Business Organization (Whitehead) 01/25/2010 Introduction - Issues covered by this course (changing right now) - Insider Trading: Securities

10d-5 - Proxy rules - Board oversight (e.g. AIG/Citigroup) - Hillary the Movie case - Focused organization: corporation - dominant structure (time permitting, LLP/LLC) - Code oriented course - Delaware law (50% of public corporations are incorporated in Delaware) - Revised Model Business Corporation Act (RMBCA) - Five goals - Application of the law to the fact: complicated - Get comfortable to look at statutes - Certain themes: Information gab, differences in incentive, etc - U.S. Securities law: Proxies rules, Sarbanes-Oxley (corporate governance), trends (corporate law as a federal law/increase federalization) - What corporate lawyers do in litigate context - What is corporate law? - Three relationships (1) Between shareholders and board of directors (2) Between majority shareholders and minority shareholders or hostile shareholders and the remaining shareholders
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(3) Between a company (legal person) and shareholders / a company and creditors - Characteristics - Limited liability: liability is limited to the capital - Freely transferable stock - Centralized management: board of directors - Separate legal person (some limitation though) Salomon v. Salomon (1897) - Limited liability by shareholders case - Mr. Salomon owned 99% of the stock of the company - He made a loan through the venture to the company which was fully secured - After one year, the business failed and other unsecured creditors got nothing What the creditors lawyer could do? - Piercing corporate veil - No other purpose other than boot strapping and knocking out creditors - Motivation: fraudulent conveyance - Under capitalized: The assets will not be equivalent to the obligations - The company was an agent acting on behalf of Mr. Salomon The Mrs. Fields hypothetical problem (three agency problems) - Her interest as an owner is the same as a manager - Making a decision for investment over the next 10 years: $400,000 - Continuing to work for the existing job, XYZ - Buying 10 year T-bill, 7% interest rate = $28,000 - Cookie business = $28,000 T-bills are riskless The business is supposed to have certain risk premium Giving up salary: opportunity cost - Expanding her business: to hire Whitehead to open her second store - Risk for F as a shareholder: liable for Ws action, reputation, her invested capital
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- Risk for W: losing his job (salary), reputation - Mismatch of incentives between F (higher risk/higher return) and W (lower risk/lower return) Agency problem: Information gabs and mismatch of incentives Agency cost to minimize agency problem: such as monitoring Ws inappropriate action by F Employment agreement: booking, accounting, auditing It applies to relationship between shareholder(s) and directors - Needing someone elses capital/diversifying Risk diversification: Porto folio the individual (unsystematic) risk is minimized, provided, that it cant manage something to impact the entire economy Less expensive way for shareholders to manage the risk Relationship between F and D (a shareholder/director and a shareholder): - Limitation of transferability of Ds stock - Conflict of interest: salary, sales of chocolate, etc Prior consent process by D - Borrowing money from the bank to purchase oven D&F and Bank (shareholder and creditor): standard oven (D&F) v. customized oven (B) Creditor has fixed return (low risk/low return) No fiduciary obligation to the bank Contractual remedy: - Security interest - Higher interest - Covenants: to stop dividends before D&F paid money to the bank first - Personal guarantee 01/26/2010
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The Corporate Form - Why Delaware? - Favorable to directors/lower share price - Sophisticated corporate law: statutes and case law less uncertainty - The law of the state of incorporation dictates internal relationship and fundamental activity - Cal. Corp. Code 2115 - A foreign corporation: Any non-California corporation - 2115(b): its regulation supersedes the law of the jurisdiction - 2115(c): exception for public corporations - As a matter of practice, C courts refer to D courts decisions - Capital structure - Debt: senior debt/subordinated debt, secured/unsecured claim - Trade debt: payment for goods and services - Equity: preferred stock/common stock - Del. Gen. Corp. Law (DGCL) 102: what the certificate of incorporation set forth - At least one class to have voting rights, be entitled to dividends, etc - Par value: money originally invested to the company (legal capital: cushion that creditors rely on) Now, relationship between par value and market value became diverse significantly: meaningless concept * It still means in terms of tax - Preferred stock - Dividends is subject to board approval but superior to common stock
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- Getting voting rights if dividends are not paid - Common stock - Highest risk/highest return - Hierarchy of three participants in the corporation - Shareholders: capital investment, limited liability, voting rights to control the company - Directors: Management of day-to-day operation on behalf of shareholders Inside/independent: companys interest v. shareholders interest Outside: other economic interests - Officers: Day-to-day operation subject to the board of directors

01/28/2010 Review Problem 1 - Certificate of Incorporation (DGCL 102) - 102(a)(1): name (it cannot be confusing) - 102(a)(2): address of registered office and registered agent - 102(a)(3): purpose (it can be broad any lawful act) - 102(a)(4): total number of authorized stock, par value, and class - Different consideration: 152 allows the board to determine consideration - 102(a)(6): initial directors * Under NY law, initial directors are actually elected - Different voting rights (DGCL 151) - It is allowed to set up different classes of stock having different voting right under 151 * DGCL 212: one voting right unless otherwise described in charter
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- Each class of shareholders may be given a right to designate a director - Number of directors (DGCL 141) - One or more as stated in by-laws or charter - Amendment of charter may be approved by the board and shareholders (DGCL 242) - Amendment of by-laws may be approved by only the board (DGCL 109) * Charter is filed with the Secretary of the state - Supermajority provision - To protect a minority director/shareholder Unanimous consent - DGCL 102(b)(4): voting power required for corporate act (DGCL 216/141(c)) - Dividends - Shareholders have different interests (richer shareholders have less needs for dividends) - Dividends is subject to the board approval How can we make dividends work? - Change the board composition - Change the voting rights subject to contingency: dividends is not paid - Shareholder agreements - Use voting trust (DGCL 218) - Proxies (DGCL 212) - 212(b): authorize another shareholder to vote - 212(e): irrevocable if it states so - Closed corporation - Limited number of shareholders - Limited transferability - Not public

- Broad board authority (DGCL 141(a)) - General rules: shareholders cannot directly get involved in day-to-day management - If shareholders step in, then they pick up liability as the board - Officers (DGCL 142) - Typically designated by by-laws - Use similar protection to dividends - Redemption of the stock in the event officers are fired or quit - Charter and by-laws (DGCL 102 (b)(1)) - Any provision to be stated in by-laws may instead be stated in charter - Hierarchy: DGCL/case law charter by-laws 02/01/2010 - Additional issue of shares - Putting cap by stating number of authorized shares in charter - Amendment of charter is required to increase or decrease of the number (DGCL 242)

- Restriction on transferability of shares (DGCL 202) - Dont want other shareholders who do not have as close interests as existing shareholders - 202 permits us to limit transfer to the others - What if one of the shareholders wants to sell the share? Contract: buy arrangement based on certain pre-agreed formula, call/put arrangement, first refusal - Rule of ethics: representing four shareholders/company - ABA 1.6 (confidentiality), 1.7 (conflict of interest), 1.13(g) (represent the company)
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- Directly adverse conflict might not come up among shareholders/company prior written consent - In case of an insider trading by a managing director in an M&A transaction (probably adverse effect to the company) - Waiver of privilege by the company (client in this case) - Report to the board of directors (the highest authority) (1.13(b)) If the lawyer is not satisfied by the boards response, go to outside authorities (1.13(c)) Preincorporation Transaction by promoters - Commencement of corporate existence (DGCL 106) - Commencement of existence upon filing charter with the Secretary of State * Actual issue of stock and election of directors are required under NY law - Requirements to be filed (DGCL 103(c)) - Organization meeting of incorporations or directors (DGCL 108) - Adopt by-laws - Elect directors - Elect officers - Notice requirement * Form of minutes of organization meeting (p1399) - Pre-incorporation subscriptions - Agreement among potential investors - Irrevocable obligation unless otherwise agreed (DGCL 165) - The board has the authority to decide consideration (DGCL 152) - Pre-incorporation transaction - Possible problems caused by ambiguity of existence of the company: - Allocation of risk of loss by non-existence/unauthorized action - Promoter may enter into any contract before actual proper incorporation - General rule: The agent is not liable for a contract when it entered into it on behalf of the company
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 In case the company does not exist, pre-formation agreement is not binding the company * RMBCA: both the promoter and the company are liable for the contract - The company directly becomes liable to the obligation by ratification The promoter is still jointly and severally liable Goodman v. Darden, Doman & Standard Associates (1983) - The promoter signed the contract as president of the non-existent company - The parties knew that the company did not exist - The court held that the promoter and the company are jointly and severally liable - Exception: if the parties knew that the company did not exist and clearly intended to make the company solely liable Company Stores Development Corp. v. Pottery Warehouse (1987) - The promoter was not liable for the obligation based on clear intention and expectation of the parties - Novation: Substituting by the new obligor (the company) to the old obligor (the promoter) with full satisfaction of the obligation under the original contract Defective Incorporation - De jure corporation: organized in sufficient compliance with all the requirements - De facto corporation: organized in insufficient compliance to constitute de jure corporation with: - A colorable attempt to incorporate - Some actual use or exercise of corporate privileges

Cantor v. Sunshine Greenery (1979) - Delayed filing of charter after entering into the lease agreement - Defense against personal liability by shareholders of the company improperly organized - Not defense against quo warranto (challenge the incorporation by the state) * There is no de facto corporation in some jurisdictions - Filed certificate of incorporation is conclusive evidence of incorporation (RMBCA) - Filed certificate of incorporation is a prima facie evidence (DGCL 105) - Estoppel - De facto corporation tend to look at the corporation action but estoppel is typically much more focusing on the other partys conduct - The party is trying to sue, saying the company exists first and it does not later The party cannot sue - Defective organization of corporation as defense (DGCL 329) - No corporation and no person sued by any such corporation shall be permitted to assert the want of legal organization as a defense to any claim Defense by defective organization is no longer available - Limit liability of shareholders by estoppel Cranson v. International Business Mach - The parties intention that they treated the entity as it were a corporation/dirty hand - The court held that the shareholder should not be personally liable under the estoppel doctrine - In torts context, the estoppel doctrine is not available because of lack of
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expectation - Modern trend: Only actively involved managing partners are personally liable Actively involved managing partners should know whether the entity is properly incorporated * RMBCA is focusing more on actual knowledge than active participation

Review Problem 2 - Draft the contract for John - Even if ratified, he is still jointly and severally liable, unless otherwise expressly agreed Let Sidney know the company does not exist and solely look at the company Sign as a president of a future corporate entity - Draft the contract for Sidney - Personal guarantee by John - Put her expectation to work for John, as a consideration, even if ratified John should be jointly and severally liable with the company - In case of forgetting to file charter after ratification - De facto corporation doctrine: two requirements - Is there a colorable attempt? - Nobody filed the documents No colorable attempt - Estoppel: - Sidney treated the entity as an existent limited liability company - Clean hand in the company 02/02/2010

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- Shareholders liability under NYBCL - The ten largest shareholders shall be jointly and severally liable - The letter agreement - valid and binding obligation for the company? - The board meeting 9/30 - Filing charter 12/1 - Opinion 12/2 De facto corporation is possible because the company tried to file charter Estoppel is also possible because Sidney treated the entity as an existing limited liability company but this is a defense Possible solution is to ratify the contract again To make sure that John is completely not liable, novate the contract The Ultra Vires Doctrine - Perpetual existence of the company (DGCL 102(b)(5)) - Broad scope of business purposes (DGCL 102(a)(3)) - English rule: if the company acted outside the authority, shareholders are not allowed to ratify the action even if unanimous - American rule: shareholders can ratify the action to the extent creditors are not injured - There were some actions traditionally considered as beyond the scope: guarantee and partnership Statutory authorization to address the problem (DGCL 123/124) - SOX: corporate governance clause overrides the state law - The court generally does not like the ultra vires doctrine A number of limitations on ultra vires - Implied power - Not a defense to tort or criminal liability - Minority rule/majority rule Goodman v. Ladd Estate Co. (1967) - Goodman brought a sue to enjoin Ladd from enforcing the guaranty
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agreement against Westover, claiming it is unenforceable because of ultra vires - Ladd guaranteed the loan to Wheatly, and Westover also guaranteed Ladd - Goodman purchased Westover, knowing that there was the guarantee Notes - Under majority rule, a partially performed executory contract cannot be relied on ultra vires If it is partially performed, the other party cannot refuse the performance - Even if it is outside the scope, the shareholder ratified it and no creditors were injured - Corporate power - Broad authority: any lawful business or 101(b)/102(a)(3)) - Implied power/specific power (DGCL 121/122)

purposes

(DGCL

- Ultra vires (DGCL 124) - Ultra vires does not largely apply because of broad corporate authority - Three exceptions: (1) The stockholders action to enjoin the ultra vires action (only when the court finds equity) (2) The corporations action to pursue the directors liability (3) The state action to dissolve the company Inter-Continental Corp v. Moody (1966) - Inter-Continental refused the guarantee, saying that it is ultra vires - Even though Inter-Continental encouraged a shareholder to claim that it is ultra vires, the shareholder can do it unless it is an agent of the company - But the court has to find equity - The court refused to permit the claim because the third party actually knew the fact

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The Objective and Conduct of the Corporation Dodge v. Ford Motor Co. (Supreme Court of Michigan, 1919) - Henry Ford, who was the major shareholder and controlled the board, announced that the company would not pay any special dividends in the future and reduce the price of cars instead - The Dodge brothers sued the company for the dividend - The trial court ordered the company to pay $19.3 million, equivalent to 50% of its cash surplus - The court affirmed the judgment and held that a business corporation is organized and carried on primarily for the profit of the stockholders and the powers of the directors are to be employed for that end 02/04/2010 Notes - The board cannot look at only the majority shareholder - Agency problem/cost - Create of the board of directors to monitor the company for beneficiary to shareholders - Broad discretion of the board under certain limitation by charter, instead of the contract between shareholders and directors - Amendment of charter (DGCL 242) - Amendment of by-laws (DGCL 109) * By-laws cannot be inconsistent with charter (DGCL 109(b)) - Fiduciary duty only to shareholders - Highest risk/return - Competing conflict between debt and equity - Primary goal of the company is maximizing the profits of the shareholders - Protection of minor shareholder is important The board of directors is responsible for exercising its discretion for the benefit of shareholders - Alternative arguments: (1) Long term benefits for the company
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(2) Dividends is subject to the boards discretion A.P. Smith Mfg. Co. v. Barlow (1953) Notes - Social responsibilities of corporation - Corporations have the power to contribute funds within reasonable limits in support of public welfare - Broad reasonable standard: amount and relation to the corporations interest Create labor force and PR - Long term interests Ambiguity and conflict between shareholders - Specific power: make donations for the public welfare (DGCL 122(9)) - The boards duty to debtors: covenants, fair dealing, good faith by contract, not fiduciary duty 02/08/2010 Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp. (1991) - In the vicinity of insolvency, the board of directors is responsible not only for shareholders but also other stakeholders

Notes: Expected Value 25% chance of affirmance ($51m) $12.75m 70% chance of modification ($4m) $2.8m 5% chance of reversal ($0) $0 Expected Value of Judgment on Appeal $15.55m - The company has a judgment $51m on appeal and the debt in the amount of $12m
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- The best evaluation of the current value of the equity is $3.55m - Now assuming an offer to settle at $12.5m or $17.5m, what are directors supposed to do? - The shareholders still prefer the litigation to the settlement because it has an expected value of $9.75m ($51m - $12m x 25% chance of affirmance) which is greater than $5.5m (the second offer of settlement), at the risk of the creditors getting less (shareholders may diversify its risk by portfolio) - Gheewalla case (Supreme Court of Delaware, 2007): Fiduciary duty continue to run solely to the equity holders until the company actually becomes insolvency - Why does fiduciary duty run to the debt holders? The equity is gone therefore it has no more stakes - Other constituencies created by statutes - Connecticut General Statutes 33-756(d): Directors shall consider other constituencies - NYBCL 717(b): Permits directors to consider other constituencies (not duty but discretion) - Principles of Corporate Governance 6.02 In response to hostile takeovers by the states, to minimize the risk of hostile takeovers The board is entitled to consider other stakeholders/long term interests of shareholders * Hostile takeovers is also considered as a corporate governance tool to make the board work efficiently - Delaware approach from case laws: duty to act for the best benefit of the shareholders, typically from long-term
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interest. The consideration of other constituencies is allowed only when it is rationally related to the benefit of the shareholders Shareholdership in Publicly Held Corporation - Publicly held corporation - Its hard for shareholders to coordinate - Cost of exercising voting rights - Large institution shareholders - Benefits from monitoring/oversight more than cost - Large ownership reduces cost - Institution Shareholder Services - Huge influence - Possible problem: subsidiary advising companys proposal - Wall Street rule: if you dont like management, sell - Difficult to criticize as long as following ISS decisions - Bee-watcher-watcher problem - Conflict-of-interest - Attached letter to 13-D document resignation: different pressure from traditional proxy contest The Allocation of Legal Power between Management and Shareholders - Election of directors (DGCL 211(b)): Directors will be elected in the annual meeting of shareholders - Removal of directors (DGCL 141(k)): May be removed, with or without cause, by shareholders - Amendment of charter and by-laws by shareholders (DGCL 242(b)/109) Charlestown Boot & Shoe Co. v. Dunsmore (1880)
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- The only limitation upon the judgment or discretion of the directors is such as the corporation by its by-laws and votes - The statute does not authorize a corporation to join another officer with the directors, nor compel the directors to act with one who is not a director - The cote choosing Osgood a committee to act with the directors in closing up the affairs of the plaintiff corporation was inoperative and void - There is no statute that makes it the duty of the directors of a corporation to keep its property insured Notes - Osgood does not have a discretion and obligation as directors have - The shareholder cannot limit the board authority under DGCL 141(a) unless stated in charter - Hypo: What if the 90% shareholders want to buy Myron Taylor hall - The shareholders cannot force the board to do it unless charter limits its authority - The shareholder can remove directors (DGCL 141(k)) Fiduciary duty runs to the shareholders as a group - Three exceptions to the fiduciary duty for the benefit of shareholders from the long-term interest (1) Statutes such as Connecticut and New York (2) Gheewallar case (3) DGCL 351: Manage the company directly in closely held company The shareholder is going to be as liable as the directors 02/09/2010

- Election of directors - Plurality vote: the highest numbers of votes even if less than the majority (DGCL 216) All the dissent Shareholders can do is not to vote
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 Favorable system to the company * Federal proxy rules (14a-8) - Voluntary policy - Amendment of charter and by-laws (DGCL 242(b)(1)/109) - DGCL 216: - NYSE rules 452: Allow ML to vote unless it did not receive instruction its customer ML tends to vote in favor of the company (potential client) - Irrevocable resignation as the director provides so (DGCL 141(b)) Vacancies and newly created directorships (DGCL 223) 4 resignation and 4 incumbency but 3 elected in office until successor is elected

People Ex Rel. Manice v. Powell (1911) - The directors hold such office charged with the duty to act for the corporation according to their best judgment - As a general rule the stockholders cannot act in relation to the ordinary business of the corporation, nor can they control the directors in the exercise of the judgment vested in them by virtue of their office - The relation of the directors to the stockholders is essentially that of trustee and beneficiary Removal of Directors - Removal of directors by shareholders (DGCL 141(k)) - Exception: (1) Classes (typically three classes due to limitation under NYSE rules) (2) Cumulative voting

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- Classifying for the purpose of takeover defense by charter - Super majority clause

- Rending voting rights to creditors with redemption by charter (DGCL 221) - NYSE rules 313 Cumulative Voting - A: 100 shares x 7 vacancy = 700 shares to vote B: 200 shares x 7 vacancy = 1,400 shares to vote 2 slots are guaranteed for A: benefit to minority shareholders Weighted Voting in Publicly Held Corporations (not covered by class) Stroh v. Blackhawk Holding Corp. (1971) - The court held that the stock which could be bought cheaper, and yet carry the same voting power per share, was not permitted to share at all in the dividends or assets of the corporation. This additional step did not invalidate the stock Providence & Worcester Co. v. Baker (1977) - P&Ws certificate provided that each holder of common stock had one vote per share for his first 50 shares, but only one vote per 20 shares for all shares over 50 - The court upheld the restrictions under DGCL 212(a), which states that unless otherwise provided in the certificate of incorporation, each stockholder shall be entitled to 1 vote for each share of capital stock held by such stockholder. Under 212(a), voting rights of stockholders may be varied from the one share-one vote standard by certificate

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02/11/2010 Schnell v. Chris-Craft Industries, Inc. (Supreme Court of Delaware, 1971) - Management has attempted to utilize the corporate machinery and the Delaware law for the purpose of perpetuating itself in office and for the purpose of obstructing the legitimate efforts of dissident stockholders in the exercise of their rights to undertake a proxy contest against management. These are inequitable purposes, contrary to established principles of corporate democracy - The advancement by directors of the by-law date of a stockholders meeting, for such purposes, may not be permitted to stand - Inequitable action does not become permissible simply because it is legally possible Notes - You dont have to own the stock in order to take over the company get proxies to vote in favor - DGCL 212 permits to use proxy (usually revocable) - Meetings of stockholders (DGCL 211) (a) Meetings of shareholders may be held at such place as may be designated by the by-laws (b) An annual meeting shall be held on a date and at t time designated by the by-laws DGCL 109 gives the shareholders the ability to amend the by-laws and the charter can authorizes the board to do so The board has the discretion the place and date of the meeting - Moving up the meeting and change the venue to limit the dissent shareholders voting rights and to change the recording date - While the board refused to create the list of the stockholders, plaintiff wanted to know who is entitled to vote in the meeting to contact them The stock ledger shall prepare the recording 10 days before the meeting (DGCL 219) - Any Shareholder can inspect the recordings for any proper purpose
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(reasonably related to such persons interest as a stockholder: soliciting proxies) (DGCL 220) - The court looked at voting rights and concluded there was breach of fiduciary duty even if in compliance with charter/by-laws

Condec Corp. v. Lunkenheimer Co. (Court of Chancery of Delaware 1967) - Lunkenheimer issued 75,000 shares for 75,000 shares of U.S. Industry (a wholly owned subsidiary), in opposition to the hostile takeover by Condec, in order to dilute its interest to a minority - The court held for Condec, stating that shares may not be issued for an improper purpose such as a take-over of voting control from others - Where the objective sought in the issuance of stock is not merely business purpose but also to retain control, it has been held to be a mockery to suggest that the control effect of an agreement in litigation is merely incidental to its primary business objective Notes - The board is authorized to issue the stock under DGCL 141(a) - The primary goal of the board to issue the stock was to retain control of the company - The court focused on equity in the context of the franchise and the primary objective regardless of consistence with the black letter law, and held that the board cannot block the exercise of the franchise like Chris-Craft case - If the primary objective is legitimately to raise capital, it would be fine to have the control effect incidental to its primary motivation - Who has the burden of proof: justification by the board or per se? Blasius Industries Inc. v. Atlas Corp. (Court of Chancery of Delaware, 1988) - Blasius was a 9% shareholder of Atlas, proposing to restructure the company and elect new directors
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- The board of the company increased its size and elected two new directors before Blasius succeeds to place a majority of new directors on the board - The court invalidated the boards action for the purpose of thwarting a shareholder vote, stating that even if it was taken in good faith to protect corporate interest, it constitutes an unintended violation of the duty of loyalty that the board owed to the shareholders

Notes - Schedule 13D: 5% rule to disclose the purpose to acquire control, including their intent to fire the directors (Securities Act 1934 13(d)) - Disclosed to plan to tender offer to get appropriate representation - Finance: Drexel Burnhams well known junk bond mechanism: subordinated debt/higher interests - Leveraged buyouts (LBO): acquisition by substantive amount of debt to pay the purchase price - Leveraged restructuring (recapitalization): sell assets/borrow debts to raise cash special dividends - The issuer cannot see the name of the shareholder because of DTC (depository trust company) The issuer deposits its stock certificate with DTC and both major brokers have accounts in DTC You do not have to move the certificate. Instead, brokers transfer electrically in their accounts Blasius is a beneficiary holder of the stock, so Atlas only knows Cede & Co. on its record - A special meeting can be called by the board unless otherwise provided in charter (DGCL 211(d)) - If there is vacancy, it does not have to be unanimous written consent (DGCL 211(b)/228) The board increased the number of the board (in this case from 7 to 9) by amending the by-laws
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unless otherwise provided in charter (DGCL 109/141(b)) The incumbency board can fill the vacancy (DGCL 223(a)(1)) In the staggered board, the shareholders cannot remove the classified director without cause (DGCL 141(k)): great takeover defense

- Even if the defense action was permitted by the statute, the charter, and the by-laws, the primary motivation to block the franchise causes fiduciary problem (Incidental effect is okay though) - Business judgment rule: - Standard of review to assess whether the boards action was in consistence with its fiduciary duty - Where there is no fraud, illegality and interest of conflict and the board acted in good faith, the court will only look at whether the decision was rational. The board will not be liable unless there is gross negligence 02/15/2010 - Plaintiff argued that defendant breached the fiduciary duties to act for the benefit of the shareholders: (1) duty of care, (2) duty of loyalty and (3) duty of good faith - Defendant argued that business judgment rule applies - The court focus more on the process, instead of second guess of the board decision - Standard of view and burden of proof: Standard of view Burden of proof Intermediate Business The board of directors: Judgment Two parts test: (Unocal standard) (1) good faith/reasonable threat - Due to possible (2) proportionate and reasonable response conflict of interests in Liquid Audio (not preclusive/coercive: Draconian) hostile takeover
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Plaintiff (complaining shareholders): to prove that board is not entitled to the business judgment presumption Shift Entire Fairness The board of directors: (Fiduciary duty Substance of decision, reasonableness, and standard) process - In this case, the court found that the board believed the threat in good faith and reasonably responded. So it seemed that intermediate business judgment rule was satisfied But the court said that in this instance business judgment presumption was warranted because the primary motivation was to block the franchise (no shareholders can control the board). The court applied compelling justification rule (the board of directors bear burden of proof) - The court mentioned that the company could have spent their money to inform their position or to solicit proxies in favor of the company, rather than blocking the franchise itself The boards motivation was to disenfranchise the shareholders by virtue of what they did and fundamentally altered the relationship between they and the shareholders, since after ther act not even a 100 percent of Shareholder function could have changed the Board action. BLASIUS goes to the Motivation of the board action. - Hypo - Suppose that the board established the requirement in the by-laws that the shareholder proposal should be presented a few weeks prior to the annual meeting More administrative reason to get ready to the annual meeting It does not seem implicate the Blasius concerns

Compelling Justification (Blasius) Business Judgment

The board of directors

Shift

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- Hypo (Mercier case) - In competing hostile takeover proposals, while the board decided that the proposal A was better, the shareholders preferred the proposal B due to the huge campaign. Two weeks prior to the annual meeting, it was clear that the proposal B was going to be approved because of a lot of proxies. Finally, the company postponed the meeting for a month - This does not cause Blasius concerns because the company tried to give more information to the shareholders - This is also different from Chris-Craft where the company moved up the meeting date and changed the record date to prevent the voting rights - This is the only case in Delaware where the court found compelling justification International Brotherhood of Teamsters v. Fleming Companies, Inc. (Supreme Court of Oklahoma, 1999) - Teamsters owned 65% shares of Fleming. In 1986, Fleming implemented the rights plan (anti-takeover mechanism) which expires in 1996 - In 1997, Teamsters proposed to amend by-laws to require shareholders resolution when the board adopts any rights plan but Fleming refused to include it in the proxy statement, claiming that the proposal was not a subject for shareholder action - The court held that shareholders may, through the proper channels of corporate governance, restrict the board of directors authority to implement shareholder rights plans - The court did not suggest that all shareholder rights plans are required to submit to shareholder approval, ratification of review Notes - Teamsters wanted to change the by-laws to make the company more attractive to hostile takeovers by taking away the takeover defense - Teamsters provided non-binding resolution to redeem existing pill for the board to get the shareholder approval. But the board objected to follow it. So they tried to include the proposal in the proxy statement to get rid of the
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poison pill - What is poison pill: issuance of rights (stock options) to the existing shareholders to entitle them to buy additional stocks with substantial discount in condition of acquisition of certain amount (15%) of shares (it cant exercise the option) in order to dilute voting rights - Rule 14a-8 (town hall rule) requires the company to include the shareholders proposal in its proxy statement because soliciting proxies by itself is very expensive The problem is that there are a lot of exceptions, such as violation of law, to refuse the proposal - DCGL 109 grants shareholders to amend by-laws Can the by-laws limit the broad authority to adopt the poison pill? CA Inc. case said no (see below) CA Inc. v. AFSCME (Supreme Court of Delaware, 2008) - AFSCME proposed to amend the by-laws to reimburse the expense of soliciting proxies in relation to election of the directors - CA requested no-action letter to SEC under the rule 14a-8 - The issues are whether the proposal to amend the by-laws is the proper subject for shareholder action and whether the by-laws violates the Delaware law - The court held that the by-laws can regulate the process for electing directors of the company unless inconsistence with the charter - However, the court concluded that the by-laws provision violates the Delaware law because it limits the boards discretion/fiduciary duties except by way of the charter 02/16/2010 - Review - The board is statutorily authorized to issue poison pills to keep away hostile takeovers to meet the fiduciary obligations to the extent it satisfies the intermediate business judgment standard - CA Inc. suggested that you cant limit the broad ability of the board to meet
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the fiduciary obligation by way of the by-laws (the Oklahoma courts decision did not get right in Intl Brotherhood case) MM Companies, Inc v. Liquid Audio, Inc. (Supreme Court of Delaware, 2003) - Liquid Audio expanded the size of the board from 5 to 7 by amendment of the by-laws and appointed two additional directors, in response to the takeover offer by MM, its 7% shareholder - The business judgment rule is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. It places the burden on the party challenging the boards decision to establish facts rebutting the presumption - In Blasius, the court ruled that the business judgment rule is not applicable when a board of directors acts for the primary purpose of impeding or interfering with the effectiveness of a shareholder vote. Instead of per se invalidation, the board of directors bears the heavy burden of demonstrating a compelling justification for such action - The Court of Chancery held that the board had to prove a compelling justification for the action within the Unocal standard of reasonableness and proportionality because the action was a defensive measure taken in response to some threat to corporate policy and effectiveness which touches upon issues of control - When the primary purpose of a board of directors defensive measure is to interfere with or impede the effective exercise of the shareholder franchise in a contested election for directors, the board must first demonstrate a compelling justification for such action as a condition precedent to any judicial consideration of reasonableness and proportionately - Since the defendant did not demonstrate a compelling justification for the defensive action, the Court of Chancery should have invalidated it Notes - Primary motivation of the poison pills is to influence the franchise of the
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shareholders - If the pills become exercisable, the shareholders discretion is very limited, being afraid of dilution - The difference between Blasius and Liquid Audio is that in Blasius even 100% shareholders could not change the board of directors because of the staggered directors but in the poison pills the shareholders still can vote out of the board of directors - Poison pill is only triggered by ownership (not proxies) and does not block its voting rights In terms of the intermediate business judgment rule, its not preclusive and coercive - The composition of the board of Liquid Audio (the staggered board): Class I (03) Flynn and Imbler Class II (04) Winblad Class III (02) Kearby and Doig Holzman and Mitarotonda - Only the board of directors can call annual/special shareholder meeting (DGCL 211(b)/(d)) MM could have got written consent to fill in the vacancy without unanimous requirements like Blasius, but did not for some reason (DGCL 211(b)) Instead, Liquid Audio filled in two directors by themselves (DGCL 223(a)(1)) - MM gave an advance notice to amend the by-laws to expand the board to 9 and nominate 6 (Holtzman, Mitarotonda and other 4) - The company is required to prepare the recordings 10 days before the meeting (DGCL 219) and MM can inspect the recordings for any proper purpose (soliciting proxies) (DGCL 220) - Liquid Audio announced the merger with Alliance and postponed the annual meeting indefinitely MM filed a lawsuit to hold the meeting as soon as possible and the court set the date - Liquid Audio announced self takeover and reduced poison pill trigger to
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block additional purchase - While 2 MMs nominees were going to be appointed (due to recommendation by ISS), Liquid Audio expanded the board to 7 by amending the by-laws and filled in vacancies (DGCL 223(a)(1)) - Even if 2 MMs nominees are appointed, any shareholder could not take control of the board because of the staggered board (but Liquid Audio was worried that Imbler and Winblad might resign) - Liquid Audio got no business judgment presumption because its hostile takeover Here, the intermediate business judgment standard (the Unocal standard) applied - Blasius (the compelling justification standard) also applied because the primary motivation was to block the exercise of the franchise (the effectiveness of MMs nominee) - Blasius comes after demonstrating good faith/reasonable threat and before getting proportionate/reasonable response under the Unocal - Regardless of Liquid Audio, as a matter of practice, the courts often analyze whether or not the action absolutely precludes the takeover and coerces the existing shareholders to follow the board If the courts find the preclusion and coercion, they skip Blasius and simply say it failed to satisfy the Unocal standard (they should look at the motivation first and the effect later though) - Blasius steps in only when it is related to the primary motivation of blocking the franchise The Legal Structure of the Management - The board manages the day-to-day business of the corporation What is the problem? - Constraints of time: the board does not have sufficient time to manage the company - Limit CEOs to work for no more than one company - Delegation of the authority to the committee: the board may designate
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one or more of the directors as alternate members of any committee (DGCL 141(c)) The board can rely on the committee in good faith (DGCL 141(e)) - Constraints of information - The board members have the same ability to access the books and records as the shareholders (DGCL 220(d)) 02/18/2010 - Constraints of composition - CEO has a lot of influence on inside/outside directors - The monitoring model - The board is more expected to monitor the company Sarbanes -Oxley Law (SOX) - Enacted in 2002 after the whole series of scandals Why is SOX necessary? - Corporate governance under the state law - Fiduciary duties - Voting rights to elect/remove the directors Some problems: - Plurality system (DGCL 216) - The board authority to fill in the vacancy (DGCL 223) - The board discretion to hold the annual/special meeting (DGCL 211(b)/(d)) - The unanimous written consent except to fill in the vacancy - The staggered board (DGCL 141(d)) - Limitation on the board authority: the primary purpose to block the franchise - The broad grant authority given to the board (DGCL 141(a)) Only the charter, not the by-laws, can limit the authority as long as consistent with the statute but the board consent is required (DGCL 242)
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- It makes more sense for most shareholders to sell the stock (the Wall Street rule) To influence the other shareholders by proxies, follow the Town Hall rule (14a-8) But there are a lot of exceptions under the Town Hall rule and the cost outweighs the benefits - Ease the concerns: (1) Permit to take risks from the long term interests and (2) Get good managers - Greater costs resulting from the compliance with the requirement under SOX and greater liabilities imposed on the directors/officers by SOX (criminal liability/personal civil liability) - SOX apply only to the public companies. As a result, many companies privatized and delisted - While the SEC study shows the estimated costs range from $6 billion to $4045 billion, it is hard to estimate costs because the stock price may increase by improving corporate governance to implement SOX requirements - SOX is the federal law and to address particular corporate governance issues but does not preempt the entire state law It supersedes and modifies some parts of the state law: - SOX 402/1934 Act 13(k) prohibits the personal guarantee to senior officers even if it is permitted under the Delaware law (DGCL 122/123) - PCAOB (public company accounting oversight board): broad authority over public accountant - Dealing with audit, ethics, independence of accountant - Actual inspection on the audit - The constitutionality of PCAOB is now disputed under the Supreme Court - It prohibits providing consulting services to the auditing companies, in terms of independence - SOX directly regulate board/officers behavior, in addition to the general fiduciary duties, irrespective of business judgment rule - Audit committees (SOX 301/1934 Act 10A(m)) - Require to establish the independent audit committee, regardless of DGCL 141(c)
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- Responsible for appointing, compensating, overseeing the company auditors and managing internal control - The auditors directly report to the committee - Independent/outside committee members - Disclosure of audit committee financial expert (SOX 407): at least one * Under the listing rule, every member has to have some financial literacy - While under the federal law the committee is solely responsible for the oversight, under the state law the board can rely on the committee to the extent reasonably and in good faith The board can be liable for the committee under the state law - Under the listing rules, the public companies are required to have three committees (audit, nomination and compensation) and all the members have to be independent, regardless of SOX - Certificate of financial statements (SOX 302(a)) - CEO and CFO have to sign financial statements and certify that they are accurate - They are responsible for maintaining internal control system - Forfeiture of certain bonuses and any other compensations (SOX 304) - If there is material noncompliance, CEO/CFO has to reimburse their bonuses and compensations - Only SEC has the cause of action to get the money back and was historically reluctant to go after CEO/CFO but it is increasing today - Internal control (SOX 404) - It requires the directors in public companies to do internal assessment of internal control and ask the outside accounting to audit whether or not the assessment is accurate (double check) 02/22/2010 Formalities - Board Meeting (DGCL 141(b))

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- Written consent requires unanimous votes (DGCL 141(f)) The dissent director can call the actual meeting - Majority vote is sufficient - Can decrease the quorum but no less than one-third of the number of directors including vacancies - Officers (DGCL 142) - Description in the by-laws/agreement (142(b)) - Apparent authority Suppose title was COO, Managing director and Vice President To confirm the authority, look at statute, charter/by-laws, and a board resolution - Shareholder Action - Quorum and required vote (DGCL 216) - Can decrease the quorum but no less than one-third - Vote based on outstanding or present Limited Liability Walkovszky v. Carlton (Court of Appeals of New York, 1966) - Carlton was a shareholder of 10 different corporations, including Seon Cab Corporation. Each company had two taxies and the minimum automobile liability insurance required by law ($10,000) - Walkovszky was severely injured by the taxi of Seon Cab Corporation - The plaintiff argued to disregard the limited liability based on (1) general rules of agency and (2) the enterprise liability - The court concluded that plaintiff failed to state a cause of action against Carlton because plaintiff was only entitled to hold the whole enterprise responsible for the acts of its agents under the principle of respondeat superior Notes
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- Five different theories to disregard the corporate entity - Agency (respondeat superior): deems the company as a agency acting on behalf of principal - Enterprise liability: deems the company as a part of the larger company and disregard separation - Alter ego - Torts: frauds, negligence, and misrepresentation to create direct liability against the shareholders - Violation of the dividend restriction (NYBCL 719(a)(1)/DGCL 123/124) - The court focused on the insurance in order to decide whether the company has sufficient capital - Is that the problem to set up the company solely to minimize the liability? The courts concern was the under-capitalized vehicle in terms of equity to creditors - If the insurance is sufficient under the statute, the capital is also sufficient 02/23/2010 Dividends and Limited Liability (see the PPT file) - The board can issue dividends on its discretion out of its surplus (DGCL 170) - Par value reduction may take place by amendment of the charter (DGCL 242) Increase the amount of surplus available to dividends - Delaware also permit nimble dividends to be paid out of current profits (DGCL 170) - Traditional way to minimize the creditors risk was the aggregate par value and limiting the ability of the shareholder which do not work any more Focusing more on disregarding limited liability Radaszewski v. Telecom Corp. (U.S. Court of Appeals, 8th Cir., 1992)
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- In Collet, the court stated that in order to pierce the corporate veil, plaintiff must show that defendants control of a subsidiary has been used by defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or dishonest and unjust act in contravention of plaintiffs legal rights - The court held that the whole purpose of asking whether a subsidiary is properly capitalized is precisely to determine its financial responsibility. If the subsidiary is financially responsible, whether by means of insurance or otherwise, the Collet test is met. Insurance meets this policy just as well, perhaps even better, than healthy balance sheet

Unites States v. Bestfoods (The U.S. Supreme Court, 1998) - CPC International was sought to be held liable under CERCLA without piercing the subsidiarys veil, on the ground that it directed Ott IIs operations - In general, a parent corporation is not liable for the acts of its subsidiaries. Thus, the exercise of the control which stock ownership gives to the stockholders will not create liability beyond the assets of the subsidiary - The parent is directly liable for its own action if it the alleged wrong can be traced to the parent through the conduct of its personnel and management and the parent is directly a participant in the wrong complained of - Since court generally presume that the directors are wearing their subsidiary hats and not their parent hats when acting for the subsidiary, it cannot be enough to establish liability here that dual officers and directors made policy decisions and supervised activities at the facility - Activities that involve the facility but which are consistent with the parents investor status, such as monitoring of subsidiarys performance, supervision of the subsidiarys finance and capital budget decisions, and articulation of general policies and procedures, should not give rise to direct liability - The critical question is whether actions directed to the facility by an agent of the parent alone are eccentric under accepted norms of parental oversight of a subsidiarys facility
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- The court found that CPC engaged in just this type and degree of activity at the plant through Williams action Fletcher v. Atex, Inc. (U.S. Court of Appeals, 2nd Cir., 1995) - Plaintiff sued Atex and its parent, Kodak, to recover for repetitive stress damages by the Atexs products, based on the alter ego theory - To prevail on the alter ego claim under the Delaware law, plaintiff must show (1) that the parent and the subsidiary operated as a single economic entity and (2) that an overall element of injustice or unfairness is present - In determining whether a subsidiary and parent operate as a single economic entity, the courts look at (1) whether the corporation was adequately capitalized, (2) whether it was solvent, (3) whether dividends were paid, (4) the formalities were observed, (5) whether the parent siphoned its funds, and (6) whether it functioned as a faade - The court held that plaintiff failed to raise a factual question about Kodaks domination of Atex because (1) the cash management system is consistent with sound business practice and does not show undue domination or control, (2) Kodaks approval is typical of a majority shareholder or parent corporation, (3) the fact that a parent and a subsidiary have common officers and directors does not necessarily demonstrate that the parent corporation dominates the activities of the subsidiary, (4) the statements and the use of the Kodak logo are not evidence that the two companies operated as a single economic entity, and (5) the two companies observed all corporate formalities on the former CEOs mortgage transaction - The court also stated that plaintiff failed to demonstrate the second prong: an overall element of injustice or unfairness that would result from respecting the two companies corporate separateness Notes - Alter ego: plaintiff must show injustice or unfairness in addition a single economic entity - Why does the formality matter? Focusing on whether or not the company is a fake
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02/25/2010 Sea-Land Services, Inc. v. Pepper Source - Sea-Land sought to pierce PSs corporate veil and render Marchese personally liable for the judgment owed to Sea-Land and then reverse pierce Marcheses other corporations - Sea-Land alleged that all of these corporations are alter egos of each other and hide behind the veils of alleged separate corporate existence for the purpose of defrauding plaintiff and other creditors - The court held in Van Dorn that a corporate entity will be disregarded and the veil of limited liability pierced when two requirements are met: (1) there must be such unity of interest and ownership that the separate personalities of the corporation and the individual or other corporation no longer exist and (2) circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice. - To justify disregarding their separate identities, the court focused on four factors: (1) the failure to maintain adequate corporate records or to comply with corporate formalities, (2) the commingling of funds or assets, (3) undercapitalization, and (4) one corporation treating the assets of another corporation as its own - The court found that the corporations are Marcheses playthings and they are used to avoid his responsibility to creditors - The concluded that Sea-Land met the Van Dorn and therefore was entitled to pierce the corporate veil - The court also held that since Marcheses intentional and improper financial maneuvering caused Sea-Lands inability to collect on its default judgment, the required nexus existed here Notes - Plaintiff went directly against Marchese by alter ego/torts (guarantor/misrepresentation) - Why does plaintiff also go against other 4 subsidiaries by enterprise
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liability? Even if plaintiff gets all assets of Marchese including the stock of the companies, the common stockholder is going to be subordinated to the other senior creditors (structural subordination) Minton v. Cavaney (Supreme Court of California, 1961) - There was a wrongful death. Plaintiff recovered a judgment for $10,000 against Seminole and went against the estate of Mr. Cavaney - Defendant brought a motion to dismiss - The court held that defendant was not personally liable because even if there was no attempt to provide adequate capitalization and Mr. Cavaney was a director of the company, the judgment against Seminole was not binding upon him Notes - The motivation to be a director (he was asked to do it) does not matter - Motion to dismiss Re-litigate because there was an agency problem - The court listed three possible scenarios to pierce the corporate veil: - Treat the subsidiary as their personal toy (Sea-Land) - Guarantor/misrepresentation (Sea-Land) - Actively participated in the management of the corporation and there was undercapitalization - NYBCL 630: employees can go directly against the shareholder of the closed company - Capitalization - Assets available to the creditors, not legal capitalization/not aggregate par value - When decide: at the time of initial formation, not on-going obligation (Radaszewski/Truckweld case) - Capitalization is one factor to determine alter ego (Arnold case) and pro se rule (Slottow case) Take the nature of the company (trust bank higher duty) into account
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under Slottow case - Why is capitalization so important? Largely because of an agency problem between shareholders and creditors under limited liability The courts focus on injustice or unfairness under alter ego analysis - Equitable subordination - A senior debt that controlling shareholder has is subordinated to other creditors (Deep Rock) - Improper management solely for the interest for the parent subordinated its claim (Gannet) - To avoid alter ego concerns, demonstrate incorporation with adequate capitalization Its difficult to argue alter ego and equitable subordination together because if the parents claim is subordinated, the subsidiary tends to be capitalized Arnold v. Phillips (U.S. Court of Appeal, 5th Circuit, 1941) - The court differentiated legal capital and proper capital to run the business at the time of creation - There were two loans: first one was considered as capital and second one was not The second loan is not subordinated because it was held in good faith and from a third party No subordination but it causes alter ego claim based on undercapitalization Benjamin v. Diamond (U.S. Court of Appeal, 5th Circuit, 1977) - Subordinate the debt to the extent that the creditor acts for its benefit at the expense of other creditors - Why limited liability? - Risk diversification (too simple explanation) - Efficient capital market Less likely to see piercing the corporate veil case in large publicly held
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companies In closely held companies, there is no offsetting justification so the courts are more likely to piece the veil and plaintiffs damage is more substantial and unjust - Violation of the dividend restriction (NYBCL 510/719(a)(1)/DGCL 123/124) The majority of the board voted to issue the dividends in violation of NYBCL 510 The director will be jointly and severally liable unless he affirmatively dissents (NYBCL 719) The directors can get the money back from the shareholder with knowledge of unauthorized dividends (NYBCL 720) - UFTA 4(a) allows creditors to get the money back if the company issues dividends with actual intent to defraud any creditor and without receiving a reasonably equivalent value - Bankruptcy code is the same 03/01/2010 Federal Reporting Requirements (See PPT file) - SEC Registration - (1) Transaction (1933 Act) - (2) Market (1934 Act) - Periodic reporting (1934 Act) - Annual report on form 10-K - Quarterly report on form 10-Q - Current report on form 8-K Extensive disclosure under the Federal law

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Review Problem 3
- CC has a loan from FC which is roughly equivalent to the dividends - There was overlap in the board between CC and FC but it was independently operated entity - Different cause of action to sue FC - Alter ego - Common economic entity/parent does not treat subsidiary as separate entity (a little difficult here) Have to argue undercapitalization (no undercapitalization no alter ego) Also have to show unjust or inequitable - Agency - The courts focus on the norm between parent and subsidiary - Equitable subordination - A loan from the controlling shareholder will be subordinated to substitute capital - Torts (negligence/misrepresentation) - Enterprise liability (not applicable to this case) - Possible defense by SF - Alter ego/agency Length-arm relationship: operation in consistence with normal parent and subsidiary relationship - Alter ego/equitable subordination Not undercapitalized: the trade credit suggests that creditors relied on sufficient capital - Future claims Reinforce the separateness The third party loan to avoid equitable subordination - What if transfer from parent to third party? Raise the alter ego issue again Inspection of Books and Records
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- The company shall prepare the stock ledger 10 days before the meeting (DGCL 219) - Any shareholder can inspect the recordings for any proper purpose (reasonably related to such persons interest as a stockholder) (DGCL 220) - Place burden to prove proper purpose (DGCL 220(c)) - On stockholders: other than stock ledger (because it raises more complication/suspicion) - On corporations: stock ledger - Allowed to access subsidiarys information * 5% or 1%/filing 14A shareholder has absolute right to inspect the stock ledger (CCC 1600) - Transfer agent: acting on behalf of the issuing company - Issue/cancel stock certifications - Paying out dividends etc - Maintain shareholders list Saito v. McKesson HBOC, Inc (Supreme Court of Delaware, 2002) - McKesson and HBO entered into a stock-for-stock merger agreement. As a result, HBO became a wholly-owned subsidiary of McKesson - McKesson announced the financial restatements because it found that HBO had accounting irregularities - Plaintiff brought a derivative action for breach of fiduciary duty: monitoring oversight claims - Plaintiff made a request to inspect the HBO documents but defendant refused, arguing that plaintiff does not have the cause of action to bring the derivative action - The court held: (1) The predating documents: the purchase date does not control the scope of records if activities are reasonably related to the stockholders interest as a stockholder (2) The financial advisors documents: the source of the documents does not control the inspection rights if they are necessary and essential to satisfy the stockholders proper purpose
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(3) The HBOC documents: under common law generally not accessible absent showing fraud/alter ego (piecing the veil analysis again) but does not extend as long as the parent has the documents - Mixed purpose: if the primary purpose is proper, the secondary purpose is largely irrelevant - Proper Purpose: to determine the financial condition of the corporation and to ascertain the value of the shares Notes: - Shareholders derivative action: a shareholder at the time of the transaction is entitled to bring an derivative action on behalf of the corporation for breach of fiduciary duty of the board if the following requirements are met (DGCL 327) (1) There is a valid claim that the corporation can sue (2) The board refused to proceed to go after the boards breach - The damages will be awarded to the corporation (plaintiffs lawyers will get the most benefits) - Common law usually requires the shareholders acting in good faith and having proper interests (the burden to prove is put on the shareholder) - Access to the subsidiary documents under Saito case statutorily superseded by DGCL 220(d) 03/02/2010 Pillsbury v. Honeywell (1971) - Pillsbury asked Honeywell to produce its shareholder ledger to try to minimize its involvement with the Vietnam War and to communicate with other shareholders - The court held that there was no proper purpose because plaintiff does not have any economic interest - Notes - Pillsbury might have been able to argue he has economic interest in terms
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of long term interest (such as it raises reputation) Credit Bureau Reports v. Credit Bureau of St. Paul, Inc. (1972) - Local Credit Bureau wanted, as a shareholder, to access the shareholder ledger to maximize its own benefit because Credit Bureau has decided to cut the fee for Local Credit Bureau - The court disregarded Pillsbury and held that the desire to solicit/communicate with other shareholders is sufficient to be proper purpose in limitation to the stock ledger (the secondary purpose to pursue its own profits is not irrelevant) Notes - There is a conflict between Local Credit Bureau and other shareholders and between Local Credit Bureau and the board (it happens to hostile takeover cases as well) but who can access the stock ledger is not what the court decides - What if the competitors requested to access to the information to value the stock? The court may limit or add conditions on the access to the information, such as requiring to sign the confidentiality letter, to balance the competing interests avoid misuse by competitors (DGCL 220(c)) Proxy Rules - The proxy rules apply to the publicly reporting companies under the federal law - Rule 14a-7: - Deals with proxy solicitation - Requires fair amount of information - Permits shareholders to solicit proxies to access the stock ledger (including the beneficial owners to the extent that the issuer has the information because the record name and street name do not help) at their expense - DGCL 212(b) authorizes shareholders to vote through the proxy (generally revocable unless otherwise stated in the proxy (DGCL 212(e)))
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- Proxy is dominant voting form in the US because shareholders disperse and it cost to attend meeting - 1934 Act 14(a) authorizes SEC to make rules in relation to proxy solicitation and makes it unlawful to violate the proxy rule: criminal/civil - Rule 14a-9: - No solicitation shall be false or misleading with respect to any material fact or omits to state any material fact - Can GM bring a private action against Ralf Naders statement the directors are bombs? Not clearly under Rule 14a-9 on its face but permitted by the court in Borak Still, GM has to prove the materiality defined by the court in TSC Industries: yes or not Was it solicitation subject to the proxy rule? - Rule 14a-1(l): solicitation includes (i) any request for a proxy, (ii) any request to execute or not to execute a proxy, or (iii) furnishing proxy or other communication under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy (very broad: see Gittlin) Yes, because the meeting was in two months and he was influential Rule 14a-1(l)(2)(iv)(A) excludes a communication by a security holder stating how the security holder intends to vote and the reasons therefor Maybe Nader will be qualified with this exception if he is a shareholder - The proxy rule does not apply to the record name or street name holders (Rule 14a-2(a)) - ISS is also exempted from the proxy rule but Rule 14a-9 continues to apply (Rule 14a-2(a)(iii)) - Solicitation where the total number solicited is not more than ten is also exempted except Rule 14a-9 (Rule 14a-2(b)(ii)) - Rule 14a-3(b) requires the annual report (not the same annual report as the form 10-K) for the annual meeting to elect directors
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- Largely curved out of civil liability under the federal law except fraud (10b5): recklessness standard - In a simple manner to make readers easily understand without worrying about the liability

J.I. Case Co. Borak (the U.S. Supreme Court, 1964) - The court admitted implied right of shareholders and companies to bring a private action TSC Industries v. Northway, Inc. (the U.S. Supreme Court, 1976) - The court defined the materiality: the misstatement is going to be material if there is a substantial likelihood that a reasonable shareholder would (not might) consider it important Studebaker Corp. v. Gittlin (U.S. Court of Appeal, 2nd Circuit, 1966) - The court concluded that solicitation includes trying to get access to the stock ledger 03/04/2010 - Private actions under the proxy rule - Agency problems The proxy is the only resort for the shareholders to influence the company

J.I. Case Co. v. Borak (the U.S. Supreme Court, 1964) - A shareholder brought an action under 1934 Act 14a and Rule 14a(9) to seek for damages - The proxy statement had false/misleading information in relation to the merger - The shareholders voted in favor of the merger but based on the false/misleading information
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- There is no explicit right to bring a private action under the proxy rules - The court ruled that a shareholder could bring a private action for violation of the proxy rules Notes - The exclusive jurisdiction of the federal courts includes the duties arising under 14a (27) - SEC has the statutorily granted authority to impose fines and imprisonment but overworks - The proxy rules purpose to prevent abuse of proxies and to protect investors A private action should be available even though there was no express right Cort v. Ash (the U.S. Supreme Court, 1975) - Four principle factors that the courts will consider, deciding whether or not to apply a private action: (1) Whether plaintiff is one of the class for whose especial benefit under the proxy rules (2) Whether there is any indication of legislative intent (3) Whether it is consistent with the underlying purposes of the legislative scheme: to protect investors (4) Whether the cause of action is one traditionally relegated to state law - Insider trading (1934 Act 10b-5) Mills v. Electric Auto-Lite Co. (the U.S. Supreme Court, 1970) - Mergenthaler owned 54% of the shares of Auto-Lite and sought for the merger (needs two-third votes) - American Manufacturing owned about one-third of the shares of Mergenthaler - The board of Auto-Lite solicited proxies to vote in favor of the merger but did not disclose that all of Auto-Lites directors were nominees of
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Mergenthaler and they were under the control and domination of Mergenthaler Even if implied, given nature of conflict of interest, the company should have warned shareholders to be more careful - Plaintiff brought a derivative action on behalf of the company and a private action on behalf of minority shareholders harmed by the material misstatement under the proxy rules - The court looked at what was legally required to proceed the merger is two third of voting rights Mergenthaler needed substantial number of minority votes in order for the merger to go forward - The court found that there was the material omission and deficiency in the proxy statements - Defendant had burden of proof that the merger would have proceeded without misleading statement - The Seventh Circuit said that whether or not the shareholder would have voted in favor of the merger even if the proxy statement was false or misleading depends on whether or not the terms of the proposed merger was fair to protect the minority shareholders No harm, no foul, even if the proxy rules were violated - The Supreme Court stated that Borak focused on the shareholders free exercise of the voting rights - Whether the merger terms are fair or not is not what the court decide with its economic sense but the shareholders should decide - As long as the misstatement or omission was material, actual causation is sufficiently established - The Supreme Court directed the lower court to see fairness to decide what appropriate remedy is Notes - Significant propensity to affect the voting process (might is substituted by would in TSC) - Plaintiff has to demonstrate materiality and the essential link to the relevant
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transaction - Generally appropriate remedies under Rule14a-9 depend on equitable determination by the courts Enjoin the vote or the meeting, void the merger agreement, or award money damages (the difference or fairness) - Suppose the CEO did not disclose the fact that he was ill but was planning to resign after reelection Materiality omission because CEO is important and irreplaceable Who is likely to sue the company, assuming the stock price went down due to the disclosure? Shareholders who bought the stock during the period between the proxy solicitation and the disclosure can sue the company if the company did not disclose when the proxy statement came out Virginia Bankshares, Inc v. Sandberg (the U.S. Supreme Court, 1991) - VBI was a wholly owned subsidiary of FABI and VBI owned 85% of the Banks share. - Plaintiff brought the federal claim under the proxy rules and the state claim under the breach of the fiduciary duties - The board believed that the price was high and the terms were fair - The Fourth Circuit held that even if plaintiff had the cause of action even if its vote was not necessary - The Supreme Court considered whether the statement was materially misleading, even if its a belief statement, because it came from the board - The Blue Chip was not applicable though, the court also looked at the defendants state of mind and focused more on whether the underlined subject matter (the value of the shares) was accurate: the value of the assets, the market value and the going concern value (objective test) - Regarding essential link, the court held that there was not causation under Rule 14a-9 because the votes of the minority shareholders were not required by law or the by-laws to authorize the merger

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Notes - VBI did not need the remaining shareholders votes to do the merger (different from Mills) - The board said the price was fair because they wanted to protect their jobs - The jury instruction is the Mills standard: materiality and essential link - Blue Chip - Plaintiff brought a claim under 10b-5, saying that it would have sold the stock but for the fraud - The court excluded the shareholders who held the stock because it was very difficult for defendant to prove or disprove what the plaintiffs intention was - The court considered two steps to determine materiality (1) Whether or not the board reasonably and honestly believed what they were actually saying AND; (2) Whether or not the subject matter was objectively true or false An accurate reflection of the underlying subject matter. ($) Belief Disclosure Actual Value Cause of Action 42 42 60 No 60 60 42 No 60 42 42 No 60 42 60 Yes 42 60 42 Yes 03/08/2010 Wilson v. Great American Industries, Inc. (the U.S. Court of Appeals, 2nd Circuit, 1992) - The court held that Virginia Bank did not bar the shareholders action under Rule 14a-9 if it had lost its appraisal right or some other state remedy as a result of false statements in the proxy statement Cowin v. Bresler (D.C. Circuit, 1984)
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- The court held that a shareholder who did not grant a proxy in reliance on the proxy statement that is materially misleading or omits to state a material fact has standing under Rule 14a-9 Gerstle v. Gamble-Skogmo, Inc. (the U.S. Court of Appeals, 2nd Circuit, 1973) - The court held that negligence (typo), not recklessness, sufficed to establish liability under Rule 14a-9 Notes - To the extent that outside accountants are involved, more than negligence is required (Adams case) Corporate-Governance Shareholder Proposals - The shareholder is allowed to notify the company that it intends to submit the proposal at the upcoming shareholder meeting and the company must include the shareholders proposal in its proxy statement unless the proposal fall in the exceptions (Rule 14a-8) - Under Rule 14a-7, the shareholder has to bear the cost - Rule 14a-8: - One proposal per meeting, not exceeding 500 words (Q3 & Q4) - A shareholder who has at least $2,000 or 1% for at least one year is eligible (Q2) - No-action letter states, in relation to 14a-8 exclusion, SEC will take no action - 13 bases where a company may exclude the shareholders proposal (Q9) - (1) Improperness: violation of law - By-laws cannot limit the broad discretion of the board in consistence with charter (CA Inc) - Proposal to express that the shareholders do not like the poison pills will be OK - (5)(7) Relevance/Management: - balancing test between the boards discretion to manage the company
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in the ordinary manner social policy issues (green/technology) - (8) Relates to the board election: - Proposal to nominate for election of the board can be excluded - Shareholders can propose by-laws provision to limit this exclusion (the Second Circuit decided that it could be included in the proxy statement but SEC still thinks its excludable) - (10) Substantiality implemented: - What the shareholders are trying to achieve but the board has already adopted (SEC required by-laws amendment proposal not simply be excluded) - (12) Resubmissions: - Substantially the same proposal as rejected in three years - DGCL 112 permits by-laws provision to include shareholders proposal related to election of directors in its proxy statements (enacted four months ago) after the C.A Inc CASE this permits the shareholder to do the same thing that the new Rule 14a-11seeks to do if amended so even if it is not amended section 112 can be relied on to get to the same result

03/09/2010 Proxy Contests - The cost for soliciting the proxies is substantial Who should bear it? Rosenfeld v. Fairchild Engine and Airplane Corp. (Court of Appeals of New York, 1955) - When the directors act in good faith in a contest over policy, they have the right to incur reasonable and proper expenses for solicitation of proxies and in defense of their corporate policies - In a contest over policy, as compared to a purely personal power contest,
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corporate directors have the right to make reasonable and proper expenditures, subject to the scrutiny of the courts when duly challenged, from the corporate treasury for the purpose of persuading the stockholders of the correctness of their position and soliciting their support for policies which the directors believe, in all good faith, are in the best interests of the corporation - The stockholders have the right to reimburse successful contestants for the reasonable and bona fide expenses incurred by them in any such policy contest, subject to like court scrutiny, where the majority of the shareholders vote so to reimburse such dissident shareholdersthus majority-shareholder approval Notes - DGCL 113 permits the by-laws to provide for the reimbursement by the corporation of expenses incurred by a stockholder in soliciting proxies in connection with an election of directors (not clear that DGCL 113 is inconsistent with CA Inc) - The majority allowed the expenditure to persuade shareholders. On the other hand, the dissent allowed it at most to inform them - The majority placed the burden of proof that the expenditure was unreasonable on plaintiff - Rule 14a-16: - Rule 14a-16 allows the public corporations/shareholders to put proxy materials on the public website - The dissenting shareholder does not have to provide proxy materials to all the shareholders - Still, Rule 14a-9 liability applies (the second circuits negligence standard) - SEC requires to disclose the compensation policy to the extent it has materially adverse effect

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Review Problem 4 - 13-D: intention to own the share (more than 5%) - Amend the by-laws and fill the vacancy - To gain control: tender offer/proxy solicitation/written consent solicitation - Need to know the record/meeting date and the stock ledger - Buy additional shares with irrevocable proxies - DGCL 220 statutorily granted any stockholder to access to the stock ledger, so the limitation is void - 14a-9 concerns: In the context of proxy solicitation - Materiality (reasonable/honest statement + subject matter) - Essential link - Negligence standard (the second circuit) - SEC also has the cause of action 3/11/2010 The Duty of Care Francis v. United Jersey Bank (Supreme Court of New Jersey, 1981) - Mrs. Pritchard was a director and the largest shareholder of Prichard & Baird, a reinsurance broker - The nature of the business: very risky and needs high integrity - Charles Jr. and Williams made a loan from the company instead of dividends but they did not repay (it appeared to be assets on the balance sheet) - Notes - Defense of Mrs. Pritchard - She was a family member and did not know the business, even though she was a director - She had a drinking problem It sounds like Minton case( the swimming pool case) - The analysis was negligence (ordinary care) standard: duty, breach and proximate cause
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- In Delaware, Aronson adopted gross negligence standard: focusing more on the process - The Delaware court will look at the circumstances of the individual (not taking into negative circumstances account) and nature of the business and decision - ALI 401: duty of inquiry and reliance on experts or others in good faith - Francis suggested, in order to meet the negligence standard, - To understand the business, - To monitor/be informed Duty of inquiry - DGCL 141(e): the board can rely on reports and committees - Mrs. Pritchard did not even see the financial statement no reliance - Causation - Torts law imposes the burden of proof on plaintiff - In Andrew, Learned Hand placed the burden of proof to show the causation on plaintiff - In contrast, the Delaware stated that, once plaintiff demonstrated there was a breach of the duty of care, the burden of proof to show the causation will be shifted to defendant - What Mrs. Pritchard should have done? Object on the minute or submit statement, obtain advice, bring a sue or resign The sons ruined the company in any way, then probably no causation - Officers have the same fiduciary duty as directors - Directors run the fiduciary duty to creditors only in case of insolvency (Gheewalla) The Business Judgment Rule: This does not look at the decision itself bue the process in making the decision. Kamin v. American Express Co. (Supreme Court, NY County, 1976) - This is a derivative action against Amex
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- Amex decided to issue dividends by the DLJ stocks Notes - Amex could have gained $8 mil tax savings if it had sold the DLJ shares - No fraud/bad faith was involved in this case One small question of self-dealing: 4 of 16 directors were employees and got bonuses on profits But 4 are not dominant - The board was concerned that if it reports a loss, it will be decrease in the stock value of AMEX But Wall Street knows that AMEX bought the stock and it has depreciated - The court decided it is not actionable - The board has discretion to issue dividends under DGCL 141 - The board had considered all of the facts, including selling the stock The court focused more on the process even if it disagreed with the outcome - The business judgment presumption requirements (Cede & Co v. Technicolor (Delaware, 1993)): - Actually made a decision - Informed itself - Acted in good faith - Had no conflict of interest If plaintiff shows that the board failed to meet the business judgment presumption, the board has to show the transaction was entirely fair 03/15/2010 Smith v. VanGorkom (Supreme Court of Delaware, 1985) - Trans Union did not have enough taxable income and was concerned about its tax credits to be expired without being used - Van Gorkom intended to sell Trans Union through LBO at $55 per share ($17 premium) and tried to make as much money as possible
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- On September 18, Pritzkers lawyer drafted the merger agreement and asked the Trans Unions board to approve it in three days - On September 20, Trans Union had the senior manager meeting and the board meeting called on short notice. Van Gorkom did not provide any copy of the merger agreement. CFO showed different price - The board heard about the merger agreement from Van Gorkoms 20 minutes presentation but it did not read it. Also, Van Gorkom did not disclose anything about evaluation - The board approved the agreement but attached two conditions which were not stated in the minutes - On October 8, the board approved the amendment which did not reflect the conditions and employed Solomon to solicit other offers - Amendment limited the Trans Unions ability to negotiate and to withdraw from the negotiation until it consummated a merger or entered into a definite agreement subject to the shareholder approval - The court thought there was gross negligence Notes - In LBO case, the lender cares more about cash flow to satisfy interest payment - In MBO case, the board has a direct financial stake It is not entitled to the business judgment presumption The court applies the entire fairness standard - In general, seller drafts the merger agreement, not the buyer - DGCL 141(e) allows the board to rely in good faith on reports made by officers But Von Gorkom and the lawyer did not see the merger agreements themselves - Brennan, the lawyer, was employed by Van Gorkom Independent directors should have employed independent lawyers to avoid potential conflict - 2 hours meeting was short, though it was the most significant corporate decision that the board made
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 Terminating the relationship between the existing board and shareholders - The boards direction is protected by DGCL 141(a) and the business judgment presumption - Fairness opinion (whether or not the price offered by the company is fair) is not required - The business judgment analysis - The board loses the business judgment presumption if it is grossly negligent - Van Gorkom and Romans were not reliable at the meeting - There was no prior consideration - A premium is indeterminate unless it is accessed under other competent and sound valuation - The proxy was subject to the condition on the better offer - The board should have asked questions listed on p.555 - No shareholder approval cure because of lack of sufficient information presented - After this case, insurance premium substantially went up - DGCL 102(b)(7) eliminates or limits the personal liability of a director for money damages for the breach of duty of care but not the breach of duty of loyalty, the breach of duty of good faith and unlawful dividends 03/16/2010 - Three ways to minimize the directors personal civil liability: (1) Direct limit on liability (DGCL 102(b)(7)) - Charter provision (not required) - Limit for monetary damages by breach of duty of care - Curve out the breach of duty of loyalty, the breach of duty of good faith and unlawful dividends Why shareholders agree with this amendment? To get better directors, presumably preparing to take risk, and hopefully result in greater return - Reduce the insurance cost and out of pocket in relation to possible
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lawsuits (2) Indemnification (DGCL 145(a)/(b)) (3) Insurance (DGCL 145(g)) Emerald Partners v. Berlin (1999) - The could held that the board has to demonstrate its good faith in front to rely on the affirmative defense under DGCL 102(b)(7) The claim becomes solely about breach of the duty of care, which DGCL 102(b)(7) blocks Malpiede v. Townson (Supreme Court of Delaware, 2001) - Frederick was in serious financial trouble and looking for a buyer - The Fredericks board approved the merger with Knightsbridge - The merger offer had a no shop clause, so Frederick was not allowed to solicit - Frederick declined the Veritass offer regardless of its higher price - The issue was whether the board breached the duty of care by blocking the auction process - The plaintiff brought the breach of duty of loyalty claim, which is not limited by DGCL 102(b)(7) - The court found that there was no breach of the duty of loyalty because only one director had the conflict and he did not dominate the board Notes - There was no breach of duty of loyalty, so all remains is the breach of duty of care claim The plaintiff has the burden of proof due to the business judgment presumption - Indemnification (DGCL 145(a)/(b)) - Directors are entitled to the indemnification as long as acting in good faith and in consistent with the best interest of the shareholders (like duty of loyalty)
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- Insurance (DGCL 145(g)) - D&O insurance - Even though the policy typically covers the action arisen out of gross negligence but it is difficult to differentiate from the fraud case There may be ambiguity whether or not the insurance applies

- Sentencing Guideline - It is no longer mandatory limitation but the courts likely consider it - The 2004 amendment significantly increased the responsibility of the board for compliance and ethics and permits less sentencing if the board complies with effective compliance and ethics program requirement - Directors criminal liability (1) Liability of the manages by criminal action themselves (2) Liability of the manages by criminal action of the employees (corporateofficer doctrine) Meyer case said that unless the law specifically intends, the managers are not liable for the employees action simply because they have not overseen them - Directors liability under SOX 302/404/906 Review Problem 5 - Ms. Carpenter became a director of Fields Corp (public) without knowledge of finance/business - She never attended the board meeting but signed the merits on the one-sided loan transaction - Fields Corp suffered financial problems and went Bankruptcy Notes - Under the business judgment rule, plaintiff has the burden of proof of her
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gross negligence - Even though Mr. Fields ran the company, Ms. Carpenter still has the duty to affirmatively manage it - Ms. Carpenter has liability shields: DGCL 102(b)(7) (but only money damages by breach of the duty of care), indemnification and insurance - Ms. Carpenter is not entitled to the business judgment presumption because she did nothing - Ms. Carpenter breached the duty of care because she failed to oversee Mr. Field by absence - Causation: In NY, plaintiff has the burden of proof on causation (traditional torts concept) In Delaware, the board has to prove the entire fairness (informed fair decision) - Concurrent negligence is the defense but can be a claim against other directors - In case of the public company, SOX 402 might apply (applicable to a loan to two directors) - Internal Control does not work and the failure permits the self-dealings (SOX 302)

In re Caremark International Inc. (Delaware Court of Chancery, 1996) - Caremark had regulatory problems due to the employees criminal conduct/misconduct - The court held that the board has a duty to maintain internal control, information gathering and reporting system in order to fulfill the duty, the good faith attempt by the board is required Notes - In Graham, the court held that there is no duty on the board of monitoring/establishing compliance system unless they have some cause of suspicion - In Delaware, once plaintiff demonstrates the breach of duty, the issue is not
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proximate causation but whether or not the boards decision was entirely fair - The court focused on the duty to inquiry (Von Gorkom) the board has to actively monitor the company and to make an informed decision. It also considered the sentencing guideline The court did not require the board to create the compliance program. Rather, it raised the risk of liability of damages - Under SOX, CEO and CFO have to attest to the internal control with the audit report - Plaintiff has to prove that the board knew or should have known the violation of the law were occurring and the board took no good faith effort to prevent the problem - In order to show lack of good faith, plaintiff has to show failure to exercise reasonable oversight High standard for plaintiff (the business judgment standard) - Why does the court impose the high standard? Why not gross negligence? Imagine tens of thousands of people are working in the company If directors have to worry about every single employee, it will force out the directors 03/18/2010 In re the Walt Disney Company Derivative Litigation (Supreme Court of Delaware, 2006) - A shareholders derivative action against the board of directors for hiring Mr. Ovitz - Mr. Eisner (CEO) and Mr. Ovitz knew each other for more than 20 years - Mr. Ovitz received 5-year contract with stock options and no fault termination agreement ($130 mil) Notes - The employment contract the business judgment presumption The presumption can be reversed by showing breach of the duty of
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care/loyalty or acting bad faith - Breach of the duty of care analysis - Mr. Eisner was controlling the information and did not tell the entire board about the employment agreement. Only 3 directors were aware of the discussion at the time of the approval They signed the agreement subject to the compensation committees approval Disney made a press release about the employment before the approval - The term sheet was presented in one-hour compensation committee without independent experts The court said there was no gross negligence regardless of the same situation as Van Gorkom The court looked at the nature of the decision: not a sale of the company but an employment No breach of the duty of care - Termination provisions - Mr. Eisner terminated the contract without the board approval - The board can rely on the reasonable advice of the general counsel (DGCL 141(e)) - Breach of the duty of good faith analysis - Plaintiff argued there is breach of the duty of good faith if the board made a material decision without adequate information (the duty to inquiry has the duty of good faith component) - The court looked at three categories: (1) Actual evil intent to harm (2) Gross negligence (The court said no because the statute differentiate it from good faith) (3) Acting with intent to violate the law or disregard the duty (somewhere between (1) and (2)) Something beyond gross negligence - It is not clear where the court will draw the line between duty of care and duty of good faith
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- The cause of action does not directly arise from the breach of the duty of good faith - Waste claim: when the decision was irrational even if there was the business judgment presumption Stone v. Ritter (Supreme Court of Delaware, 2006) - The banks employee was involved in the Ponzi scheme and fined due to violation of the banking law - Plaintiff brought a derivative action and claimed that the demand should be excused Notes - The standard to show breach of the duty of good faith Caremark: one of two to establish a failure to act in good faith (1) To fail to act, regardless of knowing the red flag (2) To consciously disregard to discharge the fiduciary obligation when it should have known - The duty of loyalty could be breached only by the conflict of the interests The court expanded the concept to the case where breach of the duty of good faith substantially implicates breach of the duty of loyalty (still not complete overlap though) - Plaintiff might have a private cause of action because of breach of the duty of loyalty Miller v. American Telephone & Telegraph Co. (the U.S. Court of Appeal, 3rd Circuit, 1974) Notes - The business judgment presumption is satisfied if the board had no conflict, was reasonably informed and acted in good faith - Violation of the law does not get the business judgment presumption - AT&T violated the law but it was economically good ($500 mil) for the shareholders
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- This is the policy reason: the court wants the board to comply with the law - The board is not authorization to be engage in unlawful business under the law (DGCL 101(b)) Breach of the duty of loyalty concern arises because the board is acting in the manner in consistence with the corporate is set up to do The board does not get the protection under DGCL 102(b)(7) and 145 03/29/2010 - Three different areas of hostile takeovers: - Defense measures - Bidding process - Deal protection devices - Constant themes even in the context of hostile takeovers: - The boards action intended to maximize the shareholders value - The board`s measure does not unreasonably block the value enhancing bid - Higher scrutiny - Hostile tender offers - Tender offer is an offer to buy a substantial amount of stocks to general shareholders, typically with some premium over the stock price, maybe with some conditions such as removal of protections (e.g. poison pills) and minimum shareholders tender (e.g. 51%) - Hostile tender offer: the board opposes to the offer - Three ways where acquiror can take control of the target company: - Tender offer - Proxy solicitation - Written consent solicitation - Is a hostile takeover generally good or not in society? - How the board reacts, optimistic or less optimistic
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- Motivation of the hostile acquiror - Typically substantial premium good for the shareholders - In personal level, it is disrupt even if he does not lose the job - Certain impact on the local economy if it is a large company in a small town - A hostile takeover might be considered as an additional means to control the board - Raiders may look at - Efficiency by combining two companies (synergy) - Decrease competition in the market (but antitrust concern) - Complex corporate structure The market price is lower than it should be (the market price usually does not reflect the actual value of the company Raiders can take advantage of the discrepancy - Terminology - Raider/bidder: acquiror - Target: the company sought to be acquired - White knight: it steps in to block the takeover - Management buyout (MBO): management executes the leveraged buyout of the company No business judgment presumption because of potential conflict of economic conflict The court often will consider the independent committee as less conflict and rational A third party bidder sometimes steps in - Takeover defense strategy - The staggered board: up to three classes, removal only for cause If coupled with poison pills, it is going to be very though defense But shareholders do not like this defense
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- Different classes of stock: a class of stock not publicly traded has the voting control - Super majority provision - Packman defense - Poison pills (rights plan) - Statutory authorization to issue rights on stocks (DGCL 157) - Entitles to shareholders, except the acquiror, to buy the stock with substantial discount dilution - Flip-in pills: a plan is triggered when the acquiror cross the specified ownership threshold - Flip-over pills: a plan is triggered when, after a flip-in triggering event, the acquiror initiates an event, such as a merger, self-dealing transaction, or sale of assets - A plan makes the acquisition more expensive, not entirely stop - It does not triggered by the proxy solicitation - Poison pills are removal by the board decision - Suicide defense: losing customers or reducing revenue by the triggering event - Golden parachute: substantial compensation to the directors in the event of changing control Agency problem - Williams Act - To avoid the shareholders taking a bid based on the inadequate information - 13d: disclosure of the purpose of the purchase etc if the acquiror gets more than 5% stock - 14d-1: minimum disclosure obligation of identity, finance, purpose of the purchase etc - 14d-10(a)(1): the offer has to be the same terms open (20 days) to all the shareholders (not selective) - 14d-10(a)(2): the best price rule - 14d-6/8: proration requirement - 14e: misstatement (the same concept as 14a-9)
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03/30/2010 Unocal Corp. v. Mesa Petroleum Co. (Supreme Court of Delaware, 1985) - Mesa owned 13% of the stock of Unocal (T. Boone Pickens controlled Mesa) - Mesa made a two-tier coercive tender offer: firstly to purchase 37% at $54 in cash and secondly to merge Unocal by deeply subordinate junk bonds - The Unocal board decided the offer is coercive and inadequate with 8 independent outside directors, spending more than 9 hours, based on legal/financial advices (contrast to Van Gorkom) and made a self-tender at $72, excluding Mesa Notes - T. Boone was a green mailer: buy my stock if you do not like the hostile tender offer * Statutory limit on a green mail such as NYBCL 513(c) - The merger agreement needs majority shareholders votes (DGCL 251(c)) - The two tier tender offer was coercive because the shareholders had to choose the bid - The self-tender intended to give the shareholders the alternative It works as a defense measure because it makes Unocal less attractive because of increasing leverage - The self-tender offer excludes Mesa Dodge v. Ford concern (the board has a duty to maximize the interests for all the shareholders)? The selective treatment is allowed in terms of protecting the shareholders as a group - What the court was concerned was the boards potential conflict While the court presumes the independent directors have less conflict than the insider directors, caring more about their job, even the independent directors have possible conflict because of the relationship with the insiders Shift the burden of proof to the board
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(1) Reasonable/in good faith belief, based on investigation, there is a threat to the shareholders (2) Reasonable/proportionate response, not draconian (= preclusive or coercive) Shift the burden of proof to the plaintiff - The board is not entitled to the business judgment presumption The board failed to meet the duty of care (the gross negligence standard), good faith or loyalty Shift the burden of proof to the board again - Entire fairness in terms of process and economics of the transaction - The courts analysis on existence of the threat - The adequacy offer of the price (discount/junky debt) - The nature of the timing (coercive) - Impact on the other constituency Revlon considered the other constituency only in the context of the benefit of the shareholders - Risk that the transaction fails - The court analysis on reasonableness of the response - Coercive: the shareholders are forced to sell the stock, irrespective of supporting the board - Preclusive: No one can acquire the company - Statutory basis: DGCL 157 authorizes the board to adopt the poison pill - The aggregate measures - The boards rational to choose the defense - In Unocal, the court held there was a threat because: - The offer was inadequate based on the Goldman Sachs analysis (it might be biased though) - The tender offeror was a green mailer - The two tier tender offer was coercive - The court also decided that the response to the threat was reasonable because if Unocal has to offer every shareholder including T-Boone, it benefits for its coercive offer
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 It does not make any sense * Now that 13e-4 prohibits the selective self-tender offer Unitrin, Inc. v. American General Corp. (Supreme Court of Delaware, 1995) Notes - The court talked about three general types of threats: (1) Opportunity loss: foreclosing the better opportunity (2) Structural coercion: two-tier coercive tender offer (Unocal) (3) Substantive coercion: the risk the shareholders mistakenly appreciate the value (Van Gorkom) Moran v. Household International, Inc. (Supreme Court of Delaware, 1985) - Household International adopted the rights plan, a flip-over poison pill, excluding the acquiror - Moran was a large shareholder and director of Household, considered LBO but decided not to do it - However, Household issued the pill, which were redeemable by the board Notes - 13e-4 only applies to tender offers - The Unocal standard, even though there is no actual threat of hostile takeover - Household has substantial number of independent directors as Unocal - There was a reasonable threat to future takeovers because of its vulnerability, after asking the experts - The response is not draconian because the proxy solicitation is still available to control the board and redeem the pill - The poison pill has less impact than other defense measure such as Unocal (increasing leverage) - The response is reasonable, even though there is no actual hostile tender offer, because the adoption of the pill is authorized by DGCL 157
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- There was no gross negligence because the board was properly informed The business judgment presumption is satisfied - The Unocal standard will come up again in case of the actual hostile takeover - The court considers the pill as a negotiation tool for the board to meet the fiduciary obligation to maximize the value of the shareholders - In Delaware, the board is allowed to just say no to the acquiror - The Delaware court is very reluctant to force the board to redeem the pill 04/01/2010 - Dead/no hand pill: only directors existing at the time of adopting the pill can redeem it It implicates Blasius; primary motivation is to block the franchise It also raises CTB/CA: no contractual restriction on the board discretion is allowed It fails Unocal: dead hand pill is preclusive Revlon, Inc. MacAndrews & Forbes Holdings, Inc (Supreme Court of Delaware, 1985) - Ronald Perelman intended to acquire Revlon through Pantry Pride - Forstmann is a white knight to block the hostile acquisition - Bergerac (Revlon) refused the Perelmans proposal/further discussion because they did not like him - Lazard Freres, Revlons investment banker, advised that $45 per share was a grossly inadequate - Perelman started a tender offer at $47.50 subject to obtaining financing and the rights being redeemed - Revlon commenced the self tender offer to exchange for each share one senior subordinated note of $47.50 and preferred stock at $10 - Perelman announced a new tender offer at $42 because Revlon became worthless due to the debt - Revlon began to consider finding a white knight
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- Revlon agreed to a leveraged buyout by Forstmann at $56, waived the covenants, and agreed to redeem the rights the notes price dropped - Perelman announced to engage in fractional bidding (offer a slightly higher price) - Forstmann agreed to support the notes with some conditions Notes - Lazards valuation: $60-70 (piece) or mid $50 (whole) Complication of the valuation/not effective management - Standard of review: the Unocal standard (1) Threat: the board has to prove there is a threat determined in good faith by conducting the reasonable investigation * Revlon did not have majority independent directors Low price, no control premium, liquidator, substantive coercion (2) Response: the board has to prove it is not draconian and has to be reasonable to the threat Defense measure: repurchase of the shares and debt poison pills Impact: make the acquisition more expensive and make the company less attractive by debt - Possible defense measures: - Poison pill - Staggered board - Postpone the shareholders meeting (Blasius concern) - Suicide defense (debt/customer contract) (Unocal concern) - Cup the voting rights/ownerships by charter/by-laws (DGCL 202(b)) (Blasius/Unocal concern) - Supermajority provision - Self-tender - Issuance of the additional stock - White knight - The notes have restriction on incurring additional debt, payment of dividends and selling assets What is unusual is that it is waivable by the board to protect the debt
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holders The board has the fiduciary duty to the shareholders, not the debt holders It cannot contractually subordinate the benefit of the shareholders to the debt holders (CA) - In Delaware, the Revlon board could have just said no But they did not. At the competing auction, the board cannot just say no They have to maximize the value for the shareholders 04/05/2010 - Transferring control triggered the courts heightened scrutiny - One-side favorite decision does not fulfill the fiduciary duty of the directors to maximize the value The court took the Unocal style standard in looking at the boards action - Consider each offer in good faith on an informed basis - Take a reasonable reaction based on the consideration of competing bids The court found that the board failed to meet the fiduciary obligation - Forstmanns conditions to agree to support the notes - No-shop clause: Revlon cannot pursuit another transaction competing with Forstmann Forstmann does not want to be a stocking horse - Lock-up option to purchase some valuable assets with relatively low price (Crown Jewel) - $25 million cancellation fee Lock up option and cancellation fee makes the company less attractive These conditions are not preclusive but not always necessary to exclude the possible third party Ultimately, these are very powerful and effectively ends the auction - Revlon takes out the additional debt or sells existing assets to purchase the notes
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 The company becomes worthless - The board concerned about the notes to avoid personal liability, regardless of insurance/indemnity Just nuisance lawsuit - There is a conflict of interest between the shareholders and the notes holders - Crown jewel lock-up is not per se illegal - There was one dollar difference between the offers but in fact it did not make any difference because of the interest rate of the governmental bond and time value - No-shop is not per se illegal The court focuses on the fiduciary-out provision, which permits the directors to exercise the fiduciary duty in consistence with the contractual restrictions (CTB/CA) - Termination fee is not per se illegal (1-3% in Delaware) Barkan v. Amsted Industries Inc. (Delaware Supreme Court, 1989) Notes - No single method to assess the offer Could be based on evidence that the board obtained by itself such as investment banks Paramount Communications Inc. v. QV C Network (Supreme Court of Delaware, 1994) - The Paramount board had 4 inside and 11 outside directors - Davis (Paramount) began discussion with Viacom (Redstone owned 85% voting rights) - The first thing that the parties agreed was that Davis is going to be a president of the new company - After the negotiation broke down over the price, QVC came to Paramount but Davis told not for sale - Both Paramount and Viacom conducted due diligence for the stock exchange
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transaction - Paramount approved the original merger agreement and amended the existing poison pill - QVC announced an $80 cash tender offer for 51% - Paramount approved the amended merger agreement and was granted to terminate it if it withdrew its recommendation (but still have to worry about the option agreement) - Paramount rejected the QVCs fair bidding process proposal due to contractual obligations to Viacom - Viacom raised its price to $85 and Paramount decided that the QVCs offer is not the best Notes - The court generally takes the boards independence into account (but not this case) - Three defensive provisions in the merger agreement: - No-shop provision Exception: (1) unsolicited written bona fide proposal without material finance contingency (2) The boards necessity to comply with the fiduciary duty - $100 million termination fee - Stock option agreement to grant Viacom an option to purchase 19.9% stock at $69.14 It contains two unusual provisions (1) Viacom can pay the stock by its subordinate debt (Note Feature) (2) Viacom can choose to be paid in cash equal to the difference between the purchase price and the market price (Put Feature) NYSE 312.03(c) requires the shareholders approval to issue more than 20% options - Even though the price gets higher and higher, David advised that the board cant talk to QVC due to no-shop (financial contingency/QVCs conditions) The other directors began to concern about their fiduciary duty to
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maximize the value Independent directors could have created an independent committee and retained an independent counsel/financial advisor in order to decide what the best deal is - The Paramount board decided to refuse the QVC offer based on the no-shop and the questionable Booz-Allen report - The court focuses on the problem that the minority shareholders might potentially face - Losing the voting rights due to the single majority shareholder - Much more difficult to sell the stock because of losing liquidity - Losing economic rights by cash out The court expects to see the control premium or some protection of the majority shareholders The minority shareholders have to rely on the fiduciary duty of the board/the majority shareholder - Sale or change of control of the company implicates Revlon issue The board has to affirmatively maximize the value of the shareholders - Stock-stock exchange does not implicate Revlon because there is no single control shareholder/no switch of the control Unocal is going to be applied to the defense measures against third party - Stock-cash exchange does not implicate Revlon neither because it terminates the relationship between shareholders and the company Unlike the stock-stock exchange, shareholders expect to see the control premium - The court makes clear that there are three different cases where Revlon is implicated (1) Initiating active process to sell the stock (2) Responding the offer involving break-up or sale of control (3) Agreeing with one transaction and inviting active bidding by others - Auction is not necessarily required but to maximize the value based on reasonable information is The board has to obtain adequate information on each offer, assess them and make a reasonable decision in response to the offers (Unocal type
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analysis) - Defense mechanism will be assessed in the aggregated way - The stock option agreement is not a per se problem The notes and cash feature made the stock option preclusive and coercive - The termination fee is not a per se problem With the notes and cash feature, it is viewed as effectively draconian - No-shop is not a per se problem The court said that the fiduciary duty alone should be sufficient to talk with the other bidder While the defense mechanism enhanced the value as it was expected in Revlon, the court said that it should have renegotiated to remove a part of it to promote the bidding process 04/06/2010 Hilton Hotels Corporation v. ITT Corporation (US District Court, District of Nevada, 1997) - ITT was viewed as undervalued - Hilton commenced a tender offer and proxy soliciting to get control of ITT - ITT started to sell the assets and asked the court to delay the shareholders meeting - This is a regulated industry, so ITT went to the gaming authority to oppose the deal Notes - Hilton followed Unocal and Blasius but was before Liquid Audio - Reorganization - Split ITT into the three companies - ITT created ITT Destination (they do not need the shareholders approval for this) - ITT transferred its 93% assets to ITT Destination and made it the staggered board
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 They do not need the shareholders approval for both (coercive) - Self-tender less attractive - Tax poison bill: reduction of the tax credit less attractive (coercive and preclusive) - Standard of review: Unocal and Blasius There was no threat - Hilton was an adequate operator and the offer was good - ITT did not act in good faith and do reasonable investigation The response was draconian and also effectively disfranchised the shareholder No compelling justification for the primary motivation to limit the franchise Omnicare, Inc. v. NCS Healthcare, Inc (Supreme Court of Delaware 2003) - Omnicare and Genesis were competing to acquire NCS - NCS had a financial trouble and was looking for someone to bail them out - NSC first talked to Omnicare though, Omnicare provided a miserable offer - Then NSC approached Genesis to make it a stocking horse - Genesis asked NSC to execute the exclusive agreement to lock up and preclude Omnicare - Omnicare offered pay for debt + interest and $3 per share with due diligent condition - Genesis required NSC to approve the deal quickly in return for the better offer - The independent committee and the board approved the offer - NCS entered into the voting agreement with Outcalt and Shaw and got 65% proxy Notes - Original Omnicare plan was to let NCS go bankruptcy, so equity gets nothing - NCS formed independent committee to think about the interest of the company as a whole
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 But it was really not independent but just an advisory committee, so they do not have any authority to make decisions - When Genesis wanted the exclusivity, NSC used leverage to raise the price Exactly what the court told the board to do in Revlon and Paramount - After the Omnicares offer, the NSC board tried to negotiate with Genesis to improve the offer Again, exactly what the court told the board to do in Revlon and Paramount - Genesiss requirement for the quick approval was not coercive But still the board has to make an informed decision (Van Gorkom) - Two unique conditions in the agreement - No-shop clause is not necessary because 65% votes were already locked up - In the ordinary course, after the board approves the merger, it recommends and presents to the shareholders In this case, even if the board does not approve the merger, it is contractually required to present it to the shareholders meeting (DGCL 146) - The court held that the defensive measures are coercive (the deal is done in any way) - The court also held that the board breached the fiduciary duty because there was no fiduciary-out - Even if shareholders can vote whatever way they feel appropriate, the court looked at the voting agreement because the Unocal is not satisfied Under the circumstances, the board should have taken the voting rights into account in deciding - Because the board was contractually obligated to present the merger agreement to the shareholders, the board failed to meet the fiduciary duty to maximize the value for all the shareholders by not having the fiduciary out - The board should have protected the minority shareholders in consistence with Paramount Paramount is not relevant here because the minority shareholders was
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already minority - Dissent said that per se obligation to have the fiduciary-out does not make sense Negotiation with Genesis would not have started without the voting agreement

Unocal Revlon Reasonable investigation/good faith Reasonable investigation/good faith belief in threat value enhance Reasonable/proportionate response Reasonable response 04/08/2010 - State Takeover Statutes - Delaware (DGCL 203): third generation statute - To make it more difficult for acquiror to use the targets assets for funding - Three year waiting period to merge unless prior board approval/two-third votes except acquiror - Applicable only to public companies - Amanda upheld the third generation statute to slow down the hostile acquisition - Constituency statutes allow the targets board to take constituencies into consideration Revlon said that the board can consider other constituencies as long as it is in consistence with shareholders interest Duty of Loyalty - Difference from duty of care is existence of economic conflict of the board - Hypo: a contract between a directors (Cornell law alumni) company and Cornell law Does it raise the duty of loyalty concerns?
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 No because there is not direct economic conflict, not emotional - Hypo: a contract between Company As director and Company B A mutual fund the director invested owns 3,000 shares of B (less than 1%) by chance Does it raise the duty of loyalty concerns? No because the conflict is not so material based on the objective test What if the director significantly invested through a trust without knowledge? No because the director just did not know, so it does not impact on its decision - Two types of conflicts: direct and indirect - Why family relationship? There are risk of collusion and greater need of certainty But it typically does not extend to friendship - SOX expands the scope of the potential conflict even further A director whose firm gives advice to the company is not considered as independent even if he is not a direct beneficiary - Direct conflict - Hypo: a director intends to sell the property to the company By influencing the decision making process, the company may pay too much Even if the company decided to pay the fair value, the company may buy the property for the best interest for the director, not for the company - Hypo: a director approaches a business opportunity To the extent the director approaches a business opportunity as a director he has to give it to the company When the director approaches a business opportunity individually, to what extent he has to give it to the company - Setting compensation - Direct conflict theories may apply to the controlling shareholder - Indirect conflict - Hypo: a director who controls a company intends to sell the property to the
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company Potential conflict is presumed in a transaction with a greater than 10% shareholder (ALI 1.03) - Why not per se unlawful? Conflicted partys transaction is also beneficial to the company Lewis v. S.L. & E., Inc. (US Court of Appeals, Second Circuit, 1980) - Plaintiff was a shareholder of SLE and defendants were directors and shareholders of SLE and LGT - Plaintiff had to sell the stock of SLE to LGT but did not like the book value of it Notes - No business judgment presumption because of direct economic conflict The board has to prove entire fairness The court will assess fairness in terms of process and economics - Process: negotiation/approval - Substance: price/interest - The court looked at no review and no effort for alternative contract - The economic condition becomes worse It does not matter because this was not considered at the time of the contract - LGT could not afford the rent more than they paid It also does not matter because they could have looked for someone else - Remedies: restitution (unjust enrichment) This does not effectively block this type of activities Plaintiff could end up paying more by avoiding the conflict - Disclosure obligation: existence of the conflict/terms of the contract (ALI 5.02) No affirmative disclosure obligation in arms-length transaction (caveat emptor (buyer beware)) Profitability is not necessary to be disclosed

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Cookies Food Products v. lakes Warehouse (Supreme Court of Iowa, 1988) - Herrig was a director and a controlling shareholder Notes - Iowa law required the disinterested directors/shareholders approval after the disclosure The same as DGCL 144 - Even if the disinterested directors approved it after disclosure, Herrig might have influenced them The statute does not preclude common law (minimum standard) The court will go beyond and look at entire fairness - Herrig has to prove that he acted in good faith and was fair in terms of process and substance The court agreed, focusing on profitability of Cookies - DGCL 144 Interested D/O Interested Shareholders Disinterested B/D 1 2 Shareholders 3 4 No approval (Entire 5 6 Fairness) - Approval by the disinterested board of directors Plaintiff has to prove there is a conflict in the transaction Disclosure has to be made when the disinterested directors approved the transaction Also, the board has to act in good faith and independently The court may additionally look at entire fairness If it was not fair, it raises questions on true independence/acting in good faith Ultimately, the court gives the business judgment presumption to the board Plaintiff might be able to argue irrationality 04/12/2010

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- Approval by the shareholders Assuming the board satisfied DGCL 144, it does not get the business judgment presumption Instead, the court presumed in favor of the board, like the business judgment presumption, as long as material information is disclosed and the controlling shareholder acted in good faith - Balancing between procedural safe harbor under DGCL 144 and entire fairness of both procedure and substance Hawaiian International Finances, Inc. v. Pablo (Supreme Court of Hawaii, 1971) - Pablo received commission from the Californian real estate broker when the transaction between HIF and the broker was completed, even though Pablo acted on behalf of HIF Notes - Pablo gained pecuniary benefit by using corporate position, even if it was an indirect transaction Failing the duty of loyalty - The disinterested directors could have approved the transaction But Pablo failed affirmative disclosure of the conflict under DGCL 144 - The court viewed Pablo Realty as aiding and abetting Pablo to breach the duty of loyalty It gave rise to a liability - Forkin held that the director cannot use corporate asset, absent of disclosure and approval by disinterested directors, for its own pecuniary benefit, even if the corporation may not be harmed In re eBay Inc. (Delaware, 2004) - The directors got allocation from Goldman Sachs (underwriter) based on their position in the company

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Notes - The directors received payments, not as individuals, by allocating the business to Goldman Sachs - Although there is no direct conflict and no corporate opportunity, the court focus on that the directors received payments, not based on individual positions, rather based on their position in eBay, by using corporate asset (allocating the business to Goldman Sachs)

- Corporate opportunity (ALI 5.05(b)) (1) Business opportunity that a director or senior executive becomes aware, in connection with performance as a director or senior executive or under circumstances where a director or senior executive should reasonably believe that the opportunity is expected to offer to the company, or obtained by using corporate asset Plaintiff has burden to demonstrate there is corporate opportunity (2) Any opportunity that a senior executive becomes aware that it is closely related to business in which the company is engaged or expected to be engaged It is limited to a senior executive It does not matter how a senior executive got the opportunity It is also called the line of business test or the interest or expectancy test It is similar to what the Guth case talked about Broz v. Cellular Information Systems, Inc. (Delaware, 1996) - Broz was president/shareholder of RFBC and independent director of CIS - RFBC was interested in buying Michigan-2 while CIS was under Ch. 11 procedure Notes - Unlike ALI, Delaware looked at directors and officers together and raised a series of factors in deciding whether there was the opportunity that they
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may not take for themselves and decide whether or not there is the opportunity and breach of the duty of loyalty based on the circumstances - The court will look at equity and consider circumstances around particular opportunity - Guth suggested the corporation opportunity can be found if it has interest or reasonable expectancy Under Guth, financial capability is relevant because if the company cannot take advantage of it, there may not be reasonable expectancy Under ALI, it is irrelevant whether or not there is financial capability - Unlike ALI, Delaware gives substantially greater discretion to individual director or officer to determine whether or not the particular matter is corporate opportunity to be presented to the board Under ALI, a director or officer will be pushed to disclose the opportunity to the board - Broz was allowed to make a decision not to present Michigan-2 based on CISs financial capability

- Hypo: a president of Cornell is also a director of the real estate company His long time friend tells him to buy the property First question is whether or not this is the corporate opportunity: there is interest or expectation For the real estate company, it does not fall within the definition of the corporation opportunity under both Delaware and ALI because he got the information as a personal capacity even though it was in the same line of business For Cornell, under ALI whether it falls within the definition of the corporate opportunity depends on the nature of the property but it does not matter how he got the information If the president got the information as a solely capacity of a director of the real estate company under ALI jurisdiction, as a matter of practice, the president tends to disclose it to both side, although the case law is
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very ambiguous - Hypo: the restaurant investment information from both its financial dept. and a Cornell alumna The president cannot use the corporate asset for himself or the real estate company under both Delaware and ALI Under ALI, the president has to disclose the nature of the conflict and the opportunity (relatively greater disclosure than the arms length transaction) The president has to get approval from the disinterested board or shareholders The board can rationally decide not to take the opportunity Zahn v. Transamerica Corp. (U.S. Circuit Court of Appeals, Third Circuit, 1947) Notes - Whether or not there is a controlling shareholder Even below 50% stockholder can be viewed as controlling as long as it have influence Does Transamerica control Zahn? - Yes, because it actually control the Zahn board - Class B has voting rights while Class A has twice dividends without voting rights 04/13/2010 - The board has a call option to require Class A to choose either cash or conversion to Class B If the company doesnt do well, Class A gets more protected But if the company is doing well, it calls Class A, so it has limited upside * Class B was likely original common stock and Class A came later
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during financial trouble - When the board exercises the call option, it tends to be beneficial to Class B by taking out Class A Although the option and its benefit to Class B were OK, the board has a duty to disclose the information to make an informed decision when the option is called The board failed to disclose the increasing value of the tobacco asset - The board was controlled by Transamerica, so DGCL 144 did not cure the transaction - The board has to take all the shareholders as a group into account but its controlled by Transamerica The court imposed affirmative obligation of fairness and good faith on Transamerica - The duty of disclosure to the shareholders: materiality (TSE Industrys standard) Whether material information was provided, looking at total mix of information available to them - In assessing damages, the court considered what the reasonable shareholder would have done under the circumstances (Class A would have obtained more value if it converted to Class B) - Transamerica bought Class A based on the non-public material information Today it can be insider trading, although 10b-5 did not exist at that time Sinclair Oil Corporation v. Levien (Supreme Court of Delaware, 1971) - There are three claims: dividends, corporate opportunity, and breach of contract - Sinclair owed 97% of Sinclair Venezuela and 100% of Sinclair Intl Notes - First question is whether there is a controlling shareholder? Yes Also, the court decided that there were no independent directors - Second question is whether there is a self-dealing Exclusion as well as detriment of minority shareholders of subsidiary
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- The court adopted the higher standard of review: intrinsic fairness Sinclair has the burden of proof of entire fairness - There is no self-dealing in dividends because the minority shareholders received it Absent of self-dealing, business judgment standard applies The court might find self-dealing if there were two classes of shareholders and the board paid dividends to only one of them - There is no corporate opportunity Plaintiff has the burden of proof there was corporate opportunity If there was no corporate opportunity, business judgment standard applies again - There is self-dealing in breach of the contract because Sinclair caused them to contract and forced to breach for the benefit of Sinclair Exclusion and detriment of minority shareholders Sinclair has the burden of proof of entire fairness - Sinclair is tougher standard than Zahn case In Zahn, there was no liability if Transamerica fully disclosed the information In Sinclair, Sinclair has to prove intrinsic fairness, not simply full disclosure Levco Alternative Fund v. the Readers Digest Assn Inc. (Delaware, 2002) - Class A was non-voting and Class B has the right to vote - The company proposed a recapitalization to buy class B from the fund (50% 14%) Notes - Why did Class B get more than Class A? Because of the voting rights - The recapitalization was intended to get rid of the takeover defense - The courts underlined concern is how independent the independent committee truly is Under DGCL 144, it is procedurally fine if the independent board
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approves it The court was not entirely sure about its independence, so it focused on fairness of the transaction The board has the burden of proof of entire fairness - It was not fair transaction for Class A in part because there is conflict between A and B - The court also looked at the new leverage that the Readers incurred in order to pay for Class B That made the company less valuable - The court was also concerned about the duty of care Duty to inquiries to decide what appropriate conversion should be - In Zahn, the difference between two classes was much greater Due to similarity, the court focused on whether it fulfills the duty to the minority shareholders - The court found breach of two duties: unfair dealing and duty of care (inadequate inquiries) Zetlin v. Hanson Hodlings, Inc. (New York Court of Appeals, 1979) Notes - Control premium: premium over the market price the buyer is going to pay to control the company - The buyer pays control premium because it runs the company better and increases the value It is more beneficial to minority shareholders by working less - What is the benefit to controlling shareholders? - Improving the company - Private transactions, subject to complying with the duty of loyalty - Rights in the company the minority shareholders concern the most - The controlling shareholder can resell the stock at the premium, as long as there is no breach of the fiduciary duty, no fraud or no acting in bad faith - But they cannot sell the stock, knowing that the buyer intends to ruin the company
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 There is an affirmative duty to know the purchaser 04/15/2010 Gerdes v. Reynolds Notes - The purchase price was substantially in excess of the actual value of the stock - The nature of the assets (funds) is liquid and there are a lot of leverage (but disregarded) - Paying more because the fund manager is good might be rational In this case, high premium does not make sense because all the directors resigned - Red flags: higher premium, resignation, liquid assets There is an affirmative obligation to the directors to ask questions - There is no business judgment presumption because the board had the direct economic interests - Even if the board got business judgment presumption, it failed the duty of inquiry (Van Gorkom) - The boards duty runs to creditors in bankruptcy - In light of substantial premium, the directors cannot be paid for resignation It can be breach of the fiduciary duty because the directors gained personal benefits based on their position, not in consistence with the shareholders interest - The manner of resignation (without notice/fast) is also problematic - Hypo: sold the control to three law students and ended up going down without fraud - This is open-ended area under case law - It is harder to hold affirmative obligation simply because the purchaser is inexperience - Hypo: a director resigned because he personally believed the buyer is not
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good - The director should have voiced, asked questions and made it clear in the merits (Francis) - Also, he should have hired the lawyer for himself Perlman v. Feldmann (U.S. Court of Appeals, Second Circuit, 1955) - Feldmann was a chairman/president/major shareholder of Newport, supplier of steel - It was the sellers market because of Korean War, resulting in high demand of steel - Newport got non-interest loans from buyers instead of increasing the price (Feldmann plan) - Wilport was interested in buying Newport, instead of paying the loan - Feldmann sold the control to Wilport at the premium Notes - The plan was unethical practice, so Wilport said its not the asset - Feldmann has the burden of proof of entire fairness - The normal premium does not have to be paid to the minority shareholders The excess of the normal premium has to be paid to them Essex Universal Corp. v. Yates (U. S. Court of Appeals, Second Circuit, 1962) - Yates, a president of Republic Pictures, agreed to sell the stock to Essex - Yates gave Essex an option to ask the majority of the board to resign - The stock price went up and Yates refused to close the transaction by saying that the contract is void Notes - This is open area in Delaware (more likely to be Judge Friendly) - Lumbard thought it was legal focusing on practical certainty - Yates has the burden to proof that Essex would not get the control - Lumbard said that even less than 51% is enough to have the control but
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Friendly doubted - If it is less than 51%, regardless of the contract, the board has to consider the replacement in consistence with the fiduciary obligation to the shareholders as a whole - The controlling shareholder can get rid of the staggered board by amendment of the charter - Friendly does not think less than 51% is sufficient because it is not clear that the change of control is actually going to happen - 14f-1 requires the controlling shareholders to disclose its interest to change the majority of the board Problem 6 - Alex is the only disinterested director but has influence by senior executives - What if John obtained C Corp after F Corps establishment, is it the corporate opportunity? Is there the corporate opportunity? - ALI (1) How John got the information? (2) Did John had reasonable belief that it is expected to offer to the company - Guth (1) How John got the information (2) Was there interest or expectancy (financial capability)? Is there affirmative disclosure to the board and approval by disinterested directors? - ALI requires two disinterested directors but Delaware does not Alex has pressure, so the court looks at whether he is truly disinterested under heightened scrutiny The court ultimately looks at fairness of transaction If Johns independence is suspect, the board can go to the shareholders - Employment contract: self-interested transaction (DGCL 144) - John is a director of F Corp and the owner of C Corp
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- Necessary process under DGCL 144 (1) Disclosure of the nature of the transaction/conflict (profitability is not always required) Expected to see more than arms length transaction due to the fiduciary duty (2) Approval by the disinterested director (Alex) Delaware does not require more than one disinterested director (but ALI does) The court assesses entire fairness of the transaction: good faith/independence - Purchase of the C Corp shares: self-interested transaction (DGCL 144) - Sale of 80% of C Corp shares - Directors cannot sell the offices nor resign in exchange for payment The duty of loyalty concerns by gaining personal benefits by using the company asset - What if the existing directors simply resign? Focus on the nature of the controlling premium Lumbard adopted practical certainty and thought that less than 51% is enough Friendly thought that more than 51% is necessary 2010/04/19 Insider Trading - 10b-5 deals with not only insider trading but also corporate disclosure Corporate governance The duty of loyalty at the federal level Civil/criminal sanctions - Insider trading: people who have access to companys non-public material information buy or sell stock for own personal benefit - How bad? - Insider trading gives directors an incentive to keep the inside information non-public
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-Outside investors are more reluctant to make efforts to make decisions based on their information They can take advantage of time lug (making a decision before the market reflects) - Insider trading makes market less efficient/accurate - Insider trading raises capital cost (reluctant to invest higher risk higher interest cost) - Insider trading is unfair - The accuracy of the market price helps investors to allocate their resources - Unlike 10k, 10q, 13d, 14a, and 14d, there is NO affirmative disclosure obligation under 10b-5 Instead, 10b-5 requires the information to be materially accurate if disclose - 10b-5 also applies to private companies - 10b-5 is not an exclusive liability Cady, Roberts & Co. (1961) Notes - This is a classic insider trading case - Insiders are those who have access to material non-public information such as directors, officers, controlling stockholders, and other outsiders (any person) - Information about its own company or about other companies with whom it has relationship - 10b-5: it shall be unlawful for any person, if there is any device or scheme to defraud (a), material misstatement or omission (b) or fraud or deceit (c), in connection with the purchase or sale of any security - SEC action/implied private right of action In private action, plaintiff has to sell or stock in order to have standing to sue (Blue Chip)
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Blue chip Stamps v. Manor Drug Stores (1975) Notes - Plaintiff did not actually buy/sell the stock The court did not permit plaintiff to bring cause of action because of policy reasons - It makes much easier to bring a lawsuit - Plaintiff has the information on whether or not it actually bought/sold the stock - Defendant does not have to buy/sell the stock - SEC is still entitled to sue the company - Materiality TSE Industry standard as well as 14a-9 Basic Inc. Levinson (U.S. Supreme Court, 1988) - There were three press releases - Plaintiff sold the stock at $20 during the time period the three statements being made, while the Combustions tender offer was $46 Notes - There is no affirmative disclosure obligation under 10b-5 The issue was whether they were material misstatements or there was a material omission - The statements appeared to be correct The problem was they were misleading - The court adopted the probability/magnitude test to assess materiality Very facts and circumstances oriented but the court does not tell where it draws the line (vague) Balancing test (torts) To deter insider to buy/sell the stock

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04/20/2010 - Differentiate between SEC action and private cause of action There are greater requirements for the private action: reliance and loss causation SEC has to show only materiality and scienter - Generally, absent of affirmative disclosure obligation required by other regulations, whether or not to disclose is based on the business judgment rule (TGS) - Absent of affirmative disclosure obligation, silence itself is not viewed as misleading No comment is functionally considered the same as silence What if there was no discussion and truly denied but said no comment during discussion Is it silence? It potentially creates a problem - In squeeze-out merger, a majority shareholder fully disclosed (Santa Fe) It does not give rise to an action under 10b-5 (the minority shareholder can be entitled to remedies under the state law) There has to be manipulation/deceit - Plaintiff has to show scienter, recklessness or worse (intent and high conscious disregard) * The Second Circuit only required negligence under14a-9 - Under PSLRA, the most damaged plaintiff is going to oversee the class action (not the first one) - PSLRA tightens recklessness standard (Second Circuit still uses recklessness standard) - A forward looking statement (projection) For the private action, plaintiff has to show actual knowledge, not just recklessness SEC can still sue, relying on recklessness standard - Reliance (transaction causation) Plaintiff has to show it relied on the misstatement or omission and it caused the damages
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 The two ways to see reliance: face to face relationship/the fraud on the market theory But for material misstatement or omission, investors would not have entered into the transaction - Face to face relationship (direct causation) - Omissions - Ute presumed there is reliance because material omission is sufficient to find reliance The similar idea to 14a-9 (TSC Industry standard) Defendant can still rebut the presumption by showing that plaintiff would have followed the same course even if full disclosure - Misrepresentation - The court also presumes reliance if there is material misrepresentation Reliance has to be reasonable, so it is more difficult for plaintiff to demonstrate reliance in a forward looking statement - PSLRA creates safe-harbors for a forward looking statement by meaningful cautionary language - Big boy letter: buyer acknowledges seller has material non-public information but is not going to sue SEC prevailed $12mil but it is still difficult to show deceit For private right of action, it is very difficult to show reliance - The fraud on the market theory In the class action, it is very difficult for each plaintiff to show reliance It creates a rebuttable presumption of reliance if the misstatement or omission is material Defendant can rebut by showing that there is no linkage between the misstatement or omission and the price or there is no efficient market - Loss causation - PSLRA requires plaintiff to show the misstatement or omission caused the loss The material misstatement now becoming known as a misstatement fell the stock price Open area argument: the misstatement would have increased the price
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- Aiding and abetting Central Bank held that secondary actors are no longer liable under 10b-5 Enron held that any person can be primarily liable even if misstatement comes from someone else Under PSLRA, SEC can directly sue secondary actors 04/22/2010 SEC v. Texas Gulf Sulfur Co. (US Court of Appeals, Second Circuit, 1968) - TGS decided to delay to disclose the material information Notes - 10b-5 does not create affirmative obligation to disclose But if you choose to disclose, it has to be materially accurate - What if all material information was required to be disclosed immediately? It causes anticompetitive effect at the corporate level Absent of affirmative obligation, whether or not the board should disclose the material information depends on the business judgment - The basic rule in TGS is disclose or abstain If you are an insider and choose to trade, then you have to disclose - Why just securities? Real property is much easier to assess the value There is no fiduciary relationship in a real property transaction (just caveat emptor) - Farmers/waiters do not have the fiduciary duty they have no obligation to disclose - What If TGS owned an executive dining facility and a waiter was an employee there Any person who has an access to information can be an insider - Motivation is irrelevant (black and white rule) because it is very difficult to show - Disclose or abstain means in practice dont trade It causes the duty of loyalty concerns - 10b-5-1
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- Motivation is irrelevant - Trading before getting non-public information or trading decided by others without non-public information is permitted to go ahead to buy or sell - The companies should institute the procedure to avoid the possible insider trading Forbids everybody in the company to trade the stock 30 or 45 days prior to 10-Q/K Restricts on trading for some period of time after the announcement - Law firms and others also follow the same sort of procedures Not permit lawyers to trade the clients securities - The court defined materiality as essentially extraordinary in nature Different from TSE Industry and Basic Substantial likelihood that reasonable shareholders would consider important At that time even the court was not clear as to whether insider trading should be restricted - The court also looked at unusual trading activity as means to decide materiality (not seen today) - Whether the information is effectively disclosed - Mechanical process: here Dow Jones broad tape (not broadly disseminated) It is the traders responsibility to make sure it is effectively disseminated - Nature of the information: clear or complicated The district court thought the information was properly disseminated in 24 hours - 10b-5 protects all investors to have equal opportunities, regardless of sophistication - Coates had a good defense because he acted in good faith But he does not meet scienter (reckless): an extreme departure from the standards of ordinary care - CEO did not tell the information to the compensation committee All directors got the stock option Kline had access to the material information, so he is liable
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 Holyk and Mollison are not liable because they could have reasonably assumed that the senior executives are going to disseminate the information (not reckless) - TGS was also a defendant because it made a misleading press release It could have said nothing Shareholder who sold the stock based on the press release were damaged - Damages by the insiders is actual profit gained or loss avoided (1934 Act 20A) SEC can go up to three times of the damages (four times in total) (1934 Act 21A) If willful, there is criminal liability (1934 Act 32) - The payments (the profits) are to be held in escrow in an interest-bearing account for five years There are thousands of individual plaintiffs, so they will get only fractions It is not so beneficial to plaintiffs, but it can be deterrence from insider trading - Tipper and tippee are jointly and severally liable for the purpose of deterrence - What are other potential claims under the state law? Duty of care (gross negligence) Duty of good faith (knowing disregard of their duty) duty of loyalty Chiarella v. US (U.S. Supreme Court, 1980) - Chiarella was a financial printer to prepare for a tender offer where the targets name was blank - Chiarella started to buy the stock of the target based on guess Notes - The court focused on the traditional insider in Cady Roberts Chiarella was not liable under 10b-5 because he had no relationship with the target He had no fiduciary duty to the target
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04/26/2010 - The court focused on the underline obligation to disclose - Chiarella is not a traditional insider - He dealt with the target companys stock, so he had no relationship with the target or its shareholders He had no duty to the buyers at all - Mere possession of material information does not give rise to affirmative duty to disclose Absent of the duty, the court found that Chiarella was not required any disclosure - Chiarella certainly breached something such as the duty of confidentiality to employer or acquiror Dissent focused on the unlawful advantage he personally gained based on non-public information Today, misappropriation does give rise to liability under 10b-5 (OHagan) - Under state law, Chiarella breached the duty of loyalty or confidentiality - Hypo: A senior research analyst periodically meets the offers of Fields Corp. and gives advice on her own evaluation to her major client to sell the Fields Corp stocks - She is not a traditional insider because she has no material non-public information She has no duty to the buyers - Even though she has the preferential access, 10b-5 is not intended to discourage these kinds of access to the information Dirks v. SEC (US supreme Court, 1983) - Dirks found a huge fraud in Equity Funding based on getting the information from Secrist - Dirks tried to give the information to his clients

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Notes - Whether the relationship between Secrist and Dirks is tipper and tippee? - A tippee is a person who has a duty not to profit from the use of inside information that (1) He knows is confidential (2) He knows or should know came from a corporate insider The scope of tippees is very broad, so Dirks created clearer guideline on how to deal with tippees There has to be a tipper A tippee has to know or should have known that the tipper is breaching the fiduciary obligation by gaining personal benefit by providing the information - A tipper and a tippee is jointly and severally liable - In this case, it seems that Secrist is a tipper and Dirks is a tippee There has to be material non-public information Material based on probability (strong suspicion but difficult) and magnitude (going bankruptcy) Secrist, who has the fiduciary obligation as an officer, gave the information to Dirks Why did not it give rise to 10b-5? The court looked at the purpose of the disclosure: to expose the fraud There is no breach of the fiduciary obligation, focusing on Secrist got no personal benefit (pecuniary gain/reputational benefit/gift) - Secrist would be liable under 10b-5 if he sold the stock before disclosure because he was an insider - Hypo: a waiter in a public restaurant, learning material non-public information by customer (insider) - Is a waiter tipper? No because the customer is not a tipper If it is a gift, it is sufficient to give rise to 10b-5 liability - What if it was in the company dining room? It is a traditional insider, not tipper/tippee - Hypo: CEO discussed legal aspect of a takeover with a lawyer
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- Disclosure itself is not breach of the duty by CEO The lawyer is not a tippee because CEO is not a tipper by acting in consistence with the duty - The nature of relationship, implied or explicit confidential or trust, creates a temporally Cady Roberts insider obligation running to shareholders, which gives rise to 10b-5 liability - Hypo: CEO of Choco Corp and CEO of Fields Corp discussed the possible merger C CEO declined the merger but bought the F stock based on the information from F CEO - C CEO is not a traditional insider - There is no tipper/tippee because F CEO did not seem to breach the duty - C CEO can be a temporally insider because of nature of the discussion, implying the duty of confidentiality directly to the Fields Corp shareholders (footnote 14) What if C CEO refused to sign the confidentiality agreement but F continued the discussion It does not give rise to a temporally insider liability due to lack of the duty of confidentiality F CEO breached the duty of care at the state level - Hypo: F CEO holds meeting with small group of analysts and provides material non-public information Improve the companys relationship with the analysts The analysts who got access to the information ahead of the market can tell the clients to trade Select and control the analysts, not to let them write anything negative Regulation Fair Disclosure came out because 10b-5 did not work on this - Reg. FD requires the issuers that the material information has to be equally disclosed It cannot be selected - Only SEC can police on fair disclosure - Hypo: F CEO gave the material information to the psychiatrist and traded the stocks
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- The psychiatrist is not a traditional insider - There is no tipper/tipper because F CEO did not gain any personal benefit - The psychiatrist is not a temporally insider because the confidentiality runs to F CEO personally 04/27/2010 US v. OHagan (US Supreme Court, 1997) - OHagan was a trust and estate lawyer in Dorsey & Whitney - Grand Met hired the law firm for the tender offer for Pillsbury - OHagan started to buy the stocks and options of Pillsbury based on the tender offer information Notes - The facts was exactly the same as Chiarella, so the court tried to plug the Chiarella hole - OHagan is not either a traditional insider or a temporally insider because he did not have any relationship with Pillsbury - The court relied on misappropriation theory (similar to dissent of Chiarella) OHagan traded the stock with scienter based on material non-public information (misappropriation) in breach of the confidentiality obligation to the source of the information without disclosure (deception) - There has to be deception, not just breach of the fiduciary duty, to hold liable under 10b-5 - OHagan had confidentiality obligation running to two sources: Grand Met and the law firm It is not sufficient to get permission only from the law firm The board cannot permit him to trade due to the duty to the shareholders - In OHagan, the partner said go crazy and he told the company to trade on the information All he has to do is simply notify the sources to trade based on the information (footnote 9) There is no 10b-5 violation because there is no deception any more
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 However, Grand Met and the law firm have to have the state law concerns (footnote 9) For Grand Met, it can be breach of the duty of loyalty because it looks like gift to OHagan There are state level remedies to block OHagan - 14e-3: focusing on tender offer - Substantial steps to commence the tender offer - Trading by anyone who has non-public material information and knows or should reasonably know that it has not been made in public - Acquiring it directly or indirectly from the target or anyone acting on their behalf 14e-3 violation - What is the difference between 10b-5 and 14e-3? There is no duty requirement under 14e-3 - Damages: $4.3 mil that OHagan made (20A) and three times (21A) Plaintiffs have to be anyone selling the stocks during the period before the disclosure - Hypo: a lawyer hacked the computer to the tender offer information and traded the targets stock No 10b-5 liability because he had no duty but 14e-3 liability - Defendant argued that SEC goes beyond its authority under 14 because there has to be breach of any duty to find fraud SEC relied more on the language reasonably design to prevent fraudulent trading on material - 10b-5-2: non-exclusive definition of circumstances that might give rise to the duty of trust or confidence that results in OHagan insider trading (1) Agreement to maintain information confidence (2) History or practice to share information confidence (3) Obtain information from wife, children or siblings - 16 requires insiders to disclose the profits to the company if they buy and sell or sell and buy the stock in six month (short swing trading), irrespective
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of motivation Presumption is that insiders has access to the non-public information, so short swing trading is indication of insider trading 16(b) applies only to public companies/directors, officers and 10% shareholders - Hypo: F CEO told the psychiatrist the companys bad shape and she decided to sell short - The psychiatrist is not a traditional insider or a temporally insider - There is no tipper/tippee because the psychiatrist did not gain personal benefit - There is likely OHagan insider trading There is deception and breach of the duty of confidence to the source of the information The psychiatrist misappropriated the information - What if the psychiatrist called a friend and said you should trade the stock on this There may be OHagan tipper/tippee relationship (the same analysis as Dirks) Tipper and tippee will be jointly and severally liable - What if F CEO signed waiver of the confidentiality obligation ( no duty) There is no OHagan problem There may be Dirks tipper/tippee: breach of the duty of care/personal benefit (if any) - Hypo: a lawyer in antitrust division of DOJ knows the company is under review and what DOJ is unlikely to do - The lawyer is not a traditional insider - There is deception and breach of the duty to the source of the information The lawyer is an OHagan insider - Hypo: a person traded based on advance copy of Business Week and the editor got the kickback - The trader is not a traditional insider - There is OHagan tipper/tippee relationship
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- The editor breached the duty of confidentiality to Business Week - The editor got personal benefit (the kickback) - What if the trader called his friend and said you should trade the stock on this Again there is OHagan tipper/tippee relationship - Hypo: a waiter in the company dining got the material non-public information and traded on it - She is a traditional insider - What if she traded the target stock? She is an OHagan insider - Hypo: a waiter in the Wall Street private club gave the material non-public information to a friend and said you should trade the stock on this - The waiter is an OHagan insider - The waiter has the duty of confidentiality, explicit or implicit, given the nature of business - There is OHagan tipper/tippee relationship - The waiter breached the duty of confidentiality - The waiter got personal benefit (gift) - Hypo: a waiter in a normal restaurant overheard the information from an insider and the insider told the waiter to go ahead and trade on it - There is tipper/tippee relationship - The insider breached the duty and got personal benefit - What if the waiter simply overheard the information? It is less likely to find OHagan because of its explicit or implicit duty of confidentiality - What if the information was related to the tender offer? It can be liable under 14e-3

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