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Business Associations: Anderson

Fall 2009

PARTNERSHIPS: PROCESS

I. Does a Partnership Exist? A. Definition: A partnership = (a) an association (b) of two or more persons (c) to carry on as coowners (d) of a business (e) for profits. B. Prima Facie Evidence of Partnership = Receipt of profits from net income + control = prima face evidence of partnership. 1. Receipt of net income is from statute. 2. Control is determined by matter of degree. C. Note: Under RUPA, the partnership itself is recognized is a separate entity. II. What are the rights and duties of the partners? A. Is there a partnership agreement?: A partnership agreement, which defines the rights and duties of the parties, may be oral, written, or implied. RUPA 101(7). B. If no partnership agreement, what DEFAULT RULES govern the rights and duties of the parties? 1. Default Rules: UPA 18 and RUPA 401 a. Majority required for ordinary course of business. b. Unanimity required for acts outside the ordinary course of business. c. A partner has the right to share equally in profits and losses. i. Exception: If one partner contributes money but no services, and the other contributes service but no money, they one contributing services may not be responsible for contributing to the losses. d. There is no right to remuneration (payment for services rendered). e. A partner has equal rights in management and conduct of the partnership business. f. A partner has a right to interest on a loan from the date of payment. i. Payments made in the ordinary course of business or for preservation of the partnership is a loan. ii. Advances made beyond the amount of capital contributions are loans. g. Unanimous consent of all partners is required for admission of new members. III. What fiduciary duties do the partners owe one another? A. General RULE: Partners owe EACH OTHER fiduciary duties in a partnership. B. Duty of Loyalty: can be defined, but not eliminated. C. Duty of Care: can be reduced, but not eliminated. 1. Default Standard: grossly negligent+ conduct. D. Duty of Good Faith and Fair Dealing as to both: can be defined, not eliminated. E. Duty to Account to Partnership: 1. Without Demand: ANY information concerning the partnerships business affairs reasonably required for the proper exercise of the partnerships rights and duties under the partnership agreement or the RUPA. 2. With demand: any other information concerning the partnerships business and affairs. IV. Was there an EVENT of DISSOLUTION? A. UPA 31. Dissolution is caused by 1. Without violation of the agreement, a. In a partnership for a term or special undertaking, term ends; b. In a partnership at will, partner expresses the will to cease to be associated; c. In a partnership for a term, ALL partners express the will to cease to be associated; d. Expulsion of any partner pursuant to a partnership agreement; e. Death; f. Bankruptcy; 2. With violation of the partnership agreement, a. By express will of a partner under circumstances that this section does NOT permit dissolution. i. i.e. partnership for a term. 3. Decree of Court a. A court my decree dissolution on application by or for a partner whenever a partner willfully or persistently breaches the partnership agreement or otherwise acts in a way that is NOT
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reasonably practicable to carry on the business in partnership with him. 32. i. Note: The applying partner must make sure he is clear on his pleading, if partnership for a term, he is NOT expressing is will to cease to be association, so that he himself is NOT the wrongful partner. B. RUPA 601 and 801 1. In RUPA, we have to first determine whether there was an event that causes dissociation before we determine if that event that caused dissociation also caused dissolution. a. Dissociation is caused by i. In a partnership at will, partner expresses the will to cease to be associated; ii. An event agreed to in the partnership agreement; iii. Expulsion of any partner pursuant to a partnership agreement; iv. Unanimous vote by the partnership to expel a partner IF A. Partner is a partnership or corporation being wound up; v. Judicial determination because A. Partner engaged in wrongful conduct that adversely and materially affected the partnership business, B. Partner willfully or persistently committed a material breach of the partnership agreement or a fidiciarty duty, or C. Partner engaged in business conduct that makes it not reasonably practicable to carry on the business with that partner. vi. Death; or vii. Bankruptcy. b. Dissolution is caused by i. In a partnership at will, partner expresses the will to cease to be associated; ii. In a partnership for a term A. Express will of at least half the remaining partners if within 90 days after another partners dissociation by death or wrongful dissociation under 602(b). 1. If a partner makes a rightful reactive dissociation under 602(b)(2)(i), that dissociation IS an expression of that partners will to wind up the partnerships business. B. Express will of ALL partners to wind up the partnership business, OR C. Expiration of a term. iii. An event agreed to pursuant to a partnership agreement. iv. Judicial determination. V. IF dissolution, Can a partner FORCE liquidation or DOES the partnership? A. UPA 1. If the dissolving partner with contravention of the partnership agreement, then there MUST be UNANIMOUS consent to continue the partnership. 2. If dissolution was without contravention of the partnership agreement, then ANY partner can force liquidation. B. RUPA 1. If dissolution is by death, 601(6) through (10), or wrongful dissociation, then there MUST be at least HALF of the remaining partners consent to wind up the business. a. Note: A rightfully reactively dissociating partner is counted as one who is NOT consenting to continue. 2. Otherwise, any partner can force liquidation. VI. Was the event causing dissociation or dissolution WRONGFUL? A. Both: A partners is wrongful if 1. There is a breach of an express provision in the partnership agreement; 2. In a partnership for a term, partner withdraws by express will to cease to be associated; or 3. Judicial expulsion for wrongful conduct. B. RUPA Caveat 1. A partner can rightfully reactively dissociate within 90 days after another partners dissociation by death or wrongful dissociation. 602(b)(2)(i). VII. If WRONGFUL, then what is the BUYOUT price of the WRONGFUL PARTNER? A. UPA: 1. Amount: value of his interest, NOT including goodwill, MINUS damages. 38(2)(c).
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2. Due: Silent as to timing under both 38 and 42. May be able to get it if undue hardship is
shown. 3. Security Provided: Court approved bond. 38(2)(c). 4. Compensation for Delayed Payment: Either interests OR profits + amount. 42. B. RUPA: 1. Amount: value of his interest, which is greater of the liquidation value or the going concern, MINUS damages (because wrongful). 701(b) and 602(c). 2. Due: At the end of the term OR, if the partner establishes that earlier payment would not cause undue hardship, immediately. 701(h). 3. Security: Adequate. 701(h). 4. Compensation for Delayed Payment: Interest + amount. 701(b). VIII. If RIGHTFUL, then what is the BUYOUT price of the WRONGFUL PARTNER? A. Same as wrongful, except NO damages imposed in the amount. IX. What are the RETIRING partners liabilites to THIRD PARTIES? A. UPA 35 1. A retiring partner is bound to the partnership for a. Any acts appropriate for liquidation. b. Any transaction IF the third-party i. had extended credit prior to dissolution and had NO knowledge or notice of the dissolution; or ii. knowledge = actual or constructive. iii. notice = tells the creditor or sends a written statement to his place of business or residence. c. had NOT extended credit prior to dissolution, knew of the partnership prior to dissolution, had NO knowledge or notice of the dissolution, and the dissolution had NOT been advertised in a newspaper of general circulation in EACH place at which the partnership business was regularly carried on. i. Note: However, there is an advertisement in a newspaper of general circulation at EACH place at which the partnership business was regularly carried on was circulated, then a partner cannot bind the partnership to third parties B. RUPA 1. A retiring partner is bound to the partnership for a. Any acts appropriate for liquidation. 804(1). b. Any transactions within 2 years after partners WRONGFUL DISSOCIATION if the third-party i. reasonably believed that the dissociated partner was then a partner; ii. did not have notice of the partners dissociation, AND iii. did not have knowledge under 303(e) or notice under 704(c). A. If a statement in relation to real property is filed with the appropriate office, knowledge is imputed. 303(e). B. A person who is not a partner is deemed to have notice of the dissociation 90 days after the statement of dissociation is filed with the secretary of states office. 704(c). AGENCY I. Who are the PARTIES? : Principal, Agent, Third-Parties II. What KIND of relationship are we talking about?: Principal to third-party, Principal to agent, OR Agent to third-party. III. Was the authority Actual, Apparent, or inherent authority? A. Real authority can be express or implied. 1. Express: P tells A to do something 2. Implied: P tells A to go on a business trip and when A gets there, A needs to get around, so A rents a car. (implied: reasonable person would assume P authorized A to do the implied action in order to carry out the express command). 3. Agent Liability: None (default). B. Apparent authority: agent does not possess the authority but third-party reasonably believes that the agent has express or implied authority because principal does something intentionally or negligently that induces third-party to reasonably believe and other facts and circumstances. 1. Agent Liability: liable to principal (default). C. Inherent authority: implied term in the K between a principal and all who deal with his agents
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that protects their reasonable expectations. IF THERE IS A NONEXISTENT CORP, WHO IS RESPONSIBLE FOR LIABILITY OWED TO CREDITORS? I. TWO MAIN SCENARIOS A. (1) Everyone knows the corporation doesnt exist. B. (2) Persons act thinking a corporation exists but it doesnt exist. (i.e. due to defective filing). II. SCENARIO 1: EVERYONE KNOWS THE CORPORATION DOES NOT EXIST. A. Who is liable for the agreements entered into on behalf of the unformed corporations? (Contract signed "yet to be formed corporation) 1. Before Articles of Incorporation are Filed a. Corporate Liability: A corporation cannot be liable for events that happen before its inception; a corporation comes into existence when the AOI are filed with the secretary of state. Corporate liability operates under the principal-agent theory. If there is no principal, there is no agent, and thus no corporate liability. b. Personal/Promoter Liability i. A promoter = person who acts on behalf of a projected corporation. ii. BLR: There is a rebuttable presumption that the parties intended the promoter to be personally liable for contracts entered into on behalf of the unformed corporation even after it comes into existence. A. Rebuttal: There is clear evidence of intent by all parties that the promoters are not to be bound. 1. i.e. novation or other release of liability. iii. If more than one person is acting as a promoter, then the parties jointly and severally liable. 2. After Articles of Incorporation are Filed a. Corporate Liability: While a corporation cannot be liable for events that happen before its inception, it can, after inception, be bound IF it RATIFIES or ADOPTS the contract; promoter may still be liable even after corporation ratifies the contract this just gives the creditor more options. A. RATIFY: 1. Evidence of: a. Have I made express and direct terms of Assent? = Express Ratification: A corporation can expressly adopt an agreement by signing a K, b. Have I evidenced my intent to be bound = Implied Ratification: Law presumes from the acts of the corporation an intent to be bound to the contract by : receiving the benefits from the contract, being aware of the K, moving into a building which the promoters leased, 2. Result: a. Corp is bound from the date the K was formed, not the date of the ratification b. But having once ratified the act, upon a full knowledge of all the material circumstances, the ratification cannot be revoked or recalled, and the principal becomes bound as if he had originally authorized the act. Includes the bad stuff too B. ADOPT: 1. Evidence of: Corp is aware of the transaction and evidenced intent to be bound to it 2. Result: Corp is bound from the date of adoption. C. WHICH ONE? You can only ratify that which you could authorize, so ratification cannot happen in this sense b. Personal/Promoter Liability: A promoter remains personally liable for contract (see above). i. If the person signed a personal guarantee, or the corporate veil is pierced to reach the individuals liability. B. Because a promoter cannot bind the prospective corporation to any preincorporation agreement he makes for it. The promoter has three options open to him in this situation:
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1. To take on the corporation's behalf an offer which would become a contract once the
corporation is formed and accepts the offer 2. To make a contract which binds him with the stipulation or understanding that if the company is formed it will take his place and he will then be relived of all responsibility or liability. 3. To simply bind himself personally and look to the proposed corporation for indemnity when it is formed. C. Will Partnership Law cover liability? like pre incorporation: do the people meet the definition, regardless if they are aware they are partners III. SCENARIO 2: Individuals THINKS a corporation exists but the corporation does not exist. B. Who is liable for the agreements entered into on behalf of the NONEXISTENT corporations? 1. Corporate Liability: None. See above. 2. Personal Liability: Individual are liable for K they enter into UNLESS the five doctrines apply a. Five Doctrines to shield an individual from liability, not to make a corporation liable. i. (1) De Facto Corporation Doctrine (does not distinguish amongst claimants) A. RULE: If a de facto corporation exists, an individual is not personally liable. 1. To determine whether there is a de facto corporation to exists, four elements a. There must be an existing statute in which the individual could have incorporated; b. The individual must have attempted to incorporate; i.e. put the AOI into the mail or the lawyer tells the individual that is incorporated depending on jurisdiction. c. The individual actually used the corporate form in entering into the transaction; and i.e. operated like a corporation d. The individual acted in good faith with respect to the attempt to incorporate and in the attempt to use the corporate form. B. Exam Answer: In this scenario, talking about personal liability, so don't say if these factors are met then the corporation is liable, we are saying the shield of liability is lifted as to personal liability. Now I have to decide if the corporation is liable, and examine if there is post incorporation occurrences of the corporation adopting the pre incorporation contracts C. Notes: This doctrine focuses on what the individuals have done; This doctrine protects the individual from contract and tort claimants. ii. (2) Corporation by Estoppel Doctrine (Differentiates amongst claimants) A. RULE: If the creditor deals with the individuals believing they were a corporation and the individuals were acting in good faith like a corporation, then the creditor is estopped from claiming that they were dealing with individuals. B. Notes: This doctrine focuses on how the creditor treats the individuals. This doctrine DOES NOT protect individual from tort claimants, just contracts; only contacts can be estopped. iii. (3) Hardball: MBCA 2.03 with NO 2.04 A. RULE: There is no liability because a corporation does not come into existence until the articles of incorporation is filed. B. Notes: The courts may find liability through common law if there are two or more persons associated together as co-owners running a business for profit. Anderson calls this sparkle in the eye to start a business. C. This doesnt help the person evade any liability even if they think they have formed a corporation. iv. (4) Timberline [aka OLD 2.04] A. RULE: If the participants were actively engaged in the business, then they are individually liable even if they have no knowledge the business is not incorporated. 1. If they were inactive, then they are not individually liable. 2. Timberline : Those persons who have an investment in and who actively participate in the policy and operational decisions of an organization and who assume to act as a corporation without the authority of a certificate of incorporation are jointly and severely liable for all debts and liabilities incurred or arising as a result thereof B. Notes: Active v. Inactive is generally a fact specific determination(1)Active = anything more than a passive investor. (2) Inactive = passive investor. A person only needs to be actively engaged in the business, not the specific transaction. ii. (5) MBCA 2.04 A. RULE: Even if the person is an active participant, he is not liable if he did NOT KNOW there is a corporation.
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1. MBCA 2.04: All persons purporting to act as or on behalf of the corporation, knowing there is no incorporation, are jointly and severally liable for all liabilities created while so acting. (distinguishing among owners who know there was no incorporationyou know there is no incorporation) CORPORATE PARADIGM: WAS THE VOTE BY THE DIRECTOR OR SHAREHOLDER VALID UNDER THE CORP PARADIGM: PARADIGM? I. CENTRALIZED MANAGEMENT: Corporation powers are exercised under the authority of centralized management through the board of directors, rather than fractionalized management, such as partnerships through its owners. The corporate form provides a hierarchal form for decision-making that permits the enterprise to adapt easily to changed circumstances. II. HIERARCHAL FORM A. Corporation = a legal entity created under the authority of the statute legislature. the pretend person. B. Directors= members of the board of directors manage the corporations business. 1. Powers: A director can make major policy decisions AND appoint and fire officers. 2. Majority Vote: Majority is NOT dependent on shares but the NUMBER OF DIRECTORS voting on each side. C. Officers = agents of the corporation that administers the daily affairs of the corporation. 1. Powers: Officers canexecute the policies laid down by the directors, AND provide day-to-day management. D. Shareholders = individuals that provide capital and own the stock of the corporation; no direct management rights. 1. Powers: A shareholder can sue, vote, and sell. a. Vote: primary uses: (1) electing and removing directors and (2) approving and disapproving fundamental or non-ordinary changes. i. Majority Vote: Majority is NOT dependent on the number of stockholders but the PERCENT OF STOCK owned. E. NOTES: These are statutory default rules and can be changed by private ordering. Changes made in the statutory default rule are best protected when (1) they are inserted into the articles of incorporation, (2) there is a supermajority requirement for directors to adopt any proposed amendments, and (3) there is a supermajority requirement for shareholders to approve the proposed amendments for articles and bylaws. III. SHAREHOLDER VOTING RIGHTS A. Election of Directors 1. How: Shareholders vote for directors by plurality either at an annual shareholders meeting, by proxy, or by written consent resolution (see below). (Proxy = voting power granted by a shareholder to another person to exercise the shareholders voting rights.) 2. Types of Voting a. Straight Voting (Default): votes = one vote per share. b. Cumulative Voting: votes = shares multiplied by number of director positions to be filled. c. Class Voting: voting power can be divided disproportionately between classes. 3. Terms a. Default: Directors are elected annually. b. Options: Articles, bylaws, and state statutes may require directors to serve longer or staggered terms. 4. Written Consent Resolution a. MBCA: written consent requires unanimity. b. DE: written consent by the vote of the number of shareholders otherwise required by corporate action usually a majority. B. Removal of Directors and Other Midstream Private Ordering 1. Old Common Law Rule: Shareholders cannot remove directors without cause unless specified by articles or bylaws. 2. Modern Statutory Rules: Shareholders can remove directors with or without cause by simple majority vote. a. MBCA (immutable rules) i. EVEN IF staggered term, there is NO restrictions on removal.
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ii. If removing with or without cause A. IF cumulative voting, THEN shareholders cannot remove a director if the votes cast against would have been sufficient to elect that director. B. IF class voting, THEN shareholders can remove ONLY with majority vote of that class. b. Delaware (default) i. IF staggered, THEN cannot remove UNLESS for cause. A. This is an anti-takeover device because it is a difficult to remove a director for cause: requires service of specific charges, adequate notice, and full opportunity of meeting the accusation, directors in question, opportunity to be heard before shareholder vote, etc. ii. If removing without cause A. IF cumulative voting, THEN shareholders cannot remove a director if the votes cast against would have been sufficient to elect that director. B. IF class voting, THEN shareholders can remove ONLY with majority vote of that class. IV. Shareholder Informational Rights: A. Generally: State law generally gives shareholder the right to inspect the corps books and records. B. Who may inspect: usually beneficial owners as well as holders of record (though may be restricted based on length of ownership or percentage of shares owned.) C. What records may be examined: corporate records in general 1. MBCA 16.02(b): does not give holders an automatic right to inspect sensitive material like the minute of board meetings, the accounting records, or the shareholder list. For these, a demand in good faith and for proper purpose , he must describe with reasonable particularity his purpose and the records he wants to inspect, and the records must be directly connected with his purpose D. Proper purpose: S generally may inspect records only if he does so for a proper purpose. 1. Evaluation of investment =proper; unrelated personal goal=improper, deal with other Ss=proper 2. Multiple purposes which one is proper: In DE inspection must be allowed so long as there is at least one proper purpose, the presence of an improper purpose is irrelevant. E. Financial Report: in most states corp is not require to sent annual report or other annual financial info to S F. Directors right of inspection: a director in most states has a very broad virtually automatic right of inspection. But most states deny him the right of inspection if he is acting with manifestly improper motives. FIDUCIARY DUTIES: LIABILITIES TO THE CORPORATION I. OVERVIEW A. Fiduciary duties in both a closely and publicly held corporation = duties directors and officers owe to the corporation. B. Accordingly, shareholders can only bring derivative suits for breach of fiduciary duties. II. BUSINESS JUDGMENT RULE= judicial presumption that directors are better equipped than courts to make business judgments and the directors are not liable for any decision or failure to make a decision because the corporate business decisions are made by disinterested and independent directors, acting on an informed basis, and in the good faith belief that the decisions are in the best interests of the corporation and its shareholders. A. Function: saves many corporate actions/inaction from being held to be violations of the duty of care 1. Relation to Duty of Care: (1)The duty of care imposes a fairly stern set of procedural requirements for directors action; (2) once these requirements are satisfied, the BJR then supplies a much easier to satisfy standard with respect to the substance of the business decision. B. Requirements: The BJR basically provides that a substantively unwise decision by a director or officer will not by itself constitute a lack of due care. However there are three requirements which a decision by a director or officer must meet before it will be upheld by application of the BJR. 1. Disinterested (No self dealing): The director or officer will not qualify for the protection of the BJR if he has an interest in the transaction. 2. Reasonably Diligent (Informed Decision): The decision was an informed one as the director or officer gathered at least a reasonable amount of information about the decision before it was
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made. 3. Acting in Good Faith (Rational Decision): good faith belief that the decision was in the corporations best interest C. Exceptions: Even where the three requirements of BJR are satisfied, there are two situations where the court may find the rule inapplicable: 1. Illegal: If the act taken or approved by the director or officer is a violation of a criminal statue, the D will lose the benefit of the BJR 2. Pursuit of Social goals: some courts may hold the BJR inapplicable if the director is pushing his own social or political goals (unrelated to the corps welfare).though some courts do not agree.

III. FIVE DOCTRINES THAT OVERCOME THE PRESUMPTION OF THE BJR A. Duty of Loyalty: (1) Corporate Purpose Doctrine (2) Conflicted Interest Transactions (3) Corporate
Opportunity Doctrine B. (4) Duty of Care C. (5) Duty of Good Faith IV. DUTY OF LOYALTY A. Corporate Purpose Doctrine 1. General RULE: A directors decision must have some valid corporate purpose, a reason that benefits the corporations welfare. //Dodge v Ford Motor (finding that Ford had no valid corporate purpose for withholding dividends because it did no benefit the corporation but the consumers). B. Conflicted Interest Transaction / Self-Dealing Doctrine: COI 1. General RULE: A director may not engage in a self-dealing or conflicted interest transaction. 2. Defenses: There is disinterested director approval; There is disinterested shareholder approval; or The transaction is inherently fair. 3. Was there a conflicted interest or self-dealing transaction? a. Definition: A conflicted interest/self-dealing transaction = a transaction between the corporation and i. (1) one of the corporations directors; (2) an entity in which one of the directors is an officer or director; or (3) an entity in which the director has a material financial interest. ii. Directors Salaries: The board may set director compensation unless the articles or bylaw provide otherwise. MBCA 8.11. However, setting an unreasonable compensation may make this a COI. b. Notations: DE and ALI: Includes both directors and officers/ MBCA and ALI: Includes related persons. 2. Was there disinterested director approval? a. Fully Disclosure i. The director must disclose the existence and nature of his COI. **Nature = all facts an ordinary person would reasonably believe to be material to a judgment about whether or not to allow him to proceed with the COI. A. EXCEPTION to full disclosure 1. MBCA 8.62(b). This provision says that if the director or any related person is NOT A PARTY TO THE TRANSACTION, and there is some ethical or legal restriction on him releasing the why of the conflict of interest, then all the director has to disclose is that there is a conflict of interest and that he has limitations on his ability to disclose the information. b. Majority Vote i. DE 144. Deliberation and voting can include interested directors but the interested directors vote will not count towards the required majority. ii. MBCA 8.62. Deliberation and voting cannot involve the interested directors and there must be two or more disinterested directors vote toward the required majority. 3. Was there disinterested shareholder approval? a. Fully Disclosure: The director must disclose the existence and nature of his COI. **Nature = all facts an ordinary person would reasonably believe to be material to a judgment about whether or not to allow him to proceed with the COI. A. EXCEPTION to full disclosure 1. MBCA 8.62(b). If a director or any related person is not party to the transaction and there is an ethical or legal restriction on releasing why the transaction is a COI, then all
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the director has to disclose is that there is a conflict of interest and that he has limitations on his ability to disclose the information. b. Majority Vote: Requires majority vote from disinterested shareholders 4. Was the transaction inherently fair? a. Fair price: economic and financial considerations, market value, future prospect, any other elements that affect the intrinsic or inherent value of the company stock. b. Fair dealing: evaluates when the transaction occurred, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals for the directors and the stockholders were obtained. B. CORPORATE OPPORTUNITY DOCTRINE 1. General RULE: A director or senior officer may NOT take advantage of a corporate opportunity. a. Defenses i. ALI: The opportunity was presented, fully disclosed, and rejected. ii. DE: The opportunity was presented and did not harm the corporation. 2. Was there a corporate opportunity? a. Five Possible Tests i. Line of Business Test: A corporate opportunity under the line of business test = an opportunity that is closely associated with the existing business activities. (Problems: The test is too conceptually difficult to answer.) ii. Fairness Test: A corporate opportunity under the fairness test = an opportunity that is ethically unfair under the circumstances.(Problems: This test creates an intensely factual inquiry.) iii. Combined Line of Business/Fairness Test: A corporate opportunity under the combined test = an opportunity that is closely associated with the existing business activities and is ethically unfair under the circumstances. (Problems: This test piles the uncertainty and vagueness of the fairness test on top of the weakness in the line of business test.) iv. ALI Approach 5.05: A corporate opportunity is A. IF person is director or senior officer, he becomes aware of an opportunity a. in connection with his duties OR under circumstances that should reasonably lead them to believe that the person offering the opportunity expect it to be offered to the corporation, OR b. through the use of corporation information or property and the opportunity is one that the director or senior officer should reasonably believe would be of interest to the corporation. B. IF person is a senior officer, an opportunity he knows is closely related to the business in which the corporation is engaged or expects to engage (line of business test). iv. DE Approach A. A corporate opportunity is (1) an opportunity the corporation is financially able to exploit,(2) an opportunity that is within the corporations line of business: closely related to the business in which the corporation is engaged or expects to engage,(3) an opportunity that the corporation has a reasonable interest or expectancy (fairness) and (4) an opportunity if taken will place him an unfavorable position with the corporation. 3. What defenses are available to the taker of the corporate opportunity? a. ALI Approach 5.05 (focus is on disclosure) iv. The director or senior officer must A. (1) present corporate opportunity to disinterested directors and B. (2) fully disclose the corporate opportunity and if any, conflict of interest, v. The corporation must reject the opportunity, AND vi. Either A. Disinterested D Approval: opportunity is rejected by shareholders following disclosure, 1. If is a senior officer who is not a director, the opportunity is rejected by a disinterested superior, in a manner that satisfies the standards under the BJR. B. Disinterested S approval: opportunity is later ratified and rejected by disinterested shareholders, or C. Inherently Fair: rejection, not the corporate opportunity, is inherently fair (in price and dealing) to the corporation. b. DE Approach (focus is on conduct not harming corporation) A. (1)The opportunity is presented to the director or officer in his individual and not his
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corporate capacity,(2) the opp is not essential to the corp (3) the corp holds no interest or expectancy in the opp, and (4) the director or officer has not wrongfully employed the resources of the corp in pursuing or exploiting the opp.

II. DUTY OF CARE DOCTRINE B. General RULE: A director must carry out their managerial responsibilities with reasonable care
and diligence; in actuality, most jurisdictions require more of a gross negligence or higher standard. 2. Defenses: Exculpatory Clauses C. Decisional Setting 2. Process: Was the director sufficiently informed in his decision making process? a. Smith v. Van Gorkom was the main case in this area. The BOD made what appeared to be a hasty decision without ever inquiring where the CEOs valuation estimate came from. It is okay that they made the decision in 2 hours because they were experts, but it is not okay that the directors relied on $ figures when they had no idea where they came from. 3. Substance: Was the directors decision an extremely poor decision that it would amount to corporate waste? a. Corporate waste = disposition of corporate funds or assets for (1) no consideration and no rational business purpose OR (2) consideration so inadequate in value that no person with sound business judgment would find it reasonable. b. Note: The corporate waste standard is an extremely hard standard to overcome and easily protected by the BJR. D. Non-Decisional Setting 2. Lack of Oversight: Did the director fail to act in circumstances in which due attention would have arguably prevented the loss? a. Meek case - a director who did not monitor his sons investments. The son had the company highly leveraged, and lost the money. The director (father) was held liable for a breach of the duty of care for his failure to oversee the activities of the corporation. b. In re Caremark was another case in this area, but it looked a lot like a failing to be informed case, as well. The BOD was not paying attention to the lower-level employees and their bribery of health officials. The case was in our text because it illustrates that in some situations a failure to pay attention can result in criminal violations! The directors must pay attention and make sure the corporation does not incur criminal penalties. A corporation can be a criminal defendant. E. Defenses: DE & MBCA: Duty of care can be disclaimed. III. DUTY OF GOOD FAITH DOCTRINE B. General RULE: A director must conduct his duties in good faith, and not bad faith. 2. Good faith = honesty of purpose and genuine care for the fiduciary constituents. 3. Bad faith (easier to define) = authorizing a transaction for some purpose other than a genuine attempt to advance corporate welfare or when the transaction is known to constitute a violation of applicable positive law; action taken with the intent to harm the corporation. C. Note: In DE, this is separate from the duty of care. Notion of a triad rather than of fiduciary duties. IV. EXCULPATORY CLAUSES B. Exculpation clause = clause that allows corporations to disclaim their fiduciary duties. 2. DE & MBCA: Duty of care can be disclaimed. 3. DE: Expressly states that a corporation CANNOT disclaim duty of loyalty and duty of good faith. CLOSELY HELD CORPORATIONS I. OVERVIEW

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A. Closely held corporations = corporations that have (1) very few shareholders, (2) the lack of any ready market for the corps stock, and (3) substantial participation by the majority stockholder(s) in the management, direction and operations of the corporation. B. Majority Opportunism: Because of the way the corporate paradigm is set up, close corporations are subject to majority opportunism. However, several mechanisms have developed to allow close corporations to prevent majority opportunism. (i.e. being frozen out, etc) II. RESOLUTION OF DISPUTES A. Dissension and deadlock: Dissension refers to squabbles or disagreements among shareholders. Deadlock refers to a situation where the corp is paralyzed and prevented from acting. B. Dissolution: The major judicial remedy for dissension and deadlock is a court order that the corporation be involuntarily dissolved. Dissolution means the corp ceases to exist as a legal entity; the assets are sold off, the debts are pid, and any surplus is distributed to the shareholders. 1. No general right: 2. MBCA: 3. Judges Discretion: 4. Remedy for Oppression: 5. Buy out in Lieu of Dissolution: 6. Dissolution of an LLC C. Alternatives to Dissloution 1. Fiduciary obligation of majority to minority 2. Award of damages III. WHAT ARE THE CONSEQUENCES IF THE SHAREHOLDER SUES UNDER THE TRADITIONAL CORPORATE PARADIGM? A. 2 Basic Mechanisms: There are TWO basic remedies under the corporate paradigm for minority shareholders: 1. (1) A direct or derivative suit for breach of fiduciary duties; and a. i.e. A suit to compel the payment of dividends. 2. (2) A petition for involuntary dissolution. B. Fiduciary Duties: A minority shareholder can bring a direct or derivative suit for a breach of fiduciary duties. 1. In General: Because fiduciary duties are owned to a corporation, a minority shareholder is normally required to bring a derivative suit. a. This is not very favorable to the minority shareholder since the minority shareholder is NOT interested in remedying a harm done to the corporation but to himself. 2. Exception: However, a suit against the corporation for the breach of fiduciary duty of good faith when it fails to pay reasonable dividends is one of the few suits that may result in a remedy that benefits the shareholder. a. brought suit for breach of the fiduciary duty of good faith to compel higher dividends. Court declined to find s conservative dividend policy constituted bad faith but held that larger dividends should have been declared to allow a more reasonable return. //Zidell. b. A corporations accumulation of an unreasonably large cash reserve is a breach of the fiduciary duty of good faith because it can only be explained by the controlling majoritys bad faith. //Dodge v. Ford. C. Involuntary Dissolution: The corporate norm generally treats this as a drastic remedy, available only if the shareholder proved both (1) there was wrongful conduct by those in control and (2) dissolution was the only way to prevent irreparable harm to the corporation. IV. IF NONE OF THE CORPORATE PARADIGM REMEDIES ARE FAVORABLE: Did The Parties Execute Any Ex Ante Shareholder Agreements? A. Shareholder agreements = ex ante private ordering because they deal with potential problems before they happen. In general, such agreements require unanimous consent. B. Shareholder Agreements: Did the parties execute any ex ante contract as to Directors Decisions? 1. Old View: Shareholder agreements that contracts to restrict or interfere with the discretion of the board of directors are void against policy because it sterilizes the decision making capacity of the board in which they are entitled by virtue of their office. a. Stoneham v. McQuade (holding a contract that required a director to vote for a particular officer is void against public policy because a corporation is entitled to the unfettered discretion of its directors).

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2. Modern View: Shareholders agreements that contracts to restrict or interfere with the discretion of the board of directors are valid in almost every state by statute. a. MBCA 7.32(a): Shareholder agreements are effective even if they restrict or interfere with the discretion of the board or directors and even eliminate the board of directors. i. Restrictions A. (b). Must be either (1) provided in the articles of incorporation or bylaws approved by all then shareholders or (2) provided in a written agreement signed by all shareholders at the time of the agreement was made known to the corporation. B. (d). Shareholder agreements are no longer effective when the corporation becomes public. C. (e). If board of directors are eliminated, fiduciary liabilities are transferred to the shareholders. C. Shareholder Agreements: Did the parties execute any ex ante contracts as to Shareholders Decisions? 1. There are 3 mechanisms in which shareholders contract to their decision making power. a. Voting Trusts (i.e. MBCA 7.30) i. A voting trust = a trust in which shareholders transfer the legal title of the stock certificates to the trustee, conferring on the trustee their voting power, but retain an equitable title to the certifications, retaining the beneficial interest on the dividends. b. Proxies and Irrevocable Proxies (i.e. MBCA 7.22) i. Proxy = a written authorization signed by a shareholder appointing a person to vote his shares. ii. RULE: A proxy is always revocable if the person appointed has NO interest in the corporation. iii. RULE: A proxy is irrevocable ONLY IF there is (1) a written agreement that says it is irrevocable AND (2) it is given to a person with NO ownership interest in the corporation. A. i.e. Smith: Three individuals, who together hold majority stock in the corporation, agreed that they will pool all their votes and have one of them vote all their stock per majority rule as agreed to maintain control of the corporation. c. Shareholder Voting Agreements (i.e. MBCA 7.31) i. Voting Agreements = agreements in which shareholders agree to vote their shares individually according to the agreement. A. i.e. Ramos: A groups agreed to vote their shares individually for directors whom the majority of the group agreed; the agreement also provides that if any member of the group failed to adhere to the agreement, then it constitutes an election by that shareholder to sell his her shares. V. IF THERE ARE NO SHAREHOLDER AGREEMENTS: Should The Court Apply An Ex Post Judging With Partnership Analogy? A. Partnership Analogy = ex post judging that allows a shareholder in a close corporation to sue the board and controlling shareholders directly for breaches of fiduciary duty. 1. The reason this is called partnership analogy as opposed to traditional partnership law is because a partnership law is NOT applied; it is simply saying that since the characteristics of close corporations are similar to partnerships. Accordingly, shareholders in close corporations owe fiduciary duties to each other, like partners in a partnership. B. Equality of Treatment Doctrine: A corporation must provide each of its shareholders equal opportunities. 1. Donahue v. Rodd (holding had a right to an equal opportunity to sell a ratable number of his share to the corporation at an identical price as another shareholder). C. Reasonable Expectation Doctrine: A shareholder must reasonably expect equality in treatment. 1. Wilkes v. Springside (holding must pay damages to for the salary he would have received as director and officer because had a reasonable expectation to equality in treatment; they increased the salaries for everyone else and attempted to freeze him out). D. Predominant Use: To prevent freeze-outs. E. Arguments against the Use of Partnership Analogy: Shareholders should not be allowed to come in ex post and whine for a partnership analogy. They filed as a corporation for the benefits of the corporate norms and should be bound to its disadvantages as well. F. DE: DE has its own body of statutory law developed for close corporations. If the corporation elects NOT to file as a close corporation in the outset, it is stuck. There is no corporate analogy and shareholders can generally only bring suits for breaches of fiduciary duty derivatively.
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G. Test Note: Less harmful alternative and Legitimate Business Reasons? VI. IF PARTNERSHIP ANOLOGY IS NOT AVAILABLE: Should the Court Broaden the Grounds for Involuntary Dissolution on Oppression Grounds? A. Involuntary Dissolution = a direct suit to dissolve the corporation. 1. Grounds: Some state legislatures have broadened the grounds to include oppression, so that minority shareholders in a close corporation have additional means to bring suit for involuntary dissolution. 2. Oppressive Conduct (depending on jurisdictions) = a. Definition 1: Violation by a majority of the reasonable expectation of the minority, or i. There is no reasonable expectation if you inherent your stocks. So if you arent a founder, the second applies. b. Definition 2: Burdensome, harsh, and wrongful conduct. 3. (MBCA) Election: If oppressive conduct is found A corporation or one or more of its shareholders must elect between(1) purchasing all the shares owned by the shareholder at the fair value or (2) dissolving the corporation. VII. WERE THERE ANY EX ANTE SHAREHOLDER REPURCHASE AGREEMENTS? A. Shareholder repurchase agreements = ex ante contracts that specify in advance the conditions in which the corporation or continuing shareholder will repurchase the shares of a noncontinuing shareholders. B. RULE: Courts generally enforce shareholder repurchase agreements as matter of law unless they are unenforceable under K law. VIII. WERE THERE ANY EX ANTE RESTRICTIONS ON SHARE TRANSFERS? A. Why: Shareholders of close corporations will often agree to limit the transferability of shares in the corp. This lets shareholders veto the admission of new colleagues and helps preserve the existing balance of control. B. Enforcement: share transfer restrictions will generally be enforce, so longs as they are reasonable. C. Techniques: 1. Right of First Refusal: shareholder may not sell his shares to an outside without first offering the corp or other shareholders (or both) a right to buy those shares at the same price and terms as those at which the outsider is proposing to buy. (usually the corp gets first change and then if it refuses, the other stockholders get the right buy proportionally to their holdings) a. What is the triggering event? (Attempting to sell to third party or getting offer to third party) b. What is the restriction or limitation? (Always about timing. i.e. 180 days.)(This can be a substantial restriction) c. What was the repurchase price? (Price is determined by what the third party would buy or market value) 2. First option: similar to right of first refusal, but the price is determined by the agreement creating the option 3. Consent: Stock transfers may be made subject to the consent of the board of directors or the other shareholders. 4. Compulsory Buy/Sell: buy back right is given to the corp to enable it to buy back a holders shares on the happening of certain events, whether the holder wants to sell or not. The corp is obligated to exercise a buy back right. a. What is the triggering event? (Set out in the agreement, i.e. death, etc.) b. What is the restriction or limitation? (No options)(Most restrictive both parties must do something) c. What was the repurchase price? Specified, Formula (book value as of a certain date (gross revenue-expenses=net income),external measure (judicial appraisal) d. Funding: i. Life Insurance: purchased on each shareholder in an amount sufficient to cover the estimated purchase price for that holders shares. ii. Installment Payments: usually a down payment, followed by quarterly or annual payments, usually paid out of the earnings of the business. 5. Compulsory Buy Back: Buy back right is given to the corp to enable it to buy back a holders shares on the happening of certain events, whether the holder wants to sell or not. The corp is not obligated to exercise a buy back right.

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Business Associations: Anderson

Fall 2009

a. If triggering event, the limitation is that one party has no option, the other party has option to determine whether they want to buy or not. b. A call with no put. D. Valuation: Most transfer restrictions require some valuation to be placed on the stock at some point. 4 common techniques: 1. Book value: based on the corps book value or assets minus its liabilities 2. Capitalized earnings method: a formula that attempts to estimate the future earnings of the business and then discount these earnings to present value 3. Mutual agreement method: parties agree upon an initial fixed valuation and also agree that from time to time they will mutually agree upon an adjusted number to reflect changes in its market value. 4. Appraisal: parties agree in advance on a procedure by which a neutral third party appraiser will be selected; the appraiser then determines the value. E. Requirement of reasonableness: Transfer restrictions will only be upheld if they are reasonable. 1. If the mechanism chosen by the parties is reasonable at the time the method was agreed upon, ti will probably be found reasonable (and upheld) even though it turns out to produce a price that is much higher or lower than the market price at the time of sale. SHAREHOLDER LITIGATION: DIRECT AND DERVIATIVE SUITS I. Should the shareholder bring a direct or derivative suit? A. A shareholder must bring a suit derivatively on behalf of the corporation UNLESS they qualify to bring a direct suit. B. A shareholder may bring a direct suit ONLY IF he individually suffers the alleged harm and is seeking a personal remedy for that harm. II. If derivative, then is the shareholder subject to a demand requirement? A. Demand requirement = demand that the corporation sue itself. B. MBCA 7.42: Universal demand requirement. C. DE: Demand is required UNLESS futile. 1. Aronson Test: A demand is futile and is excused IF a. (1) The directors are NOT disinterested and NOT independent, OR i. Not disinterested = director in a conflicted interest transaction. ii. Not independent = director whose decision is NOT based on corporate merits of the subject matter BUT rather on extraneous considerations or influences (subjective test). A. i.e. the directors are either indebted to the controlling shareholder or under its influence that their discretion is sterilized. b. (2) The challenged transaction was NOT the product of a valid exercise of business judgment. III. If demand requirement, can a corporation use an independent litigation committee? A. If it is a close corporation, just say this is a small corporation and we would not use it because it is really expensive ..do not discuss. B. An independent litigation committee = a committee made up of directors who are not involved in the first suit AND is given the power by the board to respond to the demand and decide whether or not the corporation should sue itself. 1. Reason: The reason a corporation uses an independent litigation committee is so that their decision to refuse demand can be protected by the BJR. If the original board involved in the first suit makes a recommendation to refuse demand, their decision is not protected by the BJR because they are not disinterested and it would be a conflicted interest transaction. C. There are four views on whether or not the BJR applies to the independent litigation committees decision 1. Auerbach (New York): IF the committee members are disinterested, used reasonable procedures in their deliberations, and made their decision in good faith, THEN the BJR is reinstated. 2. Miller (Iowa): The usage of the independent litigation committee CANNOT reinstate the BJR for their decision on the demand. 3. Zapata (Delaware): Two step process a. The committee was independent and made its decision in good faith, b. If the first prong is met, then the court has discretion and determines by applying their own independent business judgment on whether the committee decision stands. 4. MBCA 7.44: A court will dismiss a derivative proceeding on motion by the corporation if one of the three groups has determined in good faith after conducting a reasonable inquiry upon
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which its conclusions are based that the maintenance of a derivate proceeding is not in the best interest of the corporation. a. The three groups include i. (1) court appoint panel, (2) a quorum of qualified directors (majority vote required) (3) a special litigation committee consisting of at least 2 qualified directors appointed by a majority vote of qualified directors. PIERCING THE VEIL: WHAT ARE THE CREDITORS RIGHTS TO A CORPS ASSETS I. Amount Recoverable by Creditors A. Before salaries are paid, etc., creditors have first dibs on the corporations assets. However, since corporate liability is limited to its assets, statutes used to require corporation to set a minimum equity cushion to reduce creditors risk of extending credit to the corporation. Corporations are able to freely spend its assets beyond this amount. B. Terms 1. Par value = the assigned value in the AOI at which the stock cannot be sold less than. a. Most current stocks, when offered to the public, sell far in excess of the par value. 2. Legal (or permanent) capital = par value x number of shares 3. Equity Cushion = value of the legal capital C. MBCA and DE rules on Equity Cushion and Par Value 1. MBCA 6.21 has completely deleted such legal capital rules from its corporate code. a. Corporations are allowed to create and issue shares with no par value. b. There is no prohibition in issuing share below par value. c. It maintains no concept of legal capital or equity cushion to restrict distributions to shareholders. 2. DE 153, 154 is among the minority of states that continues to have legal capital rules in its corporate code. a. 154 permit corporations directors to specify by resolution what amounts of the consideration paid for the shares shall constitute capital as long as the capital is not less than the aggregate par value of issued shares having a par value. However, this can be as little as $.01 par value per share. D. Insufficient Consideration 1. The MBCA and DE leave it to the directors to determine consideration. 2. Director Liability: If the directors set an unfairly low price for its shares or accept consideration that has insufficient value, their actions constitute a breach of fiduciary duty. 3. Shareholder Liability: Absent fraud, shareholders have NO liability for purchasing shares at a bargain price. II. Restrictions on Corporate Distributions to Shareholders A. Two main TYPES of distribution to shareholders 1. Dividends and 2. Share repurchases B. Two main RESTRICTIONS on distribution to shareholders 1. Legal Capital Rules: A corporation cannot distribute the amount beyond its equity cushion (discussed above). 2. Insolvency Tests: A corporation may ONLY distribute its assets to shareholders as long as after distribution, it will a. Equity Rule: be able to pay its debts in the ordinary course of business (solvent in the equitable sense) and b. Bankruptcy Rule: still have assets equal to or in excess of liabilities (solvent in the balance sheet). C. Two REASONS for Restrictions: (1)Protect the creditors (2)Preserve the order of payment III. Piercing the Corporate Veil A. Piercing the corporate veil = a process by which courts entertain suits by creditors and allow them go to beyond the limited corporate liability and impose personal liability on shareholders. 1. Note: With the establishment of LLCs and LLPS, veil piercing is more and more commonly used in these entities than corporate entities. B. Likelihood of Piercing 1. Tort v. Contracts Claimants: Tort claimants because unlike contract claimants, tort claimants normally have not consented under an agreement. 2. Person v. Corporation Identity: Corporation.
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3. Closely v. Publicly Corporations: Closely Held Corporations because it is often not effectively controlled by their shareholders and there are no market consequences as result of piercing. C. General RULE 1. RULE: To pierce the corporate veil of corp & to hold the shareholder(s) liable, there must be three factors a. (1) Domination and Control: Shareholder must have majority or complete stock control over the corporation; b. (2) Unjust Conduct: Shareholder must engage in unjust, fraudulent, or wrongful toward the . c. (3) Causation: The control must have caused and resulted in an injury to . 2. Parent/Subsidiary cases narrow the definition of control (element 1). a. RULE: To establish control in a parent corporation, parent must exercise a complete domination of financial, policy and business practice in respect to the transaction attacked so the corporate entity had no separate mind, will, or existence of its own. D. Factors of Unjust Conduct 1. Undercapitalization: The corporation was not adequately capitalized at the time of formation. i.e. Going bankrupt and reforming a corporation over and over again. 2. Disregard for Following Corporate Formalities: Includes the idea of operating merely behind a corporate shell. 3. Commingling assets, affairs, and funds; siphoning off profits 4. Fraud or misrepresentation: In a case where the plaintiff has voluntarily chosen to enter into a contract with the corporation, courts typically require some element of deception or inequity to justify piercing the veil. Misrepresenting the finances or otherwise misleading the plaintiff could supply the necessary element. E. Direct v. Derivative 1. Direct = Generally used in close corporation and tort claimant cases. 2. Derivative = Generally used in parent/subsidiary cases. FRIENDLY MERGERS AND ACQUISITIONS I. THREE TYPES OF MERGERS AND ACQUISITIONS A. Statutory Merger: One corporation merges into another. B. Asset Acquisition: A corporation buys out another corporations assets for $$$. C. Share Acquisition: A corporation buys out another corporations shares for $$$ (tender offer). II. STATUTORY MERGERS(2 Types) A. Straight Mergers = a merger in which two or more corporations are combined into one. i. Surviving Corporation: If A becomes B, then B is the surviving corporation. i. Shareholders of disappearing corporation receive shares of surviving corporation in exchange for their canceled shares. ii. By operation of law, the assets and liabilities pass onto the surviving corporation. ii. Consolidated Corporation: If A + B = C, then C is the newly created consolidated corporation. B. Triangular Mergers = a merger in which acquiring party creates a subsidiary, transfers some shares into the subsidiary, and the disappearing corporation merges into the subsidiary. i. Advantages i. Parent corporation remains free from liability (but remember veil piercing). ii. Prevents subsidiary from carrying parents liabilities. iii. Tax advantages iv. No shareholder approval necessary for creating a subsidiary. III. VOTING RIGHTS A. RULE: Mergers must have(1) approval by board and (2) approval by an absolute majority of shareholders of disappearing company. 1. Absolute Majority = majority of all those entitled to vote, not just those present at a particular meeting. (This used to be a unanimous or supermajority requirement). B. Exceptions to Shareholder Approval 1. De Minimis Change Exception: Denies voting rights to shareholders of the surviving corporation if the merging terms will not significantly affect the pre-merger shareholders voting or equity rights. 2. Short-Form Merger Exception: Short form merger = procedure that allows a corporation that owns most of the shares the subsidiary to merge with that subsidiary by director action alone.
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IV. DISSENTERS AND APPRAISAL RIGHTS (SHAREHOLDER) A. Dissenters Rights = protective device that gives shareholders who vote against the right to have their shares purchased for cash at fair value as determined in a judicially supervised appraisal process. B. Appraisal Rights = fair value determined at a judicial proceeding if the dissenting shareholder and corporation cannot agree to a price within the time frame and procedures outlined by the appraisal statute.Gives a dissatisfied shareholder in certain circumstances a way to be cashed out of his investment at a price determined by the court. 1. Mergers: a shareholder of either company involved in a merger has appraisal rights if he had the right to vote on the merger. i. Short form merger: shareholder of the subsidiary in a short form merger get appraisal rights even though they would not get a vote on the merger 2. Asset Sales: shareholders of a corporation that is selling substantially all of its assets

get appraisal rights. i. Sale for cash, followed by quick dissolution: but if the selling corp liquidates soon after the sale, and distributes the case to the shareholders, usually there are no appraisal rights: (MBCA 13.02(a)(3): no appraisal rights where liquidation and distribution of cash proceeds occurs within one year after the sale) ii. DE: no appraisal rights to stockholders of corp that sells its assets 3. Publically Traded: many sate deny the appraisal remedy to shareholders of a company whose stock is publicly traded. The MBCA does 4. Triangular mergers: Forward: on the acquirers side, shareholders will not get appraisal rights, targets side shareholders generally will get appraisal rights 5. De Facto Merger: the court treat a transaction which is not literally a merger, but which is the functional equivalent to one, as if it were one. The result is that selling stockholders get appraisal rights. i. DE rejects the de facto merger doctrine C. Valuation: the court determines the fair value of the dissenters shares, and the corp must pay this value. 1. Fair value must be determined without reference to the transaction that triggers the appraisal rights 2. No minority or nonmarket ability discount: most courts do not reduce the value of s shares to reflect that held a minority or non controlling interest. Instead the court usually takes the value of the whole company, and then divides by the number of shares (so even though a minority holder, gets the same per share value as insiders would have gotten. 3. DE block method: Most courts use the Delaware Block valuation method. Under this, the court considers three factors: (1) the market price just prior to the transaction, (2) the net asset value of the company; (3) the earnings valuation of the company. The three factors can be weighted however the court chooses. (DE itself no longer requires this)
D. Limitations: Appraisal rights exist where there dissenters rights exist. 1. Exception to Limitation i. Short Form Mergers ii. Asset Acquisition: Shareholders of selling company in an asset acquisition are entitled to voting rights, but not appraisal rights, if the company is selling (1) substantially all of the corporations assets and the sale is (2) not in the ordinary course of business. E. DE 262 (Traditional Statutes) 1. If a dissenting shareholder brings suit in DE, he will receive the judicially determined value with appropriate interest even if it is LESS THAN what the corporation offered. 2. A dissenting shareholder in a publicly traded corporation has NO appraisal rights. F. MBCA: If a judicially determined value is higher than the corporations good faith judgment as to the fair value, then dissenter receives the difference. V. DE FACTO MERGERS A. Two Competing Doctrines 1. De Facto Merger Doctrine: Judicial characterization of a transaction that looks like a merger as
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a merger by giving shareholders voting and appraisal rights. i. All jurisdictions, acquired company has NO appraisal rights in asset acquisition. ii. i.e. GA bought assets of LC in exchange for GA common stock and GAs assumption of LCs liabilities. Immediately thereafter, LC dissolved. GA was renamed LC. Under a traditional asset acquisition, shareholders of the old LC would have no appraisal rights. 2. Equal Dignity Doctrine: Each provision of a corporation code has independent legal significant and is entitled to equal judicial respect. i. Accordingly, the framers of the re-organization may reorganize to either type of corporate mechanics to achieve the desired end because the sale of assets statute and the merger statute are two independent statutes. ii. i.e. Delaware (called doctrine of independent significance there). VI. CASH-OUT MERGERS A. Overview 1. Cash out mergers: occur when a corporation uses cash as consideration in a merger to cashout minority shareholders. i. Tool: This became a tool for enterprises to freeze out minority shareholders through cash out merger by creating corporation, merge the old corporation into a new corporation and cash out the minorities. After the merger, the new corporation changes its name to the original corporation. Dilemma: situation in cashout mergers is that the person usually does not want his appraisal rights but more damages. B. Two Approaches 1. Business Purpose Test i. RULE: A valid cash-out purpose must satisfy the business purpose and entire fairness doctrine. To determine this, a court looks to the totality of circumstances. i. Business Purpose Doctrine: Cash out mergers must have a legitimate corporate purpose for its transaction. ii. Entire Fairness Doctrine: Cash out mergers must be entirely fair in process and in price to the minority. ii. If the two doctrines are not satisfied, then the merger is an impermissible freeze-out and the person may get be able to obtain a rescission of merger as an equitable remedy. However, if impracticable, courts may award rescissory damages. i. Rescissory damages = damages equal to the value of rescission of the merger. ii. i.e. Sullivan, who gained control of the voting shares, decided to get rid of the minority shareholders through a cash-out merger. He argued that he needed to do so to restructure the Patriots. Court found no a valid corporate purpose but for his own personal benefit. Additionally, it found that there was no need to consider the entire fairness doctrine because there was no valid corporate purpose. Court noted the appropriate remedy would normally be a rescission of the merger but since it was impracticable, it awarded rescissory damages. 2. Weinberger Approach 3. The Weinberger Method Attack (Attacking the merger based on a modified fiduciary duty theory) i. We should usually give an appraisal remedy as the exclusive remedy, but sometimes we should go beyond and give rescission or rescissionary damages. The Weinberger test overrules the business purpose test. The Weinberger test instead says that the action must be based upon a breach of a fiduciary duty by the controlling shareholder or director, since we have directors on both sides. ii. In a cash-out merger, the director or controlling shareholder must show: Disinterested approval after complete disclosure, AND Inherent Fairness: fair price and fair dealing. iii. This is a Burden Shift. i. If the directors can show disinterested approval, then the burden is on the shareholders to show it was unfair. ii. If the directors cannot show disinterested approval, then the burden is on the directors to show fairness. DOES THE SHAREHOLDER HAVE A CLAIM UNDER RULE 10(b)5 of the 1934 10(b)5 SECURITIES ACT?
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I. REGISTRATION A. Is the corporation buying/selling (virtually any transfer of a security, including initial
issuance) a security (investments, including stocks, bonds and investment Ks)? B. If the corporation is selling a security, is it subject to registration requirements? 1. RULE: A corporation is subject to registration requirement if the offer to sell is a public offer. II. IS THERE A 10b-5 VIOLATION FOR SPEAKING OR INSIDER TRADING?. A. RULE: All securities, public or not, are subject to the anti-fraud provisions of SEC Rule 10b-5. 1. Rule 10b-5 a. It shall be unlawful for any person directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange[means] i. To employ device, scheme, or artifice to defraud, [fraud] ii. To make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statement made, in the light of circumstances under which they were made, not misleading, OR [misrepresentation or omission] iii. To engage in any act, practice, or course of business which operate a fraud or deceit upon any person, [scienter] b. in connection with the purchase OR sale of any security. [standing] B. Are the Statutory Elements Present? 1. Standing: (one of the biggest limitation). a. Security: investments, including stocks, bonds, and investment Ks. b. Sale or purchase requirement c. For a private party to commence an action under 10b5, the must have purchased, sold, issued or received securities. i. Where a party refrains from taking action on the basis of information which was improperly obtained or disclosed, no purchaser or seller exists 2. Instrument of Interstate Commerce Involved a. i.e. Phone system is a means of interstate commerce EVEN IF the call is completely intrastate. C. Are the Common Law Elements Present? 1. Scienter a. The level of mens rea in the conduct undertaken must be at least reckless. b. Mere negligence is not enough. 2. Reliance a. Direct Reliance: Always valid if proven. b. Fraud on the Market Theory: A presumption of reliance exists if there a material misleading statements available on the market; it is not necessary for the to prove that he relied on them. 3. Causation D. Was there a misrepresentation or omission of material fact resulting in FRAUD? 1. Was the fact material? a. Material = There must be a substantial likelihood that the disclosure of the fact would have been viewed by the (1) reasonable investor as having (2) significantly altered the total mix of information. i. Probably/Magnitude Approach [evidentiary] A. (1) What is the anticipated magnitude for the event in light of the totality of the company activity, AND B. (2) What is the probability the event would occur? 2. If speaking a. Affirmative misstatements are misleading and results in fraud: no misrepresentation or omissions after misrepresentation resulting in half truths. 3. If omission of material fact a. **Silence/no comment absent a duty to disclose is not FRAUD. E. Insider Trading: Was there a duty to disclose? 1. Arises IF a. There material and nonpublic information? i. Test for Materiality: above
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Fall 2009

ii. Test for Nonpublic: Information has not been released to the public in its widest circulation. b. There is a duty to abstain or disclose i. Duty to Disclose or Abstain: A person with nonpublic information may have a duty to either abstain from trading or first disclose the material nonpublic information. c. Common Law Theories for finding such duty i. Parity if Information Theory (Overruled by Chiarella) A. If a person has access to material nonpublic information, he has a duty to disclose or abstain. ii. Chiarella A. A person who has material nonpublic information has a duty to abstain from trading or disclose to the public ONLY IF he has a common law duty to the issuer of the security. iii. Misappropriation (OHagan) A. A person who has material nonpublic information has a duty to disclose IF he owe a duty to the person he is getting his information from. 1. i.e. A law clerk that finds out from a judge that a merger is going to happen. Law clerk has no duty to the issuing company but he has a duty to the judge where he is getting his information from. 2. i.e. OHagan gets information from the law firm regarding a transaction. OHagan is not a temporary insider because he owes no duty to the issuer (he traded in Pillsbury, not Grand Met). He would be a temporary insider if he traded in Grand Met stock. Also, no tippor/tippee liability because he doesnt work for Pillsbury. However, he owes a duty to the law firm (the third party). iv. Tipper/Tippee (Dirks) A. Tippor Liability: Tipper must have a duty under Chiarella or OHagen and have an improper personal benefit to be held liable. B. Tippee Liability: Tippee is only liable if tipper is liable (derivative liability). d. Statutory Theories for finding the duty i. Regulation FD A. A corporation that discloses material nonpublic information to an analyst MUST ALSO disclose the information to the public; this is basically an adoption of the parity of information theory with respect to analysts. ii. Rule 14e-3 A. A corporation who has material nonpublic information with respect to a tender offer has a duty to abstain from trading or disclose to the public. F. Requirements for a private right of action: 1. An outsider injured by insider trading has a right of action for damages under 10b5, if he can meet certain procedural requirements: a. Purchaser or seller: must have been a purchaser or seller of the companys stock during the time of nondisclosure b. Traded on Material, non public information: must have misstated or omitted a material fact c. Special Relationship: if the claim is based on insider trading, D must be shown to have a special relationship with the issuer, based on some kind of fiduciary duty to the issuer d. Scienter: must be shown to have acted with scienter, as in he must be shown to have had an intent to deceive, manipulate or defraud. e. Reliance and causation: must show that he relied on s misstatement or omission, and that the misstatement or omission was the proximate cause of his loss. f. Jurisdiction: There is a federal jx requirement: must be shown to have done the fraud or manipulation by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange. i. Publicly traded security: this requirement is readily met ii. Face to face sale of shares deceit, especially in a private company, the jx requisites may be lacking. LIMITED LIABILITY CORPORATIONS I. Overview: The LLC is neither a corp. or a partnership, rather A limited liability corporation has some characteristics in common with both partnerships and with corporations. They can be centralized
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Business Associations: Anderson

Fall 2009

(manager managed) or fractionalized in management (member managed). Much of it is controlled by private ordering because the statutory law in this area is not very well developed. II. Advantages: the biggest advantage of the LLC compared with either ra general or limited partnership is that in the LLC, a member (analogous to a partner) is liable only for the amount of his or her capital contribution, even if member actively participates in the business. III. Formation A. Two documents are required(1) Certificate of Formation filed with secretary of state and (2) Operating Agreement that supplements or replace the statutory default rules. 1. Operating Agreement: owners of the LLC must agree among themselves how the business will operate (i.e. whether the entity will be managed by its members or by a separate set of managers). Usually in writing a. LLC Bound: most decisions hold that the LLC is itself bound by the operating agreement even if only the members and not the LLC itself sign the agreement. This means that if one member sues the LLC, the operating agreement will control on matters with which it deals. II. Fiduciary Duty: Does freedom of K result in less fiduciary duty? A. Fiduciary duties might trump private ordering although it is clear that private ordering trumps statutory default rules. 1. A plaintiff can only recover individually if he shows the members owed a fiduciary duty to him, not the LLC. He can asset the partnership analogy to do this. III. Exit in the LLC context A. The default rules regarding a members ability to exit in the LLC context are all over the map. B. If the court looks to corporate laws, then it looks to reasonable expectations and the corporate norm analysis. The preference seems to be for the corporate rules. C. If the court looks to partnership law, then it looks to the LLC agreements. ISSUANCE OF SECURITIES I. II. III. PAR VALUE: If the shares have a par values the corp may not sell the shares for less than this par value. PREEMPTIVE RIGHTS: PUBLIC OFFERINGS: 1. Securities Act of 1933: i. Is it is a security? ii. If it is, am I exempt from registration? iii. 2. Securities Exchange Act of 1934: i. Am I a corporation that is so big that I have to file an annual and quarterly report about myself

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