Corporations Law School Legends

Professor Therese Maynard

I. Introduction 6 Basic Types of Fact Patterns A. Formation of the Corporation B. Issuance of Stock C. Role of Officers and Directors D. Role of Shareholders E. Fundamental Corporate Changes F. Securities Law Liability Under State and Federal Law II. Formation of Corporations People, Paper, Act A. Incorporators Must sign and file the articles. B. Articles of Incorporation Charter or Certificate of Incorporation 1. Corporate Name The companys name must include one of the following words: corporation, company, incorporated, limited. 2. Initial Board Members If the board members prefer to remain anonymous, then we will name only the incorporators in the articles of incorporation. In that case, at the organizational meeting, the incorporators will appoint the initial members of the board of directors.

Page 2

CORPORATIONS

LAW SCHOOL LEGENDS

3. Name of Registered Agent and Address of Registered Office a. Registered Agent Serves as the corporations official legal representative. 4. Duration The modern corporation codes provide for perpetual duration. This means the corporation can last forever. a. If the company wants to limit its duration to a specified period of time, the limitation on its duration must be expressly included in the articles of incorporation in order for it to be effective. 5. Purpose a. General Statement of Purpose Usually what you will use when you prepare articles of incorporation. Gives the corporation flexibility to expand into new lines of business in the future as its business grows. b. Narrow Statement of Purpose and the Ultra Vires Doctrine Beyond the scope of the articles of incorporation. i. Ultra vires contracts are valid. ii. The shareholders or the state can seek an injunction. iii. Responsible officers and directors will be liable to the corporation for any ultra vires losses. 6. Statement of Capital Structure a. Authorized Stock The maximum number of shares that the corporation can sell. i. Statement of Authorized Stock The articles must recite the number of authorized shares per class, and the articles must have information about par value, voting rights, and any other preferences to be conferred on a particular class of authorized stock. b. Issued Stock The number of shares that the corporation actually sells.

Page 3

CORPORATIONS

LAW SCHOOL LEGENDS

c. Outstanding Stock Those shares that have been issued and not reacquired by the corporation. d. Different Classes of Stock Common Stock vs. Preferred Stock C. File the Articles of Incorporation with the Secretary of States Office 1. Certificate of Incorporation The certificate is conclusive proof of valid formation of the business as a corporation. 2. De Jure Corporation Established when the articles of incorporation have been accepted for filing by the Secretary of States office. D. Legal Significance of Forming a De Jure Corporation 1. Business Entity is Separate Legal Person Watch for a provision in the companys articles that limits the corporations powers. a. Corporate Powers All of the powers of a natural person. Examples: i. Sue and be sued. ii. Hold title to real property. iii. Open a bank account. iv. Make reasonable charitable contributions. 2. Shield of Limited Liability Generally, shareholders of a de jure corporation are not going to be personally liable for the debts of the corporation. Shareholders risk losing only the amount invested to purchase shares. 3. Separate Tax Paying Entity Double Taxation Burden E. Defective Formation 1. De Facto Corporation Treated as a corporation for all purposes except in an action for the state. a. There must be a relevant incorporation statute.

Page 4

CORPORATIONS

LAW SCHOOL LEGENDS

b. The parties must have acted in good faith. c. The facts must show some exercise of corporate privilege. 2. Corporation by Estoppel When a third party deals with a business, treating it as a corporation, the third party may be estopped from denying the businesss corporate status. F. Bylaws Initial Adoption and Subsequent Amendment 1. A De Jure Corporation can exist without bylaws. Bylaws are not filed with the Secretary of States office. 2. Articles of Incorporation always trump the bylaws. 3. The board of directors adopts the initial bylaws. a. Amendment of Bylaws Generally, either the board or the shareholders can amend the bylaws. G. Pre-Incorporation Contracts 1. Role of Promoters A promoter is a person acting on behalf of a corporation that is not yet formed. 2. Liability of Corporation on Pre-Incorporation Agreements A corporation is not liable on a pre-incorporation contract until it adopts the contract. a. Adoption may be express or implied. i. Express Adoption Occurs where the facts show that the corporation has been formed, and at its organizational meeting the board passes a resolution expressly agreeing to be bound by the terms of the agreement that the promoter made with a third party. ii. Implied Adoption Arises out of the corporations knowing use or receipt of benefits under the contract. 3. Liability of Promoters on Pre-Incorporation Agreements Generally, unless the contract says otherwise, the promoter will remain liable on the pre-incorporation contract until there has been a novation.

Page 5

CORPORATIONS

LAW SCHOOL LEGENDS

4. Promoters Fiduciary Duties The promoter cannot make a secret profit on her dealings with the corporation. H. Foreign Corporations Corporations incorporated outside of the state. 1. Internal Affairs Doctrine The law of the state where a corporation has been incorporated governs the internal affairs of the corporation. 2. Foreign corporations transacting business in-state must qualify a. Qualifying A foreign corporation can qualify to do business in another state by obtaining a certificate of authority. b. What happens if a corporation fails to obtain a certificate of authority? i. A fine may be imposed. ii. The foreign corporation cannot sue in the state, although it can be sued in the state. III. Issuance of Stock A. Distinguish Issuance from Trading B. Subscription Agreements Written offers to buy stock from the corporation. 1. Revocation of a Pre-Incorporation Subscription Irrevocable for six (6) months unless they provide otherwise or unless the facts show that all of the subscribers agree to release you from your agreement. 2. Revocation of a Post-Incorporation Subscription Freely revocable so long as you revoke before the offer is accepted. C. Consideration Paid in Order for Shares to be Validly Issued 1. Form of Consideration Permitted Forms vs. Prohibited Forms a. Permitted Forms Money, tangible or intangible property, services already performed for the corporation. b. Prohibited Forms Traditionally, future services, good will, or promissory notes.

Page 6

CORPORATIONS

LAW SCHOOL LEGENDS

2. Amount of Consideration Par Value Shares vs. No Par Value Shares vs. Treasury Stock. a. Par Value Shares Minimum issuance price. b. No Par Value Shares No minimum issuance price. c. Treasury Stocks Shares that were previously issued but later reacquired by the corporation. Now, the corporation wants to sell its treasury stock. No minimum on treasury shares. D. Watered Stock Liability The corporation or its creditors, if the company is insolvent, can sue to recover the water (difference between the par value of stock and what it was actually sold for, provided that the shares were sold for less than par value.) E. Preemptive Rights Refer to the right of an existing shareholder to maintain her percentage of ownership by buying additional shares whenever there is a new issuance of stock for cash. IV. Role of Directors and Officers A. Number of Directors Today, you need one or more. B. Election of Directors Shareholders elect the board of directors. 1. Annual Election vs. Staggered Terms a. Annual Election Shareholders elect the entire board every year. b. Staggered Terms Shareholders stagger the terms of the board members, thereby electing less than the entire board each year. 2. Removal of Directors Shareholders can remove directors with or without cause unless the articles of incorporation of that company limit the shareholders right to remove directors, in which case the shareholders generally will be able to remove directors only on an adequate showing of cause. 3. Filling Vacancies on the Board Generally, the board or the shareholders may fill a vacancy.

Page 7

CORPORATIONS

LAW SCHOOL LEGENDS

C. Meetings of the Board A meeting is required in order for valid board action to be taken. 1. Action by Unanimous Written Consent Oral consent solicited separately from each board member is not enough to satisfy the meeting requirement. For valid board action to be taken without a meeting, there must be unanimous written consent by the board members. 2. Notice Requirements Typically, regular meetings of the board will be fixed by a provision in the bylaws. Special meetings of the board generally require two days notice, unless notice is waived. Waiver may occur by either a signed writing or by the director attending the meeting. a. Directors cannot give proxies. b. There can be no voting agreements between the directors. 3. Quorum and Voting Requirements a. Quorum Rule A majority of all directors must assemble to have a valid meeting unless the facts show that a different percentage is set forth in the companys bylaws. b. Voting Rule For a board to validly pass a resolution at a duly noticed meeting, an affirmative vote from a majority of the directors who are present at the meeting is generally required. D. Role of the Board 1. The Corporate Norm The board manages the business affairs of the corporation. 2. Committees of the Board Generally, the board can delegate substantial management functions to a committee of the board, which usually must consist of two or more directors. a. Committees cannot declare dividends. b. Committees cannot recommend fundamental corporate changes.

Page 8

CORPORATIONS

LAW SCHOOL LEGENDS

c. Committees cannot amend bylaws. d. Committees cannot fill board vacancies. E. Directors Fiduciary Duties Duty of Care and the Business Judgment Rule 1. Duty of Care Directors owe the corporation a duty of care. A director must do what a prudent person would do with regard to her own business affairs. a. Breach of a Duty of Care A director will only be liable if her breach results in a loss to the corporation. i. Nonfeasance Where the director has failed to act. ii. Misfeasance Where the directors decision does not reflect the good faith exercise of informed decisionmaking. 2. Business Judgment Rule The board will not be liable if the facts show that the directors exercised their best business judgment in making a business decision, even if the facts show that the company has been harmed. a. Burden of Proof Initially, the burden is on the party claiming that the board has breached its fiduciary duty of care. i. Fraud ii. Illegality iii. Conflict of Interest iv. Gross Negligence F. Directors Fiduciary Duties Duty of Loyalty and Conflicts of Interest 1. Duty of Loyalty The director owes the corporation a duty of loyalty. The duty of loyalty means that the director must act in good faith and in a manner that she reasonable believes to be in the companys best interest.

Page 9

CORPORATIONS

LAW SCHOOL LEGENDS

a. Interested Director Transactions Self-Dealing Transactions The transaction must involve a direct or indirect interest on the part of the companys directors. i. Modern Cleansing Statutes Delaware 144 and California 310 Interested director transactions will generally be cancelled or set aside unless the director can show either that the deal was fair to the corporation, or that the director made full and adequate disclosure of all material facts and received approval from either a majority of the disinterested directors or a majority of the disinterested shareholders. b. Competing Ventures A director cannot compete directly with his corporation. c. Corporate Opportunity Doctrine A director cannot take advantage of a business opportunity for himself until he discloses it to the board of directors and allows the board a chance to reject the opportunity. Various tests are used to decide whether a business opportunity is a corporate opportunity. i. Interest or Expectancy Test Focus on whether the particular business opportunity is one that the company has expressed some interest in or has some sort of claim to. ii. Line of Business Test Is the business opportunity closely related (or within) the companys existing operations. iii. Fairness Test Focus on whether the director learned of the business opportunity through a personal or corporate capacity. G. Other Areas of Potential State Law Liability Concerns 1. Ultra Vires Activities Responsible officers and directors may be held personally liable for any ultra vires losses. 2. Loans to Directors and Officers Federal prohibition against most company loans to executives of registered (publicly traded) companies.

Page 10

CORPORATIONS

LAW SCHOOL LEGENDS

H. Which Directors will be held Liable for Board Decisions A director is presumed to have concurred with the boards actions unless his or her dissent is noted in writing. 1. The directors dissent is noted in the minutes of a board meeting. 2. The dissenting director sends a registered letter to the corporation immediately after adjournment of the board meeting. 3. Exceptions to Director Liability a. Absent directors are generally not liable. b. Good faith reliance on others. I. Role of Officers 1. Fiduciary Duties of Officers Officers owe the same duties to the corporations that directors do. 2. Authority of Officers a. President Has the authority to enter into agreements in the usual, ordinary course of business and to act for the corporation in the ordinary course of business. b. Treasurer Has the authority to maintain corporate funds. c. Secretary Has the actual authority to maintain books and records of the corporation and to authenticate these as official corporate records as necessary. 3. Selection and Removal of Officers Directors appoint and monitor the officers. 4. Executive Compensation If executive compensation has been approved by disinterested directors, then, generally, any challenge to the amount of compensation to be paid to the CEO or other company officer is subject to the business judgment rule. Thus, one who claims that the amount of compensation is excessive generally must show that the amount paid constitutes waste.

Page 11

CORPORATIONS

LAW SCHOOL LEGENDS

J. Indemnification of Directors and Officers Indemnification claims generally relate to the companys promise to reimburse the officer or director for litigation-related expenses, as well as any personal liability, incurred as a result of something that happened while the individual was acting in a representative capacity as an officer or director of the company. 1. Where indemnification is prohibited If the facts show that the officer or director was held liable to the corporation, or was found to have received an improper personal benefit, then no reimbursement is allowed. 2. Where indemnification is mandatory If the officer or director wins a judgment on the merits or otherwise, there must be indemnification. 3. Where indemnification is permitted Anything not falling within the first two categories will fall within this category. K. D&O Insurance Director and officer liability insurance V. Role of Shareholders A. Piercing the Corporate Veil In certain circumstances, the court will decide to reach through the companys shield of limited liability in order to impose personal liability on the shareholders for the debts of the business. 1. Alter Ego Cases If the facts show that the shareholder does not respect the separateness of the corporation, the creditors do not have to respect the separateness either. 2. Undercapitalization Cases The shareholder did not invest enough to cover prospective losses from operating this type of business. B. Shareholders Acting as Managers of Companys Business Affairs Enforcement of Shareholder Agreements 1. Traditional View Void as Against Public Policy 2. Modern Statutes Close Corporation Election Requires unanimous shareholder approval. 3. Modern Judicial Enforcement of Shareholder Agreements a. No minority shareholders object.

Page 12

CORPORATIONS

LAW SCHOOL LEGENDS

b. There is no harm to the public or to the companys creditors as a result of enforcing the agreement. c. The effects of the agreements are relatively minor. C. Derivative Litigation 1. Distinguish Direct vs. Derivative Action Could the corporation have brought this lawsuit? 2. Consequences of Successful Derivative Action Recovery in a successful derivative suit goes to the corporation. The shareholder generally will recover her costs and attorneys fees. 3. Consequences of Unsuccessful Derivative Action Shareholder will not recover her costs and expenses. The shareholder may be held liable to the third-party for his costs if it is shown that the shareholder sued without reasonable cause. 4. Standing to Bring Derivative Action: a. Contemporaneous Stock Ownership The shareholder bringing the lawsuit must have owned stock in the company at the time the claim arose, or must have received her shares by operation of law from someone who did own stock in the company at the time the claim arose, and the plaintiff shareholder must continue to hold the stock until judgment. b. Continuing Wrong Doctrine If the shareholders complaint relates to a continuing wrong, then she must have acquired her shares at some point during the period of the wrongful conduct. 5. Demand Requirement a. Demand Required Cases Generally, a shareholder bringing a derivative suit must make a demand on the board of directors demanding that the board bring suit on behalf of the company. b. Demand Excused Cases Demand may be excused as futile where the shareholder would be asking the board to sue itself.

Page 13

CORPORATIONS

LAW SCHOOL LEGENDS

6. Dismissal of Derivative Suit a. New York Approach The recommendations of the special litigation committee were entitled to full judicial deference under the traditional application of the business judgment rule unless the plaintiff could show that the members of the special litigation committee were not truly independent, or if the plaintiff could show that the special litigation committee did not act on an informed basis. b. Delaware Approach In cases where demand is excused, the Delaware courts will generally review the recommendation of the special litigation committee under a more probing twopronged standard of scrutiny, which involves: i. Defendants must demonstrate three things: (A) The special litigation committees independence; (B) The committee acted in good faith; and (C) The reasonableness of the special litigation committees investigation. ii. If the decision of the special litigation committee satisfies the first prong, then the court may apply its own independent business judgment to decide whether it is in the companys best interest to terminate the shareholders derivative litigation. c. Iowa Approach Where the board suffers under a disabling conflict, the decision of any special litigation committee appointed by that board is likewise suspect. D. Voting by Shareholders 1. Who Votes? a. Rule of Record Date Ownership

Page 14

CORPORATIONS

LAW SCHOOL LEGENDS

i. Record Owner Person identified as the owner of the shares set forth in the shareholder list maintained by the company. ii. Record Date Operates as a voter eligibility cut-off date. b. Exceptions to Rule of Record Date Ownership i. Treasury Stock Shares cannot be voted while held in treasury by the corporation. ii. Death of Shareholder of Record The decedent shareholders executor will be allowed to vote the shares. c. Voting by Proxy i. Proxy Defined A writing, signed by the record shareholder, directed to the secretary of the corporation, which allows another person to vote the shares on behalf of the record owner. d. Revocation of Proxy The law favors the free revocability of proxies. e. Irrevocable Proxy i. The proxy instrument on its face must say it is irrevocable. ii. The proxy must be coupled with an interest. 2. Federal Proxy Regulations a. SECs Proxy Rules Regulation 14A b. Definition of Reporting Company i. Companies whose stock is listed for trading on a national exchange. ii. Companies who meet the following two-prong test:

Page 15

CORPORATIONS

LAW SCHOOL LEGENDS

(A) Companies who have assets of more than ten million dollars, and (B) Have a class of equity securities held of record by five hundred or more persons. c. Solicitation of Proxies Includes any communication directed to shareholders that asks for shareholder consent or approval to take some action, or that is part of a continuous plan that will lead to the formal solicitation of proxies from the shareholders. i. Proxy Statement Must include all material facts related to matters coming up for shareholder vote. d. Proxy Fraud Elements of an Implied Rule 14a-9 Cause of Action Prohibits any solicitation that is false or misleading with regard to any material fact or that omits any material fact necessary to make any statement made in the solicitation not false or misleading. e. Use of Voting Trusts and Voting Agreements (Pooling Agreements) Entered into where shareholders want to increase their influence on corporate policy. f. To be valid, a voting trust must be in writing, and: i. A copy of the written trust agreement must be delivered to the secretary of the corporation. ii. Legal title of the shares must be transferred to a voting trustee. iii. The original shareholders must receive voting trust certificates. iv. There is generally a ten-year maximum duration. 3. Where do Shareholders Vote? a. Annual Meetings vs. Special Meetings i. Annual Meetings Occur once a year. Generally speaking, the shareholders elect the directors at the annual meeting.

Page 16

CORPORATIONS

LAW SCHOOL LEGENDS

ii. Who can call a special meeting of the shareholders? Generally speaking: (A) The board. (B) Ten percent of the voting shares. (C) Others as provided for in the companys articles of incorporation. b. Notice Requirements Generally, written notice must be given to every shareholder entitled to vote for every single meeting whether annual or special. i. Special Meeting Notice must also set forth the purpose of the meeting. 4. How do Shareholders Vote? a. Quorum Rule Focus on the number of shares represented at the meeting. A quorum generally requires a majority of the outstanding shares entitled to vote be present, either in person or by proxy. b. Voting Rules If a quorum is present, then a majority of the shares actually voting is generally sufficient to constitute valid shareholder approval unless the articles or bylaws require a higher vote. c. Cumulative Voting Only available in elections for directors. Multiply the number of shares you hold by the number of directors to be elected to figure out how many votes you have to cast in the election for directors. E. Stock Transfer Restrictions Stock transfer restrictions will generally be enforced provided they are reasonable under the circumstances. 1. Rights of First Refusal A restriction that says that before a shareholder may sell his shares to a third party, he must offer to sell the shares back to the corporation.

Page 17

CORPORATIONS

LAW SCHOOL LEGENDS

2. Buy-Sell Agreements Generally valid, and therefore enforceable against the company, provided that the company has sufficient legal capital to purchase the shares. F. Shareholders Right to Inspect the Companys Books and Records 1. Standing Requirement Any shareholder can demand access to inspect the companys books and records. 2. Shareholders Written Demand and the Proper Purpose Requirement A purpose related to your role as a shareholder. 3. Consequence if the company refuses shareholder access The shareholder can obtain a court order allowing her access, and she generally will recover the costs she incurred in obtaining the court order. G. Distributions to Shareholders 1. Define Distribution a. Dividends Declared at the discretion of the board of directors. b. Redemptions i. Forced Redemption The articles will establish the corporations right to call for redemption of certain shares, typically at a specified price, which is referred to as the redemption price. ii. Repurchases Stock Buy-Backs 2. Which shareholders are entitled to distribution of declared dividends? a. Common Stock: Pro Rata Distribution Divide the amount of dividends declared by the board over the number of common shares outstanding. b. Preferred Stock Pay first. c. Participating Preferred Stock Pay again. d. Cumulative Preferred Stock Add them up.

Page 18

CORPORATIONS

LAW SCHOOL LEGENDS

3. Legally available source of funds for distributions to shareholders a. Earned Surplus All earnings minus all losses minus any dividends previously paid. b. Stated Capital Allocate the par value of each share sold to stated capital. Company can never use its stated capital to pay dividends. c. Capital Surplus The excess of the amount paid over the par value of the shares plus any amounts allocated on the sale of no par shares. 4. Insolvency Prohibition a. Equity Test The company cannot make a distribution if the company is insolvent or if the company would be rendered insolvent after making the distribution. b. Balance Sheet Test Insolvency occurs where the companys assets are less than its liabilities. 5. Liability for Illegal Distributions a. Personal Liability of Shareholders If, when she received the distribution she knew it was unlawfully paid out, then she will be personally liable. b. Personal Liability of Directors Traditional Strict Liability Standard vs. Modern Negligence Standard VI. Fundamental Corporate Change A. General Background 1. Director Approval 2. Shareholder Approval Majority of the outstanding shares entitled to vote must approve the fundamental change in order to receive the requisite shareholder approval.

Page 19

CORPORATIONS

LAW SCHOOL LEGENDS

3. Dissenting Shareholders Right of Appraisal a. Availability of Appraisal Rights i. If the company combines with another company. ii. Where the company proposes to sell or transfer all or substantially all of its assets. b. Perfecting the Right of Appraisal i. Before the shareholders vote on a proposed fundamental change, the shareholder who objects must file written notice of his objection and of his intent to demand payment. ii. The dissenting shareholder must either abstain or vote against the proposed change. iii. After the vote, the dissenting shareholder must make a written demand to be bought out. c. Judicially Supervised Appraisal Proceeding Court will usually appoint an appraiser to determine the fair market value of the shares held by the dissenting shareholder. B. Amendment of the Articles of Incorporation 1. Threshold requirements a. Board of director approval with notice to the shareholders b. Shareholder Approval Majority of the shares entitled to vote. i. Right to Class Voting If an articles amendment affects a particular class of shares, then that class must also vote to approve the change, even if their shares are otherwise nonvoting.

Page 20

CORPORATIONS

LAW SCHOOL LEGENDS

C. Mergers The acquiring corporation absorbs the business operations of the acquired corporation. 1. Short Form Merger No shareholder approval is required. A short form merger occurs where a ninety percent- or-more-owned subsidiary is being merged up into the parent corporation. 2. Squeeze Out Merger The controlling shareholder usually proposes the merger in order to eliminate unwanted minority shareholders. D. Sale of Substantially All of the Assets 1. Threshold Requirements a. Board approval along with notice of the fundamental change to the shareholders. b. Requisite approval of the shareholders of the selling corporation. 2. Liability for Purchasing Company The purchasing corporation is generally not liable for the debts of the selling company unless the terms of the agreement provide otherwise, or the company purchasing the assets is a mere continuation of the selling company. E. Dissolution 1. Voluntary Dissolution a. Board approval and approval by a majority of the outstanding shares entitled to vote. b. Unanimous written shareholder agreement. 2. Involuntary Dissolution a. Grounds for Dissolution Typically set forth by statute and generally include the following: i. Director abuse, waste of corporate assets, misconduct, or illegal or oppressive acts. ii. Director deadlock that is harming the company.

Page 21

CORPORATIONS

LAW SCHOOL LEGENDS

iii. Shareholder deadlock with a resulting failure to fill vacant board positions for at least two annual meetings. b. Alternative of Court-Ordered Buyout 3. Winding Up a. Orderly Liquidation i. Gather companys assets. ii. Convert assets to cash. iii. Use cash to pay off the creditors. iv. Distribute remaining funds to the shareholders. b. Liquidation Preference Pay the preferred shares first. VII. Securities Law Liability Under State and Federal Law A. Define Securities Investments 1. Debt Mortgage Bond vs. Debenture a. Mortgage Bond Secured b. Debenture Unsecured 2. Equity Common Stock vs. Preferred Stock B. State Law Liabilities 1. Controlling Shareholders a. Define Controlling Shareholder Voting Control vs. Working Control One who holds a majority of the voting shares or one who holds a minority of the voting shares but in a situation that gives her effective working control over the corporation. i. Working Control Minority shareholder dominates the board by being able to elect the majority of the board members.

Page 22

CORPORATIONS

LAW SCHOOL LEGENDS

ii. Sale of Controlling Interest for a Control Premium c. Sale of Controlling Interest to a Looter A controlling shareholder will be held liable if she sells her controlling interest to looters unless she can show she made a reasonable investigation. i. Sale to an undisclosed principal ii. Sale at a very high purchase price d. Disguised Sale of Corporate Assets The controlling shareholder will be held liable if her sale of the controlling interest really constitutes the disguised sale of a corporate asset. e. Sale of Corporate Office The controlling shareholder cannot sell seats on the board because it is against public policy. f. Fiduciary Duty of Controlling Shareholders Controlling shareholders cannot use their position within the company to subject the companys minority shareholders to detriment. i. Closely Held Corporations ii. Squeeze Out Mergers 2. Fraud Affirmative Misrepresentation 3. Non-Disclosure of Special Facts a. Source of Duty to Disclose Affirmative duty to disclose special facts in a stock transaction with another person is imposed on directors and officers. b. Definition of Special Facts Facts that a reasonable investor would consider important. C. Elements of Rule 10b-5 Cause of Action The Federal Anti-Fraud Rule 1. Jurisdiction Look to the transaction to see if the transaction makes some use of the instrumentality of interstate commerce.

Page 23

CORPORATIONS

LAW SCHOOL LEGENDS

2. Possible Defendants Any person or corporation, or any form of business entity, can be a defendant. 3. Possible Plaintiffs Standing Requirement a. SEC Civil Injunction Action or Administrative Enforcement Action b. Actual Buyers or Sellers Implied Right of Action for Damages 4. Conduct (Bad Acts) that Violate Rule 10b-5 a. Fraud Misrepresentation of material act. b. Non-Disclosure Failure to disclose material inside information in those cases where the facts show that there is a pre-existing source of a duty to disclose. c. Tipping Where the facts show that the insider passes along material inside information to a third party for wrongful purposes in breach of the insiders fiduciary duty. 5. In Connection with the Purchase or Sale of Securities Debt or Equity 6. Material Fact Information that a reasonable investor would consider important in deciding whether to buy or sell the security at issue. 7. Scienter The defendant must have acted with an intent to deceive, manipulate, or defraud. 8. Reliance a. Cases Involving Open Market Misrepresentation Reliance is presumed. b. Non-disclosure Cases Reliance is presumed. 9. Measure of Damages Requires plaintiff to show that as a result of defendants conduct, the plaintiff has suffered an economic loss. Punitive damages are not available. D. Insider Trading Under Rule 10b-5 Classic Insiders

Page 24

CORPORATIONS

LAW SCHOOL LEGENDS

E. Insider Trading Tipper-Tippee Liability 1. Dirks Tipper liability under personal benefit test and tippee liability F. Misappropriation Theory of Liability Under Rule 10b-5 U.S. v. OHagan G. Rule 10b-5 and the Inadvertent (Casual) Eavesdropper H. Elements of Section 16(b) Liability The Federal Anti-Speculation Rule 1. Reporting Company Plaintiff 2. Statutory Insider Defendant a. Directors b. Officers c. More than Ten Percent Shareholders 3. Buy and Sell Equity Securities 4. Short Swing Trading Buying and selling within a single six month period. 5. Calculating Damages Profit under Section 16(b) Profits are supposed to be calculated in such a manner so as to recover all potential profit from the insiders short swing trading.