6,000 +
$75,000)  no need to go to Nimble Dividends; dividends up to $618,200
ii. But if we did need to use Nimble Didivends, cannot tell from this balance sheet because need
to see net profits from past 2 years; need income statement
b. MCBA §6.40(c):
i. Equity Insolvency test: can speculate based on balance sheet but don’t really know if corp is
paying debts as they become due
ii. Bankruptcy Insolvency: assets > liabilities + amount owned to preferential shareholders
upon liquidation. 1,172,200 > $527,200 + liquidation preference … which we do not know,
but can assume it passes
E. Piercing the Corporate Veil
1. Background: Limited liability tempts insiders to exploit the corporation’s creditors. They can create
false appearance of corporate solvency, engage in self-dealing transactions, distribute corporate funds
to themselves, etc. Because of limited liability, losses fall on creditors. As protection against insider
abuse, courts sometimes disregard limited liability and “pierce corporate veil”
2. Piercing Corporate Veil: power of court to set aside entity status of corp and hold its
shareholders liable
a. Must be done sparingly: shareholders have to abuse limited liability really badly that they don’t
deserve protection of LL; this is an exception to limited liability
3. Piercing for tort creditors (involuntary creditors) vs. contract creditors (voluntary creditors):
courts are more likely to pierce veil for involuntary creditors (tort) than voluntary creditors (contract)
a. Voluntary creditors can investigate corp’s structure and obtain personal guarantees, higher prices,
or assurances on how business will be conducted.
b. Involuntary creditors cannot easily protect themselves contractually, and can’t assume risk of
dealing bc don’t have opportunity to do due diligence to avoid dealing w/ corp w/o assets.
c. However, involuntary creditors are less successful in piercing the veil, even though conventional
wisdom is that tort claimants typically get more sympathetic read from court, most likely bc contract
(voluntary) claims likely involve explicit misrepresentation, making piercing more persuasive.
4. Different Formulations for Veil Piercing:
a. Most courts use a version of 2 part test (Loowendahl Test): P must prove
i. There is unity of interest/lack of separation bw shareholder and corporation or corporation
and its subsidiaries such that separate personalities of the corporation and the individual no
longer exist; AND
ii. Honoring the veil (and allowing LL) would sanction fraud or promote injustice
1. Kinney uses broad “inequitable conduct” standard instead of fraud/injustice
iii. Kinney optional 3rd factor: what D would have discovered had D done due diligence—based on
this, may conclude D assumed a risk of debtor defaulting
b. Sea Spray Factors to Consider:
i. Sea Spray Factors to Consider for Unity of Interest:
1. Disregard of corporate formalities – Skeel thinks this is a tricky factor bc a lot of small
corps are not abusing the corporate form don’t obey the formalities
2. Thin capitalization (not enough by itself under Walkovszky)
a. Skeel: undercapitalization is the most important factor; if a company is
sufficiently capitalized, it will be really hard to pierce the corporate veil (like
Walkovszky)
3. Small numbers of shareholders
4. Active involvement by shareholder in management
ii. Factors to Consider for Fraud/Injustice:
1. Only not being able to pay judgment is not injustice
2. must demonstrate a “wrong” beyond creditor’s inability to collect, like Ds would be
unjustly enriched
c. Walkovsky: “know it when you see it” standard
5. Horizontal vs. Vertical Veil Piercing:
a. Vertical: pierce corporate veil to hold responsible the individual who set up the corporation
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 i. P piercing corp to get to shareholder; PCorpShareholder; or P subsidiary corp
parent corp individual shareholder
ii. When piercing vertically, show D using corp form for own personal gain
iii. If D unable to pay judgment, allows a P to take his ownership interest (stock) of companies,
but not actual assets until creditors are paid
b. Horizontal (Reverse): piercing to hold other group of related corporations responsible for
obligations of the corporation whose veil was pierced, rather than going after an individual
i. P piercing corp to get to sibling corp; PCorpsibling Corp
ii. If D unable to pay judgment, gives P opportunity to go directly after assets (Sea Spray)
6. Fact that veil is pierced means that other creditors may have good case for piercing the corporate veil,
but veil piercing is a creditor-by-creditor endeavor

Sea Land Services, Inc. v. The Pepper Source

Facts: SL was freighting peppers for Pepper and Pepper didn’t pay the bill. SL tried to sue and discovered that
Pepper had been liquidated, so SL sued M, the sole shareholder of Pepper Source, and many other of M’s
corporations. SL pierces to M (vertical) and to his other corporations (horizontal)
Holding: SL can’t pierce veil. SL did show first prong, unity of interest, bc M used corp accounts for himself,
failed to show basic formalities, had undercapitalized corps, etc. But, SL failed to show that honoring corp
entity and allowing LL would promote injustice only bc corp can’t pay the judgment
 Factors to consider for unity of interest:
o Absence of corporate records and corporate formalities (meetings, minutes, elections)
o Comingling of funds or assets
o Undercapitalization (by itself not enough to pierce corp veil)
o One corp treating the assets of another corp as its own
 Factors to consider for fraud/injustice:
o P must demonstrate a “wrong” beyond creditor’s inability to collect, like Ds would be unjustly
enriched.
o Must show that what M did would promote an injustice or fraud if he wasn’t held liable
Skeel:
 Reverse Piercing: SL wants to reach M, so pierces veil vertically, but also wants to reach M’s other corps,
so pierces horizontally too (reverse). First must pierce to reach M, the shareholder of all the corps, and
then go through him to the other corps.
 Why does SL want to get to subsidiary corps? Why isn’t it enough to pierce to get to M?
o M probably doesn’t have other assets. Although if M doesn’t pay his judgment SL can get his assets,
which is stock in his other companies, this is not as good as going directly for the companies bc SL
wouldn’t be entitled to these assets until creditors have been paid. However if he can pierce to get
straight to the companies through horizontal piercing, SL would be on par w/ creditors, but w/
vertical piercing wouldn’t be able to get assets right away.

Kinney Shoe Corp v. Polan

Facts: Polan (individual) sets up 2 corps: Industrial and Polan Industries. Kinney leases a building and subleases
it to Industrial, and Industrial leases it to Polan Industries. Industrial doesn’t pay bill and doesn’t have assets, so
Kinney tries to pierce to make Polan liable as an individual.
Holding: K can pierce corporate veil and hold P liable. VA uses 2 prong test: 1) unity of interest and ownership;
2) inequitable result would occur if acts treated like those of corp alone (and couldn’t hold P liable)(standard
more broad and flexible than Sea-Lane); 3) (optional) Creditor’s due diligence (not applied here).
 Prong 1: P was undercapitalized, didn’t carryout corporate formalities; clear that he was trying to create
shield to protect himself from liability. If P wishes protection of corp to limit liability, must follow simply
formalities of maintaining corporation
 Prong 2: ct determined that not piercing veil would lead to inequitable result
 Prong 3: not applied bc not mandatory. D can’t be relieved from his obligs bc P should have known better.
Skeel:

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  Difference bw SL and K: while the behavior was somewhat similar, cts applied different standards in 2nd
prong; “inequitable conduct” is more broad and flexible than “fraud/injustice” standard; might make it easier
to conclude even on SL facts that veil should be pierced
 Ct doesn’t like 3rd prong and looks for way not to use it; since P is cheating and deserves to have veil pierced.

Walkovszky v. Carlton
Facts: C was shareholder in 2 corps and each had 10 cabs registered in its name. One of the cabs belonging to
Seon Cab Corp (one of C’s corps) hit W. Each cab only had 10k insurance coverage as per statutory min. W
tried to pierce veil to reach C (vertical piercing)
Holding: W cannot pierce veil bc doesn’t show why it would be appropriate.
1) Having minimum capitalization is not a per-se basis for piercing the corporate view. C was satisfying the
insurance obligation, so his cab corps were sufficiently capitalized, if this is undercapitalization, should be
addressed with legislature.
2) Fact that corps may have been operating as one large corp doesn’t show that C was controlling all the
corps for his own behalf—there must be showing that C was controlling them all in individual capacity
Dissent: Corps were undercapitalized and corp was clearly used to escape liability.
Skeel:
 A key role of the Veil Piercing doctrine is that is it substitute for minimum capital rules; we don’t have any
set in place the VP is very loose substitute – corp needs to be sufficiently capitalized or risk of liability
through VP

IV. STRUCTURE OF/DECISION MAKING WITHIN CORPORATION

A. Background:
1. Corporation can be liable to outsiders only through its agents.
2. The authority to bind the corporation comes from the board of directors, the traditional locus of
corporate power.
B. Authority of Officers
1. Corporate law treats board as the corporate principal and the officers as agents
2. Agency: arrangement that confers legal power on agent and gives rise to duties by both principal and
the agent
a. Both parties must manifest intention to enter into agency relationship
b. Manifestation must be such that the agent reasonably understands from the action or speech of the
principal that she has been authorized to act on the principal’s behalf; doesn’t have to be verbal or in
writing
3. Whether corporation is bound to transaction depends on whether an agent had authority to act; there
are 3 types of authority an agent can get;
a. Actual: PA; look at what authority P gave to A.
i. Express Actual: Formal authority expressly given to officers whose actions, when acting in
this authority, bind the corporation. Authority can come from board of directors, bylaws,
board resolutions, etc.
ii. Implied Actual: authority implied from/incidental to authority that was expressly given
(implementing steps necessary to carry out/connected to authorized act)
iii. must have both
b. Apparent: P 3P; look at 3P’s impression of what authority P gave to A
i. Authority that a reasonable 3rd party would think A has based on the P’s actions (what
authority he gave A), even if A doesn’t actually have that authority
ii. 3P party knows that A is acting as an agent to someone else
iii. Designed to prevent fraud or unfairness to third parties who reasonably rely on P’s actions or
statements in dealing with A.
c. Inherent: 3P A; look at what authority 3rd party thought A had

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 i. if A’s action relate to transactions he is generally authorized to conduct and the 3rd party
reasonably believes A is authorized in this case, corp is bound, even if A doesn’t have authority
ii. 3P doesn’t know A is agent, think that Agent it Principal
d. Agency by Estoppel or Ratification: where A’s act isn’t authorized by P or not within inherent
agency power of A, P may still be bound by A’s acts by:
i. Estoppel: failure to act when knowledge and an opportunity to act arise + reasonable change
in position on part of 3rd party
ii. Ratification: accepting benefits under unauthorized contract will constitute acceptance of its
obligations and benefits
4. DGCL §141(c): directors can delegate almost all decision-making power/authority to a committee
a. Can have a committee of one
b. Committees cannot decide major issues
i. If incorporated before July 1, 1996:
1. Amending the certificate
2. Adopting an agreement of merger or consolidation
3. Recommend sale, lease, or exchange of all or substantially all of the corporation’s assets
4. Recommend to SHs a dissolution of the corp or a revocation of a dissolution;
5. Amend the bylaws of a corp
6. Declare a dividend, authorize issuance or a stock (unless a resolution, bylaws, or
certificate of incorporation expressly say so)
ii. If incorporated on or after July 1, 1996, committee cannot:
1. Approve or adopt or recommend to the SH any action or matter (other than the election
or removal of directors) expressly required by this chapter to be submitted to SHs for
approval; or
2. Adopting, amending or repealing any bylaw of the corporation
iii. If publicly held corporation:
1. NYSE & NASDAQ require independent nominating and compensating committees
2. Sarbox requires audit committee made up of independent directors
3. Independent = can’t have directors or CEO
5. DGCL §141(e): a director or committee member is fully protected if he relied in good faith on the
opinion of an expert (like banker, lawyer) who has been selected w/ reasonable care by or on behalf of
the corporation

White v. Thomas
Actual & Apparent Authority
Facts: W (P) authorizes B (A) to buy tract of land for $250k or less at auction. She bids and pays $327.5k and
to solve problem she tries to sell 45 acres of the land to T, claims she has power to make the transaction. W
isn’t happy w/ transaction and claims B didn’t have authority to make it.
Issue: did S have authority to sell land to T on W’s behalf?
Holding: in order to W to be liable for B’s actions and for sale to be binding, B’s actions must fall into scope of
her apparent authority. Declaration of an agent that she has authority is not sufficient to establish apparent
authority.
 No actual authority:
o No express actual to sell land, only to buy land for $250k
o No implied actual: selling land was not a responsibility W gave to B by virtue of allowing her to
purchase land for $250k; selling not necessary to accomplish the buying transaction not connected
to authorized act
 No apparent authority: 3P must reasonably believe that P gave A authority
o T: B had blank check, had previously completed transactions on behalf of W, and since she had power
to buy acres, reasonable that she would have power to sell them
o CT: Buying and selling as not so closely related that 3rd person could reasonably believe that
authority to purchase=authority to sell
o CT: T didn’t even do due diligence to determine whether she had authority to sell the land; RP would
do due diligence, not just take someone’s word that they had authority
25
 Hypo: suppose that when B entered into purchase agreement, as a condition of that agreement she had to
sign check for 1% of sale price as a deposit on the purchase. B makes check out for $3,275 (1%) and signs
it. W finds out and disapproves because didn’t authorize her to spend $327.5k for transaction nor to sign
this check for this amount, and stops the payment. Did B have authority to sign the $3,275 check?
o Argument for apparent authority: W gave B bank check, and she’s filling it out for a relatively small
amount of money. W acted in way that made B’s actions look legitimate.

Gallant Ins. Co. v. Isaac

Inherent Authority
Facts: G sells car insurance through its agent TH, whose authority includes power to bind G on new insurance
policies and interim policy endorsements. I asked her insurance agent at TH for renewal and agent said she
had it; I said she would pay following Monday. The next day she gets into a car accident, makes a claim, and G
claims the TH agent had no authority to renew contract w/o payment, so I isn’t insured.
Holding: TH had inherent authority to bind D bc reasonably 3rd person would think the agent could do that
when he always has been able to renew before. TH’s renewal is act that usually accompanies insurance
transactions that it is authorized to conduct, TH had practice of telling insured that they were bound despite
not receiving payment until later, I could have reasonably believed that TH had authority to orally bind
coverage.
 Inherent Authority:
o Conduct relates to authorized conduct: TH authorized to bind G on new insurance policies and
interim policy endorsements by fax or phone. Practice is similar to unauthorized conduct of binding
verbally
o Reasonable belief by third party: I reasonably believed that TH had authority to bind coverage and
allow her to pay money bc previously interacted w/ TH every time she changed his policy and TH had
practice of telling insured that they were bound despite not receiving payment until later.
o No notice of limited authority: I didn’t have notice that TH wasn’t authorized to verbally bind
coverage w/o payment, didn’t know TH wasn’t principal.
 Actual Authority:
o Express: actual insurance agreement said that policy goes into effect when premium is paid, and
premium not paid until after accident so G didn’t give authority to PH to start new policy
o Implied: G told TH that it didn’t have authority to tell insureds that they were covered before receipt
of payment, waiving this is not incidental to its given authority
 Apparent Authority: I didn’t even know TH was an agent for G. However; in Indiana SC, ct said TH’s
actions were w/in apparent authority bc G put TH in position where they could be seen as having capacity
to bind coverage, so this would be actions of the principal.

6. Hypo:
a. Abercrombie & Fitch case: Muslim woman wearing a head-scarf for religious reasons applied for a
job and got denied bc A&F said it was inconsistent w/ their dress policy. Woman won the suit bc it
was a violation of her religious freedom. Assume that while this case was being fought, A&F realized
this was a bad idea and the CEO agreed to settle for 450k and signed a settlement w/ P. Would the
CEO have the authority to enter into this settlement?
i. Actual express: authority to CEO can be given in certificate (unlikely bc more day-to-day
operation), bylaws, board resolution/board-approved contract through provision that allows
CEO to unilaterally enter into settlements/contracts under certain amount
ii. Implied Express: if bylaws say something about CEO having ordinary control of the business,
can construct implied authority argument
iii. What if no such provision exists anywhere? Then go to apparent authority 
iv. Apparent authority: general rule is that CEO has apparent authority to make ordinary
business decisions on behalf of the firm (unlike any other firm officer)
a. Argument that settlement isn’t w/in ordinary course of business: settlement of
very controversial litigation isn’t w/in apparent authority of CEO, but this is close
call.

26
 b. Way to solve this problem is to have board make these decisions, not CEO

C. Shareholder Voting
1. Background: shareholder voting gives self-help remedies to the shareholder majority and gives them
power to protect their position as last-in-line claimants of the corp’s profits.
a. Voting rights: to elect directors, to approve fundamental corporate changes adopted by the board, to
initiate limited changes to the governance structure.
2. Each corporation must have at least one class of voting stock: DGCL §151
a. Common shares carry voting rights; Preferred shares sometimes have voting rights; debt doesn’t
have voting rights
3. Each share of stock carries one vote (default rule, can be changed in certificate) - DGCL §212(a)
4. Shareholders’ Meetings: there are two kinds of shareholders’ meetings: annual (regular) and special
a. Annual Meetings: mandatory yearly meeting where shareholders elect directors and conduct other
regular business/vote on current issues
i. DGCL §211: every corp is required to have an annual meeting for the election of directors in
the manner provided by the bylaws, or if not designated, as determined by the board of
directors, unless SH act by written consent to elect directors in lieu of annual meeting
ii. DGCL §211(c): if corp doesn’t have annual meeting within 13 months, any shareholder or
director can petition to chancery court to compel annual meeting
1. Shares of stock represented at such meeting, either in person or by proxy, shall
constitute a quorum for the purpose of such meeting, notwithstanding any provision of
the certificate or bylaws to the contrary
iii. Primary Voting Opportunity: SH can amend and repeal bylaws, remove directors, adopt SH
resolutions, request that board take certain actions
1. DGCL §109: SH have inalienable rights to change bylaws; cannot be taken away
b. Special Meetings: Authorized SH can call meetings bw annual meetings where they can do
whatever they are able to do at annual meetings, except election of directors (change size of board,
amend bylaws, remove directors, etc), or take any extraordinary action that prompted calling the
meeting.
i. Usually requires some voting or share threshold to get meeting (might be something like if
10% of shares want a special meeting, will be called; threshold can be in bylaws)
ii. DGCL §211(d): special meetings can be called by the board or anyone authorized in the
charter or bylaws
1. Director’s right to call special shareholder meetings needs to be in certificate of bylaws;
most corps give directors this right, some give it to SHs, some don’t.
2. Pros: allow SH to better monitor corporate management
3. Cons: expensive and cost senior executive time
4. Takeover context: if you want to take over a company by replacing the board, the ideal
company to take over is one in which the board is not staggered and its easy for
shareholders to call meeting to replace the board
5. Notice: DCGL §222(b): shareholders entitled to vote must be notified no less than 10 and no more than
60 days before meeting (both annual and special)
6. Location of Meetings: can have meetings anywhere; bylaws usually specify timing and location of the
annual meeting
7. Quorum: minimum number of shares that must be present or represented by proxy at the meeting for a
vote to count
a. firm can set different quorum requirements in its certificate or bylaws, but can’t be less than 1/3 of
shares (not shareholders)
b. Quorum needed for: voting on ordinary matters, amendment to bylaws
8. Proxy: shareholder fills out a proxy card and authorizes someone else to act of their behalf at the
meeting

27
 a. Proxy card usually comes w/ annual report of company. Card has to give you choice about how that
representative will vote, so it will have company’s nominees and competing nominees or the issue
being voted on (e.g. merger)
b. DGCL §211(e): permits a board to allow electronic voting, but outside of SV firms, no one does this.
1. If corps did this, all shareholders would show up electronically at the meting, but corps
don’t want this because they are afraid of shareholder unity. Shareholders can do
whatever they want at the meeting so corps are worried about having enough
shareholders there to propose something like a radical bylaw change and have enough
votes to get it passed.
2. With meetings as they currently are, there is a barrier to entry and corps want to keep it
this way and prevent all shareholders from coming to the meetings
9. Voting:
a. Ordinary Matters: DGCL §216: majority of shares present at the meeting or represented by proxy
at which quorum is present (can be changed by certificate or bylaws or statute)
b. Amendment to Bylaws: majority of shares present at the meeting or represented by proxy
i. DGCL §109: SH can amend bylaws; this power can’t be taken away from them;
ii. Directors can also change bylaws if that power is given to them in the certificate
c. Electing Directors: plurality of shares present or represented by proxy at the meeting (candidate
receiving most votes, although not necessarily a majority) (based on record date)
d. Fundamental Transactions: requires board proposal for fundamental transaction (quorum +
majority of board members present) + vote by majority of all shares (not just shares that are
present). There are 4 fundamental transactions 
i. Certificate changes: DCGL §242(b)(2)
ii. Mergers (both companies’ SH votes): DCGL §251
iii. Sales of most or all of the assets of the firms: DCGL §271
iv. Dissolution of the company: DCGL §275
v. Written consent DGCL §228
vi. NOT fundamental: issuing debt, borrowing
10. Record Date: DGCL §213: Date by which we determine the shareholders who can vote
a. Corps want to make sure that the shareholders that are voting are the real owners of the stock. Since
person who owns stock now might be different than person who owns it at the time of the meeting
bc stock changes hands a lot, every state requires that firm set a record date before voting event
b. Record date can’t be less than 10 days or more than 60 days before the meeting—people who no
longer own shares may be entitled to vote
c. Usually set by bylaws or board
i. If no record date is set, it is at the close of business on the day before the day on which notice
of the meeting is sent
ii. If notice is waived, it is at the close of business on the day before the day on which notice of the
meeting is sent
d. SEC NOBO (non-objective beneficial owner) Rules
i. If an individual buys stock through a broker, he doesn’t actually get the certificate, the broker
gets it and is technically the owner of the stock. Brokers often transfer legal ownership of stock
to depository corporations, which hold billions of shares of stock. This is because it makes it
easier to move stock around and just make an adjustment in a depository trust as to who the
owner is, rather than transferring a certificate from person to person. So, since shareholders
are often not the record owners this creates a voting issue bc corps want to make sure that the
shareholders, not depository corporations are voting. This is why SEC put these rules in place.
ii. Record owner of stock has to make all reasonable efforts to get the vote to the beneficial
owner of the stock.
1. NOBO asks broker to share his info w/ the corp and the corp has to get info to the NOBO.
2. if the NOBO system fails, there is no voting on that share.
11. Voting by Written Consent: DGCL §228
a. Allowed, but corp can take power away

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 b. Any action required to be taken at an annual meeting or special meeting can be taken w/o a meeting,
w/o prior notice, and w/o vote if written consent is obtained from minimum number of voting
shares required to approve that action at a meeting attended by all shares (so majority of shares)
D. Electing and Removing Directors
1. Annual election of directors is a shareholders’ foundational and mandatory voting right
2. Number of directors on board must be in bylaws, unless it is in certificate DGCL §141(b)
3. Every corp must have a board of directors; board can be just 1 director
4. Voting Methods: Straight Voting vs. Cumulative Voting:
a. Straight Voting: (usual method) each shareholder can vote their shares (1 share=1 vote) for each
open director position, and whichever candidate gets most votes for each position wins.
i. This can let shareholder holding majority of shares to elect the entire board; can be
undesirable for minority shareholders
ii. If there are 5 spots and A has 51 shares and B has 49 shares, A can give his director pick for
each spot 51 votes, while B can only give his director pick 49 votes. A would pick the whole
board.
iii. DE uses this
b. Cumulative Voting: each director can accumulate all of their votes (number of voting shares she
owns X number of director seats open) and allocate them among a few or 1 candidate to ensure
election. Candidate with most votes gets the spot.
i. If A has 70 shares and B has 30 shares, and there are 5 director spots, A has 350 total votes
(70x5) and B has 150 total votes (30x5). A and B can both put any portion of their vote for any
candidate, instead of having to vote their shares per spot, which ensures that B can fill at least
1 spot.
ii. Not very popular; few corps adopt this to ensure board representation for minority
shareholders
c. Cumulative Voting Formula: for determining how many shares assure the election of a director:
N=((X) (D+1)) / S
i. N=number of directors that the minority surely can elect
ii. X=number of shares that the minority shareholders have
iii. D=number of director slots
iv. S=total number of shares that get voted in the election
v. *always round down bc can’t get director and a half.
vi. HYPO: 6 director seats, 2 shareholders. S1=60% of shares; S2=40% of shares. 1,000 shares.
1. Majority = 600 x 6 = 3,600 total votes
2. Minority = 400 x 6 = 2,400 total votes
3. How many directors can the minority elect?
4. ((400) (6 +1) / 1,000  2,800 / 1,000 = 2.8  2 directors
5. so if minority puts all its votes on two directors, they will be elected
d. Policy:
i. Pros:
1. Increases possibility of minority shareholder representation on board
2. Puts a dissenting voice on the board to keep it in check; provides caution
3. Gives minority shareholders a voice, even if they always get out-voted on board
4. Defense: in other contexts, it’s not uncommon to have representatives of different
constituencies on the board
ii. Cons:
1. Creates divisiveness: complicates decision-making process, can lead to disagreements
2. Very easy to undermine. Majority shareholders can change the board in way that makes
cumulative voting less valuable (reducing D will take a bigger X)
5. Frequency of Voting for Directors: Unitary Board vs. Staggered Board
a. Unitary Board: all directors are elected annually
b. Staggered Board: DGCL §141(d): directors are divided into 1-3 classes, each class w/ a multiyear
term, which come up for election in different years
iii. Pros:
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 1. Most effective anti-takeover device: takeover bidder usually not willing to wait for 1-2
years to gain control of board. But to be effective anti-takeover device, staggered board
should be in the certificate, which shareholders cannot amend, not in bylaws.
a. Ineffective staggered board: staggered board that is in the bylaws, so it can be
amended and taken away by shareholders
2. Can help new IPO firms: IPO firms are unstable at first and there is a risk that someone
will try to take advantage of the company. Staggered boards help maintain stability.
3. Give managers stability: Managers have better information than shareholders, and if
shareholders have ability to change board every year there is risk of takeover and
managers will have to cater to shareholders and not to what is good for the company
iv. Cons: takeovers are good for shareholders because they give a premium for stock, so
conventional wisdom is that staggered boards are bad for shareholders because they make it
hard to takeover
v. Evidence on staggered boards is mixed. There was big de-staggering movement in big corps
and a lot got rid of their staggered boards bc belief that firms w/ staggered boards are worth
less; in law few years studies have shown that they are actually good and actually increase
firms’ value
6. Newly Created Director Vacancies: DGCL §223: unless otherwise provided for by certificate or
bylaws, when there are director vacancies bc of newly created directorships:
a. the remaining directors vote to fill those vacancies (majority vote, even if less than quorum); or
b. if there is only one other director, by him
7. Removal of Directors: DGCL 141(k)
a. Generally, directors, or even entire board, can be removed at any time for any reason by majority of
shares entitled to vote at an election of directors (quorum + majority of present shares) (can do this
through annual meeting, special meeting, or written consent)
b. Exception: DGCL §141(k)(1)
i. Staggered Boards: unless certificate says otherwise, directors on a staggered/classified board
can only be removed during their term “for cause”
1. Staggered board is very significant defense against takeovers bc takes at least 2 annual
meetings to change board firm has made commitment to stability. Making it hard to
remove the directors is consistent with this stability.
ii. Cumulative Voting: a director elected under cumulative voting can’t be removed w/o cause if
any minority faction with enough shares to have elected him by cumulative voting votes is
against his removal; doesn’t apply to getting rid of entire board
8. HYPO: Un-Fireable CEO:
a. Morrison is a 25% shareholder of a company, and Minow is a 51% shareholder of a company and
wants to takeover as quickly as possible.
b. Certificate: allows only directors to amend bylaws and allows cumulative voting.
c. Bylaws: corp has a staggered board, with 9 directors
d. How can Minow take immediate power?
i. Unlawful Bylaw Provision in Certificate: Minow can point out that the provision allowing
only directors to amend bylaws is unlawful, and she would win under DCGL §109 which states
that shareholders have right to unilaterally change bylaws, and this right cannot be taken
away from them.
ii. Bylaw Amendment; Staggered Board Regular: since the bylaw provision in the certificate
will be stricken down, Minow can amend the bylaws to get rid of the staggered board (which
she can do w/ 51% of shares bc majority)
iii. Get Rid of Directors: Two limitations: 1) Staggered Board: with a regular board Minow
can remove directors without cause (but not w/ staggered board). Since she got rid of the
staggered board, this won’t stop her from removing directors. 2) Cumulative Voting: The
certificate includes cumulative voting, which doesn’t allow getting rid of directors w/o cause if
minority has enough votes to elect directors votes against the removal. However, DGCL
§141(k) doesn’t apply to removal of a whole board, only removal of some of the board, so this

30
 also is not a limitation here. Minow will be able to remove the whole board. OR she can also
increase the size of the board.
iv. Cumulative Voting of New Directors: once old directors are removed, shareholders will have
to vote for new directors. Under cumulative voting (as per certificate, which can’t be changed
bc shareholders can’t change certificate) with 51% of the shares, Minow can put in 7 of the 9
directors, making the majority of the directors sympathetic to her.
E. Director Voting
1. Directors’ Meetings: DGCL §141(b): more relaxed bc boards are smaller than shareholders
a. Notice: if there are regularly scheduled meetings, notice is not required (in most states). For special
meetings, notice is required and action taken w/o notice is invalid.
b. Quorum: default: majority of total numbers of directors. Can be raised up to requiring full board
present and down to as low as 1/3 (except when there is a board of 1, in which case quorum = 1)
c. Voting: need quorum and majority of the directors present at the meeting, unless certificate or
bylaws says something else
i. Each director has one vote and can’t vote by proxy
ii. HYPO1: corp has 9 directors and 4 of them are at meeting and there is 2-1 vote in favor of
action A. Under 141(b) default rule, there is no quorum bc no majority of total directors
present, and no proper vote bc 2 is half of directors present (4), not majority. If the firm had a
1/3 quorum rule, 3 directors would be quorum so 4 directors would pass, but still no proper
vote. Would need 3 to vote to make it a proper vote.
d. Meeting Rule: directors can’t vote separately and must act together as a body at a properly-
convened meeting; approval of a transaction by individual directors outside a meeting is not binding
e. Meeting Rule Exception: Decision Making w/o Meeting:
i. DGCL §141(f): only legitimate if there is unanimous consent
F. Proxy Voting
1. Because of widely dispersed share of ownership of most corps, public shareholders are unlikely to
attend shareholder meetings; in order to still get quorum, boards are permitted to collect voting
authority from shareholders through proxies
a. Shareholders vote primarily by proxy
b. Who attends shareholder meetings: CEO, directors, people that have free time; if there is a
controversial topic to be discussed, some more people are likely to go
c. Anyone w/ minimum stock (1 share) can go
2. DGCL §212(b): proxies allow shareholders to vote on certain matters prior to a meeting or assign the
voting right to another person who will be present at the meeting. Managers send out proxies to the
shareholders requesting their votes for issues to be voted on at the shareholder meeting.
a. Requirements:
i. Proxies must record the designation of the proxy holder by the shareholder and authenticate
the grant of the proxy (i.e. through proxy card)
ii. Proxy holder must exercise the proxy as directed: card must have a list of specific nominees
and specific issues on which proxy holder proposes to vote
3. Proxy Contest: battle for control of a firm in which a dissident group of SHs seeks, from the firm’s other
SHs, right to vote those shareholders’ shares in favor of the dissident group’s slate of directors/issues.
Both insurgent and incumbent sides spend money to get other shareholders to vote their way.
a. Can come up in a situation where board can exclude your proposal from the proxy materials under
14a-8. So, you pay for the material to be distributed to the shareholders so you can win the vote.
Then, you want to get reimbursed for your expenses. Insurgents will only get their expenses
reimbursed if they win and gain control of the board.
4. Default Rule for Proxy Solicitation and Expense Reimbursement (Rosenfeld)
a. Incumbents can always get paid (win or lose) as long as:
i. The issue is a policy issue
1. Not personal gain/power
2. Director compensation is grey area (Skeel thinks its personal, Rosenfeld says its policy)
3. Proposing poison pill= policy issue
ii. Expenses are reasonable/proper; and
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 iii. Directors in good faith believe their position is in the best interest of the corporation
b. Insurgents can only be reimbursed if they win proxy fight and:
i. Install new board of directors that approves reimbursement and successfully solicit
shareholder ratification of board’s action
ii. would first require approval by majority of directors present at meeting and then vote of
majority of shares present at meeting.
iii. So insurgents will only get reimbursed if they are successful and also win control of
board bc old board isn’t going to approve reimbursement to insurgents
iv. w/o SH ratification, reimbursements to successful dissidents might be attacked as self-dealing
c. Role of Courts: courts can disallow expenses:
i. When spent for personal power, individual gain, or private advantage;
ii. If expenses were not in the best interests of shareholders and corporation; or
iii. Where fairness and reasonableness of amount spent is successfully challenged

Rosenfeld v. Fairchild Engine & Airplane Corp

MP: lays out rule for proxy reimbursement (above)
Facts: Insurgent SHs waged proxy contest bc they thorugh the CEO was being paid too much; they won the
issue and control of the board. Before they took over the board, the old directors reimbursed themselves
$106k for part of their proxy expenses. After insurgents took over the board, they reimbursed the old board
the additional $28k they were stilled owned (probably to justify/smooth out new board reimbursing
themselves). They also reimbursed themselves, which was ratified by 16:1 SH vote. R sought to compel return
of $261.5k paid to reimburse both sides for their expenses in proxy contest.
Holding: Reimbursement to both the insurgent and incumbents was proper. Directors have right to make
reasonable and proper expenditures for purpose of persuading stockholders of correctness of their position
and soliciting their support. If they were not financially supported, the firm’s position would not be
represented.
Dissent: Insurgents shouldn’t be reimbursed at all, and incumbents should get limited expenses bc not w/in
corp’s power (ultra vires)
Skeel:
 Why pay insurgents? Reimbursing insurgents may keep directors on their toes. Also, incumbents are on
their way out, and they are probably worried that insurgents will not pay their proxy expenses, so they
pay insurgents to keep things smooth
 Why would Rosenfeld bring this action? He had 25/ 2 mil shares, so very small stake
o Precedent value of case/ cares about the issue
o Likely reason: if successful, attorney’s fees shift. Under common fund doctrine: if attorney is
successful, gets paid before proceeds to shareholders or corp solution to perceived collective action
problem, and incentivizes attorneys to take on these cases.
 Alternative proposals: insurgents would be paid if they are successful in obtaining a certain percentage
of votes (would facilitate more challenges when appropriate)

d. HYPO 1: Suppose insurgents were not fighting over CEO issue, but rather wanted to get the
staggered board taken off of the bylaws. The incumbents did not like this idea because they wanted
stability through a staggered board. The insurgents won the proxy fight over the bylaw change to
remove the staggered board.
i. Whose expenses get paid? Under Rosenfeld logic
1. Incumbents: Incumbents get paid as long as 1) their expenses are reasonable and
proper, and 2) the contest is over policy, not personal issues.
2. Insurgents: Insurgents get paid only if they win the proxy contest, and if winning the
contest displaces the existing board, and new board proposes that incumbents get
reimbursed and shareholders must ratify. Here the board was not displaced, so old
board likely won’t propose paying insurgents’ expenses
e. HYPO 2: Bylaw amendment that shareholders can unilaterally reimburse themselves for
proxy contest?

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 i. This would allow insurgents to get proxy expenses if they have a majority of shares
ii. DGCL §141(a): DE decided that kind of bylaw is illegal
1. SH expenses/reimbursement bylaw is impermissible bc it takes discretion away from
board
2. Idea is that corporation is managed by or under direction of board of directors; if
shareholders have broad power to put bylaws in place, makes it easy to sidestep board
iii. DGCL §113: allows SHs to pass bylaw that would make the corp reimburse expenses incurred
by a stockholder (like insurgent’s proxy expenses) in soliciting proxies in connection with an
election of directors
G. Shareholder Information Rights
1. DGCL §220: Shareholders have a right to inspect the company’s books and records for a proper purpose
a. Proper purpose: purpose reasonably related stockholders’ interests; it is broadly construed and
once its shown court won’t consider whether the shareholder has an additional improper purpose
2. DE courts recognize two types of requests: Stock list and books and records
a. Stock List: (don’t need proper purpose)
i. Discloses identity, ownership interest, and address of each registered owner of stock
1. Order will often require the company to also furnish NOBO list if company has it
2. NOBO list is important to those who want to communicate directly w/ real owners and
voters of the stock
ii. Per se proper reason for SH to get list under DE law: if interested in waging proxy
contest/exercising shareholder democracy through directorial elections (Pillsbury)
iii. BOP: on company to show that SH doesn’t have a proper purpose (DGCL §220(c))
1. Getting stock list is seen as a right, while books and records are more difficult to get
iv. Policy: so SH can communicate w/ other SH or challenge management in a proxy contest
b. Books and Records:
i. Corporation is not enthusiastic about sharing this information; it takes longer to get than the
stock list and company will take its time deciding whether a proper purpose exists to disclose
the information
ii. BOP: on shareholder requesting the information to show proper purpose and courts carefully
screen motives and the consequences of granting the request (DGCL §220 (c))
iii. Reasons for stricter BOP:
1. Broad request for information bc of vague suspicion of wrongdoing is not enough
2. It is more expensive to provide books and records than stock list
3. books and records contain a lot of sensitive company information and there is a risk if
will be misused if disclosed
c. If company doesn’t reply to request for stock list or books and records w/in 5 days, can go to
chancery court (DGCL §220)
d. DE judges have cracked down on attorneys for bringing litigation w/o using §220. Prior to filing a
lawsuit, attorneys must use 220 to get information.
e. Why does shareholders need this information:
i. To be more informed when voting, endorsing/proposing something
ii. Stock decisions: books and records help w/ valuation of stock, useful when deciding to sell or
buy stock
iii. Shareholder litigation: info on what directors said in meeting, what they have been doing,
finding wrongdoing helps for ligation purposes – see if SH can even bring claim
f. HYPO: Shareholder A contact company saying he wants their books and records. How does corp
respond?
i. Corp asks why, requires more information to decide whether there is a proper purpose for
disclosing the information, and will take its time carefully making this determination.
Shareholder A will likely not get an answer tomorrow
Pillsbury v. Honeywell, Inc.
Facts: HW made bombs. P, a SH of HW, thought it was awful and wanted to try to change that through corp
governance, so asked for SH list to talk to the other SHs. HW argued that P was interfering with operations of
business which is not a proper purpose
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 Holding: MN court said P can’t get SH list
DE: P always has to get SH list:
 Even if P is not concerned about effect of making bomb’s on HW’s business, and only concerned about
moral purpose, if P is interested in exercising shareholder democracy (like through raising his opinion) to
do something concerning a directorial election, that is per se a proper purpose for to obtain a shareholder
list under DE law (only list, doesn’t apply to books)
H. Techniques for Separating Control from Cash Flow Rights
1. Circular Control Structures: DGCL §160(c) / Spieser
a. Getting around not being able to vote on your own shares
b. Part 1: if the corp owns shares of its own stock (authorized, un-issued), it can’t vote in those shares
(“shares of stock of the corporation belonging to the corporation shall not be voted upon directly or
indirectly”)
i. “Belonging to the corporation” = treasury stock
ii. Speiser interprets “belonging to” broadly
c. Part 2: if a corp owns > 50% of a subsidiary, which directly or indirectly owns shares of the parents,
the subsidiary corp, it can’t vote its parent shares (bc those are its own)

Speiser v. Baker
Facts:
 Chem is a business w/ 4 types of shareholders: public investors (40%); Speiser (10%); Baker (8%);
Health Med (42%).
 Health Med is owned by Speiser, Baker, and Medallion (really Chem bc Medallion 100% owned by Chem)
o Speiser: 50% of common stock, 1 director seat, 45% vote
o Baker: 50% of common stock, 1 director seat, 45% vote
o Medallion (Chem): 9% of convertible preferred stock, 95% vote of common stock when converted
This is what it looks like:

 Convertible Stock Exercised: If Medallion’s (Chem’s) convertible preferred stock were exercised, Chem
would hold 95% of Health Med’s voting power, Health Med would not vote its Heath Chem’s stock (160(c)
prong 2).
 Purpose of Circular Control Structure: Speiser and Baker controlled Health Chem through Health Med.
It allowed them to control voting power of Health Chem without owning more than a combined 35% of
stock. Possible to control corp w/ just 35% of vote, there are a lot of shareholders, some of them don’t
vote. (35% is important for tax/accounting purposes).
 Issues: Speiser is president of all 3 corps and him and Baker have falled out. Speiser wants to hold Health
Med’s shareholders’ annual meeting to consolidate his control, but can’t bc Baker won’t show up, which
means quorum isn’t met (only 2 shareholders), so he goes turns to court to compel. Baker argues that
Speiser wants to hold meeting to replace Baker as director; Speiser has control over Medallion board so
he will win majority of votes bw two.)
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 o 1) Can Speiser compel meeting?
o 2) Does circular control violate DGCL §160(c)?
Holding:
 1) Speiser can compel annual meeting. DGCL §211(c): if court orders meeting, whoever shows up
constitutes a quorum.
 2) Health Chem is precluded from voting its 42% voting shares in Health Chem bc Health Chem is a
majority voting stockholder in Health Med.
o Ct uses 1st prong, not 2nd prong of §160(c), and interprets “belonging to” broadly
 Health Med’s stock belongs to Chem since Chem would own a majority of Health Med if its stock
converted to common stock (95%) through Medallion, which is 100% owned by Chem.
 C  100% M  9% (95%) HM  42% C
 Ct interprets “belonging to” to apply to companies owned indirectly as well as directly
 If allowed, would deprive owners of Chem from choosing directors: “principal effect of
arrangement is to muffle voice of public shareholders of Chem in governance of Chem”
o Under the 2nd prong:
 M’s unconverted voting stock in HM is only 9%
 Skeel thinks would be consisted w/ DE law to treat M’s stock as converted to 95%, but judge
construes prong 1 broadly w/ next cases in mind

2. Vote Buying
a. Buying the voting right of the stock, but not the economic interest of the stock
b. Can also mean paying someone to vote a certain way (Schreiber)
c. Note: if a transferor sells stock after a record date, court of equity will be inclined to give transferee
a proxy to vote the stock, unless transferor specifically retains voting right to protect legal interest in
the stock, or the corp is strong enough to support grant of irrevocable proxy
d. Rule (Schreiber)
i. Any arrangement separating stock voting rights and ownership rights must be viewed in light
of its purpose
1. Purpose to defraud or disenfranchise other SHs  per se illegal
2. Purpose is something else  voidable under intrinsic fairness standard, but if majority
of disinterested shareholders approve arrangement, no need to show intrinsic fairness.
a. Intrinsic fairness is a tough standard that tends to be pro-plaintiff under DE law
ii. Application (Schreiber): loan agreement not per se void where object and purpose was not to
defraud or disenfranchise but was to further interests of all the corp’s shareholders. Also,
ratification by a majority of the independent SH, after full disclosure  loan is OK even if it is
to coax for votes
e. Skeel: issues w/ vote buying:
i. Melting-pot idea: idea that shareholders are part of a melting pot and vote buying silences the
voice of shareholder who might otherwise be part of the shareholder conversation; However,
shareholders don’t talk to each other in the same way anymore, so now this is not really a big
concern—makes us less concerned about vote buying
ii. Greenmail: situation where someone buys a lot of stock and threatens to cause trouble and
corp silences green mailer by buying back their stock; DE said not inherently impermissible—
if there’s no problem, not against the law to do this
f. Easterbrook & Fischel: separating voting right and the equity interest creates agency costs
i. Rejects argument that the market for votes will sort out the misaligned incentives bc the
market for one inconsequential vote can’t possibly price right
ii. If SH have more votes than economic rights  skew total decision making, extra votes w/ 1
person rather than spread out +
iii. If SH have less votes than economic rights  skew total decision making vote deficiency
iv. When the voting SH have economic stakes in their shares, incentive to improve the frirm

Schreiber v. Carney

35
Facts: Jet owned 35% voting power of TX Intl, which was trying to merge w/ TX Air. Jet threatened to block
proposed merger bc of tax implications. Jet had veto power bc it owned a whole class of preferred stock out of
TX Int’l’s 3 classes, and TX Int’l’s Certificate required all 3 classes to vote yes on a merger. To persuade Jet to
vote yes, TX Int’l made a “sweetheart loan” to Jet (low interest rate loan).
Issue: P challenged the loan, claiming 1) loan is vote buying; 2) loan is corporate waste
Holding: TX Int’l loan to Jet doesn’t constitute vote buying bc it was ultimately ratified by TX Int’l
shareholders
 The court rejected the idea that vote buying is always illegal
 Purpose of vote-buying prohibition: each SH should be entitled to rely on independent judgment of other
SHs, but this loan agreement doesn’t undermine the purpose of the prohibition.
 Loan agreement is voidable but not void; no need for IL standard bc ratified by maj of disinterested SH

g. Shorting Stock/”Empty Voting” (Perry Mylan)

i. Shorting Stock: someone bets that the price of the stock is going down so they enter into a
contract to sell it and before they do so, they buy it from the market at a cheaper price, so end
up making a profit on the stock they sell.
1. Another scenario is they borrow stock from someone for some time, sell it to someone
else, buy it back cheaper from market to give to original lender, and keep profits. Same
idea.
ii. Policy:
1. Arguments in favor of short selling:
a. Can improve efficiency of stock prices bc produces more info (another way to
make a statement abut a stock)
b. If people can bet against a stock, it will eliminate distortions in market patterns
2. Arguments against short selling
a. When you’re betting against a stock, you have an incentive to make the company
not do well so the price goes down

Perry Mylan
Facts: There was a proposed merger bw two pharmaceutical companies: Mylan and King. Mylan was to
acquire King through a cash-out merger. Both companies’ shareholders needed to approve the merger. Perry,
a hedge fund that wanted the merger to happen, owned 10% of King, bought 9.9% of Mylan. Perry then
shorted his entire position in Mylan, and therefore didn’t’ have an economic interest in Mylan.
 P had a put option: right to put stock to broker at the end of option period, which meant that if the stock
went down in price, P could put it to broker, and broker would have to pay the market price at time put
option was made (so higher price)  P wouldn’t suffer downside
 Broker had a call option: if stock went up in price, broker would call it at market price at time of call
option; buy it back at lower price P wouldn’t receive upside
 Broker shorts the stock
 Effect is that broker ends up with stock at the end regardless, so P will not own the stock when the vote
takes place
Problem  empty voting: P has right to vote bc he is the beneficial owner of 9.9% of stock, but he has no
economic interest in the stock at all bc Broker has the stock.
Argument: people thought price Mylan was going to pay was high, and P is essentially buying these votes to
nevertheless make the transaction happen since he’s a stockholder in King and wants the transaction
Outcome (Skeel): In form, this doesn’t look like vote buying, just problematic behavior; P bought Mylan
shares to have voting rights but didn’t have economic stake in it. DE would find way for this to not happen
again, but not under vote buying. If DE applied Schriber, this likely wouldn’t come out at vote buying
Current Event about Perry: P has been in papers lately bc it is shutting down its hedge fund. A lot of funds
are having trouble now bc the market is doing great but nothing else is bc interest rates are close to 0.

3. Controlling Minority Structures

36
 a. Pyramiding & Cross-ownership ties: not popular in US bc we tax inter-corporate dividends, so
moving money requirements on structures is expensive and Investment Company Act of 1940
imposes stringent regulatory/reporting requirements on structures tied together by webs of
minority holdings
i. Pyramiding: In a pyramid of two companies, a controlling minority shareholder holds a
controlling stake in a holding company that, in turn, holds a controlling stake in an operating
company  not favored because permits controller to completely control without holding
more than some % of the company’s cash flow rights
ii. Cross-ownership ties: Linked by horizontal cross-holdings of shares that reinforce and
entrench power of central controllers. Voting rights used to control corporate group
distributed over entire group rather than concentrated in the hands of a single company or
shareholder. But, like pyramiding, permits controller to exercise complete control over
corporation with an arbitrarily small claim on its cash flow rights
b. Dual-Class Share Structures / Super Stock Voting
i. Firm issues two or more classes of stock with different voting rights
ii. Most common CMS structure in U.S.
iii. Like Facebook: Facebook has Class A and Class B stock. One share of Class A has one vote. One
share of Class B has ten votes
1. Zuckerberg also entered into voting agreements w/ Class B shareholders committing
them to vote the way he wants them to
2. If you sell your Class B shares, they automatically become Class A shares
3. Zuckerberg also has ability to displace directors
I. Federal Proxy Regulation
1. Background: shareholders in public corps vote primarily through proxy. Proxy voting creates
opportunities for management abuseif management obtains open-ended proxies from shareholders,
they van vote however they want and if they don’t inform shareholders how their proxies will be voted,
they escape accountability. To protect management from overreaching, there is strict regulation as to
what has to be in the solicitation
a. Securities Act 1933
b. Securities Exchange Act of 1934
2. Securities Act of 1933: Deals with IPOs and the registration requirements
3. Securities & Exchange Act of 1934:
a. Periodic disclosure requirements
b. Tender offer and takeover requirements
c. Proxy contest requirements
d. Anti-fraud provisions
e. Number of more recent securities law interventions into things like:
i. Tender offer regulation (first TO regulation put into place in 1968 through Williams Act);
ii. Proxy rules
f. Created SEC, main securities regulator (before, NYSE was main regulator)
4. Securities & Exchange Act of 1934 – Overview of 4 parts against proxy abuse:
a. SEC-mandated disclosure: requires any party soliciting proxies from shareholders to file w/ SEC
and distribute to shareholders specified information in a proxy statement
b. Regulation of proxy solicitation: prescribe form of proxy card and scope of the proxy holders
power
c. Town meeting provision: Rule 14a-8 permits shareholders to include their proposals in corp’s
proxy materials
d. General Anti-Fraud Provision: 14a-9 allows shareholders private cause of actions for
false/misleading proxy materials
5. SEC Proxy Rules apply to companies whose securities are registered under §12 of the Exchange Act:
a. Listed companies: publicly held firms listed on national stock exchange
b. OTC companies: >500 non- accredited shareholders OR ≥ 2,000 shareholders and > $10mil assets
6. Costly for Corps: when corp has to include SH proposals, corp is subsidizing the SH proposals
a. Advantages:
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 i. Low costs for shareholders
ii. Promotes shareholder democracy by allowing shareholders to use co-financed proxy
machinery to propose their own resolution
b. Disadvantages:
i. High costs for company
ii. Proxy statement could become so long its unintelligible

7. Rules 14a-1 – 141-7

a. §14a: makes it unlawful for any person, in contravention of any SEC rule to solicit any proxy to vote
any security registered under §12 of the Act
i. §12:
1. Listed companies: publicly held firms listed in national stock exchange; and
2. OTC companies: whose stocks are traded over-the-counter: 500 non- accredited
shareholders OR ≥ 2,000 shareholders and > $10mil assets
ii. apply to issuing corporations AND 3rd party seeking to oust incumbent management through
proxy fight
iii. led to protests that SEC was overregulating communications among shareholders leading to
1992 amendment of proxy rules
b. §14a-1(a) – 14a-2
i. 14a-1(a): 1992 amendments limited term “solicitation”
ii. 14a-2: created new exemptions:
1. Exemption for ordinary shareholders communicating with non-management
shareholders as long as neither try to act as proxy and don’t give or ask for a proxy card
(doesn’t apply to communications by management, director nominees, those already in
proxy fight w/ management)
2. Released institutional shareholders (banks, mutual funds, insurance companies), in
limited circs, from requirement to file disclosure form before they could communicate
with other shareholders about the corp. Prior to these amendments, institutional
shareholders ran risk of being deemed to have solicited a proxy, which would have
required them to file costly proxy statement
3. Exception for solicitation to less than 10 shareholders
4. Exemption for shareholders, so they can announce how they intend to vote, even if such
announcements include sharing their reasoning
c. 14a-3: anytime a shareholder’s proxy is solicited, a proxy statement must accompany/precede the
solicitation—info inside depends on who is soliciting the proxy, management, or non management
i. management: if management solicits proxy and solicitation is for annual election of directors,
management must send corporations annual report which must contain balance sheet and
current income statement.
d. 14a-4 – 14a-5: what a proxy has to look like so that shareholders don’t give management or anyone
else a blank card
i. proxy card must state who is soliciting it and the matters to be acted on
ii. for election of directors, card must allow SH to vote yes, no, or abstain from voting; for other
matters must have vote yes or no (and instruct how to vote)
iii. 14a-4: short-slate nominations: where an activist shareholder wants to challenge few directors
on board and propose replacements, he can put in his nominees in proxy card and company
can put in their nominees. Certain circs under which dissident can solicit votes. “Nothing in
this section shall prevent any person soliciting in support of nominees who, if elected, would
constitute a minority of the board of directors…” (14a-4(d)(4)(i-iv)
e. 14a-6: if proxies are solicited, each shareholder must be sent a copy of the proxy statement and
preliminary copies of the proxy statement and proxy card must be filed with SEC. This lists formal
filing requirements, not only for preliminary and definitive proxy materials, but also for solicitation
materials and Notices of Exempt Solicitations

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 f. 14a-7: management must mail, either separately or with corp’s proxy materials, any shareholder’s
soliciting materials if the shareholder agrees to pay the corp’s reasonable expenses. Or, management
can provide list of shareholders to SH (so SH can send themselves)
g. 14a-12: special rules applicable to contested directors, or more specifically, solicitations opposing
anyone else’s (usually management’s) candidate for the board
i. Permits dissident solicitation prior to the filing of a written proxy statement as long as
dissidents disclose their identifies and holdings and don’t furnish proxy card to security holders
ii. also deals with treatment and filing of proxy solicitations made prior to delivery of proxy
statement
8. §14a-8 (Town Hall): Is firm required to subsidize a shareholder proposal and include it in the
company’s proxy materials?
a. Shareholder who identifies a value-producing idea generally must commit financial resources for a
proxy campaign and overcome management’s domination of the corporate-funded proxy
mechanism. SEC rules attempt to overcome the impediments.
i. Management can be compelled to help shareholder communicate w/ others at his expense
(141-7)
ii. In specified circumstances, management must include “proper” shareholder proposals in the
company’s proxy mailings to shareholders at corporate expense. Supposed to mimic a town
hall meeting (14a-8)
1. Corp only pays for sending proposal out w/ proxy materials; any advertisements or
additional messages to shareholders are done at the proposing shareholders’ expense
b. Alternatives to using proxy process w/ shareholder proposal:
i. Shareholder can make the proposal at the special meeting but this isn’t a good option bc no
one actually comes.
ii. If this is issue SH really wants to pursue, should really use proxy process
c. Procedural requirements for shareholder proposals:
i. Identity of shareholder: any shareholder who has owned 1% or $2,000 worth of public
company’s share for at least one year can submit proposal (14a-8(b)(1))
ii. Can only submit 1 proposal (14a-8(c))
iii. Supporting statement cannot exceed 500 words (14a-8(d))
iv. Proposal must be submitted at east 120 days before the proxy materials are released to
shareholders (14a-8(e))
v. If SH fails to meet procedural requirements, corp has 14 days to notify him to let him fix it, and
he has 14 days to fix it, but if he misses deadline, corp doesn’t have to notify him (14a-8(f))
vi. Subject matter of the proposal must be “proper”; 13 reasons of why management can find it
improper and exclude it (14a-8(i))
vii. No action letter: if management decides to exclude the proposal it must file its reasons with
the SEC for review, and SEC must write no-action letter, saying that if management excludes
this proposal, SEC will not take action and argue that corp violated 14a-8 (14a-8(j))
1. burden to persuade SEC to allow exclusion is on corp and SEC will take action against
corp if they say exclusion is not allowed and corp does it anyway
viii. if none of the 14a-8 exclusions apply, the company cannot exclude proposal and must include
it in the proxy materials; if corp is allowed to exclude, that is the end of the campaign, but can
try 14a-7 (mailing it out yourself)
d. 14a-8(i) Exclusions:
i. Proposal is improper under state law: proposal is not a proper action for shareholders under
law of the company’s state corporate law
1. To avoid this exclusion, cast proposal as a recommendation (precatory) and not as
binding, bc if its binding, it probably violates state law bc shareholders cannot tell
directors what to do (DGCL §141(a)); unless SH is trying to change bylaws to something
SH can clearly do, but if there is any question, SEC tends to allow this exclusion
a. DGCL 141(a): business affairs of corp shall be managed by board of directors
2. Go with consider X vs. must do X.
ii. Proposal is a violation of law: has to do with violation of any other law
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 iii. Proposal is violation of proxy rules
iv. Personal Grievance: proposal is aimed to benefit proposing shareholder or small number of
shareholders or relates to redress of personal grievance
v. Relevance: proposal relates to operations which account for less than 5% of company’s total
assets and net earnings and sales not otherwise significantly related to business
vi. Absence of power: corp lacks power/authority to implement proposal
vii. Management functions: proposal deals with matter relating to company’s ordinary business
operations, not something shareholders should be making decisions on
1. This is most commonly used exception
2. Management of workforce, hiring/promotion/termination, production quality/quantity,
except when these matters focus on a significant social policy issue
3. Consider degree to which proposal seeks to micro-manage the company by probing too
deeply into matters which SH would not be qualified to make informed judgment on due
to their lack of business expertise or intimate knowledge of corp’s business
viii. Directors elections: if proposal relates to an election for corp’s board of directors. Can’t put
particular candidates into it, can’t disparage company’s candidates, but can make procedural
proposals (look at list, pg 1536)
1. proposals that are not specific to a particular election, or about election
process/procedure are not excluded
ix. Proposal conflicts company’s proposal submitted for the same meeting
x. Proposal has already been substantially implemented
xi. Proposal substantially duplicates another proposal already submitted that the company
intends to include in its proxy statement
xii. Proposal is being re-submitted, was submitted in last 5 years and didn’t get big vote (look at
list, pg 1537)
xiii. Proposal relates to specific amount of cash or stock dividends
e. Exclusion of Social Issues under Exclusion 7 of Management Functions:
i. SEC has flip-flipped a lot about whether socially charged issues are excludable or not, so
outcome depends on when proposals were made
ii. Today these proposals are made in ad hoc
iii. Before 1976: tough on SH, easier on corps, allowed exclusion. (Big social issues: nuclear
power, Vietnam War, Civil Rights Movements)
iv. 1976-1992: pro-SH (Big social issues: South Africa divestment)
v. 1992-1998: pro-corps, allowed exclusion (big social issue: sexual orientation discrimination,
sweatshops, fair trade)
vi. After 1998: case-by-case (mixture, a lot of environmental and discrimination issues)
f. HYPO1: the class wants to put together a shareholder proposal to instruct the board of Wells Fargo
to implement a new policy that bans Wells Fargo from taking cross-selling into account in any way
in salaries and bonuses.
i. Class comes up with $1,500 and buys WF stock and wants to submit proposal at next meeting
1. Procedural issue: to be able to submit proposal, shareholder needs either $2,000 or 1%
of stock, AND hold stock for a least a year. Here, none of the reqs are met
ii. Someone in class has $2,0001 of stock and has owned it for a year, so the proposal goes
forward.
iii. Arguments corp can make to exclude class’s proposal:
1. Exclusion 7: management function.
2. Exclusion 1: improper under state law (shareholder doesn’t have authority to make this
proposal—to avoid this make proposal precatory, not insisting board take this action)
g. HYPO2: Company A makes mostly snacks, but has a cigarette and tobacco division that is 2% of its
business. Shareholder B submits proposal asking for shareholder vote on whether company should
consider divesting its tobacco interest.
i. Consider divesting vs. must divest: to avoid exclusion 1 – improper action by SH under state
law. Unless Sh is trying to change bylaws to do something SHs can clearly do (like increase size

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 of boards, put in new directors), but if there is any question about it, SEC usually allows it to be
excluded under 1.
ii. Possible Exclusions:
1. Precatory, so not excludable under 1.
2. Exclusion 5: Relevance. Cig and tobacco is only a small portion of the business.
a. SH response: it is otherwise significantly related to the business; even though it is
a tiny part it is still important to ethos/perception of company
b. In this case, SEC has judgment call
3. Exclusion 7: management: this is a manger and director decision, not a shareholder
decision (whether to divest line of business is not something shareholders can decide
on)
a. Exclusion case for 2% is weak: this is important, it is related to business, it is
important social issue, so shouldn’t allow #7.
b. Is this a social issue under 7? 
iii. if change hypo that tobacco and cigarettes are 60% of business instead of 2%, case for
exclusion gets stronger:
1. the bigger the percentage of the business an issue that SH doesn’t like is, the less
compelling his argument to stop this issue gets 
2. when an SH buys into company w/ 2% of cig/tobacco business, it is a such a small part
that SH isn’t as informed about it
3. when SH buys into company w/ 60% cig/tobacco business, and they make this proposal,
they are basically saying they don’t want this company to exist anymore, but SH knew
what kind of company it was when bought into it
a. should be fighting to make tobacco or cigs illegal, but not making these changes
through 14a-8, not what its meant for
h. HYPO3: SH of Disney wants to vote on giving each share of stock two visits to any Disney theme
park for the rest of his life
i. Exclusion 4: person grievance. This is a proposal that applies to a limited group of
shareholders and it is personal for them.
J. Proxy Access:
1. Over the last decade, corporate governance has grappled w/ whether to open board nomination process
in public companies so shareholders could include their nominees in the company’s proxy materials at
company expense
2. Proxy Access: Facilitating and subsidizing minority shareholders’ ability to nominate and elect
directors
a. Proxy access is about giving SHs ability to propose candidates (nominate their own directors to
oppose company’s directors AND have that included in the company’s proxy materials)
3. Proxy Access Developments Timeline:
a. 2003: SEC proposed new Rule 14a-11 which would have permitted SH w/ 5% of company’s shares
to nominate 1-3 directors of company’s board, if authorized by majority of shareholders in previous
election cycle  not adopted
b. 2008: 14a-8 amended to make it clear that any proposal related to an election was excludable; when
recession hit, there was no proxy access. If SH proposed a bylaw amendment that allowed SH to
nominate directors and have them included in corp’s proxy materials, that could be entirely
excluded.
c. 2009: it was clear to DE that Congress was going to step in and pass regulation to allow proxy
access. DE didn’t want proxy access because:
i. most important reason: DE caters to managers and managers didn’t want proxy access
because it made it easier to have contested election
ii. SH didn’t think proxy access increased value of company
iii. DE didn’t want Congress encroaching w/ federal regulation and determining what outcomes of
corporate law were going to be.
So, De enacted 2 provisions to pre-empt Congress:

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 i. DGCL §112 and §113: allowed shareholders to amend company bylaws to provide for proxy
access and mandatory reimbursement of proxy expenses incurred by shareholders in
director elections
d. 2010: Congress passed Dodd Frank Act: authorized SEC to promulgate proxy access rules.
i. SEC amended 14a-8 and allowed Exclusion 8 Director Elections to not apply to proposals
related to election procedures (which is what we have today, not excludable)
ii. Brought back 14a-11: if SH or group of SH have 3% of stock and had stock for 3 years and
committed to not trying to take control of the entire board could nominate up to 25% of slots.
1. 3 year requirement and promise not to take control to keep out activists who want to
take control, like hedge funds
2. This was struck down, SEC didn’t conduct cost-benefit analysis of rule; SEC didn’t try
again
4. Today: DGCL §112-§113 and 14a-8
a. DGCL §112: SHs can amend bylaws to require corps to include in their proxy materials SH nominees
for directors
b. DGCL §113: SH can change bylaws to reimburse SHs for expenses incurred in proxy expenses in
director elections
c. 14a-8: SHs proposals relating to director election procedures are not excludable under 8.
d. DGCL §112/13 requires 2 votes: first SHs would have to vote on proxy access (would have to pay
this time) and then in second vote a year later SHs can include nominees and won’t have to pay
i. w/ SEC 14a-11 proposal, it would have been certain that SH meeting rule requirements would
be able to put their director nomination in the proxy statement immediately
5. HYPO1: How SH can put directors on board at lowest cost:
a. First Election Year:
i. Propose to amend bylaw to allow director proposal, which is allowed under §112.
ii. Then propose to amend bylaws to allow reimbursement for proxy expenses related to director
elections under §113.
iii. *Problem here is that under 14a-8(c), a shareholder can propose only 1 proposal at a time.
Either the corp will allow SH to propose 2, or 2 shareholders can bring the proposals.
iv. Corp will put proposed bylaw change into proxy material
b. Second Election Year:
i. if these proposals are voted on and other SH approve them, next year SH can nominate
candidates and they will be included in company’s proxy materials
ii. *Conflict bw DE law and 14a-8: while 14a-8 exclusion 8 says corp can exclude things relating
to current elections from proxy materials, if §112 is approved by SH, SH can propose director
nominees in proxy materials. Which rule governs?
1. SEC will likely step aside and not impose 14a-8. Corp knows it has these bylaws which
were approved by SH so wouldn’t make sense to not allow them and impose 14a-8.
K. Proxy Fraud
1. While the federal proxy rules impose an ex ante disclosure regime specifying information that
shareholders must receive when asked to vote by proxy, courts have developed ex post disclosure
regime that enforces full and honest disclosure through private litigation. Courts review adequacy of
disclosure.
2. 14a-9 Anti-Fraud Provision:
a. generally: SEC’s general proscription against false or misleading proxy solicitations
b. Private Right of Action: private right of action exists under 14a-9, so shareholder can make a claim
(JI Case v. Borak)
i. Usually, shareholder sues after management undertakes a merger or other control transaction
accomplished w/ an allegedly false or misleading proxy. Shareholders can bring private
federal claims under 14a-9 and courts review the disclosure.
c. Elements of 14a-9 Action:
i. false or misleading statement about a material fact, or which omits to state any material
fact necessary in order to make statements therein not false or misleading
ii. Misstatement/omission:
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 1. Misleading: if directors say a belief that implies they did research when they didn’t, and
they omit the fact that they didn’t do research, can be actionable
2. False: if directors have a false motivation, and the underlying fact is also false, not
actionable.
a. Directors don’t believe merger transaction is high value, but it IS high value  no
cause of action
b. Directors say they believe merger transaction is high value when they actually
don’t think this, and its not high value cause of action
c. Director’s truly believe merger transaction is high value (after due diligence),
even though its actually not  maybe, depends on director’s culpability; need
negligence.
iii. Materiality of Fact: statement is related to material fact if there is substantial likelihood that a
reasonable shareholder would care about the information in deciding how to vote
iv. Culpability: Likely negligence, maybe recklessness (indifference to truth); not fully clear - SC
hasn’t resolved question and most lower courts haven’t required showing that party making
misrepresentation knew it was false or misleading (scienter, knowledge of wrong, not
required)
v. Causation:
1. Transaction causation: the proxy solicitation is an essential link to the accomplishment
of the transaction – so proxy caused shareholder to vote for transaction, transaction
couldn’t have happened w/o this proxy
a. If like in Virginia Bankshares SH vote doesn’t matter and won’t affect outcome of
transaction, there is no causation (like if SHs are minority and transaction is
assured regardless of how they vote)
2. Loss causation: the resulting transaction caused harm to the shareholder
3. Loss of a State Remedy: if but for this misstatement, you would have had some remedy
under state law and now you have lost that remedy under state law, might still get 14a-9
cause of action and it substitutes for state remedy (like appraisal rights)
vi. Reliance: 14a-9 doesn’t address whether SH must have relied on defendant’s
misrepresentation. Mills v. Electric Auto-Lite eliminated reliance as an element in proxy fraud
case.
vii. Remedies: courts might award injunctive relief, rescission, or monetary damages
3. HYPO 1: Assume directors said “we believe that this transaction gives a high value to shareholders,
$42/share,” and truly did believe this. However, the value is clearly not high, and out of line with
reasonable value for the stock. Could there be 14a-9 liability?
a. By saying “we believe this is high value,” directors implied they have done reasonable due
diligence, like getting investment banking opinion.
b. Liability if directors have actually made no effort to verify statement and they omit facts such as:
i. they didn’t actual bother looking into the value
ii. they didn’t really get an outside opinion
c. or if they say they talked to an investment banking expert who actually didn’t do any work
d. main point is that when someone says we believe this transaction is legal, it implies they got
advice, so if they actually didn’t but don’t reveal this to shareholders, it is misleading to say so; if
statement of belief is misleading bc it implies research that wasn’t actually done, can be
liable.
e. Not liable for fact that they truly believe value is high if its not, only if they mislead.
4. HYPO 2: if directors said “this transaction gives a high value to shareholders,” but didn’t actually believe
it was a high value is there liability under 14a-9?
a. We don’t have enough info—we need to know the motivation for statement that they lied about,
and whether the underlying statement is false.
b. If directors’ said their motivation for this transaction is that it has a high value, while this was
not really their motivation, and the value is not high, they can be liable because the underlying
fact, which is the value of transaction, is false.

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 c. If directors’ said their motivation for the transaction is that it has a high value, while this was not
really their motivation, but it does have a high value, they are not liable because the underlying
fact, which is value of transaction, is true.
d. Just lying about beliefs isn’t enough, must also show that the underlying fact is false.

Virginia Bankshares, Inc. v. Sandberg

Facts: First American Bankshares through its 100% owned subsidiary Virginia Bankshares already owned
85% of the target First American Bank of Virginia. FAB decided to acquire the remaining 15% through a
freeze-out merger of FABOV into VB. FAB caused FABOV to solicit proxies for the merger, even though it was
not required to do so as it controlled 85% of the votes (FAB could have just submitted the issue for voting at
the shareholders meeting, and approval of the merger was assured). In the proxy materials, FABOV directors
stated that the offer of $42/share was op for minority shareholders to achieve high and fair value, and that
they approved the transaction for this reason, but evidence at trial showed that $60 was a fair value. Arg is
that FABOV directors lied about believing that the deal was high-value so that they could keep job as
directors.
Issues: 1) Can statement of belief be basis for 14a-9 action? 2) Can causation be established if minority vote
was not needed for transaction’s completion?
Holding: 1) statement of belief may be basis for 14a-9 action only if the underlying fact that the belief relates
to is false. Directors lied about why they proposed the merger, and the underlying objective fact was that the
price was not fair. 2) No causation bc shareholder vote was not an essential link in the accomplishment of the
transaction (it could have passed w/o SH vote bc they are minority, FAB’s vote would be enough)
Rule:
 Actionability of Motivations, Opinions, and Beliefs: lie about motivation for transaction AND
underlying statement is false actionable
 Causation:
o If vote wouldn’t matter no causation: no causal link established if the outcome of the vote wouldn’t
have been different
o If you lost state law remedy MIGHT have causation: if but for this misstatement, SH would have had
some other remedy under state law and now he’s lost it under state law (breach of fiduciary duty,
appraisal rights), you might get the 14a-9 cause of action and it effectively substitutes for that state
law remedy
Skeel:
 Case is interpreted as saying that the loss of a state law remedy is sufficient to establish causation
 Mills: point of 14a-9 is not just to protect SHs’ wallets, its to protect process. We want SHs to have full and
accurate information and to not be misled. Fact that the transaction was fair doesn’t eliminate the cause
of action, assuming there was not untrue fact.

V. FIDUCIARY DUTY

A. Overview
1. Those who control and operate a corporation, directors, officers, and controlling shareholders, are
obligated to act in the corporation’s best interests, which traditionally means for the benefit of
shareholders. Those in control owe a fiduciary duty, a duty of trust and confidence.
2. Small vs. Large Shareholders:
a. Most small shareholders care more about fiduciary duty than their voting rights
b. Large shareholders (institutional investors) care more about voting rights. Big institutions can have
their way w/o going through the formalized processes – can have conversations w/ managers by
threatening to withhold votes for directorial election. Also, voting will not harm a relationship bw
shareholder and directors as much as suing would.
3. There are two traditional fiduciary duties: duty of care and duty of loyalty
4. Duty of Care: duty to use ordinary diligence in making ordinary business decisions
a. Requires informed decision-making

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 b. Includes to duty act lawfully (breaking the law is a per-se violation of duty of care)
c. Applies when there is no conflict of interest
d. Comparatively director friendly
e. Can be waived
f. This is where business judgment rule comes in
5. Duty of Loyalty: applied when there is a conflict of interest (one or more directors or officers are on
both sides of a transaction
a. Requires corporate fiduciaries to exercise their authority in a good-faith attempt to advance
corporate purposes (against conflicts of interest)
b. Examples:
i. Self-dealing
ii. Director’s compensation
iii. Corporate opportunity
c. Can’t be waived
6. Duty of Good Faith:
a. DE courts articulated this duty as a part of Duty of Loyalty, but doesn’t look like other duty of loyalty
causes of action, ends up looking like its own
b. Applies when directors intentionally violate law w/ purpose other than the corporation’s best
interests, or with conscious disregard for duties to act
c. Applies when there is no conflict of interest
d. Can’t be waived
7. Takeover or “Intermediate” Duties
a. When takeover cases of 1980’s arose, traditional fiduciary duties didn’t apply that well to them.
Takeover duties fall somewhere in between loyalty and care
i. Not quite duty of care case
ii. Directors don’t have direct conflict of interest in a takeover, but we still don’t trust them bc
their job is on the line (displaced if takeover happens)
B. Duty of Care
1. Background:
a. The board of directors manages and oversees the corporation’s business and affairs. Judicial review
of the board’s decision-making and oversight is governed by the duty of care, which is confined by
the business judgment rule did director follow duty of care? Are his actions fine anyway bc BJR so
counts like he did?
2. Duty of Care Generally:
a. Applies to ordinary business decisions
b. Requires directors and officers to use ordinary diligence when acting on behalf of the corporation
c. Business Judgment Rule protects directors
i. Avoids hindsight bias that would discourage director risk-taking
1.
ii. Courts will not second-guess the merits of a business decision if it was made:
1. On an informed basis;
2. In the absence of a conflict of interest;
3. With honest belief that it is in the best interest of the corporation; And
4. In good faith
d. Law protects corporate officers/directors from liability for breach of duty of care:
i. Statutory:
1. Authorizes corporations to indemnify the expenses incurred by officers or directors who
are sued by reason of their corporate activities (DGCL §145)
2. Authorizes corporations to purchase liability insurance for their directors/officers
(DGCL §146)
3. Authorizes corporations to waive directors’ (and sometimes officers’) liability for acts of
negligence (DGCL §102(b)(7))
ii. Judicial/Common Law: BJR

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 e. Three Approaches to Duty of Care Standard: determining whether director met duty of care
depends on which standard of duty of care state uses:
i. What courts generally do in duty of care (i.e. non-DE cases)
ii. DE: BJR starts as a presumption and P has to rebut the presumption to prove D’s liability in
breaching duty of care
iii. Model Statutes: did state adopt one of these?
1. MBCA 8.30: (little warped bc doesn’t really give us BJR, so 4.01 probably better
representative of model statute)
2. ALI 4.01
f. Model Acts’ Attempts to Codify Duty of Care: *Note that DE doesn’t use model statutes

MBCA §8.30: States Duty of Care (what we want directors to do)

 (a) Directors must act (1) in good faith and (2) in the manner the director reasonably believes to be in the
best interests of the corporation.
 (b) Discharge duties with the care that a person in a like position would reasonably believe appropriate
under similar circumstances. [Skeel: Seems to compare to director with similar background (e.g. will be
compared to people with special expertise if you have that; if not, won’t be compared to someone with
special expertise)]
 (c), (d), (e): directors can rely on committees and reports generated by officers. Skeel: Can rely on
experts

MBCA §8.31: States Standards of Liability (like BJR) – Post-dates Van Gorkum – asks if there is 102(b)(7)
 (a) director shall not be liable to corp of shareholders for any decision to take or not to take action, or any
failure to take any action, as a director, unless the party asserting liability in a proceeding establishes
that:
o (1): any provision in articles of incorporation…doesn’t preclude liability (like 102(b)(7)); and
o (2): challenged conduct consisted of or was result of:
 (i) action not in good faith; or
 (ii) a decision (a) which director didn’t reasonable believe to be in best interests or corp; or (b)
as to which director was not informed to extent director reasonable believed to be appropriate
under circs; or
 (iii) lack of objectivity due to director’s familial, financial, or business relationship with, or lack of
independence due to the …another person having a material interest in challenged conduct
(basically conflict of interest); or
 (iv) failure of director to devote attention to ongoing oversight of business affairs; or
 (v) receipt of financial benefit to which director wasn’t entitled

ALI 4.01 (Pre-dates Van Gorkum & 102(b)(7), so no room for it)
Framework
 If there was not an informed decision  4.01(a)
 If there was an informed decision  4.01(c)
 (d): Burden of proof. Plaintiff has the burden of proving a breach of the duty of care, including the inapplicability
of the provisions as to the fulfillment of duty under (b) or (c).

Substance
 (a): A corporate director or officer is required to perform his or her functions (1) in good faith, (2) in a manner that
he reasonably believes to be in the best interests of the corporation, and (3) with the care that an ordinarily prudent
person would reasonably be expected to exercise in a like position and under similar circumstances. (Skeel: Like
MBCA, seems to compare to director with similar background (e.g. will be compared to people with special
expertise if you have that; if not, won’t be compared to someone with special expertise)
o (1) Duty to inquire: Includes obligation to make or cause to be made an inquiry when circumstances would alert
a reasonable director or officer of the need to do so.
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 o (2) Reliance on other persons: To perform his functions, director or officer entitled to rely on materials and
persons in accordance with §§ 4.02 and 4.03. (Skeel: emphasizes that can rely on experts)
 (b) Delegation to committees: The board can delegate to committees certain functions and can rely on those
committees to fulfill their duties (board still has ultimate oversight responsibility)
 (c) Director or officer who makes a business judgment in good faith fulfills his 4.01 duties if:
o (1) He is disinterested
o (2) He is informed to the extent the director/officer reasonably believes to be appropriate under the
circumstances
o (3) He rationally believes that the business judgment is in the best interests of the corporation [Skeel thinks
biggest difference between two is that “rationally believes” is meant to be much more director-friendly than
“reasonably believes” (negligence standard)  most directors would probably want this provision]

Skeel’s Analysis:
 Part (a) is the duty of care [standard of conduct by which we want directors to behave], and it has a “reasonable”
standard, which is tougher than “rational” standard.
 Part (a) corresponds to MBCA §8.30: Standard of conduct
 Part (c) corresponds to MBCA §8.31: BJR: liability standard

3. Business Judgment Rule:

a. DE starts everything with a BJR presumption
b. Rebuttable presumption that that directors did not breach their duty of care; a P must rebut it in
order to prove that a director breached
c. Relationship bw Duty of Care and BJR:
i. Duty of Care (MBCA §8.30 & ALI §4.01(a)): Standard of Care directors must maintain (how we
want them to act)
ii. BJR (MBCA §8.31 & ALI §4.01(c)): Standard of Liability (whether to hold directors liable)
d. Commission vs. Omission
i. In order for BJR to apply, must make a decision
ii. Francis = omission (director didn’t do anything)
iii. Kamin = commission (directors did something)
iv. Scrutiny is much tougher in an omission case
1. If a director is informed and makes a decision, likely to get business judgment deference
2. If a director doesn’t make a decision where he should have, he doesn’t get business
judgment deference, scrutiny will be much tougher; more like negligence standard
3. – if A doesn’t make a decision, can lose the BJR rule
e. BJR is not statutorily codified bc each state has it a little differently and corporate law is state law,
but generally, Courts will not second guess merits of a business decision if it was made:
i. On an informed basis;
ii. In the absence of a conflict of interest;
iii. With honest belief that it is the in the best interest of the corporation; and
iv. In good faith
v. DE says BJR is a presumption that you’ve done all these things you should have done, so if you
did, you won’t be liable
f. Overcoming BJR: challenger to BJR must overcome presumption by proving: Gross Negligence
i. Failure to become informed in decision making/inattention;
ii. Conflict of interest;
iii. lack of rational business purpose (waste);
iv. bad faith/fraud/illegality
g. Reasons for BJR:
i. Court is converting a question of fact (whether the directors exercised the care a reasonable
person would exercise in similar circs) into a question of law, which encourages dismissal of
some claims before trial and allows judicial resolution of remaining claims that go to trial
ii. Court is converting question of whether the standard of care was breached into easier
questions: was the director disinterested? Did the director exercise good faith?
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 iii. Avoids Hindsight Bias: avoids scrutiny of legitimate decisions that at the time may have
seemed reasonable allows you to make a decision w/o being blamed for it later
iv. Encourages Risk Taking: w/o deference to directors, directors would be too scared of liability
and wouldn’t be willing to take any changes. Where there is uncertain but positive business
opportunities, we want directors to take chance w/o being second guessed. Don’t want them
to be too cautious.
v. Shareholder value maximization: shareholder value is increased when directors and officers
are not risk averse
vi. Avoids judicial meddling: judges are not business experts
vii. Even though it is hard to find breach of duty of care via BJR, there is social value to announcing
that there is a duty of care
h. DGCL §102(b)(7): Duty of Care of Exculpatory Provision: in response to Van Gorkum, DE provided
that charters can include amendments that provide that a corporate director has no liability for
losses caused by transactions in which the director had no conflicting interest or otherwise was
alleged to violate a duty of loyalty

Francis v. United Jersey Bank

Point: Omissions can give rise to director liability under negligence standard, no BJR presumption
Facts: a family-owned corporation operated as a reinsurance broker, handling large amounts of money as a
fiduciary for its clients. The Pritchard sons, who ran the reinsurance brokerage, stole funds in guise of
shareholder loans and never paid back loans or interest until they went into bankruptcy. Mrs. P (mom) was
director who was never involved in the business. The trustee sued her in bankruptcy for breach of duty of
care.
Holding: Mrs. P breached duty of care.
Rule:
 Act of Omission/Negligence standard:
o A director has a minimum duty acquire rudimentary understanding of the business they oversee, and
to keep informed of the corp’s business. Review of financial statements may give rise to duty to
inquire further if illegal activity is discovered.
o Duty of care is based on reasonable person in your position. For example, an attorney or accountant
would have a higher duty of care than Ms. P.
 Causation: Director has duty to take reasonable attempts to prevent misappropriation of funds. Director
found liable for nonfeasance (failure to perform) has causation bc if she did intervene, could have stopped
the misappropriation by informing officials, etc.
Reasoning:
 Mrs. P was negligent
o A director should acquire at least a rudimentary understanding of the business: lack of knowledge is
not a defense to failure to exercise ordinary care
o A director has a duty to keep informed of the activities of the corporation: A director needs to
generally monitor corporate affairs and policies. A director should be familiar with the financial status
of the corporation by regularly reviewing financial statements
o Mrs. P should have inquired further into her sons’ illegal “shareholder loans”: this wouldn’t have
required any special expertise
 Mrs P’s negligence was a prox cause of her sons’ misappropriations:
o P’s arg: 1) even if she had been paying attention, she wouldn’t have been able to figure out what her
sons were doing; 2) even if she figured out what was going on, she would have been outvoted
o Court: 1) If she had informed the directors or a lawyer that something sketchy was going on, this
would have at least deterred her sons’ behavior; 2) she would have had to show that had all the
directors (entire board) been fully informed, the harm still would have occurred, everyone would still
outvote her
Skeel:
 Why does trustee have standing to sue here?

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 o Case looks like it should be shareholder action against the director of the reinsurance company, but
the company went bankrupt, and if corp is insolvent, duty owed to the creditors. Trustee can enforce
that duty.
o Also looks different bc corporation stole its clients money. Suggestion in case law that duties might be
a little different than ordinary companies bc of risk/danger when corp has a lot of other peoples’
money.
 Why is court so harsh to Mrs. P?
o Mrs. P is already dead during the proceedings, which are against her estate, whose beneficiaries are
her sons, the only directors. This is a way to call her out her sons, and also directing money that would
otherwise go to her sons bc they are beneficiaries of her estate, back to creditors.
 Causation: Courts and ALI concerned w/ situation in ordinary business decisions where some directors
vote yes and claim that even if they voted the right way the same outcome would have happened – don’t
want this to become a regular defense.
o ALI 7.18: you can only make a lack of prox cause defense argument if the harm would have happened
even if entire board would have fulfilled its fiduciary duty

Kamin v. American Express Co.

Point: Commission through informed decision applies BJR
Facts: BoD at AmEx decided to distribute to its shareholders as a special dividend the shares of DLJ. Other
option would have been for AmEx to sell the shares at a loss, which would have reduced its taxable income,
and decreased its profits, which could have lowered its stock price. Shareholders sued, arguing that the sale
of shares would be more beneficial than the divided.
Issue: whether to find directors in breach of their duty of care for distributing shares as a dividend to avoid
detriment to share price rather than selling the shares to reduce taxable income?
Holding: upholds directors’ decision to distribute dividends whether distribution foregoes tax saving that
would have resulted from liquidation.
Rule:
 BJR: One gets the presumption of satisfying the duty of care if he is 1) disinterested; 2) informed; and 3)
acted in good faith
 Dividends: corp directors’ decisions on dividends are generally exclusively matters of BJR for
management and not actionable as breaches of care w/o fraud, self-dealing, bad faith, and oppression
Reasoning:
 Dividend granting = BJR: the question of whether to grant a dividend is a business judgment for board,
not for the courts or shareholders
 Board considered alternative: the board wasn’t negligent in its decision-making bc it acted in an
informed manner after considering the alternatives – directors explained that they were concerned
liquidation at company level would have adversely impacted the corp’s accounting net income figures and
even though it would save money, profit numbers would look lower and the market wouldn’t like that --
appearances could be more important than actual cash effects.
 Claim of self-dealing can’t be supported: a majority of the directors who made the decision were
outside directors w/o conflict of interest
Skeel:
 Different from Francis bc this is a commission case:
o Francis: no BJR bc Mrs. P didn’t actually make a decision to do anything
o Kamin: duty of care + BJR satisfied: classic illustration of extent to which court will bend over
backwards to protect directors who have exercised care

Smith v. Van Gorkum

Facts: TransUnion had substantial net operating losses, and had tax benefits that it couldn’t use, so looked to
merge. If they merged with corp that was making profits, the company would be able to use its tax losses to
reduce its taxable income. Also, CEO Van Gorkum was nearing retirement, and some suggestion that he was
looking for his retirement plan to be put in place, which would be to be paid premium for his TransUnion
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stock. Van Gorkum speculated about a price that might be a realistic price, and at time, TransUnion trading
for $35/share, so Van Gorkum came up with $55/share ($20 premium). Someone internally went through the
numbers and concluded that this was a plausible price. Pritzker agreed to buy at $55/share, board had a
rushed 2 hours meeting accepted offer and VK signed docs at an opera.
Issue: whether TransUnion directors were grossly negligence even though transaction looked attractive
Holding: Violation of duty of care. Standard is gross negligence, and TransUnion was grossly negligent.
Reasoning:
 Failure to inform = gross negligence. Court doesn’t like that:
o Agreement signed at beginning of an opera
o Decisions made quickly; merely 2 hours
o Ability to consider other bids was very limited
o Board never sought an expert opinion
o Nobody read the merger agreement
 Rejects the argument that deal was at premium: only expert advice was the internal advice that ran the
$55/share to see if it was plausible price; never sought an independent assessment of TransUnion’s value.
Skeel:
 Point: directors did not fully inform themselves, even though transaction was a premium  no BJR
o Substance vs. process: this case is really about failure to follow proper process (made a decision w/o
informing themselves) and not about substance (the share price seems fair)
o If directors do inform themselves and make a decision BJR
 Surprising decision by DE SC:
o While decision was made quickly, TU had been looking for potential buyers for a year
o The price was 40% over market value
o Sophisticated BoD
o 3-2 split (DE opinions w/ dissenting judges are very uncommon >5%)
o prior to this case, finding a BoD liable for breaching duty of care in case where there was no conflict of
interest and they were informed was harder than finding a needle in a hay stack
 Three musketeers defense: went wrong bc board adopted a three musketeers defense for all directors
o They chose to defend together as a board, rather than each director individually. If they had defended
individually, it is likely that the internal directors could have satisfied their duty of care since they
were more informed than the outside directors (Skeel thinks some outside directors still might have
gotten off)
o But they thought this would be inconceivable for DE to find that the entire board breached its duty of
care in a situation where they got a premium of 40%
 Effects:
o DE responded by reversing VG by statue in DGCL §102(b)(7): allows firms to waive duty of care in
their certificate, but cannot waive duty of loyalty or duty to act in good faith (and can only waive for
monetary damages, not injunctive relieve, and can’t waive intentional violations of the law)
o Most corps adopted one of these provisions – then in situation asking for monetary damages, question
becomes “what is your violation of good faith”  Disney answers this
 How to Avoid VG liability:
o Don’t look hasty
o Get independent valuation of a company  court said that it wasn’t requiring an investment bank
opinion, but noted that VG didn’t do anything
o Try to shop around for the best deal
o Read agreement  board members still don’t read entire merger agreements, despite court’s
observation about the facet of the transaction

i. §DGCL 102(b)(7) Duty of Care Waiver (note exculpations only apply to directors, not officers)
i. After Van Gorkum decision, perception grew that service as a corporate director became more
risky. In response, DE and most other states enacted exculpation statutes

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 ii. allows corporations to add to their certificates a provision eliminating or limiting personal
liability of a director to the corp or its stockholders for monetary damages from breach of
fiduciary duty, but remains liable for:
1. Breach of loyalty: it doesn’t eliminate/limit liability for breach of loyalty;
2. Breach of good faith: acts or omissions not in good faith or involving intentional
misconduct or knowing violation of law;
3. Improper personal benefit: transaction where director received improper personal
benefit (like insider trading)
iii. only applies to monetary damages claims: court can still impost injunctions on transactions
iv. Clause & Duty to Monitor: one can find a violation of the duty to monitor, notwithstanding a
§102(b)(7) clause
4. Good Faith: Disney
a. Duty of care and good faith are distinct duties
b. Good Faith: breach of GF = conduct motivated by subjective bad intent and by an actual intent to
harm corp. Also, intentional dereliction of duty and a conscious disregard for one’s responsibilities.
Not only definitions of lack of good faith
c. Examples: (1) Intentional act in not advancing the corporation’s best interest; (2) An intent to
violate positive law; (3) Intentionally failing to act in the face of a duty to act (e.g., conscious
disregard of duty).
d. Proof: GF violation is harder to prove than duty of care violation. If director/officer didn’t breach
duty of care, then she didn’t breach GF duty (bc BJR has GF, so if didn’t breach it, that means have GF,
bc if didn’t have good faith, wouldn’t get BJR)

In re Walt Disney
Facts: Ovitz was hired as pres of Disney by CEO of Disney Michael Eisner. Ortiz hiring didn’t work out, he
received ~$130 mil in compensation and severance after being fired w/o cause and serving only 14 months
as pres. Ps attacked large amount of compensation for such short tenure, claiming breach of duty of care and
good faith, and waste. Approx $92 ml of $130 mil was result of stock options Ovitz was able to keep as long as
termination wasn’t for cause.
Important Dates in Case:
Date Event Who Approved Decision:
Aug 14, 1995 Letter Agreement Eisner signed, then called board
Sept 26, 1995 Ovitz hired Compensation committee, then
full board
Oct 16, 1995 Options approved Compensation committee makes
decision, but then gets full board
approval
Dec 27, 1996 Ovitz fired Eisner makes decision
Issue: Whether board/Ovitz breached their:
 Duty of care or good faith by:
 Approving the OEA w/ NFT options and
 Paying Ovitz $130 mil in severance compensation (firing Ovitz w/o saying it was for cause)
 Corporate Delegation: did decision make have authority to do that?
Holding: the board and Ovitz didn’t breach duty of care or good faith
Rule:
 Duty of care and good faith are distinct duties. A failure to exercise due care is not a violation of
good faith (bc many other factors can make breach of duty of care even when GF is exercised)
o Good faith: A lack of good faith would include conduct motivated by subjective bad intent and by an
actual intent to harm the corporation. In addition, an intentional dereliction of duty and a conscious
disregard for one’s responsibilities. Court leaves the door open for other things to constitute “lack of
good faith.”
o Proof: GF violation is harder to prove than duty of care violation. If director/officer is found not to
have breached duty of care, she didn’t breach duty of good faith.
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 Rationale:
 Duty of Care: despite process failure, there was enough evidence that the board acted in an informed
manner  no violation of duty of care
o §102(b)(7): there was a provision in the certificate. Therefore, don’t need to talk about duty of care
bc liability for that is waived. But, still mention in case to clarify standard:
o Process Must Be Adequate, not Ideal:
 The process did not meet best practice standards, but was not bad enough to constitute a breach
 Best practices would have been to explain to the compensation committee all the various
potential outcomes if Ovitz left Disney before contract expired. Actual process informed
committee members of the pay package overall, but didn’t give as much detail as best practices
would have demanded.
o Alleged Process Failures that court rejected:
 Didn’t use analyst expert; hired compensation guru, but then didn’t even have him at the meeting
where they were making decision (like TransUnion)
 Didn’t’ get legal advice on whether could terminate Ovitz w/o making that compensation
payment; std in K was would get termination benefits unless grossly negligent or involved in
malfeasance
 Never saw full compensation agreement, only a term sheet (like in TransUnion)
 Only talked about it for an hour (like in TransUnion)
 Good Faith: no breach
o Proving a good faith violation would require more egregious behavior than a duty of care violation
(must be more than gross negligence). Since there was no lack of due care, there couldn’t be lack of GF
 Rationale: DE legislature in §102(b)(7) allowed for exculpation of duty of care damages but made
an exception for actions not in good faith. Therefore, duty of good faith is harder to violate than
duty of care.
 If GF is part of BJR, if you violate Good Faith, do you automatically violate BJR?
 Corporate Authority to Hire/Fire: cert had provision that directors hire/fire executives. Bylaws had
provision that chair and CEO had authority to direct and supervise officers.
o Did Eisner have authority to hire or fire Ovitz? Bylaw provision gives Eisner authority to
supervise implied actual authority to fire
o Possible apparent authority: Eisner was hiring and firing people and no one at Disney stopped him, so
reasonable third party would believe there was authority.
o Skeel says both are a stretch
 Delegated Authority to Compensation Committee: Charter gives Board power to choose officers.
Board delegated hiring/firing authority to compensation committee.
 Claims Against Ovitz:
o Conduct Before Officer: dismissed bc he didn’t have fiduciary duties to SHs when compensation
agreement was negotiated. “de facto officer” arg rejected
o Conduct During Termination: Ovitz didn’t breach his fiduciary duty of loyalty bc he played in part in
decisions to be terminated and that termination wouldn’t be for cause under comp agreement
o Waste: rejected. When BJR can’t be rebutted, P can resort to waste remedy--- hard to prove.
Skeel:
 Delegating Authority After 1996: Today, BoD can’t delegate decision-making authority to a committee
for something that the directors have to vote on, like fundamental transactions. Committees can still make
recommendations, but can’t make whole decisions, like they did here and in Van Korkum.
 Court is setting out best practices to give corps guidance: Don’t need to follow best practices to satisfy
the duty of care, but court is telling corps how it wants them to behave (if they follow the best practices,
they won’t be subjected to litigation)

5. Directors & Officers Indemnification and Insurance

a. Directors and officers can be named in private lawsuits brought by shareholders or in governmental
proceedings challenging corporate behavior. To encourage individuals to accept corporate positions

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 and take good-faith risks for the corp, corporate statutes permit the corp to indemnify directors and
officers against liability.  D&O insurance supplements
b. Indemnification: corporation’s reimbursement of litigation expense and personal liability of a
director sued bc he was a director. Applies when director is/was a D in any civil, criminal,
administrative, or investigative proceeding. In general, corp may indemnify non-director officers,
employees, and agents to same extent as directors.
i. DGCL §145: Waltuch: a corporation cannot indemnify officers or directors for actions done in
bad faith, since §145 only allows indemnification for good faith
ii. DGCL §145(a): Discretionary Indemnification for 3rd party actions of judgment, settlement,
expenses, as long as in GF
1. Corp has the power to indemnify any person for defending himself in a suit or
proceeding arising by reason that he was a director or officer of corp if 1) he acted in
good faith and in a manner the person reasonably believe to be in or not opposed to best
interests of corp; and 2) for a criminal action, the person had no reasonable cause to
believe his conduct was unlawful
2. Can you be negligent and indemnified? YES bc need gross negligence negates good faith
and best interest, not negligence; so can’t have gross negligence
iii. DGCL §145(b): Discretionary Indemnification for Derivative (SH) Action Expenses as long as
in GF:
1. Gives limited rights of indemnification for derivative (SH) suits:
a. Must have acted in GF + best interest
b. Can only indemnify expenses (no authority to indemnify judgment or settlement
amount)
c. Also, if director is found liable, expenses can only be reimbursed if court explicitly
says they can be reimbursed
iv. DGC §145(c): Mandatory Indemnification: if the director or officer had been “successful on the
merits or otherwise” in defense of any action, suit, or proceeding, he must be indemnified for
expenses actually and reasonably incurred in connection w/ that suit (no GF req, can assume
he had good faith)
1. Waltuch: settlement w/o payment counts as successful on merits  Skeel: might be
different if Waltuch paid for part of the settlement
v. DGCL §145(f): “indemnification…provided by this section shall not be deemed exclusive of
any other rights to which those seeking indemnification…” – basically permits corporation to
indemnify directors under provisions in bylaws or in a contract even though the statute
doesn’t contemplate it
1. Waltuch: but must have good faith! there are additional indemnification rights that a
corporation can exercise, which don’t conflict w/ the GF requirement:
a. Mandatory indemnification unless prohibited by statute
b. Mandatory advancement of expenses, which the indemnitee can, in many
instances, obtain on demand;
c. Accelerated procedures for the determination required by §145(d) to be made in
the “specific case”
d. Litigation “appeal rights” of the idemnitee in the event of an unfavorable
determination
e. Procedures which a favorable determination will be deemed to have been made
under circs where the board fails or refuses to act
f. Reasonable funding mechanisms
2. Skeel Hypo: if corp bringing suit as P, directors can be indemnified under this part. A
and B limited to defense.
c. Directors and Officers (D&O) Insurance: to supplement indemnification and to cover liability to
the corporation, the corporation can also purchase liability insurance for its directors and officers.
So the corp can indemnify indirectly through insurance what it is prohibited from indemnifying
directly.

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 i. DGCL §145(g): corp can purchase/maintain insurance for any person who is a director,
officer, agent, or employee of the corporation against any liability asserted against that person
“whether or not the corp would have the power to indemnify such person against such liability
under this section” (basically can insure against whatever you want)
1. Cover things like self-dealing, actions in bad faith, illegal compensation, knowing
violations of law, willful misconduct, etc.
2. However, standard policies usually have GF carve out—if you are found by court to have
acted in bad faith, insurance policy is likely to not cover you.
ii. Why would corps purchase insurance for directors and officers rather than raising
salaries and board fees and then allowing directors and officers to take the money to
purchase their own insurance?
1. D&O insurance might be cheaper if the company acts as a central bargaining agent for all
D&Os
3. Uniformity may have value in that it standardizes directors’ individual risk profiles in
decision making, and avoids potentially negative signaling that would arise from
directors having different levels of coverage
4. Tax law may favor firm-wide insurance coverage since D&O insurance is deductible
expense
5. Directors may under-invest in D&O insurance if left to themselves bc shareholders also
benefit from D&O insurance
6. Disguises total amount of compensation
iii. Incentives for trial/settlement?
1. Directors: likely want to settle
2. Insurance: likely prefer trial as long as trial expenses aren’t > settlement or potential
judgment
a. If Ds win will pay trial expenses. Going to ask if settlement, would that be worth
more than trial expenses to determine if worth to go to trial
b. If Ds go to trial and lose insurance may not have to indemnify if D acted in bad
faith
c. Can only say BF if in trial; Ds won’t admit or deny BF in settlement
d. If Ds lose, Ds may lose money and insurance won’t (if BF carve out)
3. Cases generally settle
a. Why would directors want to settle?
i. Certain liabilities of settlement vs. uncertainty of trial/potential huge payout
later (business model depends on expected liabilities, so certainty is good)
ii. Not going to be able to sell insurance if don’t encourage settlement
iii. Managers wan to be able to settle and insurance companies tend to let
directors make decision about settlement vs trial.

Waltuch v. Conticommodity Services, Inc.

Facts: W traded silver for clients of his firm Conticommodity Services. After silver market crashed, silver
speculators filed suits against W and Conticommodity. W spent 1.2 mil in legal fees defending himself against
civil lawsuits, from which he was dismissed, and $1 mil to defend himself in CFTC enforcement proceeding,
which he settled. W then sued Conticommodity for indemnification for his expenses. Art. 9 of Conti’s cert
doesn’t require that corp officer acted in good faith. DGCL §145(a) does require good faith. §145(f) allows
corps to indemnify officers beyond what is set out in §145, W argued that §145(f) + Art. 9 taken together
mean he should be indemnified.
Issue: whether to grant W indemnification under §145(a) or §145(f) if he acted in bad faith (parties
stipulated to this in court)
Holding: Conti’s Art 9 grant of indemnification violates §145(a) since it exceeds scope of corporate power
granted by §145(a), which is limited to where officer acted in GF. Since W had foregone his opportunity to
demonstrate good faith in court, he is not entitled to indemnification. However, he was successful on merits
of otherwise satisfying §145(c) since he obtained settlements and §145(c) required indemnification for
successful defense of claims.
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Rationale:
 Statutory construction of §145(a), (b) must act in good faith for indemnification
o (a) indemnification for 3rd party actions expressly grants a corp the power to indemnify directors,
officers, and others, as long as they acted in good faith and not opposed to best interest of corp  this
limits scope for corp’s power
o 145(f) says person seeking indemnification may be entitled to “other rights”  it doesn’t speak in
terms of corporate power, and it therefore can’t be read to free a corp from the “good faith” limit
imposed in (a) and (b).
o the court’s reading of (a) and (b) is emphasized by looking at §145(g) (insurance) which is framed as
grant of power to have insurance for D&O
 145(g) applies even to stuff that the corporation would not have power to indemnify for, which
suggests that there are things the corp doesn’t have power to indemnify for
 Therefore, under 145(g) a company can insure you even if you don’t act in good faith (but
remember insurance policies have carve-outs that look like good faith requirements)
 So, really no indemnification for those that acted in bad faith
o 145(f) not meaningless if read that way court does bc there are number of indemnification rights that
are “beyond those provided by statute” and that are at the same time consistent w/ the statute
 Entitled to indemnification under §145(c): a settlement counts under 145(c) as successful on the
merits

6. Duty to Monitor
a. Concerns failure to monitor the actions of the corporation to ensure they don’t do illegal things; asks
whether the cop is adequately overseeing what is going on before them
b. Caremark: conditions for director oversight liability when there is employee misconduct or
violations of the law
i. Directors utterly failed to implement any reporting or information system or control; or
ii. They implemented such a system, but consciously failed to monitor or oversee its operations
thus disabling themselves from being informed of risks or problems requiring their attention
iii. Skeel: Corp has to proactively put in place an internal control system, but judges aren’t going
to aggressively scrutinize it and will give you slack
iv. What qualifies are Caremark claim: employee misconduct or violations of law, NOT
business risk
c. Citigroup: Business Risk = BJR: oversight duties are not designed to subject D&Os to personal
liability for failure to evaluate business risk, for this use BJR
d. §102(b)(7) won’t waive duty to monitor: sustained or systematic failure to exercise oversight
establishes a lack of GF. 102(b)(7) doesn’t waive GF, and since oversight = GF violation, can’t waive.
e. Sarbanes-Oxley §404: SEC adopted rules requiring reporting companies to include in their annual
report a statement of management’s responsibility over internal controls, statement of how these
controls are evaluated, and assessment of their effectiveness. So if no compliance programs in place,
violating §404; vague about consequences
f. Older Standard in Allis-Chalmers (no longer applied after Caremark)
i. Unless directors had reasons to suspect the existence of a violation (i.e. red flags), directors
have no obligation to install a system of monitoring or reporting. They are entitled to rely on
the honesty and integrity of the employees, especially true in large corporations
ii. Duty May Vary: Potentially even more relaxed duty to monitor when the corporation is large,
and the directors’ duties are by necessity restricted to general business policy.

Grahm v. Allis-Chalmers
Facts: AC is a large corp and its non-board members were engaged in price fixing, but board wasn’t. At board
meetings, directors consider general business policy, rather than specific pricing of company’s divisions.
Directors failed to prevent antitrust violations by employees. There was no evidence that directors were

55
aware of antitrust violations. Ps claimed that directors should have implemented a compliance-monitoring
program, especially because the corporation agreed to consent 20 years earlier to not violate the antitrust
laws.
Issue: Whether to hold directors in breach of their duty of care for failing to monitor for antitrust violations
Holding: no breach of duty of care, since there was no reason to suspect anti-trust violations
Rule (practically overruled by Caremark): Duty to Monitor: unless directors had reasons to suspect
antitrust violations (like unless there were red flags), directors have no obligation to install a system of
monitoring or reporting. Entitled to rely on honesty and integrity of employees.
Rationale:
 Rejects argument of knowledge of previous consent orders: three directors knew of the consent decrees,
but upon their investigation, concluded that corp had never committed antitrust actions. Therefore, this
didn’t put board on notice of possibility of future price fixing
 Directors didn’t need to install system of monitoring: they are entitled to rely on honesty and integrity of
employees where there is no reason to suspect violations. Size of corp also forced directors to confine
control to broad policy decisions.

In Re Caremark International Inc. Derivative Litigation

Facts: Caremark provided alternative site healthcare services and entered into illegal consulting agreement
w/ doctors to incentivize them to use Caremark treatments. Corp plead guilty and agreed to pay 250 mil in
fines and damages bc certain employees violated Anti-Kickback statute. Then SH suit brought against
directors for breach of their duty of care by a failure to monitor the employees and not stopping the
misbehavior
Issue: Whether Caremark board breached its duty of care to Caremark.
Holding: No breach of duty for failure to monitor
Rule:
 Affirmative obligation to implement internal monitoring system:
o Even if there is no reason to suspect lack of compliance (no red flags), some monitoring system must
be in place in order to satisfy the obligation that directors need to be informed for both legal
compliance and decision-making.
o Skeel: focus of courts is on process of the programs rather than the substance
 When directors are liable for failure to monitor: if there is a sustained or systematic failure to exercise
oversight sufficient to indicate lack of good faith
Reasoning:
 Two types of loyalty problems:
o Liability for directorial decisions, which comes from a directorial decision that results in loss bc that
decision was ill-advised or negligent (good faith or rational?)
o Liability for failure to monitor
 Some monitoring system need to be in place to satisfy obligation to be informed
 No evidence of lack of good faith in monitoring or knowing violation of law
o Only a sustained or systematic failure of the board to exercise oversight will establish lack of good
faith that is a necessary condition of liability
o Caremark Board had a functioning committee charged w/ overseeing corp compliance
o Corp’s information systems represented good faith attempt to be informed of relevant facts
Skeel:
 Departure from Grahm: Grahm said no independent duty to monitor unless there are red flags;
Caremark says board has proactive duty to install corporate monitoring and reporting system to detect
misconduct, no red flag requirement
 How is Caremark different from Francis? In Francis Mrs. P did nothing; in Caremark, taking due care
(putting compliance monitoring systems in place) did not prevent unlawful conduct
 Caremark had a §102(b)(7) clause; How does this affect analysis?
o Provision waives some fiduciary duty of care, but doesn’t waive duty of good faith, so there can still be
violation of duty of care if there is violation of good faith

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 o This care is about inattention, and in order to be liable under inattention, must not have good faith, in
which case 102(b)(7) won’t protect you, so here doesn’t make a difference that provision exists
 Caremark standard mostly used to get firms to put compliance mechanisms in place (they don’t
look at the substance, just look at whether you have it)
 Sarbanes-Oxley Act: §404: SEC adopted rules requiring reporting companies to include in their annual
report a statement of management’s responsibility over internal controls, statement of how these
controls are evaluated, and assessment of their effectiveness. So if no compliance programs in place,
violating §404.

Re Citigroup Inc. Shareholder Derivative Litigation

Point: Caremark duty imposed to monitor employee misconduct/violations of law, NOT for failure to
evaluate business decisions.
Facts: shareholders of Citigroup, brought an action against the D&Os of Citigroup, alleging that they breached
their fiduciary duty to monitor the risks the corp faced from the subprime lending market and for failing to
properly disclose Citigroup’s exposure to subprime assets. The shareholders alleged that there were lots of
red flags: the world economy was falling apart and the real estate market was about to collapse; corp should
have paid attention to signs and prevented losses, but they didn’t have monitoring mechanism in place to
detect these issues.
Issue: Did D&Os of Citigroup breach their duty to monitor for failing to disclose Citigroup’s exposure to
subprime assets and failing to manage the risk from subprime assets?
Holding: No breach; this was a business decision. BJR applies, not Caremark.
Rule: Oversight duties under DE law are not designed to subject directors/officers to personal liability for
failure to evaluate business risk (rather, the typical Caremark claim has been for failure to monitor employee
misconduct or violations of law). Failure to evaluate business risk is evaluated using the business
judgment rule (assuming directors informed themselves).
Reasoning:
 Informed business decision  BJR: shareholders are just saying that the D&Os made a bad business
decision so used BJR
 This was a business decision, Caremark only applies to overseeing potential misconduct
 Only similarity w/ Caremark analysis is that Ps could establish liability by showing acts or omissions
constituting bad faith: directors consciously disregarded an obligation to be reasonably informed about
business and its risks or consciously disregarded duty to
Skeel:
 Why isn’t Citigroup liable under duty to monitor?: Caremark is about internal compliance wrt
detecting misbehavior/illegality, not wrt business risk. Business risk is heart of BJR—want to encourage
directors to take business risk, which is why we protect them with BJR.
 Red Flags: After 2008, signs were obvious, but before 2008, there weren’t many people who saw the
crisis coming hindsight bias.
o Citigroup CEO: “may not want to dance, but as long as music is playing, gotta keep dancing”. People
were saying there is a bubble in the market and it can’t go on forever, but everyone was making a lot
of money and gotta keep going in business while it ilasts
 Discussion of BJR: DE developed doctrines to deal w/ fid duty of care focused on director decision-
making process rather than substantive merits of decision. (how directors made business decision, rather
than what the decision actually was)
o BJR is presumption that directors are making a decision on an informed basis and in GF
o Burden on Ps to rebut presumption by showing interestedness or GF violation
o If fail to rebut, can’t second-guess directors’ decision
o Standard of director liability: predicated on concept of gross negligence, but its not doing any work
except saying that if directors breached duty of care they are grossly negligent

7. Violations of the Law:

a. Miller: violation of the law is an automatic breach of the duty of care

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 Miller v. AT&T
Point: Violation of law automatically violates fiduciary duty
Facts: Shareholders argued that AT&T provided $1.5 million of phone services to the 1968 Democratic
Convention and never billed for it, so as a result, it made a contribution of that $1.5 million. Therefore, it
violated campaign finance laws bc illegal for firms to make campaign contributions, which is a per se violation
of duty to act lawfully.
Issue: Did directors breach their duty of care by not collecting the 1.5 mil in expenses?
Holding: Possibly. If Ps can show that AT&T violated the law, then AT&T has breached its duty of care (and is
certainly not afforded BJR protection). If no violation of the law, and if the decision was informed, AT&T
afforded BJR protection.
Rule:
 BJR doesn’t insulate directors from liability if they acted illegally or against public policy
 Violating the law per se is a violation of the duty of care
 Failure to collect a debt is afforded BJR protection, unless failure to do so is illegal
Reasoning:
 Debt Collection: Generally, business decision  BJR; Lack of debt collection is illegal act  no BJR
protection
 Purpose of criminal statue: the particular crim statute in the case was designed to limit corporate
influence and to protect shareholders, supports breach of fiduciary duty claim
 Elements of statute (18 U.S.C. §610): AT&T (1) made a contribution of money or anything of value to the
DNC; (2) in connection with a federal election; (3) for the purpose of influencing the outcome of that
election
 Analysis: If Ps can show there was a violation of law, then there is no BJR protection (per se violation
of duty of care). If Ps cannot show there was a violation of law, and cannot show decision was
uninformed, BJR applies.
Skeel:
 If Ps don’t succeed in showing that directors violated the campaign finance law, what arguments could it
make for other duties?
o If trying to make duty of care argument in DE:
 1. Start w/ BJR presumption
 2. Ps must try to rebut presumption (D’s not informed, etc).
o If trying to make Caremark claim, must make argument that there was internal misconduct;
improper/illegal behavior and no monitoring device
o If there is 102(b)(7) provision, Ps will need to prove there was bad faith

DUTY OF CARE CLAIM

1. Was act illegal? (Miller)
2. If not, assuming no §102(b)(7) exculpatory provision  argue violation of duty
a. Act or Omission? Did the directors make a decision? (did they decide not to collect $ or did
they not even think about it?)
i. Omission: if directors did not act:
1. Francis: should board have acted? If board was paying attention (informed),
would they have done something? If board didn’t need to make decision
2. Caremark: should board have had monitoring (internal control) system for
lower-level employees that would have brought this to their attention?
10(b)(7) doesn’t negate duty to monitor.
ii. Act: If directors made a decision gross negligence standard for what directors did
1. if directors were not informed breached duty of care (Van Gorkum)
2. if directors were informed  BJR: D/O gets presumption that he acted 1) on
an informed basis; 2) in good faith; 3) in the honest belief that the action taken
was in the best interests of the company
a. Burden is on P to rebut this presumption (Citigroup)

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 b. Skeel: this is really question about whether corp went through the
right process, and doesn’t look at the substance of the decision
i. Kamin: (dividend granting): SH challenges substance of board’s
decision when board had a good decision making process
BJR
ii. Citigroup: taking on business risk  BJR
iii. if rebut presumption of BJR=breach
3. If there IS §102(b)(7) exculpatory provision in certificate:
a. Cannot waive duty of loyalty or duty of good faith or illegal action
b. Only applies to monetary damages (court can still impose equitable remedy, like injunction)
c. For liability, SHs would have to show bad faith OR duty of loyalty problem. Can show by:
i. Subjective bad intent/ actual intent tot harm the corp (Disney)
ii. Intentional dereliction of duty and a conscious disregard for one’s responsibilities
(Disney)
iii. A successful Caremark claim
iv. If court finds didn’t breach duty of care, then def didn’t breach duty of GF, bc GF is
harder (Disney)
C. Duty of Loyalty
1. Generally
a. Applies to fiduciaries’ conflicts of interest and requires fiduciaries to put the corporations’ interests
ahead of their own (while duty of care applies more to business decisions)
b. If there is a conflict of interest  duty of loyalty
c. Note that DE has described GF duty as a duty of loyalty issue
d. Tradeoff: directors shouldn’t benefit financially at the expense of the corp in self-dealing
transactions, but we also don’t want to deter some mutually beneficial transactions
e. Three Duty of Loyalty Problems:
i. Self Dealing: situation where director/officer is on both sides of the transaction
1. Officer/director sells personal property to the corp or buys corp property
2. Fiduciary’s corp contracts w/ another corp or business entity in which the fiduciary has
a significant financial interest
3. Two corps have common directors but they have no significant financial interest in
either
4. Two types: controlling SH and non-controlling SH
ii. Corporate Opportunity Doctrine: director finds out about promising venture and pursues
it herself rather than giving that opportunity to the corp itself
iii. Compensation of Directors: the director in a sense is contracting w/ herself for
compensation
f. Default Standard: Entire fairness
i. Burden of proof traditionally on directors (unlike duty of care, where burden on P)
ii. Recently, more willing to give BJR treatment (means deference as opposed to EF analysis)
2. Self-Dealing Transactions
a. When a fiduciary takes advantage of his position in a transaction and acts for his own interests
rather than in interests of shareholders
i. When someone is on both sides of a transaction (like the decision maker of Corp A has a stake
in Corp B which he is doing business with) there is a conflict of interest and it is not likely that
the decision maker will have the best interest of the first company in mind, and transaction
may not be fair (in terms of pricing)
b. Key terms in duty of loyalty context is “interested/disinterested” (means do you have a direct
stake in transaction) and are you independent (i.e. are you somehow controlled by someone else?)
 none of the three statutes identifies independence as a concern, but sneak it in (at least in DE)
c. Absolute Duty to Disclose: (Hayes) Directors have an obligation to disclose if they are interested,
regardless of whether the transaction is otherwise fair
d. Self-Dealing Provisions: to provide certainty to corps trying to ensure validity of transactions bw
corp and its directors
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 i. Cookies: 3 prong Iowa Statue standard:
1. Director may engage in self-dealing without clearly violating duty of loyalty when: (1)
full disclosure of relationship/financial interest to board approval; (2) full disclosure to
shareholders entitled to vote + shareholder approval; (3) fairness to corporation
2. Satisfying 1 of 3 prongs is necessary but not sufficient, despite what Iowa Statue says.
Have to also show GF, fairness, and honesty in every case.
ii. DGCL §144:
1. if you have disinterested SH or director approval w/ full disclosure, will get BJR
scrutiny, meaning transaction is no longer treated as a conflict of interest, and
transaction will likely be upheld
2. Quorum + majority of disinterested SH/directors
3. Not used w/ parent-subsidiary cases

a) DGCL §144: Self-Dealing Transactions/“Safe Harbor” Statute: creates safe-harbor for self-dealing
transactions if approved by fully informed, disinterested, independent director/shareholder
i) Applies to:
(1) Contract/transaction between a corporation and 1+ of its directors/officers;
(2) contract/transaction between a corporation and another corporation in which the
corporation’s directors/officers have a financial interest or are directors/officers. (Corp and a
3rd party where we are worried about CoI)
ii) No C/T listed above will be void or voidable SOLELY for conflict of interest IF 1 of the 3 following
criteria is met:
(1) Disinterested Director Vote w/ Disclosure: The material facts regarding the director’s
interest/relationship and of the contract/transaction are disclosed or known to the board of
directors, and the board in good faith authorizes by affirmative vote of majority of
disinterested directors (even if disinterested directors constitute less than a quorum);
(2) Shareholder Vote w/ Disclosure: The material facts regarding the director’s/officer’s
relationship/interest and of the contract/transaction are disclosed or known to voting SH and
the contract/transaction is specifically approved in good faith by a vote of the SH;
(3) Fairness: The contract is fair to the corporation at the time is it authorized, approved or
ratified by the board of directors, committee, or shareholders. (Fair = In corp’s best interest)
(4) Outcome: if any of these are met, they get BJR scrutiny, meaning transaction is no longer
treated as a conflict of interest, and transaction is likely upheld (if passes BJR)
iii) SKEEL:
(1) So if C/T meets 1-3, it can’t be void w/o some additional reason to the conflict of interest 
meeting safe harbor is necessary to not be straight void, but not sufficient, can still be voidable
for something else
(2) If you have disinterested director or shareholder approval  BJR form of scrutiny; C/T will
likely be upheld (moving away from Cookies and Iowa statute)
(3) In DE, Shareholder vote w/ good faith also requires the shareholders voting to be
disinterested
(a) while SH prong says there needs to be GF, DE cts require SH to be disinterested too; would
say its not good faith if SH are not disinterested. So must have disclosure, GF, and
disinterested
b) Interested board members can count toward quorum (but maj of DISinterested must approve C/T)

iii. ALI 5.02:

1. Self-dealing is valid if after full disclosure court finds the transaction to be fair; majority
of disinterested shareholders approved/ratified transaction; OR majority of
disinterested shareholders approved/ratified transaction and its not a waste of corp
assets.
2. Quorum + majority of disinterested SH/directors

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 a) ALI 5.02(a): Self-Dealing Transactions is there a majority rule for SH/dirs. Approval?
i) The transaction will fulfill the duty of fair dealing and will not be voided if:
(1) Disclosure (interest, value, and defendants’ profit) concerning the conflict is made to the
corporate decision-maker who authorizes in advance or ratifies the transaction (if decision-
maker know without you telling them, counts as disclosure); AND
(2) Satisfies 1 of the following 4 conditions:
(a) Transaction is fair to the corporation when entered into;
(b) Following disclosure, transaction is authorized (before transaction) by (maj of)
disinterested directors who could have reasonably concluded transaction was fair at time
of authorization;
(c) Following disclosure, transaction is ratified (after transaction) by (maj of) disinterested
directors who could have reasonably concluded that the transaction was fair and
(i) Disinterested decision-maker acted for the corporation in the transaction; and
(ii) Interested person disclosed conflict to the disinterested decision-maker; and
(iii) Interested person did not act unreasonably in failing to get advanced authorization;
and
(iv) Failure to get advanced authorization did not adversely affect the interests of the
corporation in a significant way.
(d) Transaction is authorized or ratified by (maj of) disinterested shareholders and is not a
waste of corporate assets
(3) Burden of Proof: The plaintiff has the initial burden of proof, but if that person establishes that
(b), (c), or (d) have not been met, then the burden shifts to the defendant to prove it was fair
(a).
ii) SKEEL:
(1) Note that for Directors, it’s “reasonably believed to be fair,” and for SHs, it’s “waste”
(a) Waste = throwing money away
(b) Shows ALI has more confidence in SHs than directors
(2) Standard is higher for ratification (after the transaction) than for authorization (before the
transaction) because it is harder for disinterested decision-makers to say no after the fact.
(3) ALI adjusted level of scrutiny depending on which decision maker we’re using
(4) Majority of disinterested directors can’t be less than 2

State Ex Rel Hayes Oyster Co. v. Keypoint Oyster Co.

Facts: Basically, Verne Hayes  23% of C.O, AND 25% of HO  50% of KO. C.O’s board approved transaction
to sell two oyster beds to K.O for 250k. VH is on both sides of the transaction. Coast Oyster didn’t know about
Hayes Oyster’s and Venre’s interest in Keypoint. After Verne sold his Coast Oyster shares, Coast’s new
managers sued him for profits obtained from the Coast-Keypoint transaction.
Issue: Whether VH violated his fiduciary duties as officer of Coast by failing to disclose his indirect interest in
Keypoint before entering into a transaction w/ Keypoint on behalf of Coast.
Holding: Court forces Hayes Oyster to give up its stock in Keypoint on behalf of Coast.
Rule: failure to disclose conflict of interest is per se unfair.
Skeel:
 Argument that conflict of interest isn’t as big as it seems:
o VH’s has greater stake in Coast (23%) than in Keypoint (12.5%). From this perspective, can argue that
his incentives weren’t distorted. But courts don’t care about the size of interest; once you are on both
sides of transaction, duty of loyalty applies.
 What if transaction was an appropriate price?
o Even if transaction is fair and should be upheld, if there is no disclosure and there should be, the court
will strike the transaction down  absolute duty to disclose
 What is the logical remedy?
o Standard remedy in self-dealing cases is difference bw price in this transaction, and what would be a
fair transaction.
 Remedy here: take away all profits - VH ended up with no stock, had to give his stock back to Coast

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 Cookies Food v. Lakes Warehouse
Facts: Cookies had bad sales so asked Herrig, a minority SH of Cookies and owner of auto parts business to
market the sauce. Agreement formalized through exclusive distribution agreement w/ his company Lakes
Warehouse. Cookies retained right to fix sales price of its products and agreed to pay Lakes 30% of its gross
sales. Herrig bought controlling stake in Cookies and replaced 4/5 board members w/ his own.
 Herrig’s changes:
o Extended terms of exclusive distributorship agreement w/ Lakes and expanses scope of services for
which it compensated Herrig and his companies.
o Additional Royalties to Herrig: royalty for Herrig’s taco sauce recipe and his additional role in product
development
o Additional compensation to Herrig
Minority SH of cookies sued Herrig bc they couldn’t make money on their investment: he wouldn’t let corp
make dividends and no market for minority shares so they couldn’t sell them.
Issue:
 Ps alleged that D, by acquiring control of Cookies and executing self-dealing contracts, breached his
fiduciary duty to company and fraudulently misappropriated and converted corporate funds. Took issue
with exclusive distributorship agreements, taco saucy royalty, warehousing fees, and the consultant fee
 IA Statute: Director may engage in self-dealing without clearly violating duty of loyalty when: (1) full
disclosure of relationship/financial interest to board approval; (2) full disclosure to shareholders entitled
to vote + shareholder approval; (3) fairness to corporation
Holding: Herrig met his burden to prove contracts were fair so transactions are valid
Rule:
 Statutory / Common Law Process for Validating Self-Dealing Transactions:
o Satisfying one of the three IA statutory requirements is necessary, but not sufficient to validate a self-
dealing transaction.
o Must also have to show that the interested party acted in good faith, honesty, and fairness.
 What is “fairness”? Showing a “fair price” and showing a fairness of the bargain to the interests of the
corporation
Reasoning:
 Even though language of statute makes meeting any 1 of the 3 conditions a sufficient condition to uphold
the transaction, this state has always required a showing of good faith, honesty, and fairness as well.
 Four agreements in issue have all benefitted Cookies, and even if assume Cookies could have procured
similar services from other vendors, not convinced that Herrig’s fees were unreasonable
 All members of board were well aware of Herrig’s dual ownership in Lakes and Speed’s
Skeel:
 If disinterested directors considered and approved contracts, would outcome be different?
o DE: as long as procedures look good and disinterested directors are signing off, there is no conflict of
interest and BJR review applies
o Cookies doesn’t take this approach: not enough to just have disinterested directors sign off—also
requires showing of good faith, honesty, and fairness to address skepticism of whether directors are
truly disinterested.
 If Harrig can show that disinterested directors approved transaction but can’t say transaction was
fair, would that be approved under ALI 5.02?
o If there is something related to fairness, may be upheld, but if can’t show anything fair at all, then
won’t be upheld bc directors must reasonably conclude transaction was fair

e. Controlling Shareholder Self-Dealing

i. Fiduciary duties also apply to any shareholder w/ voting control (sufficient voting shares to
determine outcome of shareholder vote) – a controlling shareholder
1. Bc has power to select board, approve fundamental changes, so can act to detriment of
minority shareholders

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 ii. Self dealing in parent-subsidiary setting (Sinclair): occurs when the parent (the controlling
shareholder), by virtue of its domination of the subsidiary (the corporation), causes the
subsidiary to act in way that the parent receives something from the subsidiary to the
exclusion of, and detriment to, the minority stockholders of the subsidiary.
1. Standard of review: while conflict of interest statutes cover transactions when a director
has a relationship to another corp. statutes don’t really provide conclusive standards for
parent-subsidiary dealings
2. Don’t use §144
3. Sinclair Standard:
a. If effect of transaction is proportionate on all shareholders BJR (Even if effect is
bad, at least everyone is getting the same bad treatment) (burden on minority
shareholders)
b. If effect of transaction is not proportionate on all shareholders  Intrinsic
Fairness (burden on controlling SH to prove transaction was fair)
iii. Freeze-out mergers: (Weinberger) when controlling shareholders seek to buy out minority
interests:
1. Parent (controlling SH) and subsidiary (corp) agree to a merger under which
subsidiary’s minority SHs receive cash or other consideration for their shares. Parent
retains subsidiary’s shares and becomes corp’s sole shareholder.
2. Conflict of interest: parent will want to minimize its payment to the minority
shareholders and parent controls the corp’s board and has voting power to approve the
transaction
3. Old standard of review: (Singer v. Magnavox): transaction must be fair, and must have a
business purpose for the merger. DE abandoned this standard
4. Weinberger test: Entire Fairness - 2 prongs: transaction must have a fair price and fair
dealing
a. Fair Price: rejected exclusivity of DE block method, which gave weight to
earnings per share, asset value per share, and market price, which was
undervaluing minority shares. Instead, court allowed any generally accepted
valuation method.
b. Fair Dealing: relating to when transaction was timed, how it as initiated,
structured, negotiated, disclosed to directors, and how approvals of directors and
stockholders were obtained. Recommended corp install independent negotiating
committee of outside directors to act as representative of minority shareholders.
iv. Weinberger: freezeout
1. If one corporation controls the other, DE doesn’t apply §144.

Sinclair Oil Corp v. Levin

Facts: Sinclair, an oil corp, owns 97% of the shares of subsidiary Sinven (other 3% owned by public
shareholders), which operates as an oil company in Venezuela. International, a 100%-owned subsidiary of
Sinclair, enters into Ks w/ Sinven. Sinven minority SH complain that:
o Sinclair forced Sinven to make high dividends that crippled Sinven;
o Sinclar diverted oil contract opportunities away from Sinven;
o International didn’t purchase all the oil it was supposed to purchase from Sinven under an oil contract
bw Sinven and International that Sinven would sell exclusively to International
Issue: should intrinsic fairness standard of BJR standard apply to these transactions?
Holding: BJR applied to dividend issue. IF applied to failure to enforce contract w/ subsidiary.
Rule: Self-Dealing in controlling SH (parent-subsidiary) setting
 If effect of transaction is proportionate on all shareholders  business judgment rule applies
 If effect of transaction is NOT proportionate on all shareholders  Intrinsic fairness applies
 Self dealing: “Self-dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the
subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of,
and detriment to, the minority stockholders of the subsidiary.”

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Reasoning:
 Dividend was not self-dealing bc available proportionately to minority SH BJR. All shareholders
received dividend payments in proportion to their SH interest
o When would dividend be self-dealing?: Corp has two classes of stock: Class A (maj SH) and Class B
(min SH). Corp declares a dividend for Class A but not Class B; IF would apply bc disproportionate
impact.
 No corporate opportunities taken form Sinven no self dealing  BJR: P was unable to show any corp
opps taken from Sinven
o If there had been an opportunity to divert corporate opp from Sinven, then IF standard would apply
bc diverting opp to another subsidiary is benefitting Sinclair to detriment of Sinven
disproportionate
 Failure to enforce contract w/ subsidiary self-dealing IF test: bc effect is disproportionate, standard
of review is IF.
o A benefit to International would benefit Sinclair, but not Sinven  disproportionate impact.
o While deciding whether to pursue contractual breach claim is a duty of care issue, IF applies and not
BJR bc the effect is benefiting parent corp to the detriment of the subsidiary
Skeel:
 Would §144 apply? (if DE courts applied it to controlling SH actions)?
o High dividend payments: no  internal distribution, not a transaction w/ outside party
o Diverted corporate opportunities: no  although it involves a director taking an action w/ an outside
party, problem is that there was no transaction bc Sinven and another party
o Failure to enforce contract bw subsidiaries: yes transaction bw minority SH corps and business in
which one of cors directors has an interest. But DE doesn’t use §144 w/ parent-subsidiary cases.

Weinberger v. UOP, Inc.

Facts: Signal Oil  %50.5 UOP. 6 of 13 UOP directors were nominees of Signal. Signal had an excess of cash
and decided to take UOP private (i.e. buy out minority shareholders). Signal eventually offered $21/share.
(premium over market price). Minority shareholders brought action under Singer claiming lack of entire
fairness in FO.
 UOP’s investment bankers, Lehman Brothers, issued a 2-page fairness opinion (in ~ 3 days) indicating
that the offer was a fair price.
o The deal was “negotiated” with Crawford (CEO of UOP), who was a Signal appointee.
o Signal also agreed that the merger require a positive vote of the majority of the minority (MoM) SH
o The independent directors of UOP met privately and agreed to the merger.
o The shareholders approved the merger, which received the positive vote of the minority.
o No one ever disclosed that Signal had put together a report saying that it thought $24/share of UOP
would be fair.
Previous Standard: majority SH who eliminated minority must meet burden of proving IF. Also merger must
have business purpose, other than elimination of minority SH. (Singer v. Magnaxox)
Holding: remanded for determination of a fair price and rescission damages.
Rule:
 Rejected business purpose requirement for freezeout mergers: Freezeout mergers no longer need to
be for a business purpose because of the protections given by the fairness standards.
 Requirements of fairness in a parent-subsidiary duty of loyalty scenario: Fairness involves both fair
dealing and fair price; i.e. involves both fair process and substance.
o Fair Dealing (PROCESS): Fair dealing involves full disclosure by the control group, as well as fairness
in the timing, initiation, negotiations and structure of the merger, and method for obtaining director
approvals.  The court found a lack of fair dealing.
o Fair Price (SUBSTANCE): Relates to economic and financial considerations of proposed merger (e.g.,
market value, earnings, future prospects, other elements that affect intrinsic or inherent value)
o Calculating “fair price”: Rejected DE Block Method and now accepts any generally acceptable
valuation method.
Reasoning:

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 Fair Dealing:
o Non-disclosure of study violates duty of candor: A feasibility study prepared by 2 directors of UOP
(who also served as Signal directors) indicated that a price up to $24 would be a good investment.
The feasibility study also indicated that paying $24 instead of $21 had a large impact to UOP minority
shareholders. This report was never disclosed to the independent directors or the minority
shareholders  unfair dealing and lack of complete candor. When directors of a DE corporation
are on both sides of a transaction, they must demonstrate their utmost good faith and the most
scrupulous inherent fairness of the bargain.
o Time constraints: The entire transaction was presented and approved within 4 days. Signal’s
insistence on a quick approval, and time constraints faced by UOP (and set by Signal) added to
unfairness. Cursory preparation of fairness opinion by investment bankers.
o Minority shareholders were given the impression that the negotiations were deliberate and lengthy.
Did not disclose the cursory investigation of price.
o Shareholders were not informed of how cursory the fairness opinion study and negotiations
were and also not informed of research supporting a price of $24. The majority of the minority
provision is normally considered a good thing, but didn’t matter in this case because the shareholders
were not informed.
o Fair price: Abandoned “Delaware block approach” requirement previously used in appraisal. The
court now will accept valuation techniques generally accepted in the financial community.
Skeel:
 Lessons learned from Weinberger:
o Disclosure: There was disinterested shareholder approval and disinterested director approval, BUT
the problem was a failure to disclosure a report that would buy at up to $26/share.
o Independent Negotiating Committee: now must have independent committee negotiating on
behalf of the corp representing minority SH.
 Would §144 apply?
o Applies bc there are directors of Signal who are also directors of UOP. DE doesn’t talk about §144;
ignored in freezeout cases bc assumption that these cases are different than ordinary self-dealing
transactions.
o Transaction wouldn’t pass §144:
 Fail disinterested director vote bc authorization was not in GF since UOP director leading entire
transaction was interested
 Fail disinterested SH approval prong bc not all materials facts about conflict of interest were
disclosed, not based on full information – report that said fair value is 24/share was not shared
with anyone at UOP.
 There is higher valuation, so it is probably not fair – will be hard for Signal to show that it was fair
 Appraisal Rights: right in certain transactions (primarily mergers) to require that the firm buy you out
at a price set by the court
o case tried to make appraisal rights an exclusive remedy:
o Held that minority’s appraisal rights are normally the exclusive remedy when a freezout merger is
challenged on basis of price.
o When merger is challenged on basis of fraud, misrepresentation, self-dealing, deliberate waste, or
palpable overreaching (so all lack of fair dealing) then appraisal rights are not the exclusive remedy.
o DE construed the exception generously so it doesn’t have much teeth—while appraisal rights are still
used they are not really exclusive

3. Corporate Opportunity Doctrine

a. Corporate manager cannot usurp corporate opportunities for his own benefit unless the corporation
has rejected the opportunity
b. Corporate Opportunity: when a fiduciary pursues a business opportunity on her own account even
though this opportunity might arguably belong to the corporation
c. DGCL §122(17): Explicitly authorizes a waiver in the charter for corporate opportunity constraints
for officers, directors, or shareholders

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 i. Motivated by growing culture of “interlocking” boards in SV companies in which
entrepreneurs from closely related companies would sit on each others’ boards and it would
be messy if they couldn’t take other opportunities
ii. Only part of the duty of loyalty that can be waived:
1. 102(b)(7): can’t waive: GF, duty of loyalty
2. Unless DE carves out specific duty of loyalty, cant wait it, and §122(17) is the partial
exception that you can’t waive duty of loyalty
d. 4 Tests for determining which opportunities belong to the corporation:
i. Interest of Expectancy Test: if a corporation has an existing expectancy (interest/stake) in a
business opportunity, the manger must seek corporate consent before taking the opportunity.
Also covers presumed expectancies. Most narrow test.
ii. Line of Business Test (DE): any opportunities falling w/in a company’s line of business that
firm has financial ability to pursue in its corporate opportunity (anything that a corp can be
reasonable expected to do is a corporate opportunity)
1. Factors affecting this determination include: (1) how this matter came to the attention of
the director, officer, or employee; (2) how far removed from the “core economic
activities” of the corporation the opportunity lies; (3) whether corporation information
is used in recognizing or exploiting the opportunity; and (4) financial ability of
corporation to take deal.
2. Whether corp can pay is now disfavored as a standard bc corp opportunity might
generate the finances needed; also makes it easy for director to claim that they’re fine bc
corp didn’t have money
iii. Fairness test: Focuses on the fairness of holding the manager accountable for his outside
activities. Relies on many factors (e.g., how a manager learned of the opportunity, whether he
used corporate assets in exploiting the opportunity, indicators of good faith and loyalty,
company’s line of business, etc.)
1. Miller v. Miller combines fairness w/ line of business
2. “know it when you see it”
iv. ALI §5.05

 (a) Is this a corporate opportunity?

 An opportunity to engage in a business activity that a director/officer becomes aware of:
 In connection with the performance of his functions as a director/senior executive or under
circumstances that would reasonably lead him to believe that the person extending the offer
expects it to be offered to the corporation; OR
 Through the use of corporate information or property, if the opportunity is one that the
director/senior executive should reasonably be expected to believe would be of interest to the
corporation; OR
 Any opportunity to engage in a business activity that the officer/director becomes aware of and
knows is closely related to a business in which the corporation is engaged or expects to engage.
 (b) If this is a corporate opportunity, the director or officer can take it if and only if:
 (1) The director/officer offers opportunity to firm and makes disclosure re: conflict of interest
and corporate opportunity; AND
 (2) Opportunity is rejected by the corporation; AND
 (3) The rejection meets any of these requirements:
 (A) Rejection is fair to the corporation;
 (B) Rejected by the disinterested directors in advance of the director / officer taking the
opportunity in a manner satisfying the business judgment rule;
 (C) Rejection is authorized in advance or ratified by disinterested shareholders following
disclosure and the rejection does not constitute waste.
 Note – Test Used for Rejection by Corporate Decision-Maker:
 Rejection by the disinterested directors means the business judgment rule would apply to any
challenge to the board’s action.

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  Rejection by disinterested shareholders means that a waste test would be used.
 Burden of proof: Plaintiff has the burden of proof, except if plaintiff establishes that §5.05(a)(3)(B)
and (C) are not met, the defendant has the burden of proving that the rejection and the taking of the
opportunity were fair to the corporation.
 Defective disclosure  Can still be OK: [§5.05(d)] Essentially, re-ratification by the same
decision-maker after disclosure: A good faith but defective disclosure of the corporate opportunity
can be cured if at any time until a reasonable time after the filing of the suit challenging the taking a
corporate opportunity, the original rejection of the corporate opportunity is ratified—following the
required disclosure—by the disinterested board, the shareholders, or the disinterested corporate
decision maker who initially approved the rejection.

Northeast Harbor Golf Club, Inc. v. Harris

Facts: Harris, pres of a country club golf course, acquired property adjacent to the golf course at two different
times:
 The first property was offered to Harris as president, with the thought that the club would be
interested.
 Years later, she acquired additional property that was adjacent to the golf course (found out about
property while golfing on the Club’s property).
In both cases, she informed the board after she bought the property and board took no action. Club would
have been unable to purchase either property bc it continually faced financial difficulties; through it did have
spurs of fundraising. For several years board took ambivalent position towards development. Years later,
after change in board membership, board sued bc of usurpation of corporate opportunity.
Procedure: TC used the “line of business” test found no violation because the property was not in the line of
business of the country club, and because the financial difficulty of the club made it unable to purchase the
property, and because Harris had exhibited good faith
Issue: whether Harris, as an officer of the corporation, improperly usurped a corporate opportunity
Holding: under ALI
 1st Property – Usurpation of corporate opportunity because offered to her in her capacity as President;
 2nd Property – Closer call b/c offered to her while playing golf on Club property w/postmaster who told
her about it  remands
Reasoning:
 Court rejected “line of business” test: Rejected the line of business test as being difficult to apply,
particularly in this case where the club was not in the business of purchasing land, but could have been
interested in limiting adjacent development. Club, at various times, had considered reversing its policy of
not expanding its operations to include development of the surrounding real estate.
 Expressed concern over the “financial incapacity” factor of the “line of business” test: The court expressed
concern over the presence of a financial inability element in this test. The court noted that the
director/officer taking advantage of the opportunity is also often the one who is in a position to solve the
corporation’s financing problems. Allowing the fiduciary to make a personal gain creates a strong
disincentive for the fiduciary to do her job (like if you can make corp have money but if corp doesn’t have
money you get the property disincentives you to do your job)
 Court rejected fairness test: Court rejected the fairness test because it is too open-ended and provides no
real guidance to fiduciaries.
 Court uses the ALI test:
o Remands to trial court for use of the test, but speculates that taking the first property may be a
corporate opportunity because Harris found out about it from a broker who was actually extending
the offer to the corporation.
o Adopts ALI test because disclosure is so important. Disclosure is a way that the defendant can
insulate herself, while still protecting her ability to pursue business ventures free from the
possibility of lawsuit.
Skeel:
 Harris would want interest of expectancy test: clear that the corp didn’t have a stake in these
opportunities, so under this test she’s fine.
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 How to analyze this case under ALI 5.05:
o 1. Determine whether it was corporate opportunity; if its not Harris is off the hook
o 2. Determine whether there was adequate disclosure, whether the opportunity was rejected, and
whether it satisfies 1 of the 3 standards
 Argument that 1st property is a corporate opportunity: 1) 1st prong: Harris learned about this
because the person that told her wanted to tell the president of the corp – she became aware in
connection of performance of her function a director/senior executive; 2) 2nd prong: Harris did
not disclose her purchase to anyone in the corp prior to the purchase
 Argument that 2nd property is a corporate opportunity: 1) 1st prong: clearly corporate
opportunity, she got it when she was using corporate property. 2) was it rejected? Harris will
argue yes: she talked to directors about it, and they didn’t do anything. 5.05(d): good faith but
defective disclosure can be cured if rejection is ratified w/in reasonable time following a required
disclosure. Harris can argue that she tried to disclose but it was defective so disclosed again after
purchase was made subsequent ratification=rejection of opportunity. This won’t work bc she
didn’t even have a first disclosure.
 Under ALI, must clearly present opportunity to the firm. If you don’t very hard to win.
 ALI and Financial Inability: financial inability can be relevant as basis for firm rejecting the opportunity.
While directors can’t argue that it wasn’t a corporate opportunity bc the firm couldn’t afford to pursue it,
if directors present an opportunity and corp thinks about it and can’t afford it, this is a legitimate basis for
rejecting the opportunity. This is the only place where financial inability is still relevant.

4. Compensation of Directors
a. Compensation Issue: If directors are deciding on their own compensation, there is a conflict of
interest. However, compensation is necessary, unlike other self-dealing transactions (e.g., loans to
officers/directors). So, there’s no way to avoid a conflict of interest. However, because compensation
is a common business decision, even if it involves self-dealing, it differs from other interested
director transactions, which may not be in the usual course of business.
b. Portions of Compensation:
i. Fixed salary: compensation for current services, set annually. Unlikely to induce manager to
accept risky projects
ii. Variable performance-based compensation:
1. Stock options: option to buy a specified amount of the company’s stock at a fixed price
during a specified period
2. Stock: gives executive a shareholding stake in the business
iii. How stock options and stock affect SH and Managerial Incentives:
1. Stock Options:
a. Perception in 2000s that stock option (as opposed to stock) compensation
contributed to director misbehavior bc w/ stock option get all upside and not
downside.
i. Share of stock: if director takes bad risk  going to lose $
ii. stock options: don’t lose $ if stock goes down, just don’t exercise option. If it
goes up, exercise option.
b. Therefore stock options give directors incentive to make risky decisions that
will increase stock price.
c. Study: relationship bw extent of option-based pay and likelihood of financial
scandal
2. Stock:
a. aligns SH and manager incentives: By having stock and not options, just like
shareholders do, managers have “skin in the game” bc their risks will affect the
price of their stock which they always have (since w/o stock options, no option to
not exercise when price is down), which is a check on them to not take too many
risks.

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 i. Economic Theory: When incentives aligned, directors will respond to SH:
they both get benefit when stock goes up, and downfall when stock goes
down
ii. Non-Economic Theory: SH are owners so its natural they would be decision
makers, whether or not incentives are aligned
b. SH Incentives: As soon as equity gets to 0, losses don’t matter to the shareholders
bc they are the last to get paid, so at that point, they want the investment with the
highest chance of bringing the stock price up, regardless of the risk. Also, many
directors are themselves shareholders.
iv. stock-option-based compensation is still used, however, shares of stock are used more. Stock
is restricted; executives can’t sell it right away, they must wait some time. This reduces
incentive to focus on short-term gains and forces them to take long-term view.
c. Executive Compensation in Stock Options Effect on Executive Decision Making:
i. Shareholder Directors usually make good decisions, but if company has less equity, SH’s
incentives can start to skew, and they don’t have inventive to take creditors’ loses into account
bc they know they aren’t getting paid anyway.
ii. Stock options magnify these incentives: if someone has a stock option rather than a share of
stock, more likely that their decision-making incentives will be distorted – they’ll want corp to
take risks to get stock prices up to exercise their stock options
iii. If a company is solvent, SH will make good decisions, but if a company is nearing insolvency,
and a business option can help make it solvent, SH’s incentives are skewed to take that risk.
d. HYPO: Illustration of Stock Option Incentives:

Assets Liabilities
$100 $90
Net Worth
$10

i. Equity = SH/Directors; Debt = Creditors

ii. Firm has 2 investment options:
1. Opportunity A:
a. 90% chance of $2  expected upside =1.8 (.9 x 2)
b. 10% chance of -$10  expected downside = -1.0 (.1 x -10)
c. net present value of opportunity A = + .8
d. Analysis:
i. Equity: upside: 1.8; downside: -1.0; equity will bear all of it bc will bear
anything up to $10.
ii. Debt: no downside or upside, indifferent, bc this opportunity will increase
value of the firm, and the firm is already solvent, so creditors will be paid in full
regardless of whether or not this opportunity is picked.
2. Opportunity B:
e. 90% chance of $3  expected upside = 2.7 (.9 x 3)
f. 10% chance of -$50  expected downside = -5 (1 x 5)
g. net present value of opportunity B = -2.3
h. Analysis:
i. Equity: upside: 2.7; downside: only up to $10, bc once it hits 0, they’re out of
money, not getting paid no matter how low it goes
ii. Debt: bears $40 of $50 downside; no upside – get further and further away
from getting paid
iii. Net present value = chance of return + chance of loss.
iv. Once equity is at 0:
a. SH only look at the chance of return bc they don’t care about creditors losses since SH
know they’re not getting paid and just want to get the stock back up.

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 b. Creditors will look at net present value bc thats when some creditors are get payment
priority (senior creditors get paid first, and junior creditors start getting nervous about
whether they’re getting paid at all)
v. SH can only get paid out of the net worth which is $10, so once any opportunity gets lower
than $10, it doesn’t matter to them how low bc its all below 0.

Oppty Equity’s View of Investments (SH) Debt’s View of Investments (creditors)

A 1.8 0
-1.0 0
=0.8 =0
No effect; debt will be paid in full w/ or w/o,
because this opportunity will just increase value
of the firm and firm is already solvent.
Creditors will still be paid in full.
B 2.7 0
-1.0 (equity only pays attention to the -4.0
first $10 loss; other $40 will be borne =-4.0
by creditors) Creditors will try to reject this option because
=1.7 they must bear the negative cost
Shareholders will want this option bc
1.7>.8 which is bigger value for equity

iii. If firm had more equity ($30 equity rather than $10) and less debt, equity’s view of option B
would change, because it would value the downside differently
1. Even w/ 30% equity, if stock option rather than stock, once again your distortions are
even worse bc negative outcomes are not relevant to you
2. Equity upside still 2.7, but now outcome of opportunity B is -3.0, not just -1.0, so
expected downside would be -.3, so would go with Op A.
3. Even with 30% equity, if decision maker has a stock option, rather than stock, then he
has a distortion bc the negative outcome isn’t relevant to him, the only thing relevant is a
positive outcome.

Equity Debt
2.7 0
-3.0 0
--- --
-.3 0

e. Compensation Review:
i. Executive employment contracts, like any other transaction must be properly authorized.
Some statutes require that stock options be approved by shareholders.
ii. Or, board often delegates task of reviewing and approving executive pay to a compensation
committee of outside directors.
iii. Executive compensation doesn’t get fairness review as long as it is approved by directors that
are informed, disinterested, and independent.
f. Judicial Treatment of Compensation: (Lewis)
i. Shareholder Ratification of Compensation:

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 1. Ratified by Shareholders: if executive compensation is ratified by shareholders (even if
proposed by a self-interested board) then burden shifts to the shareholder challenger to
prove waste (only remedy)
2. Approved by informed, disinterested, independent directors: no fairness review
3. Not approved by informed, disinterested, and independent directors, nor ratified by
shareholders (or they voted no): fairness review (whether challenged compensation is
fair and reasonable to the corporation
4. independent committee advises: BJR bc no CoI (Goldman Sachs)

Lewis v. Vogelstein
Facts: complaint attacked plan on ground that its approval by shareholders was invalid bc the grant itself
constituted a waste of corporate assets.
Rule: if a stock option grant is ratified by shareholders (even if proposed by a self-interested board), a
remedy is only available if the compensation constituted waste.

In re Goldman Sachs
Facts: Goldman had a pay for performance compensation model where its compensation is a certain ratio of
net revenues. Goldman used an independent compensation committee to review the compensation for the
officers. Compensation committee compared the compensation ratio to Goldman’s competitors. P claimed
that the compensation model created a business strategy that is not in the best interest of shareholders b/c
encouraged officers to take on too much risk. Goldman also had an Audit Committee overseeing the
company’s management of risk. Ps claimed Goldman directors violated their duty of care by allowing this
compensation model.
Holding: Directors didn’t violate their duty of care
Reasoning:
 There was an independent compensation committee, so this case is about duty of care, not duty of loyalty
(no conflict of interest).
 Goldman had a Del. § 102(b)(7) provision, so there is only a breach if there was a breach of the duty of
good faith.
 Ps did not show facts constituting an intentional dereliction of duty or conscious disregard by the
directors in setting compensation levels.
o Allocating compensation as a percentage of net revenues doesn’t make it inevitable that management
will work against the interests of the shareholders
 Waste = compensation was a waste of corporate assets – compensation had no relation to value of
services promised. Lies beyond range at which any reasonable person might be willing to trade
o Here, compensation didn’t rise to level of waste
o Even 2008 bonuses were not waste – bonuses could have gone to successful traders even though
trading on average didn’t produce profits.
Skeel:
 Not a duty of loyalty case
o Case is just about compensation of employees; none of the directors were a part of the authorization,
and there is review by an independent committee, so no conflict of interest. This is a duty of care case,
and Goldman gets BJR.
o Ps try to make this a duty of loyalty case, by claiming that mangers made the decision, but managers
don’t get you to the directors.
 Goldman has a 102b7 exculpatory provision, so have to show BF to get liability

D. Shareholder Litigation
1. Generally:
a. This is the process by which fiduciary duties get enforced, which is why we encourage it
b. Through SH litigation, courts are trying to balance two objectives:
i. To facilitate enforcement of fiduciary duties: if individual shareholders had to pay for their
own expenses to bring a suit, there would rarely be cases to enforce fiduciary duty
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 ii. To discourage strike suits: frivolous litigation filed in hopes of extracting settlement money
from directors and the firm
1. So don’t want to make SH lawsuits too easy to bring to prevent this
2. Interested and Independent Definitions
a. DE:
i. Interested = director has a direct financial stake in transaction, family member relationship to
transaction
ii. Independent: whether you can be trusted to make an objective decision in a situation where
you yourself are not interested
b. ALI 1.23: (combines interested & independent) A D/O is interested in a transaction if either:
(1): D/O is party to transaction
(2): D/O has business, financial, or familial relationship w/ party to transaction and that
relationship would reasonably be expected to affect director’s or officer’s judgment wrt
transaction in manner adverse to corporation;
(3): D/O or their associate or person w/ whom they have business has a material pecuniary
interest in transaction (other than usual and customary directors’ fees and benefits) and this
would reasonably be expected to affect director’s or officer’s judgment wrt transaction in
manner adverse to corporation;
(4): D/O is subject to controlling influence by a party to transaction or person who has
material pecuniary interest in transaction or conduct and that controlling influence would
reasonably be expected to affect director’s or officer’s judgment wrt transaction in manner
adverse to corporation
3. Shareholder Litigation Steps:
a. First ask who was harmed to determine whether suit was direct or derivative
i. Derivative vs. direct matters bc w/ derivative suit, it belongs to the corp
ii. If there is a choice, try to bring suit directly; but sometimes cant
b. Tooley Test:
i. Who suffered harm? The corporation or shareholders? (was harm to corporation and SHs got
harmed by association, or was it directly to the SHs?)
ii. Who will get the benefit of the recovery? (skeel: not helpful bc this is circular test: if it’s a
derivative suit, then company will benefit. If direct suit, shareholders will get relief. However,
getting at who will be helped by recover in suit?)
iii. Skeel: not that helpful of a test bc still have to decide what counts as harm to shareholder. Key
benefit was removing old DE test which required showing “special injury” to sue directly,
which was problematic.
c. Direct:
i. When shareholder sues in her personal capacity to enforce her rights as a shareholder, as
opposed to rights of the corp; suit not brought on behalf of the corporation.
ii. Usually in form of class action by a group of all shareholders
iii. Examples: generally vindicate individual SH’s structural, financial, liquidity, and voting rights
1. Allegation that SH has been harmed in relation to dividend. Right to dividends is
distinctive, rights are inherent and part of share of stock, so a SH can bring a direct suit if
his dividend rights have been interfered with
2. Proxy contest
3. Voting rights: like if SH have interest in operating company. Operating company is
merged into another company, and new company is parents, and operating company is
subsidiary. SHs end up with stock in parent rather than subsidiary – his direct say in
operating company is taken away
4. Fiduciary duty violations where the effect is to reduce the value of the corporation
d. Derivative:
i. Shareholder is suing on behalf of the corporation to enforce the rights of the corporation,
saying the corporation should have brought this litigation but didn’t
ii. w/o this procedure, management’s fiduciary duties to the corporation would be meaningless
iii. SH sues the corporation to have the corporation being an action to enforce corporate rights
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 iv. Any recovery runs to the corporation (since suing on behalf of corporation)
v. Requirements:
1. SH has to have owned stock at time of alleged harm
2. SH has to continue to own stock through duration of litigation (DGCL §327)
3. Some states require security for expenses Ps but up bond that can be used to pay
attorney’s fees and other expenses if Ps lose and court concludes it was bad case; DE
doesn’t have one, easy to evade)
4. Demand on other SH to show majority of other SHs want to go forward (isn’t really a
thing anymore although technically in place in DE – don’t have to comply if it would be
administratively inconvenient to comply w/ which it always is)
5. Demand on Directors: a board of directors can decide the fate of derivate litigation if a
pre-suit demand on the board is required (Most Important Requirement)
a. If SH makes demand and director refuses  Director’s decision to not proceed
stands (suit will go away unless it was wrongful) (BJR deference)
b. If SH doesn’t make a demand, must show that it was excused bc it would be futile to
bring the matter to the board. In DE use Aronson test to determine whether
demand is excused. SH-P must show
i. Reasonable doubt that at time of demand, a majority of directors on whom
demand would have been made are disinterested in the suit outcome and
independent; OR
ii. Reasonable doubt that at the time of transaction, the challenged transaction
was protected by BJR (by showing conflict of interest, bad faith, grossly
uninformed decision-making, failure of oversight)
c. Purpose of Aronson Test:
i. DE cares about not completely eliminating directors’ discretion (based on
DGCL §141(a)). DE standard designed to kill strike suits (frivolous). Gives
directors oppty to figure out solution internally rather than going through
litigation.
ii. Litigation in a derivative suit is saying that directors violated fiduciary duty; if
SHs make demand to them to decide fate of litigation, they would be approving
to sue themselves which they wouldn’t do.
iii. If you make demand in DE, you’re acknowledging that they are capable of
making decision on behalf of firm about litigation and therefore conceding that
directors are disinterested and independent and their decision will be
upheld no one actually makes demand in DE
iv. How Theses Cases Work: SH files suit, says demand is excused because it
would be futile, tries to prove one prong of Aronson test; if directors win, ct
says demand is required and the suit goes away, SH-Ps don’t pursue it. If SH-Ps
win and ct says demand is excused, case settles and SH-Ps get money from
directors and insurance companies (almost always settle)
4. Double Derivative: SH of parent corp sues it bc its wholly-owned subsidiary corp breached its fiduciary
duty. Bc subsidiary is wholly-owned, it has no outside SH that could complain
a. Parent Board:
i. Rales Test: For demand to be excused, SH-P must show that there is reasonable doubt that the
parent board that is deciding what to do with the litigation is not disinterested in suit outcome
and independent (this is almost identical to Aronson prong 1) (must show MAJORITY of dirs
are interested/not independent)
1. *note: directors w/ stake in litigation are not per se interested; must show they breached
fiduciary duty
ii. 2nd prong of Aronson doesn’t apply here bc it talks about the transaction having bjr, but the
parent did not approve the transaction
b. Subsidiary Board: For demand to be excused, prove one prong of Aronson test
5. ALI 7.03 Demand Requirement: Requires demand in every case, but has made requirement less
problematic for Ps demand excused if you can “make a specific showing of irreparable injury” (easier
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 to continue case even if demand is rejected) – gets at idea that if SH thinks making a demand to directors
might change things, which is useful so they shouldn’t be punished for it (bc if make demand not proving
directors are disinterested)

Levine v. Smith
Facts: GM buys out Perlot and SHs claim violation of fiduciary duty
Type of Suit: derivative: arguing that wasting GM assets through buyout (harm to corp)
Issue: did SHs make a demand? Demand wasn’t made, and question of case is whether demand was required.
Held: Making demand would not be futile
Skeel:
 What’s the argument that this was a good case? (that SHs did show that demand was futile)
o Perot is saying directors are clowns  edging towards a personal interest that is different than just
making a business decision; one could argue that they’re not completely disinterested
o Disinterested directors are influenced by the interested director (but Court rejects this arg., although
Skeel thinks its plausible)

Rales v. Blasband
Facts: Parent-Subsidiary case/double derivative suit
 Structure/Parties
o Parent: Danaher; 100% owned sub: EASCO
o Rales bros. are controlling shareholders of and have 44% of Danaher
o Blasband, P, is a minority SH of Danaher
o R  44% D 100% E
o B  >SH D
 Blasband sues Danaher because its 100% owned sub EASCO entered into a K with Drexel for junk bonds,
which are not safe securities violation of fiduciary duties.
o B Danaher bc EASCO + Drexel
 Hence, double derivative suit: because Blasband not SH of company (EASCO) in which directors breached
duties, but of parent of that company (Danaher)  in DE, under certain circumstances, SHs can bring that
kind of suit
Type of Suit: derivative; directors were destroying corporation value by buying unsafe bonds harm to
shareholders as a whole
Issue: how do derivative suits work where corp where SH-P has stock didn’t make a decision, but rather its
subsidiary made the decision?
Holding: demand was futile bc a majority of the parent corp’s directors were interested – demand excused
Rule: (Rales Test) for derivative suit to go forward, SH-P must show:
 Parent(D): reasonable doubt that at time of demand, directors could exercise disinterested and
independent judgment regarding litigation
 Subsidiary (E): have to show full Aronson test
Reasoning:
 Parent Danaher: directors were not disinterested or independent at time of demand
o R bros + Caplin: not disinterested
 They are directors of Danaher, and also EASCO
 A 3rd circuit court said that based on a related case with the same facts, the board of directors of
EASCO is likely to be liable for their transaction w/ Drexel for breaching duty of care
 Therefore these 3 Danaher directors will be liable for EASCO’s transaction
 They are conflicted and NOT disinterested they are interested in the outcome of this litigation
because they are liable for the transaction the SH want to sue Danaher for EASCO’s transaction,
and since these 3 are liable for EASCO’s transaction, they have direct interest in this suit’s
outcome
o 3 interested director is not enough, bc for Rales test must show majority of directors are
disinterested/independent. Board has 8, so need 5 for majority
o Two other board members:
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  2 of the other directors work for R bros companies; financial consequences of not being in R bros
good graces is enough to raise doubt about their independence – financial stak can allow court to
conclude they are under sway of R bros.
o Rales test is therefore met
 Subsidiary Easco: 2 prong Aronson test; both prongs are satisfied
o Prong 1: was the EASCO board independent and disinterested at time it dealt w/ demand?
 No. 3rd party company (Drexel) has close relationship w/ EASCO’s parent Danaher  relationship
bw Milken, from Drexel, and R bros, from Danaher. R bros dominate the EASCO board, so the rest
of the board isn’t independent can’t be disinterested bc would be approving to sue themselves for
allowing decision for junk bonds
o Prong 2: was EASCO’s board decision to buy junk bonds a valid business judgment?
 No—there was a breach of duty of care because the board said they wanted to invest in low risk
securities, but junk bonds are high risk securities. Directors said they would do one thing but did
something else—this is breach of duty of care and gets no business judgment presumption
Skeel:
 Danger of construing broadly the idea that any director in jeopardy from lawsuit is not
disinterested:
o Then this rule would be applied in every case—anytime in any derivative suit when directors that are
deciding on the demand are directors that are to be sued, they are interested
o So if interested means any stake in litigation, directors will never be disinterested in these situations
o this is not what case is implying
o if there is strong evidence that directors have breached their fiduciary duty, then they become
interested
 in this situation, Ds likely breached their duty bc there is 3rd Cir opinion saying so.
 If they were regular defendants who didn’t breach duty but could be defendants in case, they are
not interested
 Must be more evidence than simply director is getting sued to make them interesting
 This is example of per-se disinterested/independent
o Ps can also show interestedness/ non-independence in practice
o Disney example; Eisner clearly dominated board of directory—they were not independent
o Even if there is no financial stake, etc—if other directors will clearly do what CEO says, that can be
enough to disprove independence

6. Special Litigation Committees: Zapata

a. If directors in a suit are interested/not independent, they can appoint a special litigation committee
of disinterested directors who decide whether suit should go forward
b. Procedure: SH-Ps sue board if board is clearly interested they set up a special committee of
independent directors to consider whether litigation should move forward committee
investigates the suit and issue a report, usually say the suit will not be successful and isn’t in best
interest of the corp special committee asks the chancery court to stop the litigation and the
chancery court decides whether to accept the report or not  if court doesn’t accept the
committee’s recommendation, case will go forward. If could does accept recommendation, the case
stops
c. Rule: Court’s Procedure for Reviewing Special Committee’s Recommendation (whether to
dismiss or allow the suit)
i. Step 1: court reviews special litigation committee to determine if they are disinterested and
independent. Burden of proof to show on directors; AND
ii. Step 2: court uses its own business judgment to determine whether committee’s
recommendation should be followed or not (discretionary)
iii. This is BOTH/AND test; both prongs must be met; but 2nd prong is discretionary, so courts can
choose not to use it
iv. This is rigorous test, not deferential to directors, but unpopular

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 Zapata Corp v. Maldonado
Facts: Zapata directors knew there was going to be a tender offer for the company and they were ok with it.
they had stock options, and their exercise date was after the tender offer. Directors changed the exercise date
to be before the tender offer for tax benefits (would be taxed less if they exercised the options earlier). Tax
deduction for directors isn’t good for the corporation, basically takes money away so shareholders sued
saying this was a breach of fiduciary duties. Instead of litigating, Zapata board set up a special litigation
committee of disinterested directors to consider whether the litigation should go forward.
 Reason for Special Litigation Committee:
o It is very clear that the directors are interested in outcome of litigation since they themselves made
exercise date earlier and want it that way so if there was no committee, the board wouldn’t pass the
Aronson test, demand refusal would fail, and they’d have to pay. They install planed B special
commission of independent directors that would make a decision on whether litigation should go
forward.
Rule: Court’s Procedure for Reviewing Special Committee’s Recommendation (whether to dismiss or
allow the suit)
 Step 1: court reviews special litigation committee to determine if they are disinterested and independent.
Burden of proof to show on directors
 Step 2: court uses its own business judgment to determine whether committee’s recommendation should
be followed or not (discretionary)
Skeel:
 How this test is different from Aronson:
o Aronson is an either/or test, 1 of the 2 prongs must be satisfied. Zapata test is a both/and test so both
prongs must be proved, however the 2nd prong is discretionary; court doesn’t have to use the 2nd
prong
o Burden of proof: in Aronson, burden of proof for first prong is on the SH-Ps, but in Zapata burden is
on the directors to show the committee is independent and disinterested
o BJR: In Aronson, we’re talking about the corp’s BJR, but in Zapata, talking about court’s own business
judgment in deciding whether a suit should move forward.
 Zapata has been unsuccessful – it is not an effective way to distinguish bw good and bad suits but it is still
the law

7. Attorneys Fees Problems in SH Litigation:

a. We are concerned that attorney’s incentives are different than SH-Ps—attorneys are concerned
about their fees, not highest possible recovery for SH
b. Chance that attorneys will agree to settlement that pays them well but doesn’t do much for SH
c. Milly Vanilli: Settlement in suit was that victim would get $2 off next CD from that production
company, while attorney got 10mil
8. Common Fund (Fletcher)
a. Even if SH-Ps don’t get $ (just governance changes), may be possible for attorney to get paid as the
“substantial benefit rule” (as long as they produce a substantial benefit)
b. Common fund idea: attorneys get paid first (shift from normal American rule that everyone pays
their own attorney’s fees)
i. Normative justification: otherwise, we wouldn’t get much shareholder litigation
ii. 1995: Congress thought too much strike suit litigation, so Congress required lead P to be
biggest shareholder that’s willing to serve
iii. Seen as creating its own limitations:
1. Attorneys end up being real party in interest. Named shareholders usually have a limited
stake, whereas attorney has a big stake because will make a lot $ if case settles; so just
pay them first and they will do the best they can.
2. Concern: Attorney will collude with directors to detriment of shareholders. Insurance co.
paying all of it (if settlement, insurance pay attorney’s fees paid by insurance co, and
insurance co will pay director’s fees.

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 3. Defense: if didn’t have common fund, attorneys wouldn’t bring suit (collective action
problem)
iv. Potential limitations:
1. Look at % going to attorneys (incentivizes attorneys to go to biggest judgment) 
Delaware has leaned this way
2. Rather than hours (incentivizes protracted litigation)
3. DE: Pay attorneys off the top out of common fund to solve a collective action problem
9. Loser Pays Provision: DE upheld this, but now illegal per DGCL §102 (cert) and 109 (bylaws)
a. was big problem bc meant no one is gonna sue the corp
10. Forum Selection Provisions (can be in cert or bylaws): DGCL §115: validates exclusive forum
provisions: exclusive forum provisions are OK if chooses DE, but cannot have exclusive forum provisions
that all cases can be brought in another state. Can say another state and DE, but DE must always be
option.

VI. TRANSACTIONS IN CONTROL

A. Sales of Control
1. Why and How Control Sold
a. Control premium=additional value, above the financial value of the shares, that comes with
controlling the corp’s business
i. If A has 3mil/10mil shares and each share is $50, value of her holding is more than $50/share
because 30% shareholder of a public company has effective control. If B wants to buy A’s
shares, A can demand extra for her control block and B will pay this premium because of the
increased value to him of being able to control the corp. This is the control premium.
b. Why buyers pay premium for control:
i. Private benefits: power to capture salary, perks, and perhaps self-dealing opportunities,
prestige value of being the company’s indisputable boss
ii. Public benefits: Buyer believes he has a superior business plan to increase value of stock
iii. Function of markets: Control blocks costly to create (drive up price when attempt to buy
enough stock for a control block), so the block commands a premium on sale
c. Regulatory Tradeoff: If hinder purchase of control at premium, mitigates risk of opportunistic
transfer to “bad” acquirers, but hinders efficient transfer to those acquirers who will use company
assets in more profitable ways
2. How Buyers Acquire Control:
a. Purchasing a controlling block of shares from an existing controlling shareholder.
b. Purchasing the shares of numerous smaller shareholders
i. w/o ex-ante regulation, anti-takeover defenses, or ex post derivative litigation, looter could
exploit collective action problem of disaggregated SH by buying 51% of a target corp as a high
price and appropriate large part of the value of remaining 49% as a private benefit
ii. regulatory measures: mitigate collective action problem of target SH
1. Minimum tender offer periods
2. Mandatory cash-out rights for minority SH
3. Power of controlling mangers to bargain on behalf of SH
3. Market Rule: A controlling SH is free to sell, and a purchaser is free to buy that controlling interest at a
premium price – SH doesn’t need to share the premium w/ other shareholders pro rata
a. When acquirer of a control block offers, NOT required to offer to buy all shares at the same price
paid in control transaction. (Zetlin).
b. Minority SHs do not have right to sell their stock back to the company in that circumstance.
c. Advantages of Market Rule (Easterbrook & Fischel)
i. Unequal distribution of benefits of sale of control block facilitates sale of control blocks (more
efficient than dealing with numerous sellers) and increases the incentive for inefficient
controllers to relinquish their positions

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 ii. Difficult for a seller to detect a buyer that intends to “loot” a corporate opportunity/asset.
Scrutinizing transactions for “looters” would likely over-deter beneficial transactions, so
looting is best deterred ex post by fines/imprisonment for the looter.
4. Exceptions to Market Rule: to discourage harmful transfers of control, state courts recognize
exceptions to the general rule of free transferability
a. Sale to Looters: a controlling SH may not sell control if the seller has reason to suspect that the
buyer will use control to “loot” (steal corporate assets or engage in unfair self-dealing transactions)
i. If a reasonably prudent person would be suspicious of the transaction of buyer then there is an
affirmative duty to investigate the bona fides of the buyer and exercise case so that others who
will be affected by the actions will not be injured by wrongful conduct. Ask
1. Look at the business the buyer is in, how is his reputation?
2. Does he have experience?
3. What did the seller know and do in terms of investigation?  might question unaudited
financials, ownership of subsidiaries, any debts or fraud judgments?
4. What was the sales price? (weird premium? Excessive premium should cause suspicion)
5. Is buyer hurried or dishonest? (does he show little interest in corp’s bussiness?)
6. Seller is going to be hurt if buyer loots?
ii. if after sale buyer loots: evaluate actions under duty of care and duty of loyalty
b. Sale of Control of Directors (office): seller of a control block can promise as part of sale to give the
buyer working control of the board, accomplished by resignation of seller’s directors, w/ each
vacancy filled w/ buyers’ directors (w/o this, buyer would have to conduct special SH meeting to
elect new board)
i. It is illegal to pay for director resignations (obvious if selling non-controlling block of stock at a
premium and directors you control change afterwards, or if sales price exceeds premium the
control block alone commands)
ii. Also problem if buyer did not acquire working control and could not have elected his own slate
(not enough to elect the director seats)
iii. Might need series of resignations
1. DGCL §223(a): unless the charter or bylaws provide otherwise, director vacancies filled
by remaining board of directors (selected by majority of directors left after resignations,
even if less than quorum, and if only 1 left, by him)
2. Hence to transfer control of board, controlled board members must resign in waves
(a.k.a. “Seriatim Resignation”)
3. E.g. if controlling SH has 7 of 11 directors, would have 2 resign at a time, which would
leave you with 5 of the remaining 9)
c. Using control blocks to coercively recapture control rights that were previously bargained
away
1) Delphi: two classes of shares; charter had provision that removed possibility of control
premium in a later acquisition; when later acquisition came, controlling SH wanted control
premium and convinced board to amend charter by threatening to block the good deal
otherwise. Note: might have been able to change certificate provision had it been in ordinary
course of business rather than in connection with an acquisition)
d. Selling corporate opportunities at premium (Perlman – selling future profits of corp)
i. Feldmann (CEO, pres., and dominant SH) sold controlling interest in Newport to Wilport,
which includes corporate oppty because before sale, could sell steel to whoever wanted, and
after sale, would only sell to Wilport. Hence corporate asset sold at a premium.
ii. Problem: (1) Giving up oppty to choose buyers (which could cut shipping costs by picking
close by or help build customer base). Feldman, therefore, by selling stock is capturing value
rather than Newport (that is, value of ability to determine who buys steel); (2) Can no longer
do Feldmann plan (make people pay for steel in advance to take advantage of interest rates; $
now = worth more later).
iii. Can’t not share corporate opportunity premium that doesn’t inhere by itself in fact of holding a
controlling interest in company (corp opp that doesn’t stem from being a controlling SH)

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 Zetlin v. Hanson Holdings
Facts: Zetlin (P) owned 2% of Gable Industries’ shares. Hanson Holdings (D) owned 44.4%. Hanson sold
interest to another party at a premium, as his 44.4% was a controlling interest. P sued arguing that minority
shareholders should be entitled to share in the premium.
Holding: Rejects equal opportunity rule (that D must share premium pro rata with all shareholders).
Reasoning: Equal opportunity rule would require, essentially, that a controlling interest be transferred only
by means of an offer to all stockholders, i.e. a tender offer.
Rule: Market Rule (Common Law Rule) - Absent looting of corporate assets, conversion of a corporate
opportunity, fraud or other acts of bad faith, a controlling SH is free to sell, and a purchaser is free to buy that
controlling interest at a premium price w/o sharing premium w/ other shareholders.

Perlman v. Feldmann
Facts: Feldmann was the dominant SH, president of the corporation, and the chairman of the board of
directors of Newport Steel. Feldmann sold his 37% (controlling) interest to Wilport Co (Newport’s customer)
for $20/share (market price = $12/share).
 Bc of the Korean War, there was a steel shortage, so Eisenhower placed an unofficial freeze on the price of
steel. To get around the price freeze, Newport was using the “Feldmann Plan,” whereby they had their
customers pay now for steel that they were going to get in the future. This enabled Newport to profit
because due to the interest rate, money today would be worth more tomorrow.
 Wilport didn’t want to operate under the Feldmann Plan, and once Wilport bought Feldmann’s controlling
shares, wouldn’t have to
 SH brought derivative suit claiming that by allowing Wilport to buy controlling shares, corp would
lose money bc: 1) Wilport wouldn’t use Feldmann Plan; 2) Newps would lose benefit of being able
to pick economically sensible buyers – Wilport was very far away and after war when price
controls were over, it wouldn’t be economically sensible to ship steel that far
Issue: SHs claimed that Feldmann breached his duty of loyalty by selling his controlling interest at a
premium. Argument is that by selling his stock, Feldmann himself is capturing value instead of Newport
(Newps loses value)
Held: Feldman breached his duty of loyalty by selling his controlling interest to Wilport.
Rule: Two interpretations
a) Narrower Reading – Although it’s okay for a controlling shareholder to get a control premium for
selling his controlling interest, it’s a breach of his duty of loyalty to get a corporate opportunity
premium. (can’t keep premium to self while the sale to the buyer allows the buyer to do something
that will cause corp to lose money) (consistent with American corporate law generally)
b) Broader reading – Equal opportunity rule: Not ok to receive any control premium; controlling SH
must share control premium with every other shareholder. (This is not a prevailing argument;
American corporate law generally does not impose this sort of rule, unless the above exceptions)
Rationale:
 Not an ordinary case of duty of loyalty: No fraud, misuse of confidential information, contracting with the
corporation, or looting. No indication that Wilport is misbehaving or is going to rip off Newport.
 Corporate opportunity claim:
o Before the sale to Wilport, Newport could sell to whomever they wanted. After the sale, they are going
to sell to Wilport.
 Giving up opportunity to choose its buyers. Although there is a price freeze, Newport could have
sold to customers near the location of the steel, so they could cut (shipping) costs and build up
this customer base.
 Can no longer do the Feldmann plan (b/c Wilport isn’t going to pay in advance).
o Burden of D establish the fairness of his dealings with trust property.
o Allowed SH Ps to collect directly: Since this was a derivative suit, recovery would typically go to the
corporation. But if Feldman paid the control premium back to Newport, Wilport would benefit as 37%
owner of Newport. Therefore, court decided recovery should go to the SHs other than Wilport.

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 Dissent: Majority is completely unclear about exactly what duty Feldmann breached (since he’s controlling
shareholder, director, and president). Also, bullshit that majority allows the shareholders to collect directly
when this is a derivative suit (harm was to the corporation).
Skeel:
 Don’t have to have 50%+1 to be in effective control
 Rule
o OK to sell corporate asset as long as not selling director resignations ;
o OK to sell controlling stake and you can profit from that.
o Can’t not share corporate opportunity premium that doesn’t inhere by itself in fact of holding a
controlling interest in company (corp opp that doesn’t stem from being a controlling SH)
 This is unique case where selling stock was effectively selling some of the value of the corp

In Re Delphi Financial Group SH Litigaiton

Facts:
 Delphi: two classes of authorized capital stock:
o Class A, which was largely held by the public, and
o Class B, which was held solely by one of the Defendants, Rosenkranz
 Rosenkranz: only held approx 12.9% of stock, each share of Class B stock was entitled to ten votes
(versus one vote per share of Class A stock), providing Rosenkranz with a 49.9% stake for voting
purposes
 Delphi’s Charter – No disparate treatment upon merger involving payments on Class A & B Shares:
in merger Class A and B stock have to sell equally, can’t get differential payout
 Delphi merged w/ TMH. Rosenkranz was negotiator and wanted a premium. Wanted to amend the
charter to allow disparate consideration for the Class A and B shares. The Board accepted this
because they felt the deal was still good for the minority SHs.
Procedure: SH sue saying unfair to minority SHs. Minority SHs argue “coercing the consent of the minority
SH” b/c Rosenkranz would hold up the deal unless he gets his premium not allowed in the charter.
Issue: Rights of controlling SH to act in his own interest as a SH, including trying to amend the charter and to
get a control premium, are in conflict with his contractual agreement not to get a control premium, as
reflected in the corporate charter
Holding: Ps demonstrated reasonable probability of success on merits, but injunctive relief not appropriate;
harm remediable by damages.
Reasoning:
 Rosenkranz can’t negotiate another control premium here because he basically sold it in the IPO when he
agreed to the terms of the charter protecting the Class A shares from precisely this sort of exertion of
control.
 Also noteworthy that Rosenkranz was negotiating on behalf of Class A stock, even though their interests
were not aligned and he knew that he was negotiating a price that he himself would not have accepted for
the sale of his own shares.
 His attempts to “coerce” the amendment in the sale context are a violation of his duties to the minority.
Skeel:
 Could R have just sold his class B shares? Yes, but nobody would want them because when they are
sold they transfer to Class A, so buyer would end up without a control
 Could R have just voted no, if did not give him additional compensation? Yes, could have just voted
no – pretty much all he couldn’t do is propose a change that ensures he is paid more than other SHs
 Would be fine to propose cert change in ordinary course of business and not going through
merger/no big payoff in prospect
o This was bad timing; he was clearly being opportunistic bc realized if merger goes through he
wouldn’t be able to cash out and get full value of his voting control

B. Mergers and Acquisitions

1. Up to 1890: Mergers were rare – Corporate charters were acts of the sovereign until 1840, with the
enactment of general incorporation statutes.
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2. Modern Era:
a. Innovation 1: Unanimous consent no longer need needed - Corporation statutes amended to
permit mergers and charter amendments that received less than unanimous shareholder approval,
provided that they were recommended by the board and approved by a majority of shareholders.
b. Innovation 2: Appraisal rights - Establishment of shareholders’ right to dissent from proposed
merger and demand an “appraisal” as an alternative to continuing as a shareholder in the new,
merged enterprise
c. Innovation 3: New kinds of consideration - Expansion of permissible kinds of consideration for
merger from JUST stock to all kinds of property (e.g., Cash-out merger – Shareholders forced to
exchange shares for cash)
3. Merger: unites two existing corporations where the acquiring corporation absorbs the acquired
corporation, the acquired corporation disappears, and the acquiring corporation survives and assumes
obligations of both corps. Begins w/ a public filing of a certificate of merger, usually w/ SH approval.
4. Acquisition: generic class of non-merger techniques for combining companies, which generally involve
purchase of assets or shares of one firm by another
5. Triangular Mergers: sometimes, total absorption of the target into the acquiring corporation may not
be desired: parent corp creates a shell corp for the transaction
a. Acquirer (A) forms wholly-owned subsidiary; A takes all of Asub shares, owns 100% of them
b. Asub and capitalizes Asub w/ shares of A stock or cash for consideration for target company
c. Asub enters into a merger plan w/ Target:
i. Forward Triangle Merger: T mergers into Asub  T shareholders get the A stock/cash that
was in Asub  All T assets and liabilities transferred to Asub  All T stock is cancelled  A
owns 100% of T subsidiary.
ii. Reverse Triangle Merger: Asub mergers into T  Asub’s A stock converted into T stockT
stock is cancelled  A owns 100% of T subsidiary.
d. After either merger, A continues as the sole shareholder of the surviving corp
e. Reverse vs. Forward Merger: w/ forward merger, T doesn’t survive, and this can affect contracts of
intellectual property that depend on corp’s continuing existence.
6. Purpose of Triangle Merger:
a. Insulates parent from sub’s liabilities
b. Can maintain separate business identities
c. tax benefits

7. Timberjack Agreement

Rauma (Parent) TimberJack

SHs
1
Rauma TimberJack
(Acquisition 2 (Company)
Purchaser)

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 a. Rauma has set up shell corporation, “Purchaser,” to perform transaction w/ TimberJack
i. Shell corporations mostly created soley for transaction and has no other purpose than
actuating the transaction
b. Purchaser first gives Tender Offer to shareholders of TimberJack to get control
i. Tender offer: public offer to all shareholders to purchase shares
ii. Use TO if concerned about complications in merger to ensure that purchaser has control to
ensure that merger will go thorugh
a. Tender offers are short; can set them up in 30 days and know if there is enough
shareholder support to go through with the merger
b. Full mergers are costly, require a vote, and can take months to set up
iii. Short Form Merger Possibility: DGCL §253: if an acquiring corporation owns 90% or more
of a subsidiary, the merger can go through w/o the vote of either party.
a. So if Purchaser can get 90% of TimberJack’s shares through the TO, can do a short from
merger w/o vote, which is easier, can be done quickly
b. TO + 253 merger scrutiny: used to be that TO got very little scrutiny bc of the idea that
SH can decide for themselves, and §253 got very little scrutiny, this kind of transaction
was easy and got almost no scrutiny
c. TO + regular merger has much more serious scrutiny, but DE is in process of equalizing
scrutiny (but §253 still faster merger)
iv. DCGL §251(h): (main merger provision) DE amended §251 to allow a merger w/o either
party vote if the directors invoke it, and if the acquiring company has 50% of shares and is in
the 2nd stage of the TO; allows TO and short-form merger w/ 50% interest
v. Under the agreement, purchaser must get at least 50% of TimberJack’s share approval for the
merger to go through. If purchaser gets 90% of TimberJack’s shares from the TO, can use §253
short form merger; if gets less than 90% can either do regular long merger that requires vote,
etc. OR can invoke §251(h).
c. Then Purchaser merges into TimberJack, TimberJack is the surviving company
i. This is a reverse triangular merger: the purchaser is merged into the target company
ii. Shares of TimberJack that were owned by Rauma or purchaser before the merger are
cancelled
iii. Shares of TimberJack that were owned by its old shareholders that don’t tender in TO (don’t
want to sell their shares) are cancelled, after Ruama pays them $25/share
iv. Only thing left is Purchaser’s stock, which gets renamed TimberJack
v. Ruama now owns 100% of new subsidiary TimberJack
vi. Companies can structure mergers in a lot of different ways
C. Appraisal Rights
1. Protections for Shareholders:
a. Voting rights
b. Fiduciary duty of directors/controlling SHs
c. Appraisal rights – weakest form of protection for SHs
2. Appraisal Rights: shareholders’ rights to have their shares bought back by a corporation at a price that
is set by a chancery court
3. Purpose:
a. Before, fundamental transactions like mergers had to be approved unanimously, so single
shareholders had veto rights against transaction. This made it too hard to have mergers, so states
replaced the unanimity rule w/ voting rules.
b. Appraisal rights were introduced as a replacement for the veto power that shareholders lost. They
could no longer stop a merger, but had right to exit corporation if they didn’t agree with the merger
and no longer wanted to be part of corp.
c. After the introduction of the SH non-unanimity rule to authorize mergers (now, just a majority
needed to approve major transactions like mergers), appraisal rights protected interests of SHs,
particularly when not a liquid market for the shares.
4. Determining Whether Appraisal Rights are Available:
a. Did corporation meet its obligations when transaction gave rise to potential appraisal rights?
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 i. Notice: Firm must notify SHs at least 20 days before a transaction that gives rise to appraisal
rights. [§262(d)]
ii. Other Invocations: Must give statement after the transaction to all SHs who have properly
invoked their appraisal rights saying how many shares total have invoked appraisal rights.
[§262(e)]
b. Did SH meet their obligations before invoking appraisal rights?
i. Written Demand: Must make written demand for appraisal before the vote on the merger.
[§262(d)]
1. Purpose: If bunch of SHs are going to request appraisal rights, corp. will probably think
twice about the merger
ii. Don’t Vote Yes: SH must vote no or abstain in the vote on the transaction [§262(a)]
iii. Hold on to Shares: SHs must hold on to shares through effective date of merger or
consolidation [§262(a)]
iv. 120 to get appraisal: SHs have 120 days after the vote to go to chancery court and request it
to set a price for their shares [§262(e)]
1. DE determines what a fair value for a share is
c. Are appraisal rights available?
i. Delaware limits mandatory appraisal rights to CERTAIN (NOT ALL) MERGERS
1. DGCL § 262(c): Corporation can provide in its charter that appraisal rights are available
in other situations not outlined in Del. § 262(b).
ii. 253 short form merger?
1. DGCL §253 Short Form Merger: SHs of target ALWAYS HAVE appraisal rights
a. For this type of merger, Controlling SH has at least 90% of the company’s stock.
2. DGCL §251(f) Merger Survivor SHs NEVER HAVE appraisal rights
a. §251(f): SHs of surviving corporation are not required to vote on merger (b/c no
certificate change required), either because (1) no stock is being exchanged or
(2) less than 20% of survivor stock is being exchanged.
iii. If neither of the above  DGCL §262(b): Guaranteed appraisal rights only if it is a
merger AND AT LEAST ONE IS TRUE: (in DE don’t have them unless merger)
1. You hold shares of non-publicly held corporation; OR
a. Public? Public if > 2,000 shareholders (not shares) OR listed on a national
exchange; OR
b. Purpose: Shareholder of a public firm can just sell their shares in the market
2. You are the SH of a public firm and, in the merger you are required to receive
something other than (1) survivor stock or (2) other public corp’s stock.
a. Something other than = cash, bonds, debt, either by itself OR w/ the stock
appraisal rights
b. Cash for fractional shares: You get stock as consideration for the merger, but the
number of shares isn’t even, so they give you some cash for that fraction of the
shares.  DOES NOT COUNT AS “SOMETHING OTHER THAN . . .”
c. Preferred stock: Counts as stock
d. “Other public stock” provision meant to cover triangular mergers, in which target
receives shares of survivor’s parent, but subsidiary is survivor, so technically
doesn’t get survivor stock. But DE applies the provision literally—if you get
parent stock in triangle merger from subsidiary, counts as survivor stock
d. Determining Appraisal Value:
i. Previous: DE used block method: Court came up with 4 different values for the corporation
and assigned weights to them. This systematically seemed to undervalue the shares of the
person exercising their appraisal rights, and freezeout the minority by those in control at
unfairly low prices
ii. Weinberger: said court can use any valuation mechanism to determine appraisal value
iii. DGCL §262(h):
1. Generally: Mandates the determination of “fair” value based on all relevant factors that
would fix the value of the corporation before the merge
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 2. not speculative elements: speculative elements of value may be excluded from analysis
(like projections of speculative variety relating to completion of merger)
3. doesn’t include gains from merger: does not include any element of value arising from
the expected merger
e. HYPOS
i. Survivor is in a stock-for-stock transaction w/ Target (T transferring stock to S, S
transferring stock to T)
1. Stock-for-stock merger: Survivor company issues new stock to give to T shareholders,
and T shareholders give up their stock and give it to S. S SH remains untouched, their
issues are not given away, so they don’t receive anything in merger.
2. Survivor: 50,000 shareholders, listed in NYSE; Survivor SH not receiving anything in the
merger
a. Survivor SH not receiving anything in this stock-for-stock merger bc Survivor is the
surviving corp; while T gives up all of its stock to S, and S gives T SH stocks of S, the
stocks it gives are new stocks that it issued for the merger—it is not giving up its
own SHs’ stock, they still have it. Therefore they get nothing in merger, they have
their S stock.
b. First prong: Survivor has 50,000 SH, so over 2,000 mark and listed on NYSE, NOT
non-public SH
c. Second prong: Survivor SH are NOT receiving anything in merger
d. Survivor SH do not get appraisal rights bc don’t meet either prong
3. Target: 1,500 Shareholders, and is receiving Survivor stock
a. First prong: T has 1,500 SH and not listed on NYSE, so not public
b. Second prong: T SH are receiving shares of Survivor in merger
c. Will get appraisal rights bc meet first prong (not public)
ii. Stock-for-Stock Merger bw ATT and Time Warner:
1. ATT will transfer TW shareholders ATT stock + $53/share. In return, TW shareholders
transfer all of their stock to ATT.
2. Survivor: ATT: not non-public, ATT SH not required to receive anything in this merger 
No appraisal rights bc don’t meet either prong
a. ATT makes extra shares to give to TW SH, so ATT SH not affected, don’t receive
anything for their shares since they keep them
3. Target: TW: >2,000 SH and listed on NYSE so not non-public, but get $53 w/ each
share get appraisal rights
a. If they have no choice but to take something other than the survivor ATT stock, in
this case the cash that comes w/ each share in exchange for TW shares, they get
appraisal rights.
b. If consideration of merger includes anything other than survivor stock
(cash, bonds, debt, either by itself or included w/ the stock)  appraisal
rights)
4. Will Shell get appraisal rights?
a. Technically yes, bc it only has one shareholder and is not a public company
5. What if instead of getting $53/share Target SH would get Facebook stock with the ATT
stock? Then they wouldn’t get appraisal rights bc they are getting stock of other publicly
held corp
6. ATT-TW merger procedure: Triangle Merger
a. ATT creates shell corporation, takes all of the shell corp’s stock, in return for this
stock it gives it ATT stock to be used for purpose of merger. Shell corp transfers
this ATT stock to TW shareholders, and in return, TW gives its stock to the shell
corp
b. Here, TW is technically not receiving Survivor stock bc shell is the survivor
c. This is why 262(b) treats shell stock in a triangular merger the same as a straight
merger
D. Freezeouts
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1. Background:
a. Cashout/Freezeout Mergers: controlling SH can impose a merger against the will of a disagreeing
minority by giving them cash or non-voting securities for their shares
b. Shortform Mergers (PG 81): DGCL §253: when a parent corp owns 90% or more of a subsidiary,
subsidiary can be merged into parents w/o approval by shareholders in either party
i. Usually starts w/ a tender offer: public, open offer by a prospective acquirer to all
stockholders of public corp (target) to sell their stock to acquirer at specific price during
specific time. This is how acquirer can get 90% control. Then goes to short form merger
ii. SH don’t have to vote on the merger, only requires parent BoD approval
iii. Minority SH of subsidiary that don’t give in to the tender offer are cashed out
c. Williams Act of 1968: Amends 1934 Securities & Exchange Act
i. TOs gave SHs 24-48 hours to decide whether they wanted to sell their stock w/o providing
info about identify or plans of offeror, Williams Act changed this
ii. TO has to be held open for 20 days
iii. If gets amended, stays open for 10 more days
iv. Must be available on same terms for everyone who tenders (can’t treat stockholders
differently based on how much stock they have when they tender)
v. Rule 13e-3: requires a lot of specified disclosure whenever a controller seeks to tender for the
shares of its controlled company
d. History:
i. 1970s: concern was that minority SH are getting ripped off
ii. Singer: required “business purpose” for freezeouts  undone by Weinberger: Once P alleges
and shows that transaction was between the controller and the company, D has burden to
establish that transaction was fair (i.e. process and terms of deal are entirely fair to
corporation).
2. Problem before M&F: Divergent Tests w/ different levels of scrutiny
a. Two different levels of scrutiny for one-step mergers and two-step mergers
b. Freezeout §251 long form merger (cashing out minority SHs for 100% in control) EF standard
(bc conflict of interest)
c. Tender Offer+ §253 short form merger (as long as SH has 90% control after TO) Deferential,
lax scrutiny
i. Tender Offer: unless coercive or there is disclosure problem, low scrutiny bc TO is offer
directly to SHs of Target, and its just SHs making a decision whether they want to sell stock
ii. §253 merger: upheld unless major disclosure/fraud involved; point is to be simple as
possible; doesn’t require SH votes of either party, just approval of parents corp’s BoD;
d. Made more sense for controlling SH to do two-step mergers bc less scrutiny
e. Judges realized it didn’t make sense to have 2 different levels of scrutiny based on
transaction type and DE eventually merged
f. Why BJR: these are duty of loyalty cases, and while traditionally wouldn’t be able to get out of EF
scrutiny on case w/ conflict of interest, this would otherwise cause Chancery Court judges to make
valuations on the mergers and they don’t like doing this—its messy and complicated, which is why
they switched to BJR.

Standard of Review for Freezeouts after M&F

1. Step 0: Is there a controlling SH acting to kick out minority SHs?
a. NO: this is straight one-step case or stock merger bc firms w/ no shared ownership interest,
and complaints are about price  appraisal remedy
b. YES:
i. Controlling SH owns 50%+ stake  controlling SH
ii. Controlling SH owns <50% stake  must show domination through actual control of
corporate conduct
1. Lynch: Alacatel’s 26% control considered a controlling stake under test bc
dominated corp affairs

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2. If Controlling SH is going to do Tender Offer + §253 short-form OR long-form freeze-out
merger
a. Tender Offer:
i. Is it legal?
1. Stays open for 20 days, + 10 if material changes
2. Open to all SH
3. Can’t discriminate bc SHs; all who tender have right to sell their shares
ii. SH Rights:
1. Target board has no role, no SH voting
2. If SH don’t like price, don’t have to tender
iii. Coercion/Disclosure Problem?
1. Coercion: (Pure Resources) if not met will be enjoined
a. Controlling SH must commit to no tender unless non-waivable MoM of
SHs tender into the offer
b. Controllig SH must commit in advance that they are going to promptly
do a short-form merger at the same price (must tell SHs if you don’t
tender you’ll get frozen out but at same price)
c. Cannot make threats to force SHs to accept
i. Can’t give SHs only weekend to decide to tender or not
ii. Bidder can’t say I’ll do TO at $50/share and if you don’t tender
and I get a majority I’m going to cash you out at $35/share/d-
list your shares (make them worth less and harder to trade)
2. Disclosure: must be full disclosure of TO details
b. Freezeout Merger - short or long-form
i. Standard of review: EF w/ burden on D to prove EF
ii. However, standard changes if there is 
1. Effective Special Committee. Must:
a. Recommend the transaction
b. Be independent
c. Be empowered to freely select its own advisors and to say no
definitively
i. Committee retains outside investment bankers and lawyers to
advise
d. Meets its duty of care in negotiating a fair price (able to negotiate for
best available and fair deal)
i. CNX: not given enough real power bc wasn’t authorized to seek
alternatives
ii. Doesn’t exist when subsidiary acting due to fear of hostile bid
(Lynch)
iii. M&F told committee they wouldn’t agree to any other deals,
which is acceptable. Even if SC couldn’t solicit alternative bids,
they sought advice about strategic alternatives, including
values of parent would be willing to sell (M&F)
2. Majority of Minority Vote?
a. must be informed
b. can’t be coercion
3. if there are both committee and MoM BJR (short-form – CNX; long-form – MFW)
4. if there is either committee or MoM EF remains but BoP shifts from D to P to disprove
a. Weinberger EF standard pg 63
5. if neither  EF w/ BoP on D
a. Weinberger EF Standard pg 63

Kahn v. Lynch Communications Systems

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Controlling SH proposes longform freezeout of minority SH
Facts:
a) CGE  100% Alcatel  43.3% Lynch Communications
b) 5/11 of Lynch directors are Alcatel’s designees
c) Lynch charter requires an 80% SH vote for any business combination, Alcatel has veto power
d) Lynch wanted to merger w/ TelCo and Alcatel opposes it and instead proposes a freeze-out merger
(cash-for-stock merger where Lynch SHs will receive cash for their stock). Alcatel proposes price of
$14/share.
e) Lynch sets up an independent special committee to deal with the proposed freeze-out merger, they
decided price is too low and began negotiations. Alcatel raised its offer to $15.50/share; indicates that
it will proceed with an unfriendly tender offer at a lower price if Lynch rejects. The committee
approves the sale at $15.50/share.
Issue: independent special committee of directors still has to meet EF standard; what are the reqs?
Holding: negotiating committee didn’t engage in arms-length bargaining.
Rule: EF standard bc there is conflict of interest. If there is independent committee or MoM, BoP shifts to P to
show there was no EF.
a) STEP 1: Demonstrate “controlling shareholder” status
i) Purpose: SH only owes a fiduciary duty if it owns a majority interest in or exercises control over
the business affairs of the corporation
ii) OPTION 1: Controlling shareholder/parent owns 50%+ stake  controlling SH
iii) OPTION 2: Controlling shareholder/parent owns < 50% stake:
(1) Must also show domination through actual control of corporate conduct (As low as 26%
control has been considered a controlling stake) – know it when you see it
(2)  found that Alcatel controlled Lynch’s business affairs; dominated its corp. affairs
b) STEP 2: Initial burden [STEPS 2-3 OUTDATED AFTER M&F!]
i) EF standard of review for cash-out merger transaction by a controlling shareholder bc there is
self-dealing (NOT BJR).
(1) See Weinberger for elements of entire fairness: (1) Fair Dealing (process), (2) Fair Price
(substance – price)
ii) The initial burden of establishing EF is on the party that stands on both sides of the transaction.
c) STEP 3: Shifting burden:
i) Shifting burden: if an independent committee OR informed MoM approves merger, BoP shifts
from controlling SH proving EF, to challengers disproving EF. Required Factors
ii) (1) Majority shareholder must not dictate the terms of the merger; (2) Special committee must
have real bargaining power that it can exercise with the majority shareholder on an arm’s length
basis.
iii) CAUTION: Having an effective special committee only shifts burden, NOT a different standard of
review (i.e., NOT BJR).
Rationale:
a) Court concluded that Alcatel was controlling shareholder: Even though Alcatel owned < 50% stock,
court concluded that it was a controlling shareholder based upon how Alcatel had influenced
decisions in the past and dominated Lynch’s corporate affairs.
b) A controlling shareholder standing on both sides of a transaction, as in a parent-subsidiary
context, bears the burden of proving entire fairness.
i) Weinberger said that use of an independent negotiating committee could demonstrate “fairness.”
Thus, the Court analyzed whether there was arms-length bargaining by the independent
committee, and found it was not “independent”:
(1) Committee could not sell to anyone else since Alcatel had veto power b/c of the supermajority
requirement.
(2) Alcatel’s threat to Lynch Independent Committee to take the $15.50/share offer or face a
hostile low tender offer was an ultimatum that ended any semblance of the arms-length
bargain.
Skeel:

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 Why use a special committee?  If the SC is independent, will shift the burden of proof on fairness from
directors to Ps.
 After M&F: can say no alternative transactions allowed but can’t improperly influence special committee
(can’t threaten to do a TO if special committee doesn’t accept offer)
 Arg that BoP should have been shifted:
o Committee drove proposed share price up, rejected several offers, renegotiated price 3 times. They
did their job; effective and tough special committee.
 But wasn’t shifted bc committee surrendered – there were limits to how much leverage it had. Alcatel
threatened freezeout whether committee liked it or not.

In Re CNX Gas Corporation

Point: builds off of Cox to move freezeout standard of review closer together
Context: at time of case, no judicial review bc TO direct to SH and §253 deigned to be low hassle
Facts:
a) Consol  87% CNX. Consol wants to eliminate the minority SHs through a two-step transaction: (1)
tender offer and (2) § 253 merger.
b) Before the TO, Consol negotiates w/ T. Rowe Price, a significant CNX and Consol minority
shareholder, to make sure they are on board with the tender offer.
c) Protections that accompanied the tender offer: MoM requirement; special committee review of tender
offer.
Issue: TO gets challenged
Holding: TO doesn’t get BJR protection—directors have burden to show fairness
Rule: Entire Fairness, not BJR
a) Cox Communications (when BJR applies to a two-step freezeout merger):
i) BJR applies to a two-step merger if only if:
(1) Merger is negotiated and recommended by an effective special committee of independent
directors AND
(2) Merger is conditioned on an affirmative tender of a majority of the minority stockholders
(MOM)
ii) Otherwise, entire fairness standard applies.
Reasoning:
a) Tender offer: not coercive under a Pure Resources, so it could go forward; but
b) §253 merger: Applies fairness standard bc both protections are in place but neither are effective
i) Special Committee: Court not persuaded that special committee was effective because:
(1) It was a 1 member special committee, wasn’t even sure what he could do
(2) Did not have authority comparable to what a board would possess in a third-party transaction
(a) Could only to review and evaluate the TO, to prepare a Schedule 14D-9, and to engage
legal and financial advisors for those purposes.
(b) Could not consider alternatives.
(3) Didn’t even take a position on merger (not recommending sufficient to get to fairness)
ii) MOM: Court also skeptical of MOM requirement because T. Rowe Price was going to be counted in
that majority of the minority and arguably had a conflict of interest (not independent because also
held Consol stock)
Skeel:
 Case clarification:
o Court is implying that its crazy that 1-step and 2-step mergers have different standards
o If corp has both protections in place (committee and MoM) and they are effectiveBJR.
o Corp has only 1 protection in place and it is effective  EF, but burden shifts from corp to P to show
there is no EF
 Scrutiny for TO + §253 starts w/ the TO  if there is coercion or a disclosure problem ct stops the TO, if
there is neither of these, court allows TO to continue even if it seems there could be a fairness issue, bc
253 gets fairness review

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 o Here ct said, you can do a TO and §253 but if you go through we will scrutinize it for fairness and if we
determine its unfair, you will have to have damages
 Why is there a two-step transaction, why not go straight to the merger? Bc before M&F it was
possible to get a more generous standard of review
o Straight merger: standard would have been EF. Best case scenario is that ISC or MoM will shift
burden for EF to P
o Two-step merger: possible to get BJR
 There is no fiduciary duty claim available on §253 merger
 BJR applies if:
 TO passes: not coercive + no disclosure problems; AND
 Merger approved by MoM and ISC
 This is Chancery Court opinion, and this standard for two-step mergers not repeated in M&F (DE
SC) so not exactly binding authority but is generally followed.

M&F World Wide

Point: changes standard of review for longform merger
Facts: Minority SH in subsidiary acquired by controlling SH in a going-private merger sought post-closing
relief against controlling SH and subsidiary’s directors based on breach of fiduciary duty
Rule: New standard for longform mergers: BJR as long as
 Effective Special Committee, which must be:
o Independent;
o Empowered to freely select is own advisors and to say no definitively
o Meets its duty of care in negotiating a fair price
 AND Effective MoM requirement, which must be
o Informed
o No coercion
 If only one (special committee OR MoM then EF standard  Kahn burden shifting; BoP on P to disprove
EF
 If neither exists, EF standard w/ BoP on D
Skeel:
 Court determined that corp had both so got BJR, but fn 14 said case wouldn’t have survived Motion to
Dismiss bc enough doubts about special committee and MoM vote. Practitioners have picked up on that
bc BJR not dispositive.
 Debatable set of protections: special committee had no other bidders, didn’t negotiate price; one could
plausibly conclude that it was not an effective special committee
 This is a straight freezeout case: the SH of MFW get cash for their shares, the controlling shares are
cancelled and the survivor company continues to run controlled company as wholly-owned subsidiary

VII. INSIDER TRADING

A. Securities Exchange Act §10b and Rule 10b-5 Generally

1. Insider Trading Generally: when corporate insider trades (buys or sells) shares of his corporation
using material, non-public/non-disclosed information obtained through the insider’s corporate position.
a. if he knows good news: can profit by buying stock from shareholders before the price rises from
the favorable public disclosure (and that way he can re-sell it and make money)
b. if he knows bad news: can profit by selling to unknowing investors before the price falls from
unfavorable disclosure (and that way he makes money from the stock before it falls)
2. Mis-disclosure: Misstatement made by someone representing the corporation, which allegedly harms
shareholders and they sue to recover that harm
3. Securities Exchange Act §10b: general anti-fraud provision; prohibits insider trading, mis-disclosure,
and fraud.

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 Exchange Act §10(b): [It shall be unlawful]
(b): To use or employ, in connection with the purchase or sale of any security registered on a national
securities exchange or any security not so registered [stock of public/non-public firms], any manipulative
or deceptive device or contrivance in contravention of such rules and regulations as the Commission may
proscribe as necessary or appropriate in the public interest or for the protection of investors.

Using its authority to promulgate rules that prohibit manipulative or deceptive devices in connection w/
purchase of any security…SEC created Rule 10b-5

4. Rule 10b-5: main anti-fraud provision in securities laws

Rule 10(b)-5: It shall be unlawful for any person, directly or indirectly in connection with the purchase or
sale of any security…
(a) To employ any device, scheme, or artifice to defraud [Insider trading]
(b) To make any untrue statement of a material fact or omit to state a material fact necessary in order to
make the statements made, in the light of the circumstances in which they were made, not misleading, or
[Material representation]
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or
deceit upon any person, in connection with the purchase or sale of any security.
Private right of action under 10(b)-5
Applies to ALL FIRMS, not just publicly traded firms (differs from 14a-9 in this respect)

5. Background:
a. 10b-5 is the most important anti-fraud provision in 1934 SEA. Mostly shaped by caselaw
i. note that courts have interpreted the enabling statute 10b and “manipulative or deceptive
device or contrivance” as being narrower than the rule; statute controls, and phrasing of the
rule’s prohibitions has become largely irrelevant
ii. 1st big development: private SH got right to invoke it
iii. 2nd big development: amendment of FRCP—expansion of class action rule 23(i)
b. Most common causes of action under 10b-5 are insider trading and mis-disclosure
c. SEC (insider trading) vs. Private P (mis-disclosure):
i. Almost all insider trading claims brought by SEC
1. Insider trading damages are usually disgorgement of financial benefits
2. If claim brought derivatively, it would go to firm
3. If claim brought individually, individual gets pro rata share of the amount of disgorged
proceeds, which is small
ii. Most mis-disclosure is brought by private attorneys
1. Mis-disclosure damages could be enormous and thus justify higher attorney’s fees
d. Criminal v. Civil: Criminal uncommon until 2000s
i. Chiarella brought criminally - uncommon even after Chiarella until 200s
ii. Now, must more common to bring criminal either in addition to or alternative to civil litigation
e. SEC finds out about insider trading through anonymous tipsters, monitoring trades, especially
around big-ticket events
i. Look for people who don’t usually trade that are suddenly trading
ii. Look for interestingly timed trades, like people buying a bunch of stock in 2 weeks before
something big is announced
B. 10b-5 Elements
1. 1) False or misleading statement 2) of material fact 3) made with intent to deceive another 4)
upon which that person reasonably relies 5) and that reliance causes harm
2. False or Misleading Statement of Omission:
a. TX Gulf Sulfur: Ds traded on nonpublic information about a mineral strike that would have impacted
price of stock and understated/denied that information to press  misleading
3. Of Material Fact:
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 a. Duty arises if there is a reasonable likelihood that SH would care about the information
b. Basic v. Levinson: no magic point in time for when trading violates 10b-5; depends on when
information becomes material
c. Skeel: if considering multiple TOs, might be the time when board identifies the target corp
4. Made with Intent to Deceive Another:
a. Scienter: recklessness or knowingness – D knew or was reckless in not knowing the true state of
affairs and recognized that the P might rely on the misinformation
5. Upon which that Person (P) Reasonably Relies
6. and that Reliance Causes Harm

SEC v. TX Gulf Sulfur

Facts: Corp found a mineral strike and tried to keep it secret. As rumors circulated of the strike they made a
press release on April 13 severely underplaying the findings, and disclosed the discovery on April 16. In
between the press release and the disclosure, Ds (insiders) bought stock and options.
Issue: did the failure to adequately disclose the mineral strike violate 10b-5?
Holding: All the transactions in the TGS stock violated 10b-5 bc the insiders traded on material nonpublic
information
Rule: An insider possessing material information must either disclose that information to the investing public
before trading or must abstain from trading or recommending while such information remains undisclosed.
Materiality depends on a balancing of:
 the probability the event will occur
 the anticipated magnitude of the event in the totality of the company activity; and
 the importance attached to the information by those who knew about it
Rationale:
a) The strike was “material” within 10b-5: In this case, the probability that the strike would occur was
“more than marginal” and the existence of a mine of such a “vast magnitude” would have impacted the
price of the stock. Also, the timing of the insiders’ stock purchases led the court to infer that they were
influenced by the drilling results.
b) Expansion of the definition of “materiality” will not detriment the market for corporate managers:
There are adequate incentives from stock options and employee purchase plans.
Skeel:
 This is first insider trading case
 One of the directors, Coates, went to the press release disclosing the strike information and immediately
called his broker son-in-law to buy stocks. What is argument that he hasn’t violated the law?
o Its technically public information—there was a press release disclosing information, and its only
illegal if its material non-public information
o Problem w/ this argument: its not really public at this point; the dissemination process has just
started and didn’t have time to get out into the market yet – so he traded at a time when info wasn’t
truly public
o Today, with all the fast technology, it would be fine, but in 1968, would need a few hours to reach
public

Santa Fe Industries v. Green

Facts: Minority SHs of a DE corporation were frozen out in a short form merger and offered $150 cash for
their shares (the physical assets were appraised at $640 per share). Minority SHs sued.
a) They argued that a remedy existed under 10b-5 because there was a fraud resulting from gross
undervaluation or breach of fiduciary duty in treating the minority unfairly by merging with no
business purpose and without prior notice.
b) This was alleged to be a violation of 10b-5 because defendants employed a “device, scheme, or artifice
to defraud.”
Issue: can a shareholder bring a 10b-5 claim for regular breach of fiduciary duties?
Holding: the transaction was neither deceptive nor manipulative so can’t violate 10b or 10b-5

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 Rule: 1) 10b (and therefore 10b-5) not meant to prohibit conduct not involving manipulation or deception;
2) 10b-5 not meant to cover ordinary state law breach of fiduciary duty claim—this is state law
responsibility.
Rationale:
a) No fraud: There was no lack of disclosure by the control group. There was also no prior notice
requirement for short form mergers under DE law and thus no deception.
b) No Manipulation:
(1) “Manipulation”: intent to artificially affecting market activity in order to mislead investors.
(2) Term does not capture corporate mismanagement that essentially falls under breach of
fiduciary duty.
c) Private right of action: Congress didn’t intend to create private right of action under 10b-5 for action
that is traditionally relegated to state law “The result would be to bring within the Rule a wide
variety of corporate conduct traditionally left to state regulation.”
Skeel:
 SC was trying to dial back securities fraud litigation. Their concern was that if 10b-5 is construed so
broadly that any bad behavior can be classified as fraud, 10b-5 would swallow state fiduciary duty law—
ordinary fiduciary duty suits would be characterized as 10b-5 claims. But corporate conduct traditionally
left to state regulation.
 If case is regular breach of fiduciary duty, it is not a 10b-5 federal claim, but under state law fiduciary
duty.
 Loopholes: if what looks like breach of duty can be construed as 10b-5 cause of action, it can be brought
under 10b-5. There must be decepit/manipulation, or SC will screen it out under Santa Fe.

C. Mis-disclosure:
1. 10b-5 is can also be used to bring fraud on the market claims, almost always brought as class actions
2. fraud on the market: occurs when false/ misleading, but credible and material, information enters the
market, distorts share prices, causing harm to shareholders
3. Requires a showing that P’s reliance on a material misstatement caused him economic harm
a. Reliance must show loss causation: that P’s economic harm was caused specifically by his reliance
on the misstatement
b. Misstatement must be material: there is substantial likelihood that a reasonable SH would care
about the information
c. Economic loss: P lost money after the misstatement
d. Scienter: reckless or knowing (court hasn’t defined); D knew/should have known P would rely
4. Under 10b-5, rebuttable presumption of reliance on the market: (Basic) If a market is efficient,
market prices reflect all publicly available information about a company’s stock. A corp’s material
misinformation distorts market price. Those who trade rely on the integrity of a stock’s market price.
Even if a SH didn’t rely directly on a corp’s misstatement, he relied on the market and this reliance
caused him to make a decision to buy/sell which harmed him economically, bc market was distorted
from corp’s misstatement.
a. Presumption that SH was harmed bc he was relying on patterns of an efficient market that was
distorted due to D’s misstatement; don’t have to show direct reliance on specific statement
b. Reason for presumption: showing actual reliance on misstatement is very hard: if actual reliance on
misstatement was required, it would be impossible to certify a class action bc people rely in
different ways (wouldn’t be able to show common question of law and fact), so less people would be
able to bring a claim. With a presumption, Ps are all automatically similarly situated.
i. if class doesn’t get certified, the case goes away
c. How does market w/ millions of traders reflect all info about stock?
i. The trading of knowledgeable and informed traders drives the market price bc they all point in
the same direction at the same time (like know when to buy undervalued stock, and know
when to sell overvalued stock), while the uninformed traders wash out
5. to get presumption: P must show stock was traded on efficient market and that P traded bw
announcement and truth disclosure

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 6. To rebut presumption, must show (Halliburton):
a. Stock not traded on an efficient market; or
b. SH did not actively trade stock; or
c. SH would have traded anyway even had he known about the fraud (had no choice but to trade)
d. Skeel: if company lies to you but you don’t end buy buying/selling stock, you don’t have a cause of
action
7. Can disprove loss causation before price certification stage: D can rebut presumption if can show that
price of stock wasn’t actually affected by the misstatement, and that something else affected it like an
election, change in oil prices, etc. (Halliburton)

Basic, Inc. v. Levinson

Facts: Basic and Combustion Engineering negotiated terms for a merger for 2 years, and during this time,
Basic made 3 public statements denying that it was having merger negotiations or knew of any corporate
developments that explain the large volume of market trading of its stock. Then it finally announced that it
was merging. Ps were investors who sold Basic shares between the company’s first untrue denial and final
merger announcement.
Holding: Ps are entitled to rebuttable presumption of reliance on the market
Rule:
 Materiality standard: fact is material if there is a substantial likelihood that a reasonable SH would
consider it important in deciding whether to buy or sell. Must make a case-by-case determination about
whether the information is material, can’t adopt a per-se rule.
o the probability the event will occur
o the anticipated magnitude of the event in the totality of the company activity; and
o the importance attached to the information by those who knew about it
 Reliance: Rebuttable presumption of reliance based on Fraud on the Market
o Ps in a FOM class action have a rebuttable presumption of relying on the informational integrity of
market prices instead of traditional requirement that they demonstrate direct reliance on D’s
misstatement.
o Rebuttable: any showing that severs the link bw the alleged misrepresentation and either the stock
price or SH’s decision to trade can rebut the presumption
Skeel:
 Materiality standard before Basic: there were several standards
o One standard: information is not material until there is a formal agreement in place.
 Could be a good idea bc if corps needed to disclose this information before the agreement, stock
prices might go up, and that might destabilize the merger. Also could encourage deal jumping—if
market knows Basic is willing to do a merger, would encourage other companies to try to take it
over, who they don’t want to be taken over by.
o SC rejects this: can’t adopt per se rules of materiality – case by case analysis by balancing factors
 Why couldn’t Basic directors just have said no comment?
o That means yes to the market
 Whether to allow directors to lie or not
o if they are allowed to lie, no one will trust them about anything which is inconsistent w/ goal of
having an open and honest securities market
 irony in basic: justice who wrote Basic was the justice you would least likely to expect to adopt efficient
market theory but he did bc he wanted robust enforcement mechanism w/ 10b-5

Erica P. John Fund, Inc. v. Halliburton, Co.

Facts: Halliburton allegedly misrepresented the scope of asbestos liability it had, its construction revenue,
and the benefits of a merger it had engaged in
Issue: Whether Fraud on the Market presumption is still legitimate basis for pursuing securities fraud action
Holding: FOM theory survives.
 Adds: D can rebut presumption at class certification by proving that the alleged misstatement did not
actually affect the market price of the stock
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 Skeel:
 why was Halliburton expected to be overturned?
o People began arguing that the market isn’t efficient
o General distaste about mis-disclosure securities class action -- idea that they take money from one
group of SH and give it to another group of SH

D. Insider Trading & Misappropriation

1. Bringing Insider Trading & Misappropriation cases:

a. insider trading: punishment is a disgorgement of ill-gotten gains, which are usually pretty small,
and SH’s loss is also small so its not worth it for a private P to bring insider trading claim, which is
why SEC brings it. If private P brings insider trading case, its usually just one case of action in long
complaint.
b. Misappropriation: harm is a lot bigger, so worth it for private P to bring it.
2. Insider Trading vs. Misappropriation
a. Insider trading: corporate insider trades shares of his corporation using material, nonpublic
information obtained through the insider’s corporate position – he violates his fiduciary duty to his
corporation
b. Misappropriation: insider misappropriates his company’s material nonpublic information by
trading other companies’ stock (misappropriates confidential info received as result of working
there)– he violates his fiduciary duty to his corporation by not disclosing his intentions and
therefore deceives; deception required; if tells plan, not misappropriation

Insider Trading Checklist

1. Step 0: Need these before testing for liability:
a. Sale or purchase of securities
b. Dealing w/ material information
c. Santa Fe: must involve deceit or manipulation; CAN’T be ordinary fiduciary duty claim
2. Step 1: Insider/Tipper Duty: Did the insider have duty?
a. Classic: corporate insider has fiduciary duty to firm whose stock he trades to not trade on
firm’s confidential info
i. Texas Gulf: directors of corp trade on insider info after mis-disclosing info to public
about mineral strike
ii. Chiarella: printing service used by Bidder had no duty to Target (not insider trading)
iii. Dirks: temporary insiders owe duty to corp they’re doing work for if corp expects
outside to keep info confidential
1. Can be established through regular access to confidential info: Ibankers,
Accountants, lawyers, consultants
b. Misappropriation: corporate insider has fiduciary duty to his source of confidential info not
to misappropriate it by trading on that info
i. No breach if misappropriator tells source of confidential info that he is planning
on trading on the info bc then there is no deception
ii. O’Hagan: partner at law firm has duty not to trade on his firm’s info
iii. 10b-5(1): fiduciary duty for borderline cases
1. whenever person agrees not to tell confidential information
2. if people have a history, pattern or practice of sharing confidences among two
people and trade on that relationship, such that receipt of info knows or
should know communicator expects info to stay confidential
3. when a person receives nonpublic info from spouse, child, parent, or sibling
(w/ rebuttable presumption) the person can’t use that info unless can show
that there was no duty of trust or confidence wrt the information

IF D HAD EITHER DUTY STEP 2

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 3. Step 2: Insider/Tipper: Expect Personal Gain: did the insider disclose the information bc he
expected a direct/indirect benefit or gift? VERY LOW HURDLE; never really an issue to pass this
a. Benefits Include:
i. Financial gain
ii. Intangible (like reputation at country club)
iii. Gift or confidential info to a trading relative or friend
iv. Dirks: Secrist did not have an expectation of benefit, just trying to reveal fraud

If YES BREACH; TIPPER IS LIABLE STEP 3 TO SEE IF TIPPEE IS LIABLE (it is possible for tipper
but not tippee to be liable)

4. Step 4: Tippee Breach of Duty: Tipper (insider) has breached duty by disclosing info to the Tippee
AND Tippee knows or should have known that Tipper breached his duty (so knows Tipper expected
benefit)
a. IF YES TIPPEE IS LIABILE
b. Dirks: as tippee, not liable, bc Tipper (Secrist) was not liable
c. Chain of Liability: once Tippee is liable, he assumes role of tipper, and inherits Tipper1’s
fiduciary duty, and the chain continues w/ anyone the Tippee tipped off
i. Dirks: if Dirks was liable, he would become the Tipper, would inherit fiduciary duty to
EF from Secrist, institutions he tipped would become the Tippees and if they
knew/should have known Dirks breached, they would be liable as tippees, etc.

14e-3 Checklist
*Only applies to Tender Offers: Prohibits trading by those with insider information about a tender offer
14e-3 Liability: Special Rues for Tender Offers:
1. If a person has at least taken substantial steps to begin a tender offer, it shall constitute a fraudulent,
deceptive, or manipulative act or practice for:
a. Anyone in possession of material information relating to that offer to:
b. Buy or sell any of the Target’s securities
c. If the person known or had reason to know that the information was non-public; and
d. Has been acquired directly or indirectly from the Bidder, Target, or anyone acting on one of
their behalf
2. Note:
a. No manipulation or deception requirement
b. No duty requirement - no need to show a breach of fiduciary duty for personal benefit
c. Much broader than 10b-5 but limited to TOs
d. Can only eliminate liability if D makes a public disclosure to all potential sellers

Chiarella v. US
Point: Classical 10b-5 violation (Fiduciary Duty Breach); Chiarella gets off bc he doesn’t owe duty to corp
whose stock he buys or sells
Facts: Chiarella was an employee of Pandick Press. Pandick hired by Bidder to do printing for its merger w/
Target. To keep printing corp from figuring out who the Target of merger was before merger’s
announcement, corp inserted blanks into documents, but Chiarella figured it out and bought target’s stock on
this insider info. Made $30k profit.
Issue: Does printer who learns TO details from confidential docs of the Bidder corp that employs him violate
§10b if he fails to disclose impending takeover before buying Target stock?
Holding: No, a duty to disclose under §10b doesn’t arise from the mere possession of nonpublic market
information. Chiarella didn’t have a fiduciary duty to the Target SH.
Rule: Classical Chiarella Duty: a duty to disclose in a securities transaction arises when D has a fiduciary
relationship; if D doesn’t have a fiduciary duty to the firm whose stock is being bought or sold, no liability
Rationale:

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 a) Rejects equal access theory: no duty to whole marketplace from mere possession of nonpublic market
info
b) When does duty to disclose arises: Fiduciary relationship/ similar relationship of trust and
confidence
c) When liability for non-disclosure arises: when D has a fiduciary duty to the corp whose stock is being
bought or sold
d) Application to Chiarella: not guilty of insider trading bc didn’t owe a duty to Target (firm whose stock
was being bought/sold)
i. Chiarella had a duty to Pandick, corp of which he was an insider for which he worked, but he
did not have duty to Target, corp whose shares were bought/sold.
ii. Only a violation if insider violated duty to corp whose stock was traded bc illegal to do
manipulative activity in connection to purchase or sale of stock – no connection if not trading
stock of corp who you’re defrauding
Skeel:
 If C owed duties to Target, he’d be on the hook—if he owed duties to Bidder, still not liable bc wrong
person
o Has to be “in connection w/ purchase or sale of a security” – even if this is deceptive/manipulative
practice, wasn’t in connection w/ purchase or sale of security since fraud is related to Bidder
 Having information doesn’t trigger unless there is violation of fiduciary duty. Arises if:
o Ordinary insiders: mangers, directors, shareholders?
o Tipees: people tipped by mangers
o Temporary insiders: bidders’ lawyers, bankers

Dirks v. SEC
Facts: Dirks was securities analyst whose job was to follow insurance industry. Equity Funding Corp’s
business involved selling clients life insurance and mutual fund shares. EF sold fictitious policies. Dirks
received tip from former EF officer, Secrist, that EF was committing fraud. Dirks advised his firm’s clients to
sell off their EF shares, which they did before the scandal became public.
Issue: can dirks incur 10b-5 liability as a tipee?
Holding: Dirks isn’t liable as a tippee bc his tipper (Secrist) didn’t breach his fiduciary duty (bc didn’t expect
benefit from his disclosure)
Rule:
 To be a Tipee and be liable:
o 1. Tipper must have breached his fiduciary duty
 Must have duty to the corp
 Must breach that duty by making a tip and expecting to receive a direct or indirect benefit from
that tip or give it as a gift
o 2. Tipee must know or reasonably should have known that Tipper breached
Rationale:
 Secritist didn’t breach his duty:
o Duty: he had a duty to the corp bc he was manager of EF
o Breach: Secritist wasn’t trying to get a benefit from the tip or give a gift, he wanted to expose the
company’s fraud
Dissent: By exposing this fraud, Secritist is fulfilling his desire to see the corp punished so this is benefit
Skeel:
 Purchase or Sale Req: In these situations there must be a buy or sell: 10b-5 is in connection w/ a
purchase or sale – so if someone is liable as a tipper and tippee, they are liable only as long as the
purchase/sale req is met.
o If no one buys or sells a stock, a tippee can’t be liable
o Dirks doesn’t have to be the one buying or selling
o If institutions sells but doesn’t satisfy tippee req, doesn’t matter, Secritist and Dirks can still be liable
 Suppose Secritist did expect a benefit out of this, like being hired by Dirks. Would Dirks be liable?
o Probably yes, IF HE KNEW that tipper breached. If Dirks knew what was going on, he is liable.

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 If Dirks was liable, would the institutions that he tipped off be liable?
o Tipper-Tipee Liability Chain
 If Dirks is liable, he becomes a tipper and inherits duty to EF and institutions are tipees.
Institutions will therefore only be liable if they knew or should have known that Dirks was
violating a duty to EF.
 If chain is broken at any point, chain is done, and next person cannot be liable
 The further you get in the chain, the harder it is to prove that someone knew/should have known
that the tipper breached
 Liability doesn’t depend on what happens w/ someone after you in chain wrt their liability, but DOES
depend on whether someone anywhere in chain buys or sells.

Neuman
Background: it is very difficult to show that tippee is liable bc hard to prove that Tippee knew or should have
known that Tipper breached. Prosecutors came up with the Mosaic Theory: even if any individual piece of
info is not material, several pieces of info might form mosaic of info that is material. Neuman had a problem
w/ jury instructions.
a) Language: “To meet its burden, gov’t must prove beyond a reasonable doubt that ∆ knew that the
material nonpublic information had been disclosed by the insider in breach of a duty of trust and
confidence. The mere receipt of material nonpublic information by a ∆ and even trading on that
information is not sufficient. Must have known disclosed in violation of a duty.”
b) Problem: Instruction didn’t make clear that the tipper has only violated a duty if he expected a direct
or indirect personal benefit, so what tipee needs to have known or should have known was that tipper
was violating a duty, which requires expecting benefit. Instruction says tipee must have known that
information was originally disclosed by insider in violation of duty of confidentiality, but violating
duty of confidentiality not enough for insider trading liability.
c) This is a reversible error—this is why Nueman was reversed.
d) Didn’t connect that you give tip for benefit – to be liable, Tippee must know that Tipper breached
(as in exchanged info expecting direct/indirect benefit or gift)
 Martha Stewart Tippee note: in her case, gov couldn’t prove that she knew or should have known – gov
couldn’t get her on 10b-5, got her in a lie.

US v. O’Hagan
Facts: O’Hagan was a partner at Dorsey Law Firm, who was helping client Grand Met in preparation for TO
for target Pillsbury. O’Hagan had gambling debts and literally trolled hallways of firm listening for insider info
to trade on. He found out about the TO and bought Pillsbury shares and made 4.3 million from the
transaction.
Issue: is misappropriation an alternative theory for liability under 10b-5?
Held:
a) Affirms 10b-5 fraud charges against O’Hagan under misappropriation theory.
i) Violated his duty to his law firm to maintain the confidences of clients
ii) Non-disclosure of his knowledge to his firm and
iii) Purchase of a security using the inside information.
Rule:
a) Misappropriation theory: a person is liable under 10b-5 for misappropriation when he
misappropriates his confidential insider information by trading on it in a breach of a duty
owed to the source of the information. No duty to party whose stocks traded is required. Reqs:
i) Duty to the source of the information
(1) Rule 10b-5(1) defines misappropriation for borderline cases – a duty of trust or confidence
for misappropriation includes (but not limited to):
(a) Whenever person agrees not to tell confidential information
(b) If people have a history, pattern or practice of sharing confidences among two people and
trade on that relationship

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 (c) When a person receives material nonpublic information from spouse, child, parent or
sibling (with rebuttable presumption) – the person can’t use that information unless can
show that there was no duty of trust or confidence with respect to the information
ii) Breach:
(a) Non-disclosure of plan to trade to the information source; AND
(b) Consummation via purchase or sale of security.
Reasoning:
a) Why is misappropriation theory necessary? Why can’t we use insider-trading logic?
i) O’Hagan doesn’t have a formal fiduciary duty to the company whose stock is being bought or sold,
so like in Chiarella, he would get off.
ii) He only has an obligation to his firm, and to the Bidder (since his firm has an obligation to Bidder,
their client) so the only way to find him liable under 10b-5 is w/ misappropriation.
b) 10(b)-5
i) “Classical” theory of insider trading: §10(b) and §10(b)-5 are violated when a corporate insider
trades in the securities of his corporation on the basis of material, non-public information.
Chiarella.
(1) Relates to corporate insiders
(2) Qualifies as a “deceptive device”: Because fiduciary duty between corporate insiders and SHs
ii) Misappropriation theory: §10(b) and §10(b)-5 violated when D misappropriates confidential
information for securities trading, in breach of a duty owed to the source of the information.
(1) Relates to corporate outsiders
(2) Premises liability on the deception of the principal who entrusted him with access to
confidential information.
(3) Criminal 10(b)-5 liability can be predicated on a misappropriation theory.
(a) Carpenter v. United States: SCOTUS said undisclosed misappropriation of information
constitutes fraud through the CL rule – “the fraudulent appropriation to one’s own use of
the money or goods entrusted to one’s care by another.”
iii) Deception (required) within 10(b)-5:
(1) Deception accomplished when the appropriator uses the information to make a purchase or
sale.
(2) If the fiduciary discloses to the source that he plans to trade on non-public information,
there is no ‘deceptive device’ and thus no §10(b) violation, although the fiduciary-
turned-trader may remain liable under state law for breach of the duty of loyalty.
Skeel:
 What if O’Hagan tells his firm and the Bidder that he plans to buy Target stock and they don’t care?
o Misappropriation theory requires that you deceive the source of the information; if O’Hagan doesn’t
deceive the sources since he’s telling them he’s going to do it, he is not liabile under 10b5.
o What other way can O’Hagan be liabile if not 10b-5?  14e-3
 14e-3 Liability: If a person has at least taken substantial steps to begin TO, it’s fraudulent for
anyone in possession of material information relating to that offer to buy or sell any of the target’s
securities if the person knows or had reason to know that the information was non-public and has
been acquired directly or indirectly from the bidder, target or anyone acting on one of their
behalf.
o What arg can O’Hagan make against 14a-3 cause of action?
 Even though his behavior is w/in 14a-3, it wouldn’t be valid on these facts; it exceeds SEC’s rule
making powers bc section is an anti-fraud provision but O’Hagan didn’t commit fraud because he
told the sources of the info his plan to trade
 SEC did not exceed its authority in exacting 14e3
o OK to have a rule that is broader than fraud bc it is really hard to convict people – need bigger net
than necessary to catch fraud

3. HYPOS
a. Martha Stewart Case:

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 i. Implone  Broker  Stewart
ii. An insider of Implone tips Stewart’s broker, who tips Stewart.
iii. Stewart doesn’t know where the tip came from (broker’s aren’t obvious so likely said
something like “I’d seriously consider selling Implone stock if I were you”) so couldn’t be
found liable on 10b-5 grounds because didn’t know or should have known that the insider
breached his duty.
iv. Classical Case:
1. Tipper:
a. Does Implone insider have a duty to Implone?
b. When Implone insider tipped Broker, was he expecting a benefit?
c. If so, he is liable as a tipper
2. Tippee:
a. Did broker know or should he have known that Implone breached his duty?
Probably yes – if he trades, be becomes liable right away (bc there must be a trade)
and if he doesn’t but tells Stewart, he becomes the tipper to Stewart and inherits
Implone insider’s duty.
3. Finding Stewart Liable as Tippee2:
a. Was there a Tipper duty breach? Yes, Broker has duty to Implone that he inherited
from Implone insider.
b. Did Broker expect a direct/indirect benefit or give a gift? Yes (easy to satisfy)
c. Did Stewart know/should she have known that Broker was violating this duty?
This is where it gets tricky bc it is hard to show this so far down the chain – ct
couldn’t prove this
v. Misappropriation Case
1. Sometimes can be hard to find corp insider that breached their duty by tipping, so can
start w/ the second link in the chain Broker
2. Broker is violating his professional duty and his duty to his brokerage to not trade/tip on
confidential information – breached bc conveyed info to Stewart
3. Did he expect benefit? Yes
4. Did Stewart know / should she have known Broker violated a duty? – again hard to
prove
5. However, this is a difficult argument: broker duty is so widely violated, it wouldn’t be
taken seriously.
vi. Ultimately Stewart was charged for lying about something in the case
b. Taxi driver overhears a well-dressed passenger (clearly a corporate bigwig) describe how his
employer is about to get FDA approval for a blockbuster drug  taxi driver tells broker to buy 1,000
shares. Violation of 10b-5?
i. Classical: Likely not, b/c tipper (corporate bigwig) has not breached his fiduciary duty to his
company because he is not expecting a benefit, he’s just being careless (was overheard, so not
being intentional about this).
ii. Misappropriation: Tipper didn’t breach any duty. Did the taxi driver? Possibly, but it would
require the cab company having some sort of policy that cab drivers must keep passenger
information confidential. Shows how misappropriation theory really broadened 10b-5
liability—duty can come from anywhere. If this were a limo or private car, he would
probably have duty to corporate guy to keep info confidential
c. Country Club: New member at country club implies that stock of his company will go up. Old
member buys stock, stock makes $$. 10b-5 violation?
i. Yes, new member is an insider giving a tip to the new member, and expecting a benefit in the
form of more favorable treatment w/ the club.
e. Wall Street: Charlie Sheen is young upstart broker. His boss is = Gordon Gekho. CS trying to get into
big league & impress GG. CS’s father is union rep. for a regional airline. Sheen’s father tells him about
the settlement of a lawsuit with airline (just expressing how relieved he is for it to be over), and that
there will not be a strike, which is good for the company. CS tells GG about the settlement. GG asks

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 Sheen why he should believe him, and Sheen says his dad is the Union Rep. GG buys stock, makes
tons of money.
i. Two Tips: Father  Son  GG
a. Father as Tipper: union rep would have duty to keep information confidential to
his union (not to company whose stocks are being traded, so misappropriation).
While he did disclose this info, it is not at all plausible that he was attempting to tip
his son and for benefit/gift. So to find liability here, move to the next link CS
b. CS as Tipper: CS had a familial duty to his father (10b-5(1)). Presumption that
there is a familial duty of confidence and trust in a family, so unless the family
keeps no confidences, which they would have to prove, there is a duty to keep the
confident information and CS breached it. He clearly expected benefit form GG,
wanted to be in his good graces.
c. GG as Tippee: he knows that CS had a duty and breached it – he asked him
question to make clear that this was real info from a legitimate source

VIII. TAKEOVERS and CONTROL CONTESTS

A. Takeover Background
1. How Takeovers work:
a. If a corp fails to perform well, its stock prices fall, and cheap stock presents an opportunity to those
who believe they can manage better to try to takeover the company
b. Threat of takeover incentivizes managers to run the corp efficiently
2. Takeover wave in 1980’s bc:
a. Relaxation of anti-trust enforcement;
b. Deregulation; and
c. Rise of junk bonds
3. DE Takeover Cases:
a. Takeover cases don’t fit neatly w/in either traditional duty of care or duty of loyalty
b. Duty of Care: although it’s a business decision, it is not an ordinary business decision but one that
directors have a strong personal interest in bc if their corp is taken over they lose their position as
directors, so they have an incentive to prevent takeover
c. Duty of Loyalty: There is no direct conflict of interest, nor a self-dealing transaction where company
is transacting w/ director
d. So in 1980’s, DE created intermediate duties, or “takeover duties”
i. Built on two pillars of Unocal and Revlon; then put in current form in Time Warner and QVC
4. Poison Pills: tactic utilizes by corps to prevent/discourage hostile takeovers; Target uses poison pill to
make shares of corp look unattractive to acquiring firm
a. How it works:
i. Rights to buy the company’s stock at a discounted price distributed to all SHs
ii. Rights triggered only if someone acquires more than a certain percentage of company’s
outstanding stock without first receiving board’s blessing
iii. Person whose stock acquisition triggers the exercise of the rights is excluded from buying
discounted stock  bidder’s stake will be diluted, causing bidder to overpay for stock and get
lower % of stock than planned on
iv. If a bidder is aware there is PP plan, they will not want to pursue a takeover bc will be costly
v. Put in certificicate tha pill is triggered when SH gets certain percentage
5. When we have both Unical and Revlon duties: when bids are coming in, directors have Unical duties to
behave proportionality in terms of threats posed by bidders, but when it become clear that company
will be sold, Rev duties kick in
6. Revlon duties are not just best price, consider long term

Take Over Duties

Can the board defend against a firm trying to take over by tendering to SH?
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 1. Is there a takeover bid? (usually in the form of a TO)
a. Go to Revlon if:
i. Company is being auctioned/selling itself/break-up is inevitable
1. Revlon: going to sell major assets to Forstmann to defeat Pearlman takeover
bid; break-up either way Revlon mode
ii. Change in Corporate Control
1. QVC: merger agreement would change control of Paramount SH: going from
widely dispersed public SHs where their shares matters, to SH of a firm w/ one
very big controlling SH
iii. Corp is responding to takeover bidder’s offer by abandoning long-term strategy in
favor of break-up
b. Go to Unocal if: anything else
i. Time: strategic merger in which company will stay publicly held
2. Unocal Duties: Reasonable belief of threat + reasonable proportional response
a. For a board’s defensive tactics to be upheld, the board must prove that:
i. It had reasonable grounds for believing that a danger to corporate policy and
effectiveness existed; AND
1. Inadequate price
2. Coercive TO
3. Nature and timing of offer might cause condition; SH wouldn’t understand
terms of transaction
4. Questions of illegality
5. Quality of securities being offered in the exchange
6. Risk of non-consummation (if there’s risk that threat doesn’t have financing
and regulator going to interfere)
7. Examples:
a. Unocal: coercive TO: buy shares now at inadequate price, or get cashed
out w/ junk bonds
b. Time: Paramount’s last minute TO, which led to concerns that SH
would tender to Paramount w/o understanding WB merger; and
Paramount TO designed to upset vote and confuse SHs
ii. The defensive tactic was reasonable in relation to the threat posed (proportionality
test)
1. Unocal: Discriminatory self-tender reasonable bc otherwise, self-tender would
finance Mesa’s unfair takeover
2. Revlon: poison poll and self-tender w/ notes
3. Time: changing merger (which required SH vote) to TO (not requiring vote)
3. Revlon Duties: Auctioneers charged w/ reasonably trying to get best prices for SHs (can’t focus on
other interests)
a. Revlon: lockup for Frostmann to defeat Pearlman bid  not seeking SH best price
i. Directors considered bondholder and themselves; did so by rigging bid for Frostmann
since he would support price of bondholders’ notes that would otherwise decrease in
value and subject directors to bondholder liability
b. QVC: Measures and failure to consider QVC offer not reasonably seeking best price for SHs
i. Paramount put in restrictive defensive measures in agreement w/ Viacom that
prevented it from seeking best value for SHs
ii. QVC offered better deal but BoD responded by continuing to pursue Viacom deal and
reaffirmed defensive measures against bids like QVC’s

Unocal v. Mesa Petroleum

Facts:
a) Bidder Mesa owned 13% of Unocal and made a two-step takeover for Unocal

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 i) Step 1: Mesa made TO 37% shares at $54/share cash; would own ~51% , could pass 2nd step
ii) Step 2: Freezeout merger to acquire the remaining approximately 49% of shares by offering
securities with a face value of $54, but which would really be lower bc all junk bonds.
b) Unocal saw the tender offer as being at an inadequate price and coercive to the shareholders,
so Unocal made a self-tender for $72 cash to purchase the 49% of the Unocal shares not
purchased in Mesa’s first step offer.
i) self-tender excluded Mesa - discriminatory self-tender bc Mesa is shareholder (13%) and can’t
exclude shareholders w/ TOs (must be to all)
Issue: whether Unocal breached fiduciary duty w/ the self-tender
Held: No, self-tender upheld
Rule:
For a board’s defensive tactics to be upheld 
 1) Board must reasonably perceive the bidder’s action as a threat to corporate policy (threat); AND
 2) Any defensive measure the board adopts must be reasonable in relation to the threat posed
(proportionality test)
 Threat = coercive OR inadequate price
 if corp fails either of the prongs  injunction preventing defensive measures will be granted
Reasoning:
 Prong 1: threat that a Unocal shareholder would tender into the offer bc they would rather get the$54
upfront than be stuck w/ debt that is supposedly worth $54 but is actually junk bond worth way less
 Prong 2: self-tender is reasonable response bc otherwise, Unocal would be financing Mesa’s coercive
tactics and every share that Mesa bought from self-tender would be one less share of protection for the
SHs
Skeel:
 Unocal made a discriminatory TO; now illegal to do that

Revlon, Inc. v. MacAndrews and Forbes Holding

Facts: Revlon didn’t’ want to be taken over by Perelman, started using defensive tactics to avoid takeover.
 Poison Pill
 Self-tender/notes: repurchased 20% of Revlon’s stock w/ unsecured debt at premium
 Solicited bid from Forstmann Little who agreed to offer competing bid for Revlon and support price of
Revlon’s notes in return for “lockup”: Forstmann given right to buy Revlon’s most valuable assets at a
bargain price if another bidder (Perelman) were to acquire more than 40% of Revlon’s stock division of
target at discount, even if bid falls through and someone else gets control.
 Pearlman increased his bid again, and went to Chancery Court
Issue: alleged breach of fiduciary duty
Holding: Revlon’s directors breached fiduciary duty
 Approved use of poison pill and exchange offer
 Rejected Revlon’s attempt to rig bidding and protection of notes value (lock up)
 Can’t give advantages to one bidder over another
Rule:
 Revlon duties trigger when the breakup of the company is inevitable and there are two bidders
 Duty of directors changes from defenders of corporate bastion to auctioneers charged w/ getting the best
price for the shareholders.  must do what is best for your SH and get best price you can reasonably get
for corp; fair and impartial auction
 If there is only one bidder, NOT Revlon mode bc can just say no to the bid, don’t have to try to find
another better offer
 Breakup: can be a merger, or an acquisition, where another corp comes in, and sells off non-profitable
assets, etc.
Skeel:
a) What did Revlon directors do wrong?  Destroyed bidding war by making deal with
Forstmann

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 i) Initially satisfied Unocal by stiffing Perelman, BUT once the auction developed, cannot play
favorites  need to be evenhanded.
ii) But, directors worried about getting sued by debt-holders, so they favored Fortsmann deal
(1) Putting interests of debtholders above SHs (by protecting notes) and can only be thinking
about SHs in this circumstance; and
(2) Protecting themselves from debtholder suit
iii)  Takeaway: Under certain circumstances, if there’s going to be a breakup of the company,
duty goes beyond Unocal: a duty to get the best price reasonably available for your SHs –
Revlon duty
b) Initially coming out of Revlon, obligation seems to be to hold an auction and get the highest price you
possibly can, but this is softened in following cases.
c) Evaluate what is best long-term solution for the corp

Paramount Communications, Inc. v. Time, Inc.

Facts:
a) Time carefully negotiated a friendly merger with WB (TW), and 2 weeks before merger scheduled
to close, Paramount made a higher, all cash TO.
b) Time directors feared that corp’s SH would vote to reject merger w/ WB (bc $) so Time changed
transaction from the original merger into a cash TO for 51% of the shares of Warner—went from
merger that requires Time SH vote to a transaction that doesn’t require Time SH vote
c) Time would acquire remaining 49% of Warner later for cash and securities.
Issue: Whether Time’s directors breached their fiduciary duties in defending against Paramount
Holding: no breach
Rule:
a) Revlon duties are triggered: (in these situations, go w/ higher bidder)
i) (1) when a corporation initiates an active bidding process seeking to sell itself or to effect a
business reorganization involving a clear break-up; and
ii) (2) where, in response to a bidder’s offer, a target abandons long-term transaction plan in favor of
a break-up.
b) Revlon duties not triggered when the board’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 and time stayed on strategic vision.
c) Unocal: Inadequate value or coercive tactics are not only possible threats that could justify
directors’ defensive measures. – expands Unocal first prong
i) Inadequacy of price offered, nature and timing of offer, questions of illegality, impact on
constituencies other than SH (creditors, employees, community), risk of non-consummation, and
quality of securities being offered in the exchange
Reasoning:
a) Revlon duties do not apply: there is no break up of the corporation; Time SH will continue to be Time
SH
b) What triggers Unocal? The change in the form of the transaction was a defensive measure that
triggered Unocal. Time restructures the transaction from a merger (between Time and Warner) to a
tender offer by Time for 51% of Warner shares
c) Court found that the defendant did not fail Unocal test:
i) Prong 1 – Threat: Inadequate value or coercive tactics are not the only threat a target faces. The
court indicated that there were other threats to justify Time’s defensive tender offer for Warner:
(1) Time’s concern that its SHs would tender to Paramount w/o understanding proposed plan
with Warner.
(2) Paramount’s offer had conditions that created uncertainty/confusion and skewed
comparative analysis between the tender offer and Time’s plan.
(3) Paramount’s offer timing arguably designed to upset initial vote for merger with Warner and
confuse SHs.

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 ii) Prong 2 – Reasonableness of the Defense: This decision gave a great deal of deference to
independent directors in both identifying a threat and in determining what was best for the
corporation in its response. The court indicated that deciding which was a better deal for the SHs
in this case was up to the directors.
Skeel:
a) Why did Paramount wait so long to bid? Waited until proxy materials—which stated the value of
the Time-Warner merger and that it was a “good deal”—distributed to SHs. Paramount is proposing a
better price, so Time SHs will know Paramount price is great.

Paramount Communications, Inc. v. QVC Networks, Inc.

Facts:
a) Paramount agreed to be acquired by Viacom in a friendly acquisition (VP)
i) Involved cash and shares of Viacom worth $69.14 and a “No-shop Provision” which limited
Paramount’s ability to accept another bid.
ii) In addition, defensive measures = termination fee + stock options  if (1) Paramount terminated
its agreement with Viacom because of a competing offer, (2) Paramount’s stockholders did not
approve the transaction with Viacom, or (3) Paramount’s directors recommended a competing
transaction, Viacom would receive a $100 mn termination fee and the option (“stock option”) to
buy 24 mn Paramount shares (19.9% of Paramount) at $69.14.
iii) Although the SHs of Paramount would own shares in the new merged company, the
controlling shareholder of Viacom, Sumner Redstone, would own 70% of the new company.
b) QVC offered to acquire Paramount at a higher price than Viacom had offered.
c) The directors of Paramount viewed the Viacom offer as fitting into Paramount’s long-term business
strategy and a means to increase shareholder value.
i) Paramount directors didn’t seriously consider the QVC bid even though higher than Viacom’s bid
ii) The directors refused to withdraw any of their defensive tactics, and changed the transaction with
Viacom to be tender offer by Viacom for Paramount shares.
Holding: Revlon triggered by proposal of merger w/ Viacom – expands situations when Revlon applies
Rule:
a) Revlon duties triggered when a corp undertakes a transaction, which will cause: (a) a change in
corporate control; or (b) a breakup of the corporate entity; or (c) abandonment of long-term
transaction in favor of breakup
i) Change-of-control: change of corp’s ownership from dispersed public SH to one controlling SH.
b) Revlon duties require the directors make a reasonable effort to get the best reasonable price
Rationale:
a) Revlon applies:
i) Change in Control – widely dispersed SH to 1 controlling SH
(1) change of control that would result from Viacom’s proposed acquisition of Paramount
justified the application of Revlon, and was not limited to circumstances when the breakup of
the corporation was inevitable.
(2) In Time there was no change of control since Time and Warner were both public companies
with widely dispersed shareholders and no controlling shareholders.
(3) In QVC there was a change of control: Paramount had no controlling shareholders, but Viacom
did have one. After Viacom’s purchase, Paramount’s public shareholders would be minority
shareholders in a company controlled by Viacom’s controlling shareholder.
ii) Here, the board was required to seek the best price because there was a proposed diminution
of shareholder voting power; the control premium belonging to the public shareholders
was sold; and the court was concerned with actions impairing voting rights. Once the control
block is sold, the control premium is no longer available and minority shares will trade at a
discount.
b) Paramount breached its duties under Revlon:

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 i) Paramount directors had obligation to be diligent and obedient in examining both bidders, to act
in good faith, to obtain and act on all information reasonably available on the issue of best value,
and to negotiate actively and in good faith with both Viacom and QVC.
ii) Directors decided to enter into a strategic merger with Viacom, which involved a change of
control and approved certain defensive tactics to facilitate the transaction. This activity and the
subsequent disparate treatment of the competing bidder = unreasonable process and a breach of
fiduciary duty.
Skeel:
 There is no break up here, Paramount SH will still have stake in corp
 “reasonable,” “reasonably”: Revlon duties are not impossible; don’t need to get absolutely the top
dollar, but just be reasonably best in trying to get the best price for shareholders; otherwise Revlon
duties would be impossible
 3 Revlon Circs: breakup, abandonment of long-term plan in favor of break-up, change of control
B. Termination Fees: ATT Merger w/ Time Warner
Bidder 1 and Target have a contractual relationship, and the termination fee is part of it.
Bidder #1: Values at $900 & bids $800 with a $250 termination fee
Bidder #2: Values at $950 & Bids $750 with $250 term fee

Bidder 1 will get the bid. Bidder 2 will have to pay for Target’s termination fee if it steals Bidder 1’s bid. Bidder 2
has a reservation price of 950 and faces a termination fee of $250, making the highest amount it can bid $700.
Since Bidder 1 bids $800, Bidder 1 will win the bid.

-Why Termination Fees can be problematic bc discourage other bids:

if termination fee is greater than Bidder 1’s expected profits ($900 w/ termination total $1,050) Bidder 1 isn’t
going anywhere bc isn’t going to pay a termination fee. Therefore, Bidder 2 would have to outbid Bidder 1;
however, the termination fee makes the total higher than Bidder 2’s expected profits ($1000 > $750), Bidder 2
will have to lower offer bid, and will be unable to outbid Bidder 1.

-Termination fees also lower the amount that both the Bidder 1 and 2 would be willing to bid bc termination fee
concerns.

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