BIZ ORG OUTLINE

AGENCY
WHO IS AN AGENT
A. Agency is the fiduciary relation which results from
i. Consent
a. Consent by the principle for the agent to act, must manifest that the agent will act
for him
ii.Acceptance
a. Agent must accept the undertaking, act on behalf of the principle (& both parties
intend this)
iii. Control
1. Understanding that the agent is subject to control by the principle.
(a) Control only over the goal, not the means of accomplishing it (lawyers).
B. Formation & termination of an agency relationship
i. Unlike a contract (which is negotiated etc.) an agency agreement is created very
easily. Once A agrees to do something for P, and A is acting on P’s behalf & is
subject to P’s control the agency relationship is created.
a. Gorton v. Doty, 69 P.2d 136 (1937) – woman tells the football coach who needs
to transport students to a game to use her car (but only he can drive it). She
volunteered the use of her car, no compensation. Accident happens & suit against
the woman, as the principle. Agency relationship existed here between woman &
coach. Woman consented that coach act in her behalf in driving her car by
volunteering her car & her condition that only he drive it shows the control she
had.
1. How you describe it makes the diff on whether or not it’s agency:
(a) Gave permission – this is a loan, not agency
(b) Directed - telling him what to do – this is agency.
2. This is a little extreme b/c it almost looks like it was only a loan. But fact is
that insurance is covering the woman, and the boy injured has no insurance.
So looks like court just wanted to cover the boy.
3. Solution: if she had specified she is loaning the car to him, then that would
have settled it.
b.It is not essential that there be a contract between the principle and agent or
that the agent promise to act as such, nor is it essential to the relationship of
principle and agent that they, or either, receive compensation.
ii.Agency can be terminated at the will of either party (notion that involuntary
servitude is bad). Different from contract relationship which you cannot just
breach & court will enforce.
C. Creditor-debtor relationship vs. agent-principal relationship
i. A creditor who assumes control of his debtor's business may become liable as
principal for the acts of the debtor in connection with the business
ii.Gay Jenson Farms Co. v. Cargill, Inc., P. 7 – Court found agency relationship due
to the amount of control exerted by Cargill on Warren

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 1. Consent by principle – C consented by directing W to implement certain
procedures
2. Agent acting on behalf of principle – W acted on C’s behalf in procuring
grain for C, as part of its normal operation which were totally financed by C.
3. Principle exercise control over agent - C had a lot of influence and control
over W’s financial situation.
b.An agreement may result in the creation of an agency even though parties
didn’t call it an agency and did not intend the legal consequences of the
relation to follow.
c. Someone who contracts to acquire something from a 3rd person and convey
it to another is an agent only if it is agreed that he is to act primarily for the
benefit of the other.

AGENCY POWER TO BIND - LIABILITY OF PRINCIPLE TO THIRD PARTIES IN

CONTRACT

 Actual Authority - principle gave the agent the authority explicitly; completely clear
 Implied Authority - Implied authority is actual authority circumstantially proven
which the principal actually intended the agent to possess and includes such powers
as are practically necessary to carry out the duties actually delegated.
o To determine whether implied authority exists, it must be determined whether the
agent reasonably believes because of present or past conduct of the principal that
principal wishes him to act in a certain way or have certain authority.
 Sometimes may be necessary to implement express authority
 Prior similar conduct
o i.e. Have authority because it’s something that normally goes along with the
actual authority given.
 Mill Street Church of Christ v. Hogan, 785 S.W.2d 263 (1990) – Church has hired
Bill to paint. B hires S to help, S is hurt and wants workers comp, but only for
employees. Did B have authority to hire S?
a. Bill is an agent of the Church (an employee – Church hires Bill & has control
over Bill)
b. Bill didn’t have actual authority to hire Sam, but had implied authority.
1. past conduct - Bill had been allowed to hire Sam for previous work.
2. necessary to implement the express authority - in order to finish the work,
Bill had to hire a helper.
3. agent reasonably believed he had the authority - practice in the past; Bill
never told otherwise; Church even paid Sam for hours worked.
D. Apparent Authority – when a principle acts in such a manner as to give the
impression to a third party that the agent has certain powers which he may or may
not actually possess. It is a matter of appearances on which third parties come to
rely.
i. 3rd parties have the right to believe the agent has the authority it is reasonable to
believe they have.

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 ii.Three-Seventy Leasing Corporation v. Ampex Corporation, 528 F.2d 993 (1976) –
Joyce, the only employee of 370 corp, is in negotiations to buy HW from Ampex &
is speaking to Ampex’s employee, Kays (salesperson). Kays sends Joyce an offer at
the direction of Kays’ superior.
a. An agent has apparent authority sufficient to bind the principal when the
principal acts in such a manner as would lead a reasonably prudent person
to suppose that the agent had the authority he purports to exercise.
b.Absent knowledge on the part of 3rd parties to the contrary, an agent has
the apparent authority to do those things which are usual and proper to the
conduct of the business which he is employed to conduct.
c. Kays was employed by Ampex as a salesman; it is reasonable for 3rd parties to
presume that a salesman has the authority to bind the employer to sell.
d. Ampex's actions furthered this belief; Document was given to Joyce at the
direction of Mueller, Kay's superior, and also Mueller agreed that all
communication with 370 would be through Kays. Doesn’t matter if, internally,
Kays really didn’t have this power.
E. Inherent Agency Power – authority that comes from the role/status that comes with
being an agent. The agent (in the role/status) ordinarily possesses certain powers.
i. A servant acting within the scope of his employment has inherent authority to
commit torts - basically same thing as respondeat superior.
ii.Watteau v. Fenwick, Queen's Bench (1892) - Humble sold business to Fenwick, but
Humble still manager, and Humble name on the door. Humble buys a bunch of
stuff, no payment 
a. Rest (2nd) Agency § 194 - an undisclosed principle is liable for acts of an
agent done on his account, if usual or necessary in such transactions,
although forbidden by the principle.
b. Rest (2nd) Agency § 195 - an undisclosed principal who entrusts an agent with
the management of his business is subject to liability to third person with whom
the agent enters into transactions usual in such business and on the principal’s
account, although contrary to the directions of the principal.
c. J. Learned Hand - "It makes no difference that the agent may be disregarding
his principal's direction, secret or otherwise, so long as he continues in that
larger field measured by the general scope of the business entrusted to his
case."
d.Rest (2nd) Agency § 161. A general agent for a disclosed or partially
disclosed principal subjects his principal to liability for acts done on [the
principle’s behalf] which usually accompany or are incidental to
transactions which the agent is authorized to conduct if, although they are
forbidden by the principal, the other party reasonably believes that the agent
is authorized to do them and has no notice that he is not so authorized.

LIABILITY OF PRINCIPAL TO THIRD PARTIES IN TORT

I. Roseburg says three factors:

A. Time/place

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 B. Hired to do
C. Scope of employment (see below)
II. Servant v. Independent Contractor
A. A master is subject to liability for the torts of his servants committed while acting
in the scope of their employment. As a general rule, a principle is not liable for the
torts of his non-servant agents - i.e., independent contractors.
i. Servant-Master Relationship – respondeat superior; master liable for torts of his
servants
a. Master/servant relationship exists where the servant has agreed to work on behalf
of the master and to be subject to the master's control or right to control the
"physical conduct" of the servant (the manner in which the job is performed as
opposed to the result alone).
ii.Independent contractors
a. Agent-type independent contractor - one who has agreed to act on behalf of
another, the principal, but not subject to the principal's control over how the
result is accomplished (over the physical conduct of the task).
b. Non-agent independent contractor - one who operates independently and simply
enters into arm's length transactions with others
B. Whether the relationship between the parties is an agency relationship does not
depend on what the parties call it, but what it actually is. The parties cannot
effectively disclaim it by formal consent.
i. Humble Oil & Refining Co. v. Martin, 222 S.W.2d 995 (1949) – Love gives her car
to gas station owned by Humble for servicing. Negligence by gas station & Martin
injured by the car. Humble liable for negligence? Humble says no b/c gas station
operated as an independent contractor, Schneider. Neither Humble nor Schneider
considered Humble the employer.
a. Court says it’s a servant-master relationship, so Humble is liable. Humble had
“strict financial control & supervision” over the gas station.
1. Humble furnished the station location, equipment, advertising, and a
substantial part of the operating cost (they gave a 75% commission on
Schneider's payment of utilities, so Humble was effectively paying 75% of
the utilities). Hours of operation controlled by Humble. Humble could
terminate at will Schneider's occupation of the premises. Schneider had to do
whatever Humble told them to do. The only thing Schneider had the
discretion to do was hiring, firing, payment and supervision of the few
employees. So looks more like Schneider is an employee just being paid
based on commission.
C. Control is an essential element of an agency relationship, whether a servant or an
independent contractor. To determine whether the relationship is master-servant,
the court will look at whether the principle had control over the day-to-day
operations.
i. Hoover v. Sun Oil Company, 212 A.2d 214 (1965) – gas station employee
negligently caused a fire at a service station owned by Barone. Πs brought suit
against Sun Oil, Barone & the employee. Barone leased the gas station from Sun, &

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 had a dealer’s agreement that dictated the K between them. Barone not obligated to
do what Sun would recommend, & determined the day-to-day operations. Barone
could sell whatever he wanted, although there were rules on what he used Sun’s
products for.
a. Held independent contractor - the close contact between the two show merely
that they have a mutual interest in the sale of Sun products and in the success of
Barone's business. Sun did not have control over the day-to-day operations.
1. Control or influence over the results alone is insufficient.
D. Franchise agreement - the franchisee will agree to operate its business in certain ways,
as required by the franchisor, in exchange for the use of the license. The purpose of this
is to create standardization in all the franchises nationwide (to achieve the "brand").
However, a franchise could still be a servant-master relationship if there is
sufficient control by the franchisor.
i. Murphy v. Holiday Inns, Inc., 219 S.E.2d 874 (1975) - Betsey-Len Motor Hotel
Corporation had a licensing agreement (franchise) with Holiday Inns, to use their
name/logo. Architecture of Betsey must be approved by Holidays Inn, Betsey not
allowed to sell stock w/o approval, Betsey must operate under Holiday’s rules of
operation & make quarterly reports & submit to periodic inspections by Holiday. A
customer had a slip & fall and sues Holiday Inn for the negligence.
a. Not servant-master, this is a typical franchise agreement. Holiday Inn does not
have the control or right to control the methods or details of doing the work.
The purpose of the provisions was to "achieve a system-wide standardization of
business identity, uniformity of commercial services …. for the benefit of both
contracting parties." Betsey still had the control over the day-to-day operations,
and most other powers customarily exercised by an owner.
ii.Rationale for allowing a certain level of control in franchising agreements:
a. The problem of free-riding: franchisee would take advantage of other people’s
investments (establishment of the brand name) and exploit it. If the franchisee
could do whatever they wanted, it would ruin the brand name.
III. Tort Liability and Apparent Agency
A. Advantages of setting up a business as a franchise:
i. Establish a brand name – ppl can walk in any location and know what to expect
ii.Less liability for the national company than having branches
a. But national wants some control since they’re promising something
iii. Owners will work harder than managers, even though same money & same job
B. Policy Issue for franchises – should we allow businesses to insist that they present
themselves as one enterprise for purpose of advertising, but then turn around for tort
purposes and say we’re 2 enterprises? On its face it looks like consumer fraud.
Although it’s ok for contract purposes, not clear if it’s ok for tort purposes.
C. Miller v. McDonald's Corp., 945 P.2d 1107 (1997) - Π sues McDonalds for injuries b/c
she bit into a stone while eating a burger. McDonald’s was a franchise, owned by 3K, &
had an operating agreement that required 3K to operate in a manner consistent with the
McDonald’s system, and described how it should be operated in a lot of detail. K also
explicitly stated 3K not an agent for any purposes.
i. Liability under Actual Agency: The Control Test – If the franchise agreement
goes beyond the stage of setting standards, and gives the franchisor the right to
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 exercise control over the daily operations of the franchise, an agency
relationship exists.
a. If McDonald’s retained sufficient control over 3K's daily operations, then an
actual agency relationship would exist (jury question). Agreement didn’t just set
standards - it required 3K to use the precise methods that McDonald’s
established. McDonald’s enforced the use of those methods by regular
inspections & retained power to cancel the Agreement.
ii.Apparent Agency - One who represents that another is his servant or other
agent and thereby causes a third person justifiably to rely upon the care or skill
of such apparent agent is subject to liability to the third person for hard caused
by the lack of care or skill of the one appearing to be a servant or other agent as
if he were such.
a. Question for jury whether McDonald’s held 3K out to be its agent & whether Π
justifiably relied on that representation
1. (Representation) Everything about the appearance of the restaurant identified
it with McDonald's - this image the McDonald’s had worked to create -
reputation, etc.
2. (Reliance) General public not expected to understand how franchise works.
McDonald’s cannot ignore its own efforts to lead the public to believe that all
McDonald's are the same.
IV. Scope of Employment
A. Conduct of a servant is within the scope of employment if it is actuated, at least in
part, by a purpose to serve the master (this is the minority, majority, must be in
furtherance of masters objective.) see below
i. Ira S. Bushey & Sons, Inc. v. United States, 398 F.2d 167 (1968) - Sailor (works for
U.S.) arrived back at his ship drunk, and negligently caused damaged to the ship &
drydock (owned by Π). U.S. argues it’s not liable b/c sailor acting outside scope of
employment.
a. The sailor's conduct was not so unforeseeable as to make it unfair to hold the
government liable. The employer should be held to expect risks, to the public
also, which arise 'out of and in the course of' his employment of labor. It is
foreseeable that a drunken sailor might cause damage while crossing a drydock
on the way back to his ship.
B. Rosenberg: Three ways to determine scope of employment
i. Motive, why did the person do what they did?
ii.Public policy approach
iii. Bushey standard (above, no requirement of “purpose to serve the master” as the
restatement does, just foreseeablility)

C. A servant's acts may be within the scope of employment although consciously

criminal or tortious (except serious crimes). A servant's use of force against another
is within the scope of employment if the use of force is may be expected by the
master.
i. Ex: the owner of a nightclub probably would be held liable for injuries inflicted by a
bouncer in ejecting someone from the bar. The owner presumably hired the bounder
for the very purpose of using force to eject drunken or otherwise undesirable patrons.

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 ii.Manning v. Grimsley, 643 F.2d 20 (1981) – professional baseball game, pitcher
threw a ball at Π & injured him (Π heckling him, and evidence that pitcher did it
intentionally). Court found employer liable for pitcher’s action b/c he was acting
within the scope of his employment.
a. To recover damages from an employer for injuries resulting from an
employee's assault, it must be shown that the assault was in response to the
Π's conduct which was presently interfering with the employee's ability to
perform his duties successfully.
1. The heckling was conduct that had affirmative purpose to interfere with
employee’s performing his duties successfully, and the pitcher's assault was
not a mere retaliation for past annoyance, but a response to continuing
conduct which was presently interfering with his ability to pitch in the game.
V. Liability for Torts of Independent Contractors
A. Ordinarily when a person engages an independent contractor (who conducts an
independent business by means of his own employees), he is not liable for the negligent
acts of the contractor in the performance of the contract, but there are three exceptions:
i. When landowner retains control of the manner & means of the work contracted for
ii.Where he engages an incompetent contractor
iii. Where the activity contracted for constitutes a nuisance per se.
a. Liability imposed upon a landowner who engages an independent contractor
to do work which is inherently dangerous (a nuisance per se).
1. Inherently dangerous - an activity which can be carried on safely only by the
exercise of special skill and care, and which involves grave risk of danger to
persons or property is negligently done.
2. Ultra-hazardous - an activity which necessarily involves a serious risk of
harm to the person, land or chattels of others which cannot be eliminated by
the exercise of the utmost care, and is not a matter of common usage.
Liability is absolute where the work is ultra-hazardous.
b. Majestic Realty Associates, Inc. v. Toti Contracting Co., 153 A.2d 321 (1959) -
Authority hires Toti to demolish a building which was adjacent to Π's. In the
process, there was damage to Π's building. Evidence showed that it was
hazardous work. Authority held liable b/c the work was inherently dangerous.

FIDUCIARY OBLIGATIONS OF AGENTS

VI. Duties during Agency

A. Reading v. Regem, 2 KB 268 (1948) - sergeant in the British army paid a lot of money
by escorting a smuggler's trucks. Crown gets the money
i. Servant is liable to his master if he takes advantage of his service and violates
his duty of honesty & good faith to make a profit for himself, and the position
he occupies is the cause of obtaining the money, rather than providing the
opportunity for him to get it. Doesn’t matter if master hasn’t lost any profit or
sustained any damage, or that master couldn’t have done the act himself.
ii.Examples:

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 a. Money goes to master - Police officer accepts bribes to direct traffic away from
crime scene. The only reason he had any authority to be able to direct traffic
away & the only reason he got paid, was b/c of his position as a police officer &
his uniform.
b. Servant keeps the money - Employee during time he's supposed to work,
gambles. Employer can sue him for breach of K, but the money he makes from
the gambling is his.
B. Agent has the fiduciary duty to act solely for the benefit of the principle. An
employee violates this duty by failing to disclose all facts relating to his work and by
receiving secret profits from it.
i. General Automotive Manufacturing Co. v. Singer, 120 N.W.2d 659 (1963) – Singer
worked for General. Employment K says Singer would devote his entire time, skill,
labor and attention to said employment and not to engage in any other business.
Singer doesn’t think General can fill some orders & gets them filled somewhere else,
making himself a profit.
a. Singer violated his fiduciary duty to act solely for the benefit of General, so he is
liable for the amount of the profits he earned in his side business. He had a good
faith duty to disclose the fact that he didn’t think General could fill the orders;
then General could decide what to do.
VII. Duties during and after termination of Agency (see below for more grabbing and
leaving)
A. Post-termination competition with a former principle is permitted, but the former
agent is barred from disclosure of trade secrets or other confidential information
obtained during his employment.
B. Soliciting former employer’s clients
i. Town & Country House & Home Service, Inc. v. Newbery, 3 N.Y.2d 554 (1958) -
Δ was an employee of Π, a house cleaning service. Δ leaves employment, then sets
up a competitive business. Δ had breached the confidential relationship (b/c it stole
the plan, which was unique) and also solicited customers (which it had built over the
years).
a. A former employee may not solicit his former employer’s customers if those
customers cannot be readily ascertained by means other than knowledge b/c
of the employment. Where the customer list was secured by years of business
effort & advertising, and the expenditure of time & money, constituting a part of
the good will of a business.
C. General Rules
i. While an employee you can't compete with employer b/c you have a fiduciary
duty…
ii.You can terminate the agency at will, however, so once you quit, you no longer owe
a fiduciary duty & you can compete.
a. Knowledge received by employment, reputation, etc. – you can take this with
you. What you can't do is walk away with a client list on paper.
b. Reason: Otherwise, it would be like slavery – either you stay with the same
company forever, change careers, or pay royalties to previous employer.
1. Exception – information that’s confidential like patents. But this is addressed
by non-competes (contract), so unnecessary to address in agency law.
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D. *This is different for lawyers soliciting clients, because the courts are concerned with
preserving the client’s right to chose their own lawyer. Not to protect lawyers right to
solicit (although this is the practical effect) but rather the client’s right the choose. (SEE
P. 13 for more on grabbing and leaving)

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PARTNERSHIPS
I. Elements of a Partnership
A. 5 Elements of a Partnership – UPA (Uniform Partnership Act) § 6. Partnership is an
association of "two or more persons to carry on, as co-owners, a business for
profit."
i. Association of two or more
a. agreement necessary, but no written contract. Agreement is to associate, not to
form a partnership.
b. no formal partnership agreement required
c. no governmental registration required
d. If you fit the elements of a partnership, you’re a partnership.
ii. Persons
a. Person can be a corporation (or any other business entity) or a natural person.
Some "people" are not "persons" under definition of law - minors, etc.
b. can't form a partnership with yourself, but you could with a corporation of which
you were the sole shareholder.
iii. As co-owners
a. not employee/employer.
iv. In a business
a. Not a church, not a share of stocks
b. co-ownership of a rental property as joint tenants is not enough
v. For profit.
a. Not-for-profits don't count
b. Just b/c no profit made won't mean it’s not a partnership, as long as they intended
to make profit
B. UPA § 7: Rules for determining existence of a partnership
i. Joint tenancy/joint property/part ownership doesn’t of itself establish partnership
ii. Sharing of gross returns doesn’t of itself establish a partnership
iii. UPA § 7(4) Receipt of a share of profits of a business is prima facie evidence of
partnership, but no such inference shall be drawn if (exceptions):
a. Wages or rent (even if calculated based on profit) - store may pay landlord rent
based on profits of the store w/o landlord becoming its partner.
b. Debt repayment - if business owes ex-partners money, this doesn’t make them a
partner, it makes them a creditor.
c. Annuity to deceased partner - if you want to retire, your payments should not be
based on profits; but they may be if you are dead.
d. Interest - If you lend money to the partnership & take as interest a share of profits,
you are not a partner. But if you invest money in the partnership & take a share of
the profits, you are.
1. So what becomes important is the level of control.
e. As consideration for sale - the distinction between allowing in a new investor and
selling the business is going to be tough to make if the seller still receives a share
of profits.
C. Liability Rules of a partnership

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 i. Profit Sharing Default Rule – profits are split per person/partner, w/o regard to money
or labor contribution. But you can change the default rule by agreeing to something
else in the partnership agreement.
ii. Splitting losses default rule - losses follow profits. So if you make agreement on
profits, losses also split that way.
a. 3rd party breach of K or torts - Sue the partnership & collect. But if partnership is
insolvent?
1. Partners held jointly and severally liable for the obligations of the partnership
(UPA §15). Each partner is a guarantor of the partnership’s full debts.
b. Partnership agreement can say how losses (debts) will be split. If agreement says
Partner A is liable for 90% of debts, B 10% of debts, you can still sue B for full
debt and collect. But then B can sue/collect from A the 90%.
1. Reasoning: 3rd parties entitled to rely on the entity, plus that each individual
partner puts their individual credit behind the partnership.
iii. UPA § 9: Every partner is agent of the partnership for purpose of its business. The act
of every partner for carrying on the usual way of business binds the partnership,
unless he has no authority to act in particular manner and 3rd party knows.
iv. UPA § 13: Partnership liable for any wrongful act or omission of any partner acting in
the ordinary course of the business or partnership or w/ authority of co-partners
v. UPA § 17: Person admitted into existing partnership liable for all obligations of the
partnership arising before his admission
vi. Federal Income tax purposes – income and losses of the partnership are attributed to
the individual partner; the partnership itself does not pay taxes.

II. Partners Compared with Employees

A. UPA § 42: The sharing of profits is prima facie evidence of partnership, but no such
inference shall be drawn if such profits were received in payment as wages of an
employee.
B. Fenwick v. Unemployment Compensation Commission, - Chesire works for Fenwick &
asks for a raise. Fenwick agrees only if he’s making enough money, so he gets a lawyer
to write an agreement, which said Chesire is a partner (so Chesire gets share of profits).
Chesire leaves employment, & Fenwick refuses to pay into the unemployment fund b/c
she wasn’t an employee within the meaning of the statute. Δ said the agreement was not a
partnership agreement, but just an agreement fixing the compensation of the employee.
Court held that no partnership created, the K was nothing more than a method to provide
for compensation. Just b/c the agreement says they are a partnership, doesn’t make it so.
i. Court looks at the characteristics of a partnership:
a. The intention of the parties – just b/c K said partnership, doesn’t make it so. The
real reason for the K was to provide calculation for an increase in compensation,
but to protect Fenwick in case he couldn’t afford it.
b. The right to share profits – not every agreement that gives a right to shares
profits is a partnership, so not conclusive.
c. The obligation to share losses – only Fenwick liable for debts of partnership.
d. The ownership and control of the partnership property & business - Fenwick
contributed all the capital & Chesire had no right to share capital upon
dissolution. Fenwick also retained all control.

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 e. Community of power in administration - Fenwick had exclusive control of mgmt
of the business.
f. Language in the agreement – K called it a partnership, but also excluded Chesire
from most of the ordinary rights of a partner.
g. Conduct of the parties towards third persons – didn’t hold themselves out as
partners, she was still working as the receptionist.
h. The rights of the parties on dissolution- No diff for Chesire than if she quit
i. Co-ownership – agreement only to share profits, Fenwick had ownership.
III. Partners compared with Lenders
A. The determination of whether a business organization constitutes a partnership is done on
a case-by-case analysis of all factors to determine whether they reveal the intent to do
business as co-owners; no single factor is dispositive. Thus, an explicit partnership
agreement may be deemed not to create a partnership, and an agreement specifically
denying a partnership exists may be found void.
B. The sharing of profits is not conclusive evidence of a partnership.
i. ***Martin v. Peyton, 246 N.Y. 213 (1927) - KNK, a partnership, was in financial
difficulty, and Hall, a partner there, arranged for the Δs (Peyton + others) to loan
them some securities, to be used as collateral for a bank loan to KNK. KNK creditors
sued to get their money, and argued that the loan to KNK by Δs was actually a
partnership agreement, so Δs would also be liable for KNK's debts b/c they were
partners. Although the agreement said no partnership, the rule is to look at what
actually is the case. Court looked at circumstantial evidence, & decided no
partnership formed.
a. Although profit sharing (which happened here) is considered an element of a
partnership, not all profit-sharing arrangements indicate the existence of a
partnership relationship. All of the features of the agreement are consistent with a
loan agreement, so no partnership has been formed.
b. Note: If KNK had been organized as a corporation, LLC, or LLP, Δs here would
have avoided any risk of liability. Under those forms of business organization, as
equity investors, Δs could not have been held personally liable for the firm's
debts.
a. ***While evidence of profit sharing is prima facie evidence of the existence of
a partnership, it is not dispositve, and other factors may indicate no
partnership was intended.
II. Partnership by Estoppel
A. General Rule: Persons who are not actual partners as to each other are not partners
as to third persons.
i. Exception: A person who represents, or who expressly or impliedly consents to
such a representation, that she is a partner, is liable to any third person who
extends credit in good-faith reliance on such representations. (UPA § 16)
B. Young v. Jones, 816 F.Supp 1070 (1992) – Price Waterhouse Bahamas (PW-Bahamas)
is Bahamian partnership, and price Waterhouse United States (PW-US) is a NY
partnership. Π invests money in a company, based on an audit letter from PW-Bahamas,
and later the money disappears. Π sues PW-Bahamas for negligence, and saying that b/c
the 2 are partners by estoppel, PW-US is also liable. Π say b/c PW-Bahamas’ letterhead

12
 only identified it as Price Waterhouse & used that logo, and also b/c Price Waterhouse
advertised that it had offices all over the world.
i. Since the 2 firms are organized separately, there is no partnership in fact.
ii. Also, there is no partnership by estoppel. Π doesn’t contend that he relied on the
advertising or letterhead in investing. Plus, the exception in UPA §16 only applies to
reps made to 3rd person who give credit to the partnership. No credit was extended
here, this is a case of liability for negligence. Also, Π didn’t show that they relied on
any conduct by PW-US that they had a partnership with PW-Bahamas.

THE FIDUCIARY OBLIGATIONS OF PARTNERS

I. The Fiduciary Obligations of Partners
A. Each partner has a fiduciary duty to all other partners.
i. The only fiduciary duties a partner owes to the partnership & the other partners
are the duty of loyalty & the duty of care. (UPA §404).
a. A partner’s duty of loyalty is limited to the following:
1. every partner must account to the partnership for ANY benefit and hold in
trust all profits derived by or for the partnership
2. refrain from dealing with the partnership in conduct or winding up as or on
behalf of an party with adverse interest to the partnership
3. refrain from competing with the partnership before dissolution
b. A partner’s duty of care is limited to refraining from engaging in grossly
negligent or reckless conduct, intentional misconduct, or a knowing violation of
the law.
c. Partner required to act in good faith and fair dealing with regard to the partnership
& other partners
d. A partner does not violate a duty or obligation merely because the partner’s
conduct furthers the partner’s own interest (partner CAN further his own
interests).
e. A partner may lend money to and transact other business with the partnership &
with regard to these transactions, the rights and obligations of the partner is the
same as if he was not a partner.
ii. Unless otherwise agreed (default), books of the partnership shall be placed at the
principal place of partnership's business & all partners shall have access to the books
at any time (UPA § 19).
iii. All partners shall render information affecting the partnership to other partners (UPA
§ 20)
B. Partners in a business have a fiduciary duty to inform one another of business
opportunities that arise. Joint venture partners owe each other the highest
obligation of loyalty as long as their venture continues.
i. ***Meinhard v. Salmon,– Salmon leased a hotel from Gerry for a term of 20 yrs;
Salmon needs financing, & enters into a joint venture (partnership, but never actually
called that) with Meinhard who would pay ½ the money needed for this, and would
receive 40% of the profits for 5 yrs, and 50% after. Salmon had the sole power to
manage the property & no interest in the lease ever assigned to Meinhard. Towards

13
 the end of the lease, Gerry approaches Salmon with a new, bigger opportunity, and
Salmon enters this other lease w/o telling Meinhard. Meinhard finds out and demands
he be let in on the new deal b/c the opportunity to renew the lease belonged to the
joint venture.
a. Holding: Meinhard gets % of the shares of the new deal.
1. Salmon (managing partner) owed Meinhard (investing partner) a fiduciary
duty, and that this included a duty to inform Meinhard of the new leasing
opportunity. Joint venturers owe each other the highest duty of loyalty, and
the duty is even higher for a managing co-adventurer, b/c Meinhard relied on
him to manage the partnership.
2. There was a close nexus between the original joint venture and the new
opportunity, since it was essentially an extension & enlargement of the subject
matter of the old one. This would be diff if the new opportunity didn’t involve
the same thing.
3. Salmon was also an agent of the joint venture, and this new opportunity was
only made available because he held that position in the joint venture. Salmon
would never have had this opportunity were it not for Meinhard’s initial
investment.
4. This case extended the duties of partnership far beyond duties under contract.
b. Dissent: This isn't a partnership (where the majority would be correct), it’s a joint
venture, which is a partnership for a very limited purpose & contemplated that it
would end at a certain time. Where the parties engage in a joint enterprise each
owes to the other the duty of good faith in all that relates to their common
venture. Their fiduciary relationship only exists within that scope.
II. After Dissolution
A. A partner who retires ceases to be a partner, and his former partners no longer owe
him a fiduciary duty.
a. Partners can't do anything that makes it impossible to carry on the ordinary
business of the partnership, unless authorized by all the partners (UPA §9(3)
(c)). Also, a partner is a fiduciary of his partners, & owes this duty against
negligence. But neither apply here, b/c Bane was no longer a partner once he
retired. The only complaint he could have had was if there was fraud or deliberate
misconduct (where no fiduciary relationship is necessary).
1. The business judgment rule protects the firm from liability for mere negligent
operation.
III.Withdrawing Partners Removing Clients from Firm (Grabbing and
Leaving)
A. Fiduciaries may plan to compete with entity to which they owe allegiance, provided
that in the course of these arrangements they don’t otherwise act in violation of
fiduciary duties.
i. Partners owe each other fiduciary duty of "utmost good faith and loyalty," must
consider other partners' welfare & refrain from acting for purely private gain.
ii. A partner has an obligation to render on demand true and full information of all
things affecting the partnership to any partner
iii. Meehan v. Shaughnessy, 535 N.E.2d 1255 (1989) – 2 partners in a law firm were
planning to leave & set up their own firm. They asked another partner & some

14
 associates to leave with them. They had a list of cases they were going to take with
them & sent out letters to the clients to consent to removal of their files from the firm.
As they were preparing to leave, they denied that they were leaving when asked by
the partners.
a. The fiduciary duty of a partner does not prevent that partner from secretly
preparing to start his own law firm. But they breached their duty of loyalty by
acting in secret and obtaining an unfair advantage over the firm by (1) denying
(lying) they were leaving, (2) preparing notices to go out immediately (before
firm could compete) to the clients, and (3) delaying to provide the firm with a list
of clients they intended to solicit until they had already obtained authorization
from most of them. The also gave less notice than required (30 days instead of
90). Also, the letters to the clients were unfairly prejudicial – it did not indicate to
the clients that they had a choice on whether to remain with the firm, but only that
they were leaving and needed permission to remove the files from the firm.
IV. Expulsion of a Partner
A. Dissolution is caused: (1) without violation of the agreement between the partners,
(d) by the expulsion of any partner from the business bona fide in accordance with
such power conferred by the agreement between the partners. [UPA § 31]. When a
partner is involuntarily expelled from a business, his expulsion must be bona fide or
in good faith, for a dissolution to occur without violation of the partnership
agreement.
B. Lawlis v. Kightlinger & Gray, 562 N.E.2d 435 (1990) – Lawlis was a senior partner in a
law firm and began using alcohol, so he didn’t practice for several months b/c of this, &
b/c he was seeking treatment. He later informed his partners of his problems, and they set
forth some conditions with no 2nd chance. When he relapsed, they did give him a 2nd
chance, where if he met certain conditions, they would return him to full partnership
status. He didn’t consume alcohol after that. However, Lawlis was then told they would
recommend his expulsion & a few days later the firm’s files were removed from his
office. Lawlis’s expulsion was voted on by a majority vote of the senior partners, as per
the partnership agreement.
i. Lawlis claims that the notification of the impending recommendation of expulsion &
removal of files was a dissolution of the partnership, and this was wrongful b/c it
wasn’t authorized by the majority vote.
a. Court disagrees. Everyone still considered him a partner even after this, and
Lawlis still acted like a partner. The notification was merely to say what they
planned to do. The dissolution occurred when they voted by majority for his
expulsion, in accordance with the partnership agreement.
ii. Lawlis also claims that his expulsion was a breach of the fiduciary duty between
partners, which requires each to exercise the duty of good faith and fair dealing b/c he
was expelled for the “predatory” purpose of increasing the firm’s lawyer-to-partner
ratio.
a. Court disagrees. When the firm found out about the alcoholism problem, it sought
to help him, even though he was taking substantial time off work. Even after he
violated the conditions set forth at first, the firm still gave him a 2nd chance. And
instead of recommending immediate expulsion, the firm proposed to allow him to
stay for a while so he could find other employment & retain insurance coverage.

15
 PARTNERSHIP PROPERTY, RAISING CAPITAL & RIGHTS OF PARTNERS IN
MANAGEMENT
I. Partnership Property
A. What constitutes partnership property? Issue is whether property is partnership property or the
individual property of the partner. All property originally brought into the partnership or subsequently
acquired, by purchase or otherwise, for the partnership, is partnership property. [UPA § 8(1)]
i. Where there is no clear intention expressed as to whether property is partnership property, then courts
consider all the facts related to the acquisition and ownership of the asset. Some of the factors
considered are:
a. How title to the property is held
b. Whether partnership funds were used in the purchase of the property
c. Whether partnership funds have been used to improve the property
d. How central the property is to the partnership’s purposes
e. How frequent and extensive the partnership’s use is of the property
f. Whether the property is accounted for on the financial records of the partnership.
B. Rights and Interests
i. The property rights of an individual partner in the partnership property are (i) her rights in
specific partnership property, (ii) her interest in the partnership, and (iii) her right to participate
in the management of the partnership. [UPA §24]
a. Each partner is a tenant-in-partnership with her co-partners as to each asset of the partnership
[UPA §25(1)] (Each partner, collectively, owns the whole partnership).
1. Each partner has an equal right to possession for partnership purposes (but no right to
partnership property for any other purpose w/o consent of all other partners).
2. The right to possession is not assignable, except when done by all the partners individually or
by the partnership as an entity
3. The right is not subject to attachment or execution except on a claim against the partnership
4. The right is not community property
5. On the death of a partner, the right vests in the surviving partners.
b. A partner’s interest in the partnership is her share of the profits and surplus, which is
personal property. [UPA §26]
1. A partner may assign her interest in the partnership and such assignment will not dissolve the
partnership (unless partnership agreement says otherwise). [UPA §27(1)]
(a) The assignee has no right to participate in the management of the partnership. But the
assignee is liable for all partnership obligations.
(b)
C. Co-partners do not own any asset of the partnership; the partnership owns the asset and the partners
own interest in the partnership. The interest is an undivided interest.
II. Raising Additional Capital
A. Partnerships sometimes need to raise additional capital to finance their activities.
Sometimes the issue is addressed in the partnership agreement itself. Examples:
i. “Pro rata dilution” provision – permits a call to each partner for a certain sum and
provides for a reduction in partnership shares of any partner who does not contribute
the requested sum.
ii. Provision might allow partners to invest in the firm at a reduced price or require
partners to make loans that will bear interest at a higher rate.
iii. May provide for the sale of new partnership assets to people outside the partnership,
similar to a corporation’s placing new shares on the stock market.

16
III. The Rights of Partners in Management
A. UPA §18 sets out basic rights and duties, but these are default rules which can be
changed by agreeing otherwise (in partnership agreement).
i. §18(a) – Equal shares of profits per person. Losses follows profits.
ii. §18(b) – if a partner advances money on behalf of partnership, the partnership needs
to indemnify (b/c it’s the partnership’s expense, and partnership’s liabity).
iii. §18 (c, d): 
a. The distinction between contributions and loans.
b. No interest on capital contributions.
iv. §18(e):  All partners have equal rights in management – equal votes (even if sharing
of profits is unequal). Meaning a voice, a right to information, and a right to vote.
v. §18 (f): No partner entitled to salary for acting in partnership business
vi. §18(g):  black ball rule – need unanimous vote of all existing partners to become a
partner.
vii. §18(h): Any difference arising as to ordinary matters connected with the partnership
business may be decided by a majority of the partners.
viii. §18(i):  Distinction between legislative and constitutional matters
a. Constitutional matters - things that require change in partnership agreement
requires unanimous consent (this rule can't be changed)
b. Legislative matters (ordinary matters) - decided by majority vote (this is a default
rule, it can be changed in the partnership agreement).
B. The acts of a partner within the scope of the partnership business bind all partners;
all partners are severally and jointly liable for the acts and obligations of the
partnership (unless no authority to act & 3rd party knows the restriction). Partner who
is sued con then sue for percentage of contribution from other partner. A majority
of partners can make a decision and inform creditors and will thereafter not be
bound by acts of minority partners in contravention of the majority decision.
i. National Biscuit Company v. Stroud, P.140 (1959) – Stroud and Freeman enter into a
partnership to sell groceries. There were no restrictions in the partnership agreement
on the management functions or authority of either partner. Stroud notifies Biscuit
(Π) that he would not be responsible for additional bread delivered. But Freeman
orders bread, Biscuit delivers it. Partnership is dissolved, Stroud responsible for
winding up partnership’s affairs, and refuses to pay Biscuit.
a. Court holds that Freeman’s purchases of bread bound the partnership. The
purchase was an “ordinary matter connected with the partnership business” within
the scope of the business and Stroud could not be a majority (b/c only 2) of the
partners to make a decision otherwise.
C. Where equal partners exists, differences on business matters must be decided by a
majority of the partners.
i. Summers v. Dooley, 481 P.2d 318 (1971) – Summers & Dooley form partnership to
operate trash collection business. Summers wants to hire a 3rd person to help, but
Dooley says no. Summers hires someone anyway & paid him from his own funds.
Dooley finds out & objects. Summers then sues Dooley for reimbursement from
partnership funds for money paid to the 3rd person.
a. Dooley refused consent to hire the 3rd person & objected when he found out
Summers still did. A partner who has actively opposed expense incurred

17
 individually and for the benefit of one partner rather than partnership as a whole is
not liable for the cost
D. Partnerships are distinct entities from their partners. A partnership must indemnify
a partner for injuries that occurred in the ordinary course of the partnership
business. There is no corresponding right of indemnity for the partnership against
the partner.
E. The essence of a breach of fiduciary duty between partners is that one partner has
advantaged himself at the expense of the firm.
i. The basic fiduciary duties are:
a. a partner must account for any profit acquired in a manner injurious to the
interests of the partnership, such as commissions or purchases on the sale of
partnership property;
b. a partner cannot without the consent of the other partners, acquire for himself a
partnership asset, nor may he divert to his own use a partnership opportunity; and
c. he must not compete with the partnership within the scope of the business
ii. Day v. Sidley & Austin, 548 F.2d 1018 (1976) – Day was a senior partner &
chairman at Sidley, and signed an agreement for the firm to merge with another firm.
Then they set up a new location, despite Day’s objection. Day then resigned, saying
the relocation & appointment of a new co-chairman made his continued service with
the firm intolerable.
a. Day alleges misrepresentation by Sidley that no partner would be worse off
because of the merger, & he was worse off b/c no longer sole chairman. But Day
had no legal right for Day to remain chairman of the DC office. Also, even if he
did know this to begin with, & he changed his vote, it would have no effect, b/c
all that was needed was majority vote (not unanimous).
b. Day also alleges breach of Sidley’s fiduciary duty b/c they began the merger
negotiations w/o informing all partners & didn’t reveal changes that might occur
b/c of the merger. But the only breach would be if one partner has advantaged
himself at the expense of the firm, and this wasn’t the case here. Concealing
merger plans didn’t produce profit for the other partners or financial loss for
partnership as a whole.

PARTNERSHIP DISSOLUTION
I. Dissolution
A. Dissolution of a partnership does not immediately terminate the partnership. The
partnership continues until all of its affairs are wound up. [UPA §30]
B. Causes of Dissolution: Unless otherwise provided in the partnership agreement, the
following may result in dissolution:
i. Expiration of the partnership term
a. Even if partnership is for a fixed term, partners can still terminate at will. But
since this will be breach the other partners can sue for damages.
ii. Any partner can terminate the partnership at will (b/c a partnership is a personal
relationship which no one can be forced to maintain). Where the partnership is for a

18
 term or where it is a partnership at will but the dissolution is motivated by bad faith, it
may be a breach of the agreement.
iii. Assignment. Although an assignment of a partner’s interest is not an automatic
dissolution, an assignee can get a dissolution decree upon expiration of the
partnership term or at any time in a partnership at will [UPA §§30-32].
iv. Death of a partner. On the death of a partner, the surviving partners are entitled to
possession of the partnership assets and are charged with winding up the partnership
affairs without delay [UPA §37]. The surviving partners are also charged with a
fiduciary duty in liquidating the partnership and must account to the decedent’s estate
for the value of the decedent’s interest.
v. Withdrawal or admission of a partner. Partnerships only exist if same partners.
a. This only works if very few partners, where one person makes a difference. But in
a large partnership, it doesn’t work every time one partner leaves the partnership
changes. This is a default rule, which you can change.
b. Most partnership agreements provide that losing or admitting a new partner will
not result in dissolution. New partners may become parties to the preexisting
agreement by signing it at the time of admission to the partnership [UPA §13(7)].
When an old partner leaves, there are usually provisions for continuing the
partnership and buying out the partner who is leaving.
vi. Illegality. Dissolution results from any event making it unlawful for the partnership
to continue in business.
vii. Death or Bankruptcy. (Default rule) The partnership is dissolved on the death or
bankruptcy of any partner [UPA §31(4), (5)]
viii. Dissolution by court decree. Court may do this in its discretion. Some
circumstances may be insanity of a partner, incapacity, improper conduct, inevitable
loss, or whenever it is equitable [§32].
II. The Right to Dissolve
A. Dissolution by court decree – Significant disagreement between partners that
undermines the business of the partnership, makes it impossible to continue
i. “On application by or for a partner the court shall decree a dissolution whenever …
(c) A partner has been guilty of such conduct as tends to affect prejudicially the
carrying on of business, or (d) A partner willfully or persistently commits a breach of
the partnership agreement or otherwise so conducts himself in matters relating to the
partnership business that it is not reasonably practicable to carry on the business in
partnership with him. [UPA §32].
a. Owen v. Cohen, 119 P.2d 713 (1941) – Π and Δ were partners in a bowling alley,
with no duration time set. Π loans the partnership $6,986 to be paid back to him
from prospective profits. Bowling alley running at a profit, but then the partners
started having disagreement over how the business should be run, and these
conflicts affected the profitability. Π sues for dissolution.
1. Court found that Δ’s actions severely undermined the success of the
partnership. There were bitter, antagonistic feelings between the parties while
the arrangement required cooperation, coordination & harmony. The partners
were no longer able to carry on the business of their mutual partnership.
B. There is no such thing as an indissoluble partnership only in the sense that there
always exists the power, as oppose to the right, of dissolution. But without a legal

19
 right to dissolution, there will be damages because it is a breach of the partnership
agreement.
i. Collins v. Lewis, 283 S.W.2d 258 (1955) – Π and Δ entered into partnership to
operate a cafeteria. Π was to finance the project & Δ was to supervise development &
manage it. Π would be paid back from the profits, and the rest of the profits would be
split equally. When they opened, they were not making a profit. Δ said it was because
Π refused to pay additional development costs, so that money was coming out of the
revenue. Π sued for dissolution.
a. Π has the power to dissolve the partnership, but not the right to do so without
damages since his conduct is the source of the partnership problems and amounts
to a breach of the partnership agreement.
C. A partner at will is not bound to remain in a partnership, regardless of whether the
business is profitable or unprofitable. Exercising the power to dissolve, however,
must be exercised pursuant to the fiduciary duty of good faith.

III. The Sharing of Losses

A. In the absence of an agreement to the contrary, it is presumed that partners and
joint venturers intended to share equally in profits and losses. However, where one
partner or joint venturer contributes the capital while the other contributes skill
and labor, neither party is liable to the other for losses. (The reason behind this rule is
that in the event of loss, each party loses the value of his own capital or contribution).
B. RUPA (1997) § 401(b) expressly cites and rejects Kovacik: “Each partner is entitled to
an equal share of the partnership’s profits and is chargeable with a share of
partnership losses in proportion to the partner’s share of the profits.” [losses follow
profits]
IV. Buyout Agreements
i. Because partnerships result from contract, the partners’ rights and liabilities are
subject to the agreement made among them. The agreement here provided for a
buyout if one of the partners’ died. Although the exact provision in the
agreement calculated the value of the interest as less than the fair market value,
court says that parties must be bound by the contracts into which they enter,
absent a showing of fraud or duress in the inducement.
a. Buyout provision here – if the remaining partners choose to continue the business,
it must purchase the interest of the departed partner (interest that belongs to the
estate). Here, the buyout formula is the capital account of the deceased partner
plus the average of the prior 3 yrs’ earnings. (Capital acct = partner’s capital
contribution to partnership minus losses and reduced by any distributions already
made).
B. Four main aspects of the buyout agreement:
a. Trigger Events
1. Death
2. Disability
3. Will of any partner
b. Obligation to buy versus option
1. Firm
2. Other investors

20
 3. Consequences of refusal to buy
(a) If there is an obligation
(b) If there is no obligation
c. Price
1. Book value (assets-liability/ number of shares)
2. Appraisal (but who does the appraising?)
3. Formula (e.g. five time earnings)
4. Set price each year
5. Relation to duration (e.g. lower price in first five years)
d. Method of payment
1. Cash
2. Installments (with interest?)
e. Protection against the debts of partnership
f. Procedure for offering either to buy or sell
1. First mover sets prices to buy or sell
2. First mover forces others to set price

C. Other ways to create a system for determining the price of the buyout
i. If both parties solvent, set it up where one party names the price, and the other
decides whether to buyer. This is the most fair outcome. (think about 2 little children
sharing a piece of cake – one cuts it in half, the other gets to choose which half. This
way the one cutting will try to be as fair as possible – cutting it equally).
ii. Appraisal - but must determine what kind of appraisal
a. Each side picks an appraiser, and the 2 appraiser pick a 3rd appraiser (that's if
they have money)
iii. Base the amount on gross revenues
a. Small business, less money - most common formula is book value
1. Book value - something you need to generate anyway. But problem is that the
book value can easily be manipulated - must trust the accountant.
iv. Buy life insurance on the dead partner to ensure the dead partner is solvent
D. Limited partnerships
i. Holzman v. De Escamilla
a. Limited partner took control in business by controlling the funds and planting,
thus became exposed for the liability of the general partners.
b. Rule of Law: A limited partner will be held liable as a general partner if the
limited partner acts to take part in the control of the business
1. So what do you do if you want to control and protection? They should for an
LLC or an S type corporation.

NATURE OF THE CORPORATION

21
I. Promoters and the Corporate Entity
A. Southern-Gulf Marin Co. No. 9. Inc. v. Camcraft, Inc.
i. Basically you have to treat corporations fairly even before true incorporation. Even if
the papers are filed improperly. What is important is what the other party thought, e.g.
the other party was a corporation by estoppel.
ii. Rule of Law: A party can not justify the nonperformance of a contractual obligation
by the other party’s lack of corporate capacity or the lack of stated corporate capacity
a. Minority interest in a privately held company is one of the worst positions you
can have. Way to protect interest is that “I’ll make the investment, but need to
make sure that under certain circumstances that the company need to buy out my
shares at a fair price” Firm obligation to buy back

b. Hypo: Represent large corporation that is trying to purchase large tract of land.
Framers would charge more is they knew who the buyer is. However, it is set up
so he will not know. He has no right to know, and will not be told so.

II. The Corporate Entity and Limited Liability

A. Characteristics of the Corporation
i. Separate Legal Entity. A corporation is a separate legal entity (created by the law of
a specific state), apart from the individuals that may own it (shareholders) or manage
it (directors, officers, etc.). Thus, the corporation has legal rights and duties as a
separate legal entity.
ii. Limited Liability. The owners (shareholders) have limited liability; debts and
liabilities incurred by the corporation belong to the corporation and not to the
shareholders, since they are separate legal entities. (Also vice versa, corporation not
responsible for debts of shareholders.)
iii. Continuity of existence. The death of the owners (shareholders) does not terminate
the entity, since shares can be transferred.
iv. Management and control. Management is centralized with the officers and
directors. Each is charged by law with specific duties to the corporation and its
shareholders.
v. Corporate powers. As a legal entity, a corporation can sue or be sued, contract, own
property, etc.
B. Exceptions to the Limited Liability Rule – In some circumstances, the court may
“pierce the corporate veil” and dissolve the distinction between the corporate entity and
its shareholders so that the shareholders may be held liable as individuals despite the
existence of the corporation.
i. Fraud or Injustice. Where the maintenance of the corporation as a separate entity
results in fraud or injustice to outside parties (i.e. creditors).
ii. Disregard of corporate requirements. Where the shareholders do not maintain the
corporation as a separate entity but use it for personal purposes. The rationale is that
if the shareholders have disregarded the corporate form, then the entity is really the

22
 alter ego of the individuals and decisions made are for their benefit and not the
entity’s. This is most likely to occur with close corporations.
iii. Undercapitalization. Where the corporation is undercapitalized given the liabilities,
debts, and risk it reasonably could be expected to incur.
iv. Fairness. The veil may also be pierced in any other situation where it is only fair that
the corporate form be disregarded.

III. “Piercing the Corporate Veil”

A. Piercing the corporate veil is allowed whenever necessary to prevent fraud or to
achieve equity. Whenever anyone uses control of the corporation to further his own,
rather than the corporation’s business, he will be liable for the corporation’s acts.
i. Walkovsky v. Carlton, 18 N.Y.2d 414 (1966) – Π was severely injured in a taxicab
accident, and sues the cab driver, the corporation owning the cab, and the Δ. Δ owned
that corporation and 9 others, each corporation had 2 cabs each with the min $10k
liability insurance coverage required by state law. Π alleged that the corporations
operated as a single entity & constituted a fraud to the public.
a. Court says no reason to pierce the corporate veil.
1. (1) Nothing wrong with one corporation being part of a larger corporate
enterprise (i.e. subsidiary). The only issue would be whether there was a
disregard of the corporate form, but Π did not allege this. (2)
(Undercapitalization) The state has set minimum insurance requirements & all
other cab corporations have taken out the min insurance. If insurance
protection is inadequate, the remedy is the legislature.
b. Dissent: Corps were intentionally undercapitalized to avoid responsibility for
accidents, which were likely to happen. All income was continuously drained for
this purpose.
B. Alter Ego theory –Two requirements must be met before the corporate veil can be
pierced: (1) such a “unity of interest and ownership” that the corporation and the
individual are not separate personalities, and (2) circumstances are such that not
piercing the veil would “sanction a fraud or promote injustice.”
i. To determine whether a corporation is so controlled by an individual or another
corporation that the court would be justified in disregarding their separate
identities, courts looks to four factors:
a. The failure to comply with corporate formalities or to keep sufficient
business records
b. A commingling of corporate assets
c. Undercapitalization; and
d. One corporation’s treatment of another corporation’s assets as its own.
ii. Sea-Land Services, Inc. v. Pepper Source, 941 F.2d 519 – Π received a judgment
from Sea-Land for breach of contract, but when Π attempted to collect, Sea-Land was
dissolved. Π sues Sea-Land’s sole shareholder (Δ) and Δ’s other business entities. Π
wanted to pierce Sea-Land’s corporate veil so that Δ could be held personally liable,
then “reverse pierce” Δ’s other corporations (to get the money the other corporations
have). Court held that the corporate veil could be pierced.

23
 a. Unity of interest and ownership - There was no differentiation/separation between
the corporation and the owner. Δ used same office, same phone line, & expense
acct to run most of the corporations. None of the corporations ever held a
meeting. Δ borrowed funds from corporation for personal expenses, and the
corporations would borrow money from each other. Δ didn’t even have a personal
bank acct.
b. Separate corporate existences would sanction a fraud or promote injustice - must
be something more than just a creditor not being able to recover.
1. Comment: On remand, court found in Π’s favor, b/c by receiving countless
benefits at the expense of Π and other creditors, Δ insured that his
corporations had insufficient funds with which to pay their debts.
iii. When a parent corporation controls several subsidiaries, a subsidiary is not
liable for the actions of the other subsidiaries.
a. Roman Catholic Archbishop of San Francisco v. Sheffield, 15 Cal.App.3d 405
(1971) – Π goes t Switzerland and contracts to buy a dog for $175 from a Catholic
monastery, to be paid in $20 installments. Π makes 2 payments. Monastery
refuses to ship the dog until all payments made, plus additional fees, and refuses
to refund the money. Π sues the Roman Catholic Church (parent), the Roman
Catholic Archbishop of San Francisco (subsidiary) & others.
1. Unity of interest and ownership - Δ was a distinct legal entity from the
monastery had no knowledge of the contract, and no dealings with the
monastery. Π did not allege that Δ was involved in the transaction. Although
the monastery may have been an alter ego of the Catholic Church, that’s not
the case here. There is no respondeat superior between subagents.
2. Non-piercing would sanction fraud or promote injustice – Not enough that Π
won't be able to collect if not permitted to sue Δ.
IV. A parent corporation is expected to exert some control over its subsidiary.
When, however, a corporation is controlled to such an extent that it is merely the
alter ego or instrumentality of its shareholder, the corporate veil should be
pierced in the interest of justice.
a. In Re Silicone Gel Breast Implants Products Liability Litigation, 887 F.Supp.
1447 (1995) – Δ is the sole shareholder of MEC (they have a parent-subsidiary
relationship). Δ highly involved in MEC’s daily operations. MEC sued in tort &
Πs want to pierce the veil & hold parent liable.
1. There is sufficient evidence here that MEC is Δ’s alter ego.
2. To determine if a subsidiary is merely the alter ego of the parent, the
court must evaluate the totality of the circumstances, considering factors
above (see sea-land) [first five in this case always happen: (1) same directors
or officers, (2) they file consolidated taxes, (3) the subsidiary is
undercapitalized, (4) the subsidiary gets all its business from the parent, (5)
the parent uses the subsidiary’s property for its own, (6) the parent pays
expenses or wages for the subsidiary, (7) their daily operations are
commingled.]
b. To determine whether to pierce the veil in a parent-subsidiary situation, no
showing of fraud is required under DE law. Most states that require fraud only do
so in contracts cases, not torts.

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 1. Even if fraud required – MEC’s funds may be insufficient to satisfy Π’s
claims. Also, Δ may have induced ppl to believe it was vouching for MEC, so
allowing Δ to escape liabily would be unjust.
C. Limited partners do not incur general liability for the limited partnership’s
obligations simply because they are officers, directors, or shareholders of the
corporate general partner. Undercapitalization is no reason to open liability to
limited partners who control the general partner, but there’s the remedy of piercing
the corporation’s veil.
i. Frigidaire Sales Corporation v. Union Properties, Inc., 88 Wash.2d 400 (1977) –
Commercial is a limited partnership. Δs were limited partners of Commercial, and the
only general partner was Union, a corporation. Δs were also Union’s officers,
directors, and shareholders. Commercial breached contract with Π; and Π wants to
pierce Unions veil to make Δs liable.
a. Just b/c undercapitalized, can't go after the partners in Commercial. Need to
pierce the corporation’s veil. But here, no reason to pierce Union’s veil. Π entered
into K with Commercial, and Δs signed the contract only through their capacities
as officers of Union (Commercial’s general partner). Court refused to pierce veil,
and found that Δs “scrupulously separated” their actions on behalf of Union from
their personal actions, and Π never had cause to believe Δs were general partners
in Commercial.
ii. Contract vs Tort – Courts are more willing to pierce the veil b/c of
undercapitalization in tort cases than in contract cases. This is b/c in K cases, the Π
had an opportunity to investigate the financial resources of the corporation & had
chosen to do business with it. Almost like assumption of the risk.

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 SHAREHOLDER DERIVATIVE ACTION
I. Shareholder Derivative & Direct Action
A. Two Types:
i. §145(a) – Personal claims  covers expenses, judgment, and settlement
ii. §145(b) –derivative claims  covers only expenses (maybe, only if settlement, not a
judgment)
B. Derivative Suits. A shareholder may sue to enforce mgmt’s duties. If the claim is that
mgmt’s breach reduced the residual value of the business, the shareholder must due
derivatively in the name of the corporation.
i. Problem - A person with a relatively small stake in the residual value of a business
might want to bring derivative suit just to be bought off. Requiring the Δs to make
payment to the corporation reduces this temptation for the complaining shareholder.
The real party in interest here though, is the shareholder’s attorney, b/c he may
legitimately demand payment from the corporation in connection with a settlement.
C. Limiting Derivative “Strike” Suits
i. In order to limit “strike” suits and otherwise protect against over-deterrence, most
statutes limit shareholders who may bring derivative suits, and many states have
enacted statutes requiring the Π-shareholder in a derivative suit, under certain
circumstances, to post a bond or other security to indemnify the corporation
against certain litigation expenses if Π loses the suit.
a. When security must be posted. Depends on the statute; some say when Π owns
less than a specified % of stock; others say it is at the court’s discretion (&
demanded only when there is no reasonable possibility that the action could
benefit the corporation).
b. Who is entitled to security. In most states, only the corporation may demand
security & only its expenses may be paid. Some states allow directors/officers to
demand it & receive reimbursement.
c. Covered Expenses. Usually all expenses, including attorney’s fees. Also
expenses of officers/directors that the corporation has obligated to pay b/c it has
indemnified them may be covered (indemnification doesn’t usually apply for
fraudulent actions, only for actions taken in good faith).
ii. Cohen v. Beneficial Industrial Loan Corp., 337 U.S. 541 (1949) – Π brings
derivative action in federal court in NJ against Beneficial & some of its
mgrs/directors (Δs), alleging that Δs engaged in conspiracy to enrich themselves at
the corporation’s expense. Π owned only .0125% of the total stock. NJ statute
required less than 5% shareholders who bring a derivative action to post a security
bond; the lower court here required the bond and Π appealed.
a. A stockholder who brings a derivative action assumes a position of a
fiduciary nature. He sues as a representative of a class that did not elect him
as a representative as they elected the corporate director or manager. The
state has plenary power to impose standards promoting accountability,
responsibility, and liability upon such representation.
b. Constitutionality

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 1. Doesn’t violate due process clause since it only imposes liability & requires
security only for reasonable expenses.
2. Doesn’t violate the equal protection clause by making a classification based
on the financial interest the representative has in a corporation; the
classification serves only to insure some measure of good faith and
responsibility.
c. Erie Doctrine – using state law in federal court under diversity jurisdiction. The
statute is substantive, so federal court will apply NJ statute.
D. Direct Suits - If the claim is that mgmt’s breach deprived the shareholder of some other
right (like right to inspect shareholder list), the shareholder must sue directly in her own
name.
i. If the Π-shareholder brings suit alleging that management is interfering with the
rights and privileges of stockholders and is not challenging management’s acts
on behalf of the corporation, it is a personal suit. Since this is not a derivative
action, posting of a security bond is not required.
a. Eisenberg v. Flying Tiger Line, Inc., 451 F.2d 267 (1971) – shareholder brings
suit to prevent merger & reorganization, alleging that the purpose of the plan was
to dilute his voting rights. Lower court demanded that the Π post a security bond
& Π appeals.
1. Π is not challenging mgmt of the company on behalf of the corporation; Π
claims that he has been deprived of any voice in the operation of their
company. Therefore, the Court held that the action was personal, and not a
shareholder derivative action, so no bond is required. The statute only applies
to derivative actions.
E. Note on Settlements and attorney fees
i. When derivative suits reach settlement rather than proceeding to judgment, the
company can pay the parties’ attorneys’ fees. When a judgment is rendered against
the Δs, however, except as covered by insurance, the Δs generally will be responsible
for attorneys’ fees and possibly costs. Often, the real beneficiary on the Π’s side is his
attorney, who may accept a generous fee from the corporation to settle the lawsuit
while the corporate managers who brought harm on the corporation are relieved of
the risk of personal loss.
F. Note on Individual Recovery in a Derivative Action
i. In Lynch v. Patterson (1985), the Π, one of 3 shareholders, brought a derivative suit
against the other shareholders who, in managing the corporation, had increased their
own salaries, ultimately paying themselves an extra $266k. The court awarded the Π
damages in his individual capacity, reasoning that allowing a corporate recovery
would merely put the funds back in the hands of the wrongdoers.
G. The Demand Requirement. In order to deter frivolous suits, a complaining shareholder
is required to exhaust internal remedies before bringing suit. So before a shareholder
may bring a derivative suit, he must request that the directors bring the suit, and
they must refuse. Now the Business Judgment Rule comes into play – if the directors
refuse on the basis of a good faith business judgment, the ct will dismiss the
derivative suit. However, directors may sometimes refuse in bad faith.
i. Purpose of the demand requirement:

27
 a. Creates a form of alternative dispute resolution by providing corporation directors
with opportunities to correct alleged abuses,
b. Helps insulate directors from harassment by litigations on matters clearly within
the discretion of directors, and
c. Discourages “strike suits” commenced by shareholders for personal gain rather
then for the benefit of the corporation.
ii. When a claim of harm belongs to the corporation, it is the corporation, through
the Board, that must decide whether or not to pursue the claim. Shareholder
derivative actions impinge on the Board’s managerial freedom; therefore, when
a shareholder files a derivative action, he/she must show either Board rejection
of his/her pre-suit demand, or justification why demand wasn’t made (Futility
Exception).
a. Grimes v. Donald, 673 A.2d 1207 (1996) – Π-shareholder claimed that the Bd of
Directors failed to use due care, committed waste, approved excessive
compensation, and unlawfully delegated its duties & responsibilities by entering
into an agreement with the CEO which provided that the CEO could make
decision w/o interference from the Bd, & if Bd did interfered, CEO could get
damages.
1. An abdication claim can be stated by a stockholder as a direct claim, as
distinct from a derivative claim, but here the complaint fails to state a claim
upon which relief can be granted. When a stockholder demands that the board
of directors take action on a claim allegedly belonging to a corporation and
demand is refused, the stockholder may not thereafter assert that the demand
is excused with respect to other legal theories in support of the same claim,
although the stockholder may have a remedy for wrongful refusal or may
submit further demands which are not repetitious.
iii. Futility Exception to the demand requirement: no demand necessary when it is
evident that directors will wrongfully refuse to bring such claims.
a. To qualify for the futility exception, a shareholder must allege with particularity
that:
1. Self-Interest. A majority of the bd of directors is interested in the challenged
transaction, by virtue of self-interest in the transaction or “control” by a self-
interested director
2. Incapacity. that the bd of directors did not fully inform themselves about the
challenged transaction to the extent reasonably appropriate under the
circumstances, or
3. Lack of sound business judgment. that the challenged transaction was so
egregious on its face that it could not have been the product of sound business
judgment of the directors.
b. Marx v. Akers, (Not Done In Class) – Without making a demand on Bd of IBM
(Δ), Π filed a shareholder derivative suit alleging that the Bd had wasted
corporate assets by awarding excessive compensation to IBM’s exec officers & to
its outside directors.
1. Excessive compensation paid to exec officers - no futility. Less than a
majority of the directors rec’d such compensation, indicating that the bd was
not interested.

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 2. Excessive outside director compensation – futility (yes). The outside directors
comprised a majority of the Bd indicated that a majority of the Bd was self-
interested. So demand here is excused, but ct dismissed the complaint b/c
there was no wrong to the corporation.
(a) No cause of action – Π did not allege compensation rates excessive on
their faces or other facts that would have questioned whether the
compensation was fair to the corporation when approved, the good faith of
the directors setting those rates, or that the decision to set the
compensation could not have been a product of valid business judgment.
H. The Role of Special Committees – Bd of Directors may create a special independent
committee composed of disinterested directors to decide on whether to bring the
derivative action.
i. A Board may legally delegate authority to a committee of disinterested directors
when the Board finds that it is tainted by the self-interest of a majority of directors.
The Bd is not abdicating b/c the decision to create a committee is revocable.
ii. An action must be dismissed if a committee of independent and disinterested
directors conducted a proper review, considered a variety of factors and reached
a good-faith business judgment that the action was not in the best interest of the
corporation.
iii. A committee must show that (i) its members are disinterested and used proper
methodology, (ii) the committee is independent, (iii) it proceeded in good faith,
and that (iv) it reasonably investigated the claim (procedural due process).
a. If it recommends no lawsuit then Π usually loses (see Zapata case)
b. In Re Oracle Corp. Derivative Litigation, 824 A.2d 917 (2003) – Π-shareholders
file derivative suit alleging insider trading by 4 members of the Bd. Bd forms
special litigation committee to investigate. The 2 Bd members who were named
on the committee joined the Bd after the events alleged took place & were both
Stanford professors. The committee also got expert advisors to help investigate.
After the committee conducted an extensive investigation, they concluded that the
corporation should not pursue the derivative suit. Issue is whether this was an
Independent & Disinterested Committee.
(a) Facts revealed during discovery: (i) one of the Δ-director was prof to one
of the committee members & they have remained in contact with each
other & both served on a Stanford committee, (ii) another Δ-director well-
know alumnus of Stanford & generous contributor, (iii) yet another Δ-
director had made major charitable contributions to Stanford.
(b) Although none of the Δs could deprive the committee members of their
prof positions at Stanford b/c they have tenure, ct notes that it’s not the
only motivating factor of human behavior. Social influence may also
direct behavior. The committee has not met it’s burden of showing their
independence. The ties here are substantial enough to raise a
reasonable doubt about the committee’s ability to impartially decide
whether the derivative suit against the Δs should proceed.

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 CORPORATE ROLE & PROFIT MAXIMIZATION

I. The Role and Purpose of the Corporation

A. Corporate Purpose and Power
i. Corporations must have a purpose or goal. So the question is “What purposes are
within the bounds set by the articles of incorporation and statutory law under which
the corporation was formed?”
ii. State law often sets forth the acts that a corporation may legally perform. These acts
should be in the aid of a proper corporate purpose.
iii. If the corporation engages in an improper purpose or uses an improper power, that
purpose or act is said to be “ultra vires” (beyond the corporation’s powers).
iv. Powers of a Corporation
a. A corporation has express power to perform any act authorized by the general
corporation laws of the state & those acts authorized by the articles of
incorporation.
b. In most states, corporations also have implied power to do whatever is
“reasonably necessary” for the purpose of promoting their express purposes
and in aid of their express powers, unless such acts are expressly prohibited by
common or statutory law.
B. Corporate Social Responsibility
i. Debate about the responsibility of corporations:
a. A corporation’s objective should be to produce the best possible goods and
services, that no other legal standard is enforceable, and that any other standard
allows an unhealthy divorce between management (making decisions) and
ownership; VS
b. Corporations have a “social responsibility” and that they must balance the
interests of stockholders, employees, customers, and the public at large.
C. Charitable Contributions
i. Charitable contributions tend reasonably to promote corporative objectives, and
is a lawful exercise of implied corporate power.
a. ***A.P. Smith Mfg. Co. v. Barlow, 346 U.S. 861 (1953) – Corporation gave a
gift of $1500 to Princeton University; the gift was challenged by a shareholder.
Corporation’s president & other execs say the gift was an investment (qualified
graduates would work for them), that it created a favorable environment for the
company, and that the public had a reasonable expectation of such “socially”
oriented contributions by the corporation. It’s more like advertising; they’re
furthering their corporate image.
1. A corporation may participate in the creation and maintenance of community,
charitable, and philanthropic funds as the directors deem appropriate and will,
in their judgment, contribute to the protection of corporate interests.
2. Del C. § 122: Ever corp created under this chapter shall have the power to...
(9) Make donation for public welfare or for charitable, scientific or
educational purposes
D. Business Judgment Rule
i. A corporation is organized primarily for profit of the stockholders, and the
powers of the directors are to be used for that end. However, directors have
30
 reasonable discretion, to be exercised in good faith, to act for this end. Directors
also have the power to declare dividends and their amounts. Their discretion will
not be interfered with unless they are guilty of fraud, misappropriation or bad
faith (when there are sufficient funds to do so w/o detriment to the business).
a. ***Dodge v. Ford Motor Co., 204 Mich. 459 (1919) - Shareholders of Ford
brought suit to prevent expansion of a new plant and to compel the director to pay
add’l special dividends. Corporation had surplus and Ford wanted to use it to
increase production and cut prices of cars to benefit the public (reinvestment).
1. Here, Ford’s discretion to expand the business and cut car prices is upheld.
Past experience shows Ford mgmt has been capable & acted for the benefit of
its shareholders, & it doesn’t look like any detriment to shareholders’
interests. Ford’s expansion plans can still be carried out & there would still be
surplus available for dividends. So court says the surplus dividends after that
should be distributed.
ii. It is not the function of the courts to resolve a corporation’s questions of policy
and management, and the judgment of directors will be accepted by the courts
unless those decisions are shown to be tainted by fraud, illegality or a conflict of
interest.
a. Shlensky v. Wrigley, 95 Ill.App.2d 173 (1968) – minority shareholder of
corporation that owns Wrigley field & the Chicago Cubs brought a derivative
suits against directors for refusing to install light on the field & to schedule night
games for the Cubs as other teams had done to increase revenues. Motivation in
refusing to do this was the view of the majority shareholders that it wanted to
preserve the surrounding neighborhood & believed baseball was a daytime sport.
1. Business judgment rule – presumption of good faith. No evidence that
installing lights and scheduling night games will bring extra revenue, and
there’s a detrimental effect on the neighborhood (if it brings neighborhood
down, fans may not want to see games in poor areas; property value might go
down). No evidence that the motives of directors are contrary to the best
interests of the corporation and stockholders.
2. Corporations are not obliged to follow the direction taken by other,
similar corporations. Directors are elected for their own business
capabilities and not for their abilities to follow others.

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THE LLC
LLCS AND PIERCING THE “VEIL”
I. The Operating Agreement
A. Although LLCs are governed by statute, LLC statutes generally provide that the members
can adopt an operating agreement with provisions different from the LLC statute.
Generally, the operating agreement will control.
B. Operating Agreement controls if there is no conflict with mandatory statutory
provisions.
II. Piercing the "LLC" Veil
A. It is unlcear whether corporate principals of law, like piercing the veil, applies to LLCs.
B. Uniform LLC Act § 303(b) – “The failure of a limited liability company to observe the
usual company formalities or requirements relating to the exercise of its company powers
or management of its business is not a ground for imposing personal liability on the
members or managers for liabilities of the company.”
C. Sometimes, though, the court will hold that the LLC veil may be pierced in a manner
similar to piercing the corporate veil.
i. Kaycee Land and Livestock v. Flahive, 46 P.3d 323 (2002) – Π entered into a K with
FOG, which allowed FOG to use Π’s real property. Π alleges that during its use of the
property, FOG caused environmental contamination of the property. FOG has no
assets, and Π wants to pierce the veil to hold Δ, FOG’s managing member, liable.
a. Every state that has enacted LLC piercing legislation has chosen to follow
corporate law standards. There is no reason to treat LLCs differently than
corporations. If members of an LLC fail to treat the LLC in the manner
contemplated by statute, they should not be free from individual liability.

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 DUTIES (OFFICERS, DIRECTORS AND OTHER INSIDERS)
II. Introduction
A. Directors are normally held to have the duty of mgmt of the corporation. These duties are
normally delegated to the officers; so, the directors must supervise the officers. The legal
duties of the directos and officers are owed to the corporation, so the performance of
these duties is usually enforced by an action on behalf of the corporation brought by an
individual shareholder (derivative action).
B. Fiduciary Relationship of directors to the corporation. Directors have fiduciary duty
to corporation and the mgmt of its affairs, since they manage on behalf of shareholders.
i. Duty of Loyalty. Directors are bound by the rules of fairness, loyalty, honesty and
good faith in their relationship, dealings and mgmt of the corporation, as are officers.
ii. Duty of reasonable care. Directors must exercise reasonable care, prudence, and
diligence in the mgmt of the corporation.
iii. Business Judgment. When a matter of business judgment is involved, the
directos meet their responsibility of reasonable care and diligence if they
exercise an honest, good-faith, unbiased judgment. When this standard is
applied, a director acting in good faith would only be liable for gross negligence
or worse.
COURTS WILL NOT SECOND GUESS A BUSINESS DECISION IF IT WAS MADE
IN GOOD FAITH, WAS INFORMED, AND HAD A RATIONAL BASIS.
III. The Duty of Care
A. Courts will not interfere with the business judgment of the Board unless it appears
that the directors have acted or are about to act in bad faith and for a dishonest
purpose. More than imprudence or mistaken judgment must be shown.
i. Kamin v. American Express Company, 54 A.D.2d 654 (1976) – Πs (minority
stockholders) bring derivative suit against Δ. Π claims that a certain dividend that is
to be paid by Δ is a waste of corporate assets, and demanded that Δ rescind the
distribution, but Δ rejected the demand.
a. The question of whether a dividend should be delcared or a distribution of some
kind should be made is exclusively a matter of business judgment for the Bd.
Mere errors of judgment are not sufficient, so not enough to allege that the Bd
made an imprudent decision. There is no claim of fraud or self-dealing, and no
contention that there was any bad faith or oppressive conduct.
b. The Bd carefully considered Π’s objections and unanimously rejected them.
B. The determination of whether a business judgment is an informed one turns on
whether the directors have informed themselves, prior to making a business
decision, of all material information reasonably available to them. The concept of
gross negligence is the proper standard for determining whether a business
judgment reached by a board of directors was an informed one.
i. ***Smith v. Van Gorkom, 488 A.2d 858 (1985) – Van Gorkom (Δ), Trans Union
CEO, began to explore the opportunity to sell to a company w/ more taxable income.
CFO tells him a leveraged buy-out by mgmt at $50/share would be easy, but
$60/share difficult. CEO said he would take $55/share for his shares. CEO then met
with a corporate takeover specialist, who agreed to make a cash-out merger offer at

33
 $55/share. Senior mgmt & CFO responded negatively to this, but he still brought it to
the Bd. CEO gave the Bd a 20 min presentation & the Bd approved the proposed
Merger agreement, w/o reserving the right to actively solicit alternate offers
($55/share higher than market price of $39/share).
a. Πs attacking a Bd decision must rebut the presumption that its business judgment
was an informed one. Directors are liable if they were grossly negligent in
failing to inform themselves. Directors did not adequately inform themselves as
to (1) the CEO’s role in forcing company’s sale & in establishing the per share
purchase price, and (2) the intrinsic value of the company (not necessarily
$39/share market). They were grossly negligent in approving the sale in such a
short period of time & without important info.
b. The Bd breached their fiduciary DUTY OF CARE to stockholders by (1)
failure to inform themselves of all info reasonably available to them and
relevant to their decision to recommend the merger and (2) failure to disclose
all material info such as a reasonable stockholder would consider important
in deciding whether to approve the offer.
c. Dissent - Experienced directors such as these are not easily taken in by a "fast
shuffle." Wouldn’t have entered into a multi-million dollar corporate transaction
without being fully informed.
ii. Brehm v. Eisner, 746 A.2d 244 (2000) – Disney hired Ovitz as President;
employment agreement approved by Bd contained a generous severance package in
the event Ovitz left Disney before 5yr term over and not fault of Ovitz. Shortly after,
problems with Ovitz’s performance arose. Bd allowed Ovitz to terminate the K under
the no-fault provision, & so Ovitz got the severance package which ended up being
valued at over $140million. Π-shareholders filed derivative suit alleging Bd of
directors breached their fiduciary duty in (1) approving an excessive & wasteful
employment agreement and (2) in approving the no-fault termination of the
employment agreement.
a. The standard for judging the informational component of the Bd’s decision
does not require that it be informed of every fact. The Bd is only required to
be reasonably informed.
1. Although the Bd did not calculate the exact amt of the severance payout, it
was fully informed of the manner the payout would be calculated.
b. Reliance on an expert’s opinion is entitled a presumption that the Bd
exercised proper business judgment in so relying. Π may rebut that
presumption by showing that the reliance was not in good faith or that the
expert was not selected with due care.
1. No evidence that reliance not in good faith or expert not selected with due
care.
c. A Bd’s decision on Exec compensation is entitled to great deference. It is the
essence of business judgment for a Bd to determine if a particular individual
warrants high compensation, and the ct will not second-guess the Bd, unless
the transaction is so egregious on its face that the Bd cannot meet the
business judgment test.

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 1. Parties negotiated for severance payment, & Bd considered the value of the
employee vs the value of the contract. At time K negotiation, other companies
also offering very attractive compensation packages to Ovitz.
d. Agreement limited good cause for termination only to gross negligence or
malfeasance, & Ovitz’s performance did not rise to this level. So they had to
approve the no-fault.
C. Directors must discharge their duties in good faith and with that degree of diligence,
care and skill which ordinary prudent men would exercise under similar
circumstances in like positions. A lack of knowledge about the business or failure to
monitor the corporate affairs is not a defense to this requirement.
a.  A director can be personally liable, even to third parties, if they neglect to
provide the ordinary care of staying current with corporate affairs as one would
normally do in that position, and that neglect is the proximate cause of the
damages.
ii. Francis v. United Jersey Bank, 432 U.S. 814 (1981) – Mrs. Pritchard becomes
director of P&B after her husband dies. She wasn’t involved in day-to-day ops and
knew almost nothing about the business, and didn’t check anything. Her sons
misappropriated millions and corporation went into bankruptcy.
a. Directors have a duty to act in good faith as ordinary prudent persons would under
similar circumstances in like positions. This standard is a relative concept,
depending on the kind of corporation, the director’s corporate role, and the
particular circumstances.
b. Generally, director should have at least basic understanding of corp’s business
and knowledge about its ongoing activities, which reqs a general monitoring of its
affairs and policies (not necessarily detailed inspection of day-to-day affairs).
Director has responsibility to attend board meetings and regularly review financial
statements. If there is illegal conduct, there is a duty to object, and possibly take
reasonable means to prevent such conduct or resign. Mrs. Pritchard didn’t fulfill
any of the director’s obligations.
c. Her failure to act contributed to the continuation of the misappropriation (if she
had reviewed the financial statement she would have noticed it), and proximately
caused it.
IV. The Duty of Loyalty
A. Directors and Managers – Duty of loyalty means that the directors must place the
interests of the corporation above their own personal gains. Problems arise though b/c
directors have other business involvements (causing a conflict of interest), & it is often
for this reason that they are placed on the Bd.
i. Rules to determine whether a conflict of interest transaction is voidable:
a. At early common law, the rule was that any contract between a director and her
corporation, whether fair or not, was voidable.
b. Disinterested Majority Rule. Voidable only if the director had not made a full &
complete disclosure of the transaction of the transaction (its value, her interest,
profit, etc.) to an “independent Bd” (quorum of disinterested directors), or the
transaction was shown to be unfair and unreasonable to the corporation. Director
has the burden of proof as to show the fairness of the transaction.

35
 c. Whether the transaction is fair to the corporation. Part of the “fairness”
requirement is that the director’s interest be fully disclosed, however. If the Bd is
not disinterested, the contract will be given very close scrutiny.
ii. If a director has a conflict of interest with a corporation’s transactions, the
motives of the directors are questioned, and the court will examine the conflict
with the most scrupulous care. The director has the burden to show not only
good faith in the transaction, but also the inherent fairness to the corporation.
a. Bayer v. Beran, 49 N.Y.S.2d 2 (1944) – Π-shareholders filed suit against the
company’s directors (Δs) alleging that the directors were negligent in selecting the
type of radio program during which to advertise, & that the directors were
motivated by the purpose of fostering the singing career of the President’s wife,
who was used in the commercials to sing.
1. It was for directors to decide whether or not to use radio ads, how much to
spend, and during which programs (business judgment rule).
2. Regarding the fact that Pres’s wife would benefit
(a) Wife is a competent singer & no evidence that another singer would have
enhanced the quality of the ad. She was one of many singers used, and was
in fact paid less than the other singers.
(b) As long as the ad served a legitimate and useful corporate purpose, the
fact that the wife might benefit is not enough to show breach of duty.
iii. A corporate transaction in which directors had an interest other than that of the
corporation is voidable unless the directors can show the transaction was fair
and reasonable to the corporation
B. Corporate Opportunities
i. The duty of loyalty prevents directors and officers from taking opportunities for
themselves that should belong to the corporation.
1. Directors/Officers may not:
(a) use corporate property/assets for personal uses or to develop his own
business
 Note: Although can’t use corporate assets to compete, a fiduciary may
leave the corporation & form a competing business. But the conduct of
the fiduciary while still with the corporation & preparing to leave to
form new business may be questioned.
(b) assume for himself properties or interests in which the corporation is
“interested” or can be said to have a tangible “expectancy” or which are
important to corporation’s business or purposes.
2. Defenses to charge of usurping corporate opportunity
(a) Opportunity was presented to Δ in individual capacity, not as fiduciary of
corporation
(b) Corporation is unable to take advantage of the opportunity. Officer/dir
may take advantage of corporate opportunity if it is disclosed to the
corporation first, and it is unable to take advantage.
(c) Corporation refuses the opportunity. If the corporation, by independent
directors or SH, turns down an opportunity, then fiduciaries may take
advantage of the opportunity.

36
 ii. A director may not seize for himself an opportunity from his corporation, when
(1) it would present a conflict of interest between the director and his
corporation, (2) the corporation is financially able to undertake the opportunity,
(3) the opportunity is in the line of the corporation’s business, and (4) is an
opportunity in which the corporation has an interest or a reasonable expectancy
of interest, and is of practical advantage to the corporation.
a. In Re eBay, Inc. Shareholders Litigation, 2004 WL 253521 – eBay retained
Goldman Sachs as lead underwriter of its IPO (initial public offering). Goldman
“rewarded” favored clients, including director/officers of eBay by allocating to
them thousands of IPO shares at the initial offering price, and they made huge
profits. Other SHs sued those eBay directors/officers (Δs) for usurping corporate
opportunity. Δs argue that this was just a collateral investment, not a corporate
opportunity.
1. eBay was financially able to exploit the opportunity in question. eBay was in
the business of investing in securities; investment was in fact integral to
eBay’s cash mgmt strategies & a significant part of its business. It doesn’t
matter that these were considered risky investments; the fact is that eBay was
never given an opportunity to consider the risks. Although not every
advantageous opportunity that comes to a director will be a corporate
opportunity, here the below-market investment was offered as a direct reward
for their dealings with Goldman Sachs, and this conduct placed the Δs in a
position of conflict with their duties to the corporation.
C. Dominant Shareholders
i. Generally, shareholders hold no duty to the corporation. SH can use info and give it
to a competitor, use dividends to set up a competitor. SHs are not agents of the
corporation, and are not responsible to it. BUT this rule changes when the shareholder
dominates the corporation.
ii. Majority shareholders have a fiduciary relationship to the corporation and the
minority SH.
a. This duty is manifest in several circumstances:
1. If a majority SH deals with the corporation (such as a contractual
relationship), the transaction will be closely scrutinized to see that minority
SH are treated fairly.
2. Also in corporate transactions, where the majority has the voting power to
effectuate a transaction, the effect on minority SH may be reviewed by the
courts to see that the majority acted in “good faith” and not to the specific
detriment of the minority SH.
b. A parent owes fiduciary duty to its subsidiary in parent-subsidiary dealings.
When fiduciary duty is combined with self-dealing – when parent is on both
sides of transaction – the intrinsic fairness standard applies. This standard
involves a high degree of fairness and a shift in the burden of proof to the
parent to prove that its dealings with the subsidiary were objectively fair.
1. Sinclair Oil Corp. v. Levien, 280 A.2d 717 (1971) – Δ (Sinclair) owned 97%
stock of a subsidiary. Δ appointed Bd members & officers. Then Δ drained off
dividends from subsidiary to meet its own needs for cash; the dividends
exceeded current earnings. Π-SH claimed this limited subsidiary’s ability to

37
 grow and also that Δ had failed to pay on time for oil purchased from
subsidiary & Δ did not purchase minimum contractual amounts per K.
(a) Dividends – no self-dealing. b/c parent did not receive anything from the
subsidiary to the exclusion or detriment of minority SH. They shared pro
rata in the dividend distribution. L
(b) Limiting ability to grow – since Δ did not usurp any opportunities that
normally would have gone to the subsidiary, the BJR applies, & ct will not
disturb the transaction unless there is a showing of gross overreaching,
which there was not. L
(c) Contract – Δ rec’d the benefits of the K, so it must comply with its
contractual duties. Under the intrinsic fairness standard, Δ could not meet
its burden to prove that its causing the subsidiary to not enforce the K was
intrinsically fair. W
c. The majority has the right to control; but when it does so, it occupies a
fiduciary relation toward the minority, as much so as the corporation itself
or its officers and directors.
1. Zahn v. Transamerican Corporation, 162 F.2d 36 (1947) – Π owned class A
common stock. Δs owned almost all of class B stock; so Δ controlled the Bd.
Upon liquidation, preferred stock got set amount, and Class A got double what
Class B got. Assets worth a lot more than the SHs thought. When they
liquidated the assets, they paid off the preferred shares & then paid itself
(since it controlled almost all of class B stock). Πs (Class A SH) sued,
claiming they should have rec’d $240 per share, not the $80 per share they
actually got.
(a) A majority SH may vote according to its own interests, but also has a
fiduciary duty to the corporation and the minority SHs the same as the
dirs. Actions taken by the majority must, therefore, meet standards of good
faith & fairness.
(b) Disinterested directors could have called the Class A stock. But here, the
directors were controlled by majority SH. Directors owed the duty of
acting in best interests of all SHs, these only acted in bests interests of
majority SH.
(c) There was no business purpose for call of Class A, then liquidation except
to benefit Class B SHs at expense of Class A SHs.
D. Ratification - Ratification is not a complete defense. SH must be disinterested and
well-informed to properly ratify a transaction
i. DE corporation statute §144: A contract or transaction btwn a corporation and one or
more of its directors or officers will not be void or voidable solely for this reason if
the contract or transaction is fair as to the corporation as of the time it is authorized,
approved or ratified by the board of directors, a committee, or the shareholders.
ii. When a transaction is properly ratified by SHs, the transaction is not voidable
simply b/c interested directors participated; in this case, the Π still has the
burden proof to demonstrate that the terms of the transaction are so unequal as
to amount to a gift or waste of corporate assets. However, if a majority of the
shares voted were cast by interested SHs, the Bd is not relieved of its burden of
proving fairness.

38
 iii. In Re Wheelabrator Technologies, Inc. Shareholders Litigation, 663 A.2d 1194
(1995) – Waste bought 22% of WTI stock & elected 4 of its directors to WTI’s 11-
member Bd. Waste & WTI began negotiating merger, unanimously approved by non-
Waste directors. WTI SHs file against directors claiming that proxy statement was
materially misleading & that the WTI Bd didn’t carefully consider the proposal b/c
meeting only lasted 3 hrs.
a. Directors have the fiduciary duty to disclose fully and fairly all material facts
within its control that would have a significant effect upon a stockholder
vote.
1. The 2 corps had business relationship for > 20 yrs. This would indicate that
WTI had a substantial working knowledge of W before the actual merger
discussion.
2. Merger vote was approved by a fully informed vote of a majority of SHs.
Since this vote was fully informed, the claim that the board failed to exercise
due care in negotiating and approving the merger must be extinguished.
b. When a Bd’s action has been ratified by SHs, the standard of review and
burden of proof depends on the type of underlying transaction:
1. In “interest director” transactions, approval by fully informed,
disinterested SHs invokes the BJR which limits judicial review to issues of
waste or gift.
2. In transactions btwn the corporation & a controlling shareholder (usually
parent-subsidiary mergers), the standard of review is normally entire
fairness, with the directors having the burden of proof.
c. Here, Waste was not a majority shareholder, so standard of review is BJR.

E. Obligation of Good faith

i. Compensation
a. See Disney Case, Brehm v. Eisner, Above (p. 33)
b. Transunion decision seemed worse than the Disney decision, but why did the
second group get off free?
1. First, in Disney an outside expert was hired
2. Secondly, compensation is an ordinary business decision, not usually
questioned, sale of the business is not
3. Since even under these facts there is no liability,

ii. Oversight
a. Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362 (2006) –
Corporation ended up paying $50million in fines and penalties to fed govt to
settle charges against corporation b/c it had failed to file “suspicious activity
reports” as required by statute & money-laundering regulations. Πs file derivative
suit against directors, claiming directors breached their duty to act in good faith
b/c the company’s compliance program was not adequate to prevent the
violations.
1. Ct held that the “oversight” standard in Caremark was the appropriate
standard for director duties with respect to corporate compliance issues.

39
 (a) Conditions for director oversight liability: (a) directors utterly failed
to implement any reporting or info system or controls; or (b) having
implemented such a system/controls, consciously failed to monitor or
oversee its operations.
iii. 3 most common examples of bad faith:
a. Fiduciary intentionally acts with a purpoise other than that of advancing the
interests of the corp.
b. Fed. acts with intent to violate an applicable positive law.
c. Fed. intentionally fails to act in known duty to act

*Duty of loyality “trumps” the duty of care, i.e. if in bad faith, then there is no business judgment
defense available.

DISCLOSURE AND FAIRNESS

I. Def’n of a Security
A. If something is called stock, it is probably a security. Shares of stock are almost “per se”
a security, can be a privately or publically held.
i. Robinson v. Glynn
ii. Were originally a corporation, restructured as an LLC, in both cases stock was
security.

II. Registration Process

A. Doran v. Petroleum Management Corp.
i. Sued for rescission, based on failure to register. For there to be an obligation to
register, the interest had to be a security. Reason it is a security, is that it is like stock.
This is a threshold question.
ii. ROL: Absent a registration statement, factors that determine whether an offering is
private include “the number of offerees and their relationship to each other and the
issuer, the number of units offered, the size of the offering, and the manner of the
offering”.

Hypo: Failure to disclose. Invest for $10 a share, when the information not disclosed comes out,
the share are now worthless.
 Who can you sue? 
o Anyone who signed registration statement, directors, other experts, the
underwriter(s),
 Have the benefit of the “due diligence defense”
o Suit would be for the difference in price (in this case $10 X # of shares purchased)

40
  Escott v. Barchris Constructions Co.
 Facts: Constructed bowling alleys, then went bankrupt. Sold, in a public sale,
ventures. Misstated the financial situation of the company when the shares were sold.
Class action suit was brought.
 Due diligence cannot be pleaded by the issuer (in this case BarChris)
 Issue: On the main issue of liability:
1) did the registration statement contain false statements of fact, or did it omit to
state facts which should have been stated in order to prevent it from being
misleading;
2) if so, were the facts which were falsely stated or omitted "material" within the
meaning of the Act;
3) if so, have defendants established their affirmative defenses?

 Marwicks is only liable for the expert part, not the whole statement.

III. Federal Law – Rule 10b-5

A. Rule 10B-5 – makes it unlawful in connection with the purchase or sale of any security
for any person, directly or indirectly by the use of any means or instrumentality of
interstate commerce, or of the mails, or of any facility of any national securities
exchange, to:
i. Employ any device, scheme, or artifice to defraud
ii. Make any untrue statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in the light of the circumstances
under which they are made, not misleading.
iii. Engage in any act, practice, or course of business conduct which operates or would
operate as a fraud or deceit upon any person
IV. The elements of a 10b-5 cause of action
A. The person is an “insider.” Two elements of an insider:
i. The person must have a relationship giving access, directly or indirectly, to
information intended to be available only for a business purpose and not for the
personal benefit of anyone.
ii. There must be the presence of an inherent unfairness where a party takes advantage of
such information, knowing it is unavailable to those with whom he is dealing.
B. Materiality
i. Basic Inc. v. Levinson, 485 U.S. 224 (1988) – officers & directors of Basic, including
Δs, opened merger discussion with Combustion. Basic denied 3 times it was
conducting merger negotiations. Then Basic halted trading saying it had been
approached; later announced that the Bd approved Combustion’s $46/share tender
offer. Πs-SHs sold their stock after the denial and before the trading halt. They sued
under Rule 10b-5.
a. Materiality: There must be a substantial likelihood that the disclosure of the
omitted fact would have been viewed by the reasonable shareholder as
having significantly altered the ‘total mix’ of information made available.
Materiality will depend at any given time upon a balancing of both the

41
 indicated probability that the event will occur and the anticipated magnitude
of the event in light of the totality of the company activity.
1. Mergers are too uncertain to occur. Therefore, it is difficult to ascertain
whether an investor would have considered the omitted information
significant at the time.
2. A denial of merger negotiations cannot itself render them material because
Rule 10b-5 requires the Π to show that “the statement were misleading as to a
material fact,” not just that they were false or incomplete.
3. Case is remanded to determine whether or not the fact was material.
C. Reliance
i. Reliance provides a causal connection between a Δ’s misrepresentation and a Π’s
injury.
ii. Basic Inc. v. Levinson, 485 U.S. 224 (1988) - see above
a. Fraud on the market theory
1. However, requiring Π to show reliance (by acting differently had the omitted
material info been disclosed or if misrepresentation never made) places an
unrealistic evidentiary burden on him.
2. So the court will presume reliance b/c market price of shares reflect
publicly available information and an investor relies on that information
to determine the price (and thus make decisions). Δ may rebut this
presumption.
b. Dissent: Shouldn’t use the fraud on the market theory - investors don’t always
share the court’s presumption that a stock’s price is a reflection of its inherent
value. Many purchase or sell stocj b/c they believe this price inaccurately reflects
the corporation’s worth.
iii. Fraud-on-the-market theory to prove reliance does not apply where the false
statements are not public and do not reach the market.
a. West v. Prudental Securities, 282 F.3d 935 (2002) – Δ told his customers that
Prudential was certain to soon be acquired at a big premium, while in fact there
was no acquisition pending. People who relied on this information bought the
stock & sued Δ when they found out it wasn’t true.
1. Fraud on the market theory – public information reaches professional
investors, whose evaluation of that information influences securities
prices. However, Δ didn’t release false information to the public, and
therefore they didn’t affect the market.
D. Fraud or deception
i. Rule 10b-5 was designed to protect investors by requiring full and truthful
disclosure so that investors could make informed choices as to their course of
action. There is nothing in 10b-5 that indicates any intention to prohibit conduct
that doesn’t involve manipulation or deception.
a. Sante Fe Industries, Inc. v. Green, 430 U.S. 462 (1977) – SF owned 90% of the
stock of the subsidiary, and in order to eliminate the minority SHs, used a short-
form merger as specified by statute. They (1) paid minority SHs above-appraisal
price for the shares, (2) gave notice of merger (3) gave minority SHs notice of
their right to an appraisal action in state court to dispute the price, and (4)

42
 disclosed all material info relative to the subsidiary’s stock value. Minority SHs
sued under 10b-5 claiming no other purpose than to freeze out the minority & b/c
the price offered was grossly inadequate. So although no material
misrepresentation, SHs claimed there was a breach of their fiduciary duty.
(a) There was no manipulation or deception. Here the investors were fully
informed of their rights and options and had an adequate state remedy
(appraisal) for the wrong alleged.
E. Causation and Causation-in-fact – the Δ’s action must have caused the Π’s injury.
i. Reliance – reason for reliance requirement is to insure that the Δ’s conduct caused the
Π’s injury
ii. Materiality – Causation depends on materiality. Once it’s shown that Δ
misrepresented or omitted a material fact, then it can be concluded that Δs conduct
caused the Π’s injury.
F. Purchase or Sale of securities
i. Rule 10b-5 expressly covers only the purchase and sale of securities. Purchase and
sale defined as any contract to purchase or sell – there must be something more than a
mere offer to purchase.
ii. To have standing to maintain a 10b-5 cause of action, the Π must either be an
actual purchaser or seller of securities.
a. Where Π has not sold stock but argues the stock depreciated in value due to the
misrepresentation made by the Δ, the Π has no standing b/c no actual purchase or
sale.
b. Where Π would have purchased stock but for the misrepresentation made by Δ, Π
has no standing. Rationale is b/c it’s too easy for a Π to make the claim that he
“would have” done that but for Δ’s actions, and the claim cannot be verified.
c. However, for derivative actions (b/c on behalf of corporation), Π doesn’t have to
be an actual purchaser or seller, but there must at least have been a purchase or
sale by the corporation.
d. Exception: where Π seeks an injunction against Δ’s market manipulation that
violates rule 10b-5. Π’s status as a SH is sufficient w/o actual purchase or sale.
iii. The definition of a security includes an option to purchase stock.
a. Deutschman v. Beneficial Corp., 841 F.2d 502 (1988) – Δ made knowingly false
public misrepresentations in order to stop the decline of the market price of their
stock. Π had purchased options in the stock & suffered losses when they became
worthless as a result of the misrepresentations.
1. Π has standing b/c he was a purchaser of security, although he never bought
the stock. Rule 10b-5 specifically includes option contracts in the definition of
security.
G. Scienter - In order to be held liable under Rule 10b-5, the Δ must have scienter.
I. Scienter is defined as the mental state embracing the “intent to deceive, manipulate,
or defraud.”
II. Some courts have also held that recklessness also satisfies the scienter requirement.
V. Inside Information

43
A. Insider Trading. This is when someone related to the corporation is in a position to
have inside information about how the corporation is doing & what the corporation’s
stock is or will be worth (“insider”). The insider then buys stock (with advantages over
the seller) or sells it (with advantages over the buyer). The issue concerns what duty the
corporate insider may owe to the other party.
B. In certain circumstances, a director with superior knowledge must act as a fiduciary
to SHs in buying and selling stock. If a director personally seeks a stockholder for
the purpose of buying his shares w/o making disclosure of material facts within his
particular knowledge and not within the reach of the stockholder, the transaction
will be closely scrutinized.
i. Goodwin v. Agassiz, 283 Mass. 358 (1933) – Π decides to sell his stock to on an
exchange. Δ, a director of that company, knew of a theory that he believed had value
& wanted to have the company test the theory. Δ purchased the stock in an exchange
transaction w/o disclosure of the plan. Theory was correct & stock price went up.
a. Π acted on his own judgment when selling the stock; he didn’t ask Δ or other
officers anything. Δ made no reps to anyone about his theory. The purchase was
impersonal, on an exchange. There was no privity, relation or personal
connection.
b. Materiality - The theory was only a hope, not a proven reality.
C. The essence of Rule 10b-5: Anyone who is privy to material information intended to
be available only for a corporate purpose and not for his personal benefit may not
take advantage of such information knowing it is unavailable to those with whom he
is dealing, i.e. the investing public.
i. Securities and Exchange Commission v. Texas Gulf Sulphur Co., 401 F.2d 833
(1969) – Texas detected a promising mineral deposit, drilled a test hole, and collected
a sample which contained an extraordinary level of mineral content. Some officers
who knew of this purchased stock on the open market. There was rumor of the
testing, but Texas issued a press release downplaying the significance of the findings,
& stated that more testing was necessary to determine the commercial value, if any.
SEC brings the suit for violating Rule 10b-5.
a. Basic test for materiality: Whether a reasonable person would attach
importance to the information in making choices about the transaction.
Whether facts are material when they relate to a particular event will depend
upon a balancing of probability that the event will occur and anticipated
magnitude of event in light of totality of company activity.
1. The testing yielded results which were considered “impressive.” The
undisclosed facts here might very well have affected the price of the stock, &
would certainly seem important to a reasonable investor.
b. Fraud/Deception: The court couldn’t definitely conclude that the press was
deceptive or misleading to the reasonable investor, so remanded.
D. Mere possession of material, nonpublic information does not give rise to a duty to
disclose or abstain. A fiduciary relationship between the insider and the
shareholders must already be in place before the tippee’s role will be examined.
i. Dirks v. Securities & Exchange Commission, 463 U.S. 646 (1983) – Δ (not affiliated
with EF) rec’d a tip from a former officer of EF that due to fraudulent practices, EF’s

44
 assets were grossly overstated. Several regulatory agencies had failed to act. Δ tried to
get it published in wall street journal, but they refused. Neither Δ nor his company
owned or traded EF stock. Δ discussed this info w/ his clients, who sold the stock. EF
stock dropped & its fraudulent practices became known. SEC charging Δ for
aiding/abetting violation of 10b-5.
a. Recipients of inside information only have a duty to disclose or abstain if the
insider improperly disclosed the information. So first, it must be determined
that the insider’s “tip” breached the insider’s fiduciary duty. The test is
whether the insider personally will benefit, directly or indirectly, from his
disclosure. Absent personal gain, there is no breach of duty.
1. Insider who gave Δ the info did not receive any personal benefit, but were
motivated by desire to expose the fraud. Δ wasn’t under any derivative
obligation.
E. 14e-3
i. In the case of tender offers, this rule makes it illegal to trade on the basis of non-
public information, even if this information does not derive from the company whose
stock is being traded.
ii. Is is forbidden to trade on information derived directly or indirectly for EITHER the
offeror or the target.
F. Misappropriation Theory
i. A person commits fraud in connection with a securities transaction (violating
10b-5) when he misappropriates confidential information for securities trading
purposes, in breach of a duty owed to the source of the information.
a. The misappropriation theory premises liability on a trader’s deception of those
who entrusted him with access to confidential information. The trader’s duty is
not owed to another trader, but to the source of the information. Breach of fed.
duty.
ii. United States v. O'Hagan, 521 U.S. 642 (1997) – Δ was a partner in a law firm. Law
firm (not Δ) represented Grand in a potential tender offer for common stock of
Pillsbury. Δ bought Pillsbury stock options & common stock. When Grand
announced the tender offer, the price of the stock shot up & Δ sold his stock for
$4mm profit. Criminal indictment for violation of 10b-5.
a. Misappropriation of information must involve some deceptive device or
connivance.
1. Here, Δ’s feigned fidelity to his source of the confidential information, while
secretly converting the information for personal gain. It would have been fine
if Δ told source he planned to trade on this nonpublic information.
b. Must be in connection with the purchase or sale of a security.
1. Δ’s fraud was consummated when he used the information to purchase, and
the sell, securities (not when he obtained the confidential information).
c. It is not required that there is deception of an identifiable individual, only
that the deception was in connection with the sale and purchase of securities.

SHORT SWING PROFITS

Short Swing Profits:

45
  Market analysis makes a short profit based on knowledge
o No breach unless there is a tender offer
 Hypo: Hedge Fund hires Consulting Firm who talks to the employees of three different
companies (illegal information) which is then sold to the HF.
 § 16(b) of ’34 act
 Applies to directors officers and 10% shareholders
o Shareholder must be over 10% at purchase and sale (of ANY CLASS OF
STOCK, does not need 10% of equity ownership)
o Does not apply to officer/director before and after.
o Company must be registered with the SEC under §12 of the “34 Act to qualify for
this
o Only applies in public companies
o Certain involuntary sales are also excused

Foremost-McKesson v. Provident Securities

Rule: Under §16(b) of Securities Exchange Act if you own more than 10% or are a director or
officer, must be over 10% before the purchase.

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PROBLEM OF CONTROL
PROBLEMS OF CONTROL
I. Proxy Fights
A. Introduction
i. Shareholder Voting. Shareholders are the owners of the corporation, the objects of
management’s fiduciary duty, and the ultimate sources of corporate power.
Shareholders have two ways to exercise this power – the vote and the derivative suit.
The right to vote may be allocated to others not owning the shares through a proxy or
voting trust.
ii. Proxy. A proxy is a power of attorney to vote shares owned by someone else. A
proxy establishes an agency relationship, so it generally can be revocable at any time.
iii. Controlling Corporation via Proxy Votes. Few shareholders own enough shares to
make any difference at meeting (voting), and few shareholders even attend these
meetings. Because the outcome of the meeting depends on the number of votes cast,
the person with the most proxies usually wins. So minority shareholders will try to
collect proxies in order to control the corporation.
iv. Proxy Fights. This results when an insurgent group tries to oust incumbent managers
by soliciting proxy cards (SH’s signed authorization to allow them to be their proxy)
and electing its own representatives to the Board.
v. Tender Offers. Tender offers are another method of acquiring control of a
corporation by offering to purchase shares for a price higher than market value. Both
proxy fights & tender offers are regulated by the 1934 Securities Exchange Act
(SEA).
B. Paying for Proxy Fights
i. Solicitation (1934 SEA §14): a communication to security holders under
circumstances reasonably calculated to result in the procurement, withholding, or
revocation of a proxy.
ii. Incumbent directors may use corporate funds and resources in a proxy
solicitation contest if the sums are not excessive and the shareholders are fully
informed. Such a rule protects incumbents from insurgent groups with enough
money to take on a proxy fight.
a. Levin v. Metro-Goldwyn-Mayer, Inc., 264 F.Supp. 797 (1967) – MGM has a
conflict for control between 2 groups in its mgmt with different ideas about how
to run the company; each intending to vote for their own directors at the SH
meeting. Each group actively solicited proxies. Π-SHs filed action against one
the groups (Δs) alleging they wrongfully committed MGM to pay for attorneys .
PR firms, and other proxy-soliciting orgs in connection with the proxy fight. Π
says the individual directors should pay these expenses personally.
1. Court’s concern is that shareholders are fully and truthfully informed as to
merits of contentions of contesting parties.
2. Sums are not excessive - $125k cost, and MGM big corporation worth over
$251mm.

47
 iii. When directors act in good faith to defend their position in a bona fide proxy
contest, they may recover the reasonable expenses of soliciting proxies from the
corporation.
a. Rosenfeld v. Fairchild Engine & Airplane Corp., 309 N.Y. 168 (1955) – Π-SH
files a derivative action seeking to compel the return of $260k paid out of
corporate treasury to reimburse expenses to both sides in a proxy contest.
1. If in good faith, court will allow reimbursement of proxy fight expenses. To
hold otherwise would place directors at the mercy of anyone wishing to
challenge them for control so long as such persons have amply funds to
finance a proxy contest. Directors must have the right to incur reasonable
expenses for proxy solicitation and in defense of their corporate policies.
2. No reimbursement if the funds were used for personal power, individual
gain, or private advantage and not in the best interest of the corporation.
C. Regulation of Proxy Fights: 34 Act § 14(a)
i. §14(a) of the 1932 SEA prohibits people from soliciting proxies in violation of SEC
rules.
a. A shareholder does not fall under the general SEC filing reqs if it does not
solicit proxies for itself. Ex: a pension fund that submits a shareholder proposal
may not be subject to SEC reqs even if it campaigns on behalf of its proposal, b/c
it is not asking SHs to give it proxies.
b. People who solicit proxies must furnish each SH with a shareholder proposal.
In it, they must disclose information that may be relevant to the decision the SH
must make. SH proposal would include an annual report, and anyone soliciting
proxies must disclose conflicts of interest and any major issues he expects to raise
at the SH meeting. Must be extensive disclosure. Parties soliciting proxies must
file copies of the material with the SEC.
c. When an insurgent group wants to contest mgmt & solicit proxies, mgmt
may either mail the insurgent’s group material directly to SHs (insurgents
paying), or it can give the insurgent group the SH list to distribute
themselves. Normally, mgmt wants to keep SH list confidential, so more likely
to mail it themselves. Also, sometimes insurgents have the right to the SH list, so
this rule isn’t invoked.
D. Shareholder Proposals – Rule 14(a)
i. Shareholder Proposals. Instead of independently soliciting proxies, a SH may
service notice on mgmt of his intention to propose action at the SH’s meeting. The
SH may only propose such action is (1) he would be entitled to a vote at the SH
meeting to which the mgmt’s proxy statement relates and (2) he is a SH at the time
the proposal is submitted.
a. Inclusion in Mgmt’s proxy statement. If SH’s notice of proposed action
conforms to proxy rule, mgmt must include the proposal in its own proxy
statement. If mgmt opposes the proposal, SH may also give a statement in support
of proposal, and mgmt must send it out w/ its statement.
1. If mgmt wants to omit proposals, they have to file with SEC, including reason.
SEC will review & agree/disagree. If agree, they issue a no-action letter.
b. Mgmt’s may omit SH proposals if:
1. proposal is not a proper subject for action by the SHs,

48
 2. proposal relates to ordinary business operations (SH not to interfere with day-
to-day ops
3. proposal submitted for noncorporate purpose.
(a) Noncorporate purposes are personal claims or grievances, matters not
within the control of the issuer, matters not significantly related to issuer’s
business, election of directors, proposals previously submitted.
ii. Lovenheim v. Iroquois Brands, Ltd., 618 F.Supp. 554 (1985) – Π-SH wants Δ to
include his proposal in proxy materials sent in preparation for SHs meeting. The
proposal asks the directors to form a committee to study whether the method Δ’s
supplier used (force-feeding geese) in the production of pate is immoral and
inhumane. Δ doesn’t want to include it b/c it related to operations that account for less
than 5% of Δ’s total assets & net earnings.
a. Proposals should be included despite their failure to reach specific economic
thresholds if a significant relationship to the issuer’s business is
demonstrated on the face of the resolution or supporting statements.
1. In light of the ethical & social significance of Π’s proposal, Π has shown a
likelihood of prevailing on the merits, and that he would be irreparably
harmed if he were denied b/c he would lose his opportunity to communicate
with other SHs.
E. Shareholder Inspection Rights
i. Introduction. Pursuit of SH interests may practically require inspection of some
corporate records, especially the list of SHs. At CL, a SH had a right to inspect his
corporation’s books and records if he had a “proper purpose.”
ii. Under federal proxy rule 14a-7, a security holder, or tender offeror, may insist
that the issuer either provide her with a list of security holders or mail her
communications to them (at the holder’s expense).
a. Crane Co. v. Anaconda Co., 39 N.Y.2d 14 (1976) – Π announced a proposed
tender offer of Δ’s stock. Δ opposed the tender offer and sent 4 letter to SHs
asserting that the offer was not in the best interests of the corporation. Π requested
a list of Δ’s shareholders, claiming that Δ had a fiduciary duty to present SHs with
all pertinent info regarding pending tender offer. Δ refused to provide the list b/c
Π’s reasons for request didn’t relate to Δ’s business.
1. Access to corporate records such as SH lists must be permitted to
qualified SHs on written demand. Petitioner must furnish an affidavit
that the inspection is not desired for a purpose other than the business of
the corporation, and that the petitioner has not been involved in the sale
of stock lists within last 5 years. (§1315 Business Corp. Law).
2. Π complied with all statutory reqs. Π wants SH lists to communicate directly
with SHs about pending tender offer & to reply to misleading statements by Δ.
3. Tender offer involved over 1/5 of corporation’s common stock, so it involves
the purpose of the business of the corporation.
iii. State Ex Rel. Pillsbury v. Honeywell, Inc., 291 Minn. 322 (1971) – Π-SH bought
shares in Δ for sole purpose of giving himself a voice if Δ’s affairs so he could
persuade Δ to stop producing weapons used in the Vietnam War. Π demanded access
to Δ’s SH lists & other corporate records for the purpose of communicating with SHs
to elect new directors who would represent his viewpoint. Δ refused.

49
 a. DE law: SH must provide a proper purpose to inspect corporate records
other than SH lists
1. Proper purpose contemplates concern with investment return, and Π has no
such interest. Π’s only interest was its social concern, not any economic
benefit.
b. DE court later says this case is no good.
iv. Sadler v. NCR Corporation, 928 F.2d 48 (1991) – AT&T became the beneficial
owner of 100 shares of Δ’s stock. AT&T then began a tender offer for Δ’s shares; Δ
rejected the tender offer. AT&T responded by soliciting Δ’s SHs to convene a special
meeting to replace majority of Δ’s directors. Sadler (Π) owned more than 6,000
shares of Δ. On behalf of AT&T, Π tried to acquire certain corporate records (CEDE
lists – identifies brokerage firms & other records owners who bought shares for their
customers; NOBO lists – names of persons owning beneficial interest in shares that
consented to the disclosure of their identity). Δ refused to produce these lists.
a. Δ argues that Πs are just agents of AT&T, and AT&T had no right to this request
b/c they had not held Δ stock for six months. But court disagrees –no reason to
deny Πs just b/c of the agreement with AT&T.
b. Δ also argued that it doesn’t have NOBO lists, and although they can get them in
10 days, they are not required to hand over lists not in existence. Court disagrees.
The statute is to be construed to facilitate communication among SHs regarding
corporate affairs.
c. Compilation of NOBO list properly ordered here also b/c under Δ’s corp charter,
every share not voted at the special meeting is counted in favor of mgmt. Denying
mgmt opponents access to NOBO lists is inconsistent w/ statute’s objective of
seeking to place SHs of equal footing in terms of gaining access to SHs.

F. Shareholder Voting Control

i. Stroh v. Blackhawk Holding Corp.
a. Issue: IL law barred the issuing of non-voting stock. Is non-economic stock still
voting stock?

*** Possible Structures ***

Stockholde Investment Vote 1. 2. Class B 3. Non-

r Common Class A (vote) C.S. vote
Shares (vote + C.S.
(C.S.) $)
X 10mm 20% 2 10 10 2 8
Y 6mm 30% 3 6 24 3 3
Z 5mm 50% 5 5 45 5 0

Only solution #3 works

I. F

50
A. CONTROL IN CLOSELY HELD CORPORATIONS
 Closed Corporation Statute is part of the Corporations Act. To qualify, corp. has to
state that it is a closed corp. and the shares have to be restricted in some way. If so,
you are then a closed corporation.
 Three arrangements:
a. Voting agreement
1. Generally valid (both the agree to agree and the specific types)
(a) Agreement must not restrict the board of directors (e.g. X will premantly
serve as president [see McQuade below])
(b) No term limit
b.Voting Trust
1. Shareholders convey legal title to a voting trustee
(a) Generally a term limit of 10 years
(b) Must be publicly disclosed
(c) Must be in writing
c. Classified Stock
1. Corp. sets up two or more classes of stock and give the classes different voting
power (see table above)
(a) A way to give minority voting rights equal to those of the majority even if
they have different financial rights
(b)
 Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling
a. Issue: What is permissible in creating voting blocks

Edith=Cobert (Π) 315

Aubrey- James (H) 315
John 370

2R+2H+D 2John
CT-2R D 3John

I. McQuade v. Stoneham (New York)

 Holding: Agreement invalid. Directors cannot be compelled by contract to vote
to keep any particular person in office at a stated salary. The board must be left
free to exercise its own business judgment
a. Shareholders can agree to pool their votes, but cannot use their voting
power to pool the director’s powers.
b. VOTING TRUST: In essence a self executing voting agreement.
1. Just a matter of deciding who the trustee (person with the right and
obligation to vote the shares) is.
c. Closely held corporations are more like limited partnerships, and as such
some states treat them differently
 Could be valid if signed by all shareholders (so did not disadvantage a minority
shareholder), and impairment of board powers was negligible
B. Galler v. Galler: (Illinois)
 Two parties prepared a shareholder agreement.

51
  Theory: Since all board members owe a fiduciary duty to all shareholders, so
having the shareholders dictate what they can do is inequitable
 ROL: A shareholder agreement, particularly in closed corporations, that
controls the voting for board members and the members’ management
decisions, should nevertheless be enforced as long as the agreement is not
fraudulent or harmful to the public.
 Three Requirements to be valid:
a. No minority interest injured by the agreement
b. There must be injury to the public or to creditors
c. Agreement must not violate a clear statutory provision
 Agreements are more likely to be upheld in a closely-held corporation context

C. Ramos v. Estrada
 Reasoning: Not a proxy agreement, rather an allowable shareholder agreement.
While not a closed corporation, there was not a market for the shares, so this
was to preserve shareholder
 ROL: Shareholder agreements, whether or not it is a close corporation, that
require shareholders to vote according to the will of the majority are valid.

D. Closed Corp, Case Trail

 In ringling the court said the shareholder’s could agree on how they would
vote. only problem there was the lack of an implied proxy
 In Mcquaid, less than 100% agreed on officers salary, not valid because there
was a fed. Duty to all shareholders
 In Clark v. dodge, the closed crop can agree on any
 In Galler, the agreement is valid as long as no minority shareholder objects
 In Ramos, less than 100% of the stockholders can agree on who the directors
are.
 As long as you qualify as a closed corp, cn pretty much run the corp as you
like. Can provide in the charter or the bylaws a high percentage for the vote or
forum for both stockholders or directors.

II. Abuse of Control

A. Freezouts
i. SHs in a close corporation have the duty of good faith and loyalty to one
another. If several SHs combine to “freeze out” another SH by removing him
from all decision-making roles and denying him a return on his investment, they
have breached their fiduciary duty to him.
a. Wilkes v. Springside Nursing Home, Inc., 370 Mass. 842 (1976) – Π and Δs
formed a close corporation to run a nursing home. Equal investment of cash,
shares, responsibilities, profits & each would be a director participating actively
in mgmt. Relations deteriorated. Δs voted to put themselves on salary from the
corporation; Π didn’t get a salary. Δs then voted Π out of his office & position as
director.

52
 1. Applying the good faith standard strictly would hamper the ability of the
controlling group to manage the corporation for the good of all
concerned. Therefore, the rights of the majority must be balanced against
its duty to minority SHs. So if the majority can show a legitimate business
purpose for its actions, no breach of fiduciary duty.
(a) There’s no valid purpose for taking Π’s directorship, mgmt position, and
salary from him. He was ready at all times to perform his responsibilities
to the corporation.
b. Ingle v. Glamore Motor Sales, Inc., 73 N.Y.2d 183 (1989) – Δ hires Π as a sales
manager. Π later acquires shares of Δ’s stock, making Π a minority SH. Then Π
gets fired from his corporate position and sues Δ, alleging that in terminating him,
Δ breached its fiduciary duty of loyalty and good faith they owed to him as a
minority SH in a closely held corporation.
1. Must separate the duty a corporation owed to a minority SH as a
shareholder from any duty it might owe to him as an employee.
(a) Π was an at-will employee; thus corporation owed him no duty as an
employee.
(b) Shareholder agreement did not provide Π with employment security; thus
the corporation owed him no duty as a shareholder either.
c. More on closely held corporations
1. Usually no fiduciary duty among SHs in corporations, but there is for closely-
held corps.
2. Reason for not paying out dividends and instead paying out salaries
(a) Profits paid out as dividends are taxed (corporate income tax). You can
avoid taxes by disguising the profits as salaries.
(b) Also, you can do this to freeze-out of majority SH, like in Wilkes.
(c) So not only are you ripping off the government, but each other.
(d) Problem: Hard to tell the difference between actual costs of the company
& disguised dividends. So court says there's a fiduciary duty that
shareholders owe to each other in a close corporation.
B. Conflicting Roles
i. Close corporations that purchase their own stock must disclose to the sellers all
material information.
a. Jordan v. Duff and Phelps, Inc., 815 F.2d 429 (1987) – Π is Δ’s employee and
purchased shares of Δ’s stock. Prior to selling Π the stock, Δ made Π sign an
agreement that stated upon a SH’s termination from employment, he would sell
back his shares to the company for book value. Π quits & sells back his stock for
$23k. Π then finds out that Δ is merging with another company, and if he had still
been an employee, his stock would have been worth $452k. Π sues for breach of
fiduciary duty after Δ refused to give him back the stock (Π hadn’t cashed the
check yet).
1. Jury could reasonably conclude the merger was material. Π worked longer just
so he could take advantage of a higher book value & Π could have decided to
stay longer if he knew company involved in merger negotiations. Δ also
allowed Π to decide when he would leave.

53
 2. Π was an at-will employee & could have been terminated the day before the
merger. But the court says that even in at-will employment situations,
neither party may take opportunistic advantage of the other.
III. Transfer of Control
A. Introduction. Problem involving the sale of corporate stock is when the majority SH (or
controlling minority) sells that control in a transaction from which other SHs are
excluded (controlling SH receiving a premium price on stock over book or market value);
or where all sell, but the owner of the control shares receives more pr share than other
SHs. Since a person purchasing “control” can dictate the affairs of the corporation,
“control” is valuable.
B. General Rule. A SH may sell his stock to whomever he wants to at the best price he
can get.
C. Types of Purchase Transactions:
i. Direct from SHs – purchase of stock. Purchaser may approach the SH directly to
purchase their shares. The purchaser may buy all or only a controlling portion of the
outstanding stock. If all is purchased, one price may be offered to controlling SHs,
and lower price to minority SHs.
ii. Purchase of assets. Purchaser offers to buy the corporation’s assets; corporation SHs
votes on the offer. If majority votes yes, purchaser pays the corporation, & $
distributed pro rata to all SHs.
iii. Merger or consolidation. Purchaser offers to merge the company to be acquired into
it; corporation SHs votes. If majority votes yes, company is merged into acquiring
company. SHs of the merged company receive a pro rata interest in the purchase
price.
D. Frandsen v. Jensen-Sundquist Agency, Inc., 802 F.2d 941 (1986) – Jensen owned all
stock in Δ, a holding company whose principle asset was a majority stock in Bank G.
Jensen sold majority of stock to family. Π is a non-family minority SH. Agreement that if
majority wants to sell stock, Π gets right of first refusal. Jensen negotiates with WI Corp.
to buy Δ for cash, then merging Bank G into WI Corp.’s subsidiary. Π tries to exercise
his right of first refusal, but majority refuses. Then they restructure the deal so that Δ
would sell its shares in Bank G to WI Corp. & then liquidate.
i. By selling shares in Bank G rather than selling Δ corporation, Jensen was selling a
corporate asset, which Π could not block. But since the deal originally involved
selling Δ corporation, Π argues that it doesn’t affect his right once he had already
tried to exercise it.
ii. Rights of first refusal are to be interpreted narrowly. The agreement was intended
to protect Π from finding himself confronted with a new majority made up of
strangers. The sale of the asset doesn’t result in the harm they were trying to protect
against. Agreement did not provide Π with protection against a sale of the company.
E. Zetlin v. Hanson Holdings, Inc., 48 N.Y.2d 684 (1979) – Π is a minority SH. SH-Δs
sold their controlling interest in the corporation to another party for double the market
price. Π wants to be paid the same price per share.
i. A majority interest can control the affairs of the company. Absent looting,
conversion of a corporate opportunity, or other acts of bad faith, a controlling
SH can sell the right to control the affairs of the corporation for a premium
price.

54
 F. Perlman v. Feldmann, 219 F.2d 173 (1955) – Πs are minority SHs. Δ (president) sold
his shares (37% of common stock) for $20/share. The market price at the time was
$12/share & book value was $17/share. After the sale, the new purchasers were
appointed to the Bd. Π claimed the additional compensation was a corporate asset (power
to control steel output in tight market) & was to be held in trust by Δ as a fiduciary for all
the SHs.
i. Although there’s no outright fraud, court said there was a breach of Δ’s fiduciary
duty. Δ siphoned off corporate advantages derived from a favorable market
situation for personal gain, which is not indicative of the necessary undivided
loyalty owed by a fiduciary.
G. EssexUniversal Corporation v. Yates, 305 F.2d 572 (1962) – Π contracted to purchase
28% of stock of a company traded on the stock exchange from Δ. Π had option to require
majority of existing directors to resign and be placed with Π’s nominees. Stock sold for
$8/share; market price was $6/share.
i. It is illegal to sell a corporate office or management control by itself.
a. A majority of stock may be sold with an agreement to replace directors
immediately in some instances, even at a premium over market price. However,
you can’t do this if seller should reasonably know that the buyers will loot the
company, or if a transfer of a unique corporate asset is involved (like in Feldman).
b. Δ has to prove that the interest transferred did not carry actual control.

MERGERS ACQUISITIONS AND TAKEOVERS

I. Mergers and Acquisitions

A. Defacto Merger Doctrine

I. Two ways for A to acquire T:
A. T mergers into A and T’s SH receive stock in A in lieu of their stock in T
B. T sells all assets to A, in return for stock of A. T then liquidates and distributes the
A stock to its own shareholders
 This allows A to control the debt absorbed by T, to cherry pick the debt
II. Def’n: Theory that the transaction is not really a merger, but is the functional
equivalent or a merger, and should be treated as if it were one for purposes of appraisal
rights and shareholder vote.
A. Rarely accepted, but if so:
 Stockholder gets appraisal rights
 Selling stockholders get the right to vote on the transaction
 The creditors of the seller may have a claim against the buyer
III. Farris v. Glen Alden

55
 A. Larger DE corporation was acquired by a smaller one, specifically structured to
deny the larger corps. shareholders appraisal right. Was deemed by a court a
merger, granted the SHs appraisal rights
B. Freeze (squeeze) out mergers
A. Freeze out vs. squeeze out mergers
 Freezeout – Transaction in which those who control the corporation eliminate the
equity ownership of the non-controlling stockholder
a. E.g the insiders somehow force the outsiders to sell their shares, or find some
other way to eliminate the outside shareholders
 Squeeze out – Methods that do not legally compel the outsiders to give up their
shares but in a practical sense coerces them into doing so.
a. Most common in the closed corporation setting
b. Examples: Majority might stop paying dividends or cut of a minority
shareholders salary
B. Context for the freeze out merger
 Two Step Acquisition (as the second step)
 Merger of Long Term Affiliates
 Going Private
C. Methods of Freezing Out
 Cash Out Merger
a. Most Common Method
b. Insider causes to corporation to merge into a well funded shell corp, and the
minority shareholders are simply paid cash in exchange for their shares, the
amount determined by the insiders
c.
 Short-form Merger
a. Can be used where one corporation (usually 90% or more) of anothers stock, and
the “subsidiary” can be merged into the “parent” without the vote of the minority
stockholders.
b. Minority shareholders can be paid in stock or cash
D. Weinberger v. UOP, Inc.
 Leading case of n what constitutes basic fairness in a freeze out merger
a. Fell into the merger of long-term affiliates category.
 Directors of UPO organizing the deal were also directors of Signal, thus were on
both sides of this transaction, triggered entire fairness
a. Procedural fairness
1. Signal never truly negotiated with UPO for the price. It simply informed
UPO of the $21per share price
b. Fairness of price
1. Feasibility study showed the price was closer ot $24 ps than the $21 per share
offered
c. Disclosure
1. No fair disclosure to UPO’s minotry shareholders, both the hurriedness in
which it was prepared or the true worth ($24)
d. Independent committee to negotiate

56
 1. Cases states that the best step an insider can do to insulate transaction from
attack is with a special committee of independent directors to negotiate the
transaction
(a) This meets the test of fairness because it is as though contending parties
had in fact excerted its bargaining power against the other at arm’s length.
E. ENTIRE FAIRNESS (as summed up under DE law)
 Occurs in any transaction where insiders are on both sides of a transaction,
transaction will only be sustained if this test is met
 Burden of proof (will shift to the plaintiff the show transacgtion was unfair IF ALL
the following happen):
a. Approval by the majority OF the minority
1. Majority of minority shareholders must vote to approve the transaction
b. Disclosure
1. Δ have the burden of showing they made adequate disclosure of the
transaction
F. Defacto Non-Merger
 Rauch v. RCA Corp
a. ROL: A conversion of shares to cash to complete a merger is legally distinct
from a redemption of shares and therefore redemption provisions or laws
governing redemption are inapplicable.
b. Holding: Delaware has given different corporate statutes equal dignity which
allows a company to pursue different avenues without having to worry about
violating other alternatives. Merger satisfied the provision of the Delaware
statute, so the merger was allowed.

II. TENDER OFFERS

A. Tender Offer def’n: An offer to stockholders of a publicly owned corporation to
exchange their shares for cash or securities at a price above quoted market value
 Hostile Takeover def’n: Acquisition of a publically held company over the
opposition of a target’s management
 Pressure to tender:
a. Back-end merger: Raider pays a premium for control, then merges the
corporation into his own and pay the remaining minority shareholders less the the
amount for earlier tendered shares
 Outcome:
a. Challenge beat back
b. Other bidder wins
c. Success by orginal bidder
d. Success by original bidder by becoming friendly (raising the price to the point
the board approves)
 Other terms:
a. Leveraged Buy Out
1. Used by management to acquire the company, acquisitions funded by very
large amounts of debt
b. Lock Up

57
 1. Used to give one bidder an advantage over another, selling a “crown jewel”
or giving one bidder an option to buy some stock at a favorable price
2. Often overturned by courts (see Revlon)
c. No shop clause
1. Agreement between a bidder and a target that management will present the
offer to the shareholders and not shop around for a more attractive offer.
2. Courts split on the legality of this
d. Greenmail
1. Target buys shares back from bidder at a premium price in exchange for
agreement that bidder won’t try and take over company for a specified period
of time (usually ten years)
e. White Knight
1. Bidder who is friendly to the management, who at the managements request
acquires the target so it will block the hostile bid. Done to save managements
jobs
 Poison Pill
a. A variety of provisions that will discourage a hostile takeover by making a target
more expensive or less desirable to a bidder.
b. Typically gives shareholders to right to buy shares in the target at half price
whenever a bidder tenders for or buys more than a certain percentage of the
target’s stock (usually 20%)
c. Are revocable by the board, meant only to block hostile, not friendly, takeovers.
d. Court will scrutinize under the enhanced business judgment rule
e.
B. Hostile Takeover Defenses
 Poison Pill
a. A variety of provisions that will discourage a hostile takeover by making a target
more expensive or less desirable to a bidder.
b. Typically gives shareholders to right to buy shares in the target at half price
whenever a bidder tenders for or buys more than a certain percentage of the
target’s stock (usually 20%)
c. Are revocable by the board, meant only to block hostile, not friendly, takeovers.
d. Court will scrutinize under the enhanced business judgment rule (see Unocal)
1. EBJR is a balance between the BJR and entire fairness
(a) Because there is higher than usual probability that the target’s
management and board will be acting for self interested purposes rather
than stockholder welfare, they must make a special showing in for to
qualify for the protections of the BJR.
(b) Under DE law:
 Reasonable grounds for belief in corporate objective
 Board and managers must show that they had reasonable grounds
for believeing that there was a danger to the corporation’s welfare
from the takeover attempt.
 Must not be used to merely to perpetuate themselves in power,
must be geared to protecting stockholders interests
 Reasonable Response

58
  Must show defenses measures used were reasonable in relation to
the threat posed
 Board must make the showing that it acted not only in good faith but
upon reasonable investigation
 Using independent (disinterested) directors to approve the
measures will generally prove the good faith and reasonableness
of the measures
 If the above are satisfied, then the defensive measures are protected
by the BJR
 If not, then it must meet entire fairness
e. Revlon, Inc. v. MacAndrews and Forbes Holdings
1. Illustrates how defensive measure that might be validly employed while the
target is struggling to preserve its independence are likely to be invalid if
used to favor one bidder over another once a decision to sell has been made
(a) Early defensive measures, such as the poison pill were fine until the
board made the decision to sell
(b) At this point the board’s duty changed to that of an auctioneer, charged
with getting the best price for stockholders at a sale of the company
 Board was trying to protect themselves and creditors with the pill
 Lock up was used to impair competition (end the bidding) instead of
expanding it
(c) Consequences:
 Once company is up for sale, or decides sale is inevitiable, it may no
longer use defensive measure, and must instead insure every effort to
achieve the best price for the stockholders
 Getting the best price means treating all stockholders equally, not
preferring one bidder over another
 The use of a lockup or giving confidential info to one party probably
constitutes favoritism
 In choosing among offers, the sole duty is to the common stock
holder
f. Paramount Comm. Inc. v. Time, Inc.
1. ROL: Directors are not required to favor a short-term shareholder profit over
an ongoing long-term corporate plan as long as there is a reasonable basis to
maintain the corporate plan.
(a) The court distinguished the Revlon decision as concerning a company
that already was determined to sell itself off to the highest bidder, and
therefore the only duty owed at that point was to the shareholders. In this
case, Time only looked as if it were for sale as it moved forward on a
long-term expansion plan.
(b) So Board can just say no to an all cash tender offer at a much higher rate
than market price from a raider  they can keep the poison pill in place
and refuse to let shareholders vote on it (In DE)
(c) QVC cuts back into this case.
g. Paramount v. QVC
(a) Revlaon applies in a sale of control, does not if no control is sold

59
  If you are selling to a corporation, even a publically traded one, there
is a sale of control
 If there is a sale to pay off debt, would also trigger Revlon ( a bustup)
 However if you have a stock for stock deal in the marketplace, there
is no change of control.
h. Omnicare, Inc. v. NCS Healthcare
1. Lockups that make a merger mathematically certain will be invalid, less than
that, they will probably be upheld

C. Anti-takover Statutes
 CTS Corp. v. Dynamics Corp of America
a. Upheld the Indiana anti-takeover statute,
b. Court rejected:
1. Williams Act preemption
2. Commerce Clause argument
 Delaware Act of ‘88
a. Combinations Prohibited
1. Cant combine corporation and interested stockholder (15% or more and the
associates of such a person) for three years after stockholder buys the shares
2. Prevents a back-end cashout merger
(a) Unless there is board approval before they purchase stocok, buys 85% or
more, OR gets majority of those that will beon the backend to approve

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A. Duty to Act lawfully. (NOT DISCUSSED IN CLASS) Officers and directors have a duty to act lawfully.
If they knowingly cause their corporations to violate the law, they have violated this duty. Officers and
directors also have a duty to ensure that the corporation has effective internal controls to prevent employees
from engaging in illegal acts.
i. To show that directors breached duty of care by failing to control employees, Πs must show
either (1) that directors knew or (2) should have known that violations of law were occurring
and, in either event, (3) that the directors took no steps in a good faith effort to prevent or
remedy that situation and (4) that such failure proximately resulted in the losses.
ii. In Re Caremark International Inc. Derivative Litigation (NOT DISCUSSED IN CLASS), 698 A.2d
959 (1996) – Caremark employees violated fed laws regarding payments to healthcare providers.
Caremark indicted with multiple felonies & plead guilty to mail fraud; Caremark had to pay out
$250million b/c of this crime. Derivative suit filed against Bd of directors (so corporation can recover
money), alleging that Bd breached duty of care by failing to adequately supervise employees’ conduct,
which exposed Caremark to this liability.
a. A director’s obligation includes a duty to attempt in good faith to assure that a corporate
information and reporting system exists, and that failure to do so under some circumstances
may render a director liable for losses caused by non-compliance of applicable legal standards.
However, only a sustained or systematic failure of the Bd to exercise reasonable oversight
will establish the lack of good faith that is necessary for liability.
1. Good faith attempt here – committee charged with overseeing compliance w/applicable laws.
2. No evidence that the directors lacked good faith in monitoring responsibilities, or that they
conscientiously permitted a known violation of the law to occur.
b. In the absence of grounds to suspect deception, neither the Bd nor the officers can be
charged with wrongdoing simply for assuming honesty and integrity of employees.

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