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BUSINESS ORGANIZATIONS CHECKLIST I. a. i. b.

GENERAL MATTERS Limited Liability Investor risks ONLY the assets that the investor agreed to invest in the business Personal Liability Investor risks personal assets BEYOND those agree to invest

i.

Third Party Creditor Reliance i. Investors exercising control over the business raises a reasonable expectation in a third party that the investor will be personally liable UNLESS 1. Notice to the contrary OR 2. Investor refrains from exercising control

c.

d.
i. ii. 1. 2. 3. 4.

Taxationsingle most important consideration when organizing businesses Avoiding "Double Bite" Taxation: revenues and dividends are taxed Avoiding Other Tax Liability Zeroing Outallow revenues to be disbursed as SALARY rather than dividends Capital Gainsallow revenues to be disbursed in stock instead of salary Deductionsgeneral business deductions Conduit Taxationallow losses to pass through to investors

II. a. i.
authority

AGENCY

Actual Agency: consent or agreement that an agent will act on behalf of the principal and that the principal will control the agent Express Actual AuthorityWritten or spoken words y principal to agent creating agent's

ii.

Implied Actual AuthorityConduct of the principal reasonably interpreted by agent causing agent to believe he is acting on the principal's behalf Incidental AuthorityUnless otherwise agreed, authority to conduct a transaction includes the authority to do any act incidental to, usually accompanied by, or reasonably necessary to carry out the initial transaction General AgentSeries of transactions involving a continuity of service Special AgentTransaction or series of transactions not involving a continuity of service

iii. iv. v.
vi.

Vicarious Liability 1. Liability imposed on principal for wrongs committed by agent 2. Independent Contractorsprincipal is not liable for torts but principal sacrifices control over the independent contractor UNLESS independent contractor is engaged in inherently dangerous activity 3. Non-Servant Agentsprincipal subject to contract liability NOT torts outside the scope of non-servant agent's authority 4. Consider the "work-for-hire" doctrine: agents can be acting under different capacities at different times during the agency relationship 5. Consider ALL the circumstances Creditor Liability (Balancing Test)Creditor Exercising control over agent may be liable Avoid Liability Insisting on receiving information and reports Providing business advice and counseling on discrete matters, not entire business Recommend consultants Liability Imposed Veto Power Coercing debtor to put creditor's representative in charge Provide other creditors with assurance of debtor's payment

vii.
1. a. b. plans c. 2. a. b. c.

Apparent Authority: Outward manifestations by a principal to a third party creating reasonable expectation in the third party that the agent is acting on behalf of the principal

b. i. ii.

Directwritten or spoken words from principal to third party

Indirectconduct of the principal reasonably interpreted causes third party to belief that the principal consents to the agent acting on behalf of principal

iii.

Power of PositionAbsent notice to the contrary, Where principal puts agent into position of power, third parties dealing with the agent are justified in believing that the agent has such power Inherent Agency: Power of an agent to bind the principal, emanating solely from the agency relationship, solely for the protection of persons dealing with agents

c.
i.

ii.
1. 2. 3.

Principal will be liable for all transactions under which the agency relationship was created AND Any Foreseeable transactions Undisclosed principal Partially disclosed principal Disclosed principal

Agency By Estoppel: Where a party has changed his position based on a reasonable belief that a transaction was entered into on behalf of the principal and the principal intentionally or recklessly caused such belief, knowing that such belief would change the party's position, without notifying the party, the principal will be liable. Last resort method of showing agency relationship

d.

Fiduciary Duties: Agent owes principal fiduciary duties as a matter of law. fiduciary duties as a matter of fact

e.
i.

Principal will owe agent

Definition of a fiduciary (Where principal will owe fiduciary duties) 1. Beneficiary reposes trust and confidence in the fiduciary under circumstances such that the fiduciary must act with the highest regard to the interests of the beneficiary

ii.

Fiduciary duty as a matter of law (Where agency relationship exists, agent owes fiduciary duties) Parties cannot contract around fiduciary duties but can define fiduciary duties Default Rules Agent acts solely for the benefit of the principal Agent must use standard care and skill Agent must disgorge all profits made on behalf of principal d. Disclose outside business opportunity and give principal opportunity to decline first even if no harm to the principal (Automotive) e. Once Principal questions the agent, Agent MUST disclose all relevant information (Bancroft) f. Agent cannot deal with principal as an adverse party without principal's knowledge g. Where principal knowingly deals with an agent as an adverse party, agent must deal fairly with principal and disclose ALL facts that reasonably affect the principal's judgment h. Agent cannot act on behalf of an adverse party in an agency-related transaction without the principal's knowledge i. Where agent acts for two principals, agent must deal fairly with each and disclose all facts that reasonably affect both principals' judgment j. Agent cannot compete with the principal concerning the subject matter of the agency k. Agent cannot act for anyone with conflicting interests of the principal's l. Agent cannot use or communicate confidential information m. After agency relationship is terminated i. Agent has not duty to compete, but has a duty to refrain from disclosing trade secrets or other confidential information 1. 2. a. b. c. 3

ii. information f. 1. 2. 3. 4. AND 5. g.

Must account to principal all profits realized from confidential

i.

Ratification Agent enters into transaction outside scope of authority BUT principal wishes to ratify Transaction must have been valid if agent had the authority Principal exists and is legally competent to ratify Transaction was executed or performed on principal's behalf Ratification must be executed the same way as if done rightfully in the first instance Principal must have knowledge of all the facts

Franchises i. Trademark license ii. Franchisee pays royalty to franchisor iii. Franchisor provides management assistance to franchisee iv. Contractual standards of management does not equal control UNLESS standard goes beyond articulated goals and leaves franchisee without managerial discretion v. Mere power to terminate in and of itself is not enough to allege an agency relationship h. i. ii. iii. iv. v. Trade Secrets Extent to which information is known outside of business Extent to which information is known by employees and others in the business Extent of measures taken to keep information secret Amount of money and effort to develop information Ease or difficulty with which information could be acquired or duplicated by others

III. a. i. 4

PARTNERSHIPS Association of two or more persons who carry on as co-owners a business for profit Persons can be individuals, partnerships, corporations, or other associations

ii. b.

Business can be every trade, occupation, or profession Establishing existence of a Partnership Sharing of profits is prima facie evidence of partnership existence Rebuttal Mere common interest in land Mere sharing gross revenues without sharing residual return OR Profits received as Payment for debt Wages or rent Payment for annuity to a widow of a deceased partner Payment for the sale of "good will" of a business Partners v. Employees i. Intent of parties ii. Right to share profits iii. Sharing losses iv. Control/ownership of property v. Community of power vi. Language in the agreement vii. Conduct of Parties to 3rd persons Formation of Partnership Agreements Partnership agreement Specified time for expiration (date or undertaking expires) OR "At will" partnership Can be implied in the circumstances (exlease is up)

i.
ii. 1. 2. 3. a. b. c. d. c.

d. i.

1. 2.
a. ii.

General Rule: Partners do NOT have a duty to remain partnersthey exist by agreement and "freedom to contract" principals No person can become a partner unless all partners give consent Incoming partners are liable for all past debts of the partnership, but not personally PERSONAL liability attaches to future partnership debts Common Law Theories of Terminating a Partner in a Law Firm Reasons for Termination Partnership can be terminated for ANY reason OR Termination must be reasonable OR Termination for cause only Means of TerminationTwo Approaches Only requires notice before termination OR Means of termination must be reasonable Where third party buys interest of an outgoing partner, he buys EVERYTHING, including unknown

iii.

1. liable 2.

iv. 1. a. b. c. 2. a. b. v. contingent assets vi. 5

Buyout Agreementsmethod for "winding up" affairs after partnership is terminated

Rights of Partners Partners shall be repaid capital contributions and share equally in profits and surpluses Partners shall contribute towards losses 1. ExceptionWhere one partner contributes ONLY services and no capital, serviceproviding partner does NOT contribute to losses (Kovacik) iii. Insolvent partners 1. Remaining partners contribute to insolvent's share of losses in proportion to remaining partner's contributions (exA contributes 60%, A must contribute 60% to insolvent's share of losses) iv. Act of any partner binds the partnership i. ii. f. i. ii. iii. iv. v. Fiduciary Obligations of Partners Dual Agencypartners are agents of each other Access to books at all times Disclose information affecting the partnership Account for any benefits and profits derived by or for the partnership Right to formal accounting of partnership affairs Meinharddisclose new business opportunities to partnersforeseeable to other partners Law Firms: Departing partners May solicit employees to depart AFTER notice and before departure May NOT solicit clients Joint letter giving client choice between departing partner or the firm Management

e.

vi. vii.
1. 2. a. g. i.

Partners have equal rights to management UNLESS OTHERWISE AGREED (There is no legal right to partnership management) ii. Management disputes resolved by majority vote 1. Two-person partnerships a. 51%/49% determination b. Divide and Conquer Agreements i. Each partner has majority vote on certain matters ii. Tie-Breaker Arrangementsrequest third party to be the tie-breaker where partners are deadlocked Partnership Property i. General RuleAll property acquired by the partnership or acquired with partnership funds is partnership property ii. Specific Partnership Property 1. Non-assignable, non-attachable for debt payment 2. Co-ownership of specific partnership property and holds as tenancy of partnership 3. Right to possession and use for partnership purposes UNLESS other partners give consent for non-partnership use Interest in Partnership Property Personal Property consists of Share of profits AND Surplus h.

iii. 1. a. b. 6

2. iv. 1. 2.

Assignable Rights in Management Cannot be transferred Freedom of Contract principles

v. Designated Partnership Property 1. Partners can designate property to partnership for use 2. Partnership will NOT own or acquire the property BUT 3. IF the donating partner breaches the partnership agreement, the property can be used for continuing the partnership affairs i. Causes of Dissolution

i.

Without violation of agreement AND 1. Time expires or undertaking is over 2. P'ship "at will" can be dissolved by the express will of any partner a. Unclean Hands DoctrineBreaching partner in at will partnership may NOT dissolve the partnership 3. Express will of all partners who have not assigned any of their interests Expulsion Good faith Without violating fiduciary duties In accordance with partnership agreement Violation of Partnership Agreement AND Express will of any partner, where circumstances do not allow dissolution otherwise Courts will try to find a way to dissolve without finding a violation of partnership

ii.

1. 2. 3.

iii.
1. 2. agreements iv.

1. 2. 3. j.

Others

Unlawful to continue partnership (e.g., prohibition) Death of any partner Bankruptcy

Dissolution by Decree of Court Court can decree dissolution for Mental incompetence Incapacity Guilty of conduct that prejudicially affects partnership business Breach of good faith OR Simply bad business strategies Breach of Partnership Agreement Willful Persistent OR Not reasonably practicable to carry on business because of partner's conduct Court can decree dissolution where partnership is no longer making profits Any other equitable reasons

i. 1. 2. 3. a. b. 4. a. b. c. 5. 6. 7

a. b. k. i.

Petty Discords OR Partnership Squabbles Rights of Partners After Dissolution No Breach/No Expulsion Absent agreement otherwise, partners are treated equally Assets liquidated to pay debt Surplus distributed equally among partners No Breach/Expulsion in Good Faith Absent agreement otherwise Expelled partner gets amount due AND Remaining partners have right to continue business Breach of Partnership Agreement (Cannot contract around these rights) Non-breaching partners Damages Assets liquidated to pay debt Surplus distributed equally Right to continue business Breaching partner Amount Due No rights to the value of "good will" of the partnership Rules for Distribution of Partnership AssetsWinding Up Partners must contribute equally throughout the distribution of partnership assets Absent agreement otherwise Gather partnership property and partner contributions Order of Payment Non-Partner Creditors Non-Capital, Non-Profits owed to any Partners (Partner Creditors) Capital Investments Profits Generally, partners share all losses Exceptionwhere one partner only contributes services

1. a. b.

ii. 1. a. b.

iii.
1. a. b. c. d. 2. a. b.

l.
i. ii. 1. 2. a. b. c. d. 1.

iii.

IV.

CORPORATIONS Promoters: Entrepreneurial individual who gets things together so that the corporation can get started

a.
8

Liability based on a warranty that the corporation will be formed AND that promoter will use his best efforts to create the corporation ii. Promoter owes fiduciary duties to the yet-to-be formed corporation (similar to agency theory)

i.

iii. iv. v.
1. 2. a. b. with the principal vi.

Disclosed Agentdiscloses identity of principal Undisclosed Agentpromoter fails to disclose anything (liability) Partially disclosed agentdiscloses identity of agency relationship but NOT identity of principal Individual liability OR Co-promisor/surety liability Co-promisor will share responsibility with principal if principal defaults Suretyone who promises to answer for the duty of another, will be jointly liable

Protecting Promoters 1. Novationagreement between principal and third party to voluntarily substitute an old contract with a new contract that changes either the subject matter or parties of the old contract a. All parties must be identified before novation can take place b. Novation BEFORE the transaction requires a document to account for the novation (e.g., "subject to novation") Protecting Third Parties Dealing with Promoters When corporation does not yet exist, treat transactions between promoters and third Offer to the corporation Board accepts the offer after corporation has been formed BUT is

vii. 1. parties AS a.

i.

Option Contract i. Irrevocable ii. Consideration is promoter's "best efforts" OR c. Present Contract i. Include clause(s) stating that the corporation will be formed, will adopt the contract between third party and promoter, will novate, and will deal with third party b. 1. ii. Incorporation and Limited Liability De Jure Corporation Limited liability attaches once the articles of incorporation are filed De Facto Corporation (Facts from Corporation's Perspective) Good faith effort to incorporate (sent the articles to department of state) Legal right to incorporate AND Operating as a corporation Corporation by Estoppel (Facts from Third Party's Perspective) IF Person dealing with alleged corporation Thought it was a corporation AND Would get a windfall if alleged corporation would be personally liable THEN 3rd party is estopped from contesting the existence of a corporation Enterprise liability Factors 1. Common employees 9

revocable by either party b.

i.

1. 2. 3.

iii. 1. a. b. 2. iv.

2. 3. 4. 5. 6. 7. 8. 9. 10. 11. v. 1. a. b. c. d. 2.

Common record-keeping Centralized accounting Payment of wages by one corporation to another's employees Common business name Employees of one corporation render services for another Undocumented transfers between corporations Unclear allocation of profits and losses Same officers Same shareholders Same phone number

a.
i. ii. iii. vi. c. i. ii. iii. iv. 1. 2. d. i.

Piercing the Corporate Veilseek assets of the SH where corporation has none Unity of Interest/Ownership Disregard of corporate entity Commingling funds and assets Undercapitalization Treating corporate assets as its own AND Injustice is barred from recovery AND SH/Corp would be Unjustly enriched Parent takes all assets leaving no funds for subsidiary OR Fraud Reverse Pierceseek assets of corporation where SH has none Directors Conduct, manage, and direct the business of the corporation Appoint officers and form committees Issue Dividends Types Inside Directorsdirector AND employee or officer Outsidedirector but NOT officer or employee Duty of Care Purpose of Corporation and its board of directors is to make profits and increase shareholder

wealth 1. Changing purpose of corporation to something other than maximizing SH wealth is a breach of good faith that will trigger the duty of loyalty analysis a. Charitable contributions are proper so long as the donation furthers the interest of the corporation and is incidental to the purpose of maximizing profit and increasing SH wealth ii. Directors must aspire to meet their continuing obligation to be well informed about corporation's affairs

e.

i.
1. 2.

Business Judgment Rule Judgment of directors has the benefit of a presumption of good faith Court will not interfere with business decisions, even unwise business decisions Court only scrutinizes procedures

10

ii.

Once BJR attaches, the standard is whether no reasonable person in like circumstances would have reached the same decision "Well-informed" Decisions Required Reasonably good efforts to hire experts AND Expert advice is limited to the area of expertise

iii.
1. 2. iv.

Inaction 1. BJR arguably does not apply since no decision has been made HOWEVER 2. So long as the decision NOT to take action is well-informed, the BJR should apply 3. Compliance Proceduresfailure to enact where directors were on notice that procedures were required might not be "well-informed" decision a. Notice that compliance procedures are required i. Industry lends itself to violations of the law ii. Industry involves complex area of the law b. HOWEVER, if directors know that full compliance is impossible AND decide it's too costly to implement a program, BJR might attach if well-informed decision reached v. Executive Compensation Agreements 1. Executive compensation plans receive the protection of the Business Judgment Rule and are rarely struck down, even if the plan is for an existing director who has influence over the corporation. 2. The director's decision will stand if it is rational, informed, and made in good faith. 3. Even if a compensation plan is arguable, excessive or unreasonable, if the compensation level is related roughly to the value of the director's services, it will stand. a. Exception 1: Deferred compensation plans that reward an executive in the future whether or not he remains w/ the company might be struck down as lacking in consideration. b. Exception 2: When a salary is based on a formula that is unchanged even though the corporation's conditions have drastically changed (10% of profits as a salary and profits balloon so the director receives $50 million).

vi.
1. 2. f. i. ii. iii.

IF the BJR does NOT attach, directors must show the entire fairness of the transaction Fair price based on generally accepted economic accounting methods Fair dealing beyond mere formalities Duty of Loyalty Directors and officers of a corporation owe a duty of "Undivided Loyalty" to the corporation Conflicts/self-dealing, fraud, illegality, breach of good faith triggers the duty of loyalty analysis Ratificationwhere triggers strip the protection of the BJR, proper ratification might revive the SH Vote OR Special Committee Transactions between director and the corporation are no longer void or voidable, so long as Director discloses the conflict Disinterested committee makes well-informed decision about the transaction SH ratifies OR Directors show entire fairness Corporate Opportunity Doctrine IF Directors and officers Come across a business opportunity Corporation is financially able to take opportunity

iv.

protection 1. 1. 2. 3. 4. g.

i. ii. 1. 11

Corporation is in that line of business AND Reasonable expectancy that corporation will take the opportunity iii. THEN director or officer CANNOT seize the opportunity himself iv. Director/Officer must present the opportunity to the corporation and the corporation must reject before the director can seize the opportunity for himself h. i. Shareholders Shares/Stock General ruleThere must be one class of stock/shares that contains Voting rights AND Residual rights Common Stock Voting Rights Residual rights Appreciation and depreciation Preferred Stock General rule Preferential rights to dividends AND/OR Preferential rights to amounts paid after liquidation No voting rights No appreciation or depreciation Cumulative Dividends on preferred stock Preferred amount carries over to the next year if dividends are not issued Non-Cumulative Dividends on Preferred Stock Preferred amount does NOT carry over to the next year if dividends are

2. 3.

1.
a. b. 2. a. b. c. 3. a. i. ii. iii. iv. b. i. c. not issued

i.

Cumulative to the extent earned i. Preferred amount carries over to the next year ONLY IF corporation has earned enough to pay the cumulative amount e. 1. 4. a. Participating Preferred Preferred SH participates in excess dividends or residual rights (Assets Amount Over)(n%) + Preferred Amount

d.

i.

Conversion of Interests Upstream Conversion i. Converting interests from a risky to less risky position to the detriment of others is prohibited (Deep Rock Doctrine) b. Downstream Conversion i. Converting interests from less risky to riskier position is permissible Low Risk: 1. 2. 3. 4. Bonds (Secured Loans) Debentures (Unsecured Loans) Preferred Stock Common Stock

High Risk 12

ii.

1.
a.

Dominant Shareholders Controlling SH owe fiduciary duties to minority SH Control the vote, vote controls major transactions Controlling SH can sell shares at a premium above the market price UNLESS Looting corporate assets Converting corporate opportunities Fraud OR Acts of bad faith Freezeouts Depressing stock for the purposes of buying out the minority Equal opportunity provision Minority SH must give right of first refusal to minority SH If minority declines, majority SH must buy shares at the same

2.
a. b. c. d. 3. a. b. 1. 2. price (poison pill) iii. 1. a. b. 2. a. votes per director) 3.

Shareholder Voting Staggered Elections Election of directors at intervals Impacts on the ability of control once a SH obtains a controlling interest Straight Voting # of shares = # of votes for each director (10,000 shares, 3 directors, 10,000

Cumulative Voting # of shares x # of directors up for election = number of votes for any director (10,000 x 3 directors = 30,000 for any director) b. Formula for Cumulative voting: # of votes required to elect directors S + 1 n(D + 1) c. S = # of total shares to be voted d. D = # of Directors to be elected e. n = # of Directors SH wants to elect f. Removal of director can be blocked with the # of votes that would elect one director under this scheme 4. Proxy Fights a. Others soliciting proxies and SH appoints agent to vote on behalf of that SH b. Agent owes fiduciary duties to the SH relating to matters of corporate governance

a.

i. ii.

5. a.

b. c. 13

Preemptive Rights Power of existing SH to purchase a proportionate part of any newly issued shares Protects voting power Protects economic rights Newly authorized shares Previously authorized but NOT previously issued

d. e.

Treasury shares Preemptive rights do NOT exist between classes of shares Blasius standard for Shareholder Voting Prevention a. SH must show that the board acted for the primary purpose of thwarting the exercise of a SH vote i. Failing to give SH full and fair opportunity to vote b. Board has the burden to demonstrate a compelling justification for its actions c. IF SH fails to meet its initial burden of showing Board's primary purpose, the BJR attaches (Duty of Care Analysis) UNLESS can show fraud, illegality, conflict, etc. (Which would trigger the duty of loyalty analysis) Shareholder Actions Direct

6.

i. i. 1. a. b. c. ii. 1. 2. a. discovery) 1. 2. 3. relaxed

i.

SH seeks to enforce rights based on an injury directly affecting the individual SH Inspect Books SH has an individual right to have an independent and autonomous board Dividends (can also be derivative) Derivative Whether the wealth from the lawsuit will accrue to the corporation Demand Requirement Although demand is generally required, SH argue that demand was EXCUSED SH must specifically allege with particularity ("tools at hand" no Conflict OR Directors are dominated OR Failure to use proper methodology NY standard is generally the same but the particularity requirement is

ii.

3. Board can establish a special litigation committee to determine whether the corporation should bring the suit on its own behalf (authorized by statute) a. i. faith b. 1. 2. 3. Committee created at the initiation of the lawsuit Decision to bring suit or not is entitled to the BJR Presumption of good Committee created AFTER the SH brings an action Committee must show Members are disinterested and independent Used the proper methodology Proceeded in good faith AND Reasonably invested the claim (Zapata) Committee must also show that the SH suit will HARM the corporation

i.

4.
ii. more than benefit the corporation

Joy AlternativeIn addition to this showing, court will make its own independent judicial finding that the lawsuit is not beneficial to the corporation i. Court will not give deference to the committee because of inherent bias (directors at issue usually pick committee members) 14

c.

4. MBCA requires written demand in all suits. Failure of the board to take action within 90 allows SH to bring suit. If the board does act within 90 days, either a quorum of disinterested directors OR a disinterested special committee can make the decision. 5. PlanningSet up a committee early on and keep them disinterested. Notify all SH that this committee alone will proceed on behalf of the corporation iii. Dissent and Appraisal

1.
transactions

Limited statutory right granted to minority SH when SH objects to fundamental Fundamental transaction include sale of substantially all assets and mergers Two Step Merger Buyer acquires majority interest of corporation by buying majority Obtains control of the Board Controls the minority SH Buyer acquires the minority interest (buys them out)

a.
i. b. interest at a premium above the FMV 1. 2.

ii.

2. Dissident SH can have a judicial appraisal of shares. The court determines the FMV of shares based on financial evidence General Ruleremedy to dissenting SH is appraisal by court UNLESS the board of directors violates its duty of loyalty

3. 4.

Appraisal MethodologyCourt will accept evidence of accepted accounting methods in the

community j. 1. 2. 3. a. b. 4. speculative ii. Inside Information Common Law No Duty to disclose absent affirmative fraud Directors have a duty to abstain from trading or disclose information to SH Special Facts TestDisclosure is required IF Concealment of identity in the transactions AND Inside information would have a dramatic impact on stock value Anonymous purchase on the market is OK especially where information was highly

i.

Rule 10b-5 1. Unlawful for any person directly or indirectly by use of interstate commerce a. To employ any device, scheme, or artifice to defraud b. Make any untrue statement of a material fact OR omit to state a material fact necessary in order to make the statement made not misleading OR c. Engage in any act, practice, or course of business operating as fraud d. In connection with the purchase or sale of any security (information caused the purchase or sale) 2. a. 15 Insiders One who owes fiduciary duties to the issuing company

i.

b. material nonpublic information c.

Temporary insiders Hired for certain transaction relating to the issuing company leading to

i. ii. iii.

Tippees

information to tippee fiduciary duty

No fiduciary ties to the issuing company Tipper (Insider) personally benefits from disclosing material nonpublic Tippee knows or has reason to know that the tipper is breaching a

d. i. ii. iii. iv. v. 3. a. the transaction i. ii. k. i. 1. 2. 3. 4. 5.

Misappropriation Theory Nonpublic, material information protected by confidentiality (lawyers) Trade on basis of the information Breach of a fiduciary duty to the source of the information Based on a corrective justice theory Reducing protection of market analysts Material Information Reasonable investor would attach importance in determining choice of action in Actually or inferred from the circumstances Never really litigated Short-Swing Profits Section 16(b) prohibits short swing profits under a strict liability theory. Officers, directors, 10% beneficial owners of any class of stock Corporation with 5M in assets and minimum 500 shares in a national exchange Equities and convertibles More than one purchase Within six (6) Months

ii.

Investor Confidence Theory: prevent the appearance of impropriety and prevent churning the market. The court will construe the transaction to get the most money for the corporation TestIf officer, director, or 10% beneficial owner of stock participates in two covered transactions within six month period, the gains realized from the transactions must be returned to the corporation regardless of intent 1. 10% beneficial owner Owner of any instrument that can be converted into stock (that is why they are a

iii.

a.
beneficial owner)

2.
a. b. 3. 16

Covered (Sale Purchase OR Purchase Sale but usually Purchase Sale) Existing 10% beneficial owner BEFORE the purchase AND 10% beneficial owner BEFORE the sale Transactions: "Sale or Purchase"

a. i. ii.

Transaction is one that gives rise to speculative abuses Trading on material nonpublic information OR Churning the market

17

DUTY OF CARE/DUTY OF LOYALTY BURDEN-SHIFTING ANALYSIS


Correct Methodology Business Judgment Rule Duty of Care: Incorrect Methodology If YES, Burden on Directors to show Fundamental Fairness *No triggering events. *Would reasonably prudent person in like circumstances make the same decision? Court defers to business decisions of directors, evaluates procedural methods Burden on SH to show waste If YES, SH must show waste BUT SH or Comm. Ratification (disinterested, well-informed) If NO, Dir. must show fundamental fairness

Burden on Dir. to show fundamental fairness Duty of Undivided Loyalty If YES, SH has the burden of proving waste SH or Committee Ratification (disinterested, well-informed) If NO, Dir. has the burden of proving fundamental fairness *Conflict of Interest *Fraud *Illegality *Breach of Good Faith *Controlling SH has Conflict of Interest

IF SH shows fraud, illegality, conflict, or breach of good faith, Duty of Loyalty Analysis is triggered

SH shows Board's primary purpose was thwarting exercise of SH vote (no full and fair opportunity to vote) Shareholder Voting SH fails to show primary purpose was thwarting SH vote

Board has burden to demonstrate "compelling justification" for its actions SH has burden of proving fraud, illegality, conflict of interest, or breach of good faith

18

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