Agency Law

• Core of All Business Entity Law

• People Act “on Behalf” of the
Business to Bind the Business in
Relationships with Third Parties
• Course Starts with Simple Agency
Relationships
• Separate Contract and Tort Cases
 Creation of an Agency
Relationship
• Consensual (Contract)
– Oral or Written (“manifestation of consent” of
one and “consent” by the other)
– Express or Implied
– Ex Ante (Before the Act) or Ex Post
(Ratification; After the Act; “relates back”)
• By Matter of Law (Equity)
– Apparent Authority (Constructive)
– Authority by Estoppel (Cannot Deny)
 Termination: General Rules
• Default Terms:
– Terminable At Will of Either Party
– Otherwise End of “Reasonable Term” or When Specific
Act Performed (or on Violation of Duty)
• If Parties Stipulate a Set Term (by Time or by
Task)
– Either can Breach (Principal Revokes; Agent Renounces)
– Remedy Limited to Damages (No specific enforcement
by injunction) Policy??
Agent’s Liability on Contract
• General Rule: Agent not liable on
contract executed on behalf of
principal
– Exceptions: Partially Disclosed (Unless
Otherwise Agreed) or Undisclosed
Principal.
• Atlantic Salmon v Curran: Agent
liable when no disclosure of specific
identity of principal.
 Agent’s Fiduciary Duties
• Supplement Express or Implied Contractual Terms of the
Agency. “Default Terms” or “Gap Fillers” Rest. (2nd) § 376.
Agent is a Fiduciary. Rest. (2nd) § 13.
• Duty of Care. Rest. (2nd) § 379
– Standard (reasonable) Care and Skill for Task and Profession
– Obey Directions; Act only as Authorized
• Duty of Loyalty. Rest. (2nd) § 387
– No Conflicts of Interest. Rest. (2nd) §§ 388-395
– Account for Profits
• Duty of Candor. Rest. (2nd) § 381
– Duty to Give Information, Keep and Render Accounts. Rest. §§
381-382
Effect of Termination on Agent’s Duties

• Duties of Confidentiality & Loyalty Survives

Termination. Rest. § 396. [written lists/memory
distinction]
• Town& County House & Home v Newbery:
– Ex-employees’ solicitation of employer’s customers,
obtained at considerable cost, was a breach of a duty of
loyalty.
– [Note Appellate Court’s conspiracy theory; en masse
departure]
• Partnership Cases: Meehan v Shaughnessy (next
Chapter)
 Plaintiff’s Problem: Lack of Agent’s
Express Authority to Contract.
Principal Bound Anyway..
• General Direction Only: Specific Power
Implied in Fact (Hogan). Actual Authority.
• Explicit Reservation of Authority Disregarded
(Cannot use Implied Authority): Apparent or
Inherent Authority
– Explicit Reservation of Authority Disregarded;
Undisclosed Principal: Inherent Authority
(Watteau)
• Contract Formalities Fail (Authorized Agent
Does Not Sign; Cannot use Actual Authority):
Apparent Authority of Employee (Ampex)
Vicarious Liability (Respondeat
Superior)
• Principal Liable for Acts of Employees
(Servants)“Within the Scope of Employment” [“Let
the master answer”]
– Even If Principal Does Not
• Specifically Order, Direct or Intend Employee’s Tortious Act
• Nor Breach a Personal Duty to the Victim
• Limits
– Distinguish Non-agents/Agents Rest.§ 1
– Distinguish Agent “Independent Contractors”/”Servants”
Employees [Control or Right to Control] Rest. §§ 2, 220
– Distinguish “Inside/Outside Scope of Employment” [Kind,
Time, Space, Motive] Rest. §§ 219, 228-32
 Partnership
Not Created by the State (Privately
Created)
Distinguish Sole Proprietorship (one
owner) from Partnership &Joint
Venture (multiple owners)
Created by State Certificate
Limited Partnership/Limited Liability
Company/Corporations
 Joint Ownership: Default
Rules
• All Owners (Partners)
– Are Liable as Principals RUPA §§ 305 & 6
• Are Jointly and Severally Liable for Debts of
the Business
– Are General Agents of Partnership
(Meinhard case) RUPA §301
– Share Equally in Control RUPA§401 (f) &
(j)
 Partnership Formation
• Actual (Real; By Consent): RUPA §201
– Affirmative: co-owners of a business for a profit
– Negative: Not a tenancy in common,
employer/employee relationship (sole
proprietorship), lender/debtor relationship
– Factors: sharing of profits (not gross returns)
[Proxy for control??]
• By Law (Implied in Law; Equity: Partnership by
Estoppel (Holding Out) RUPA § 308
 Partnership Governance
• Default Rule: UPA §401(j). Majority of
partners have the power to make all
business decisions within the ordinary
course of partnership business.
– Minority, dissenting partner cannot opt out,
even by informing third party of her dissent
– Third party cannot rely on authority of
minority, dissenting partner to bind partnership
[problem: apparent authority]
 Partnership Property
• Default Rules:
– Partnership Holds Property as an Entity Separate from
Partners. RUPA § 203
– Partner’s Property Rights. RUPA §501:
• (1) right to use specific partnership property (RUPA §
401(g), “tenancy in partnership” ?),
• (2) owns a partnership “interest” (RUPA § 502, personal
property)
• (3) right to participate in management
• Case: Putnam v Shoaf. Legal Claim for
embezzled funds. Did exiting partner have an
interest in the claim?? Held: No. Partner can only
convey “interest”; legal claim a partnership asset.
 Partnership Dissociation,
Dissolution, and Liquidation
• RUPA Terms: Dissociation/Dissolution/Winding
Up/Liquidation
• Default Rule for At Will Partnership RUPA
§801(1): Any partner can walk and force
liquidation absent other circumstances
(partnership agreement/ bad behavior).
– Duty of Confidentiality; Duty to Account Survive
– Default Rules a Problem for Modern Business (too easy
to leave (no capital lock up). Remaining equity owners
must reconstitute business.
 Distribution Problems: Default
Rules (UPA)
• Marshall Cash. Pay Cash in Order, UPA
§40(b) to
– (1) Creditors
– (2) Partners on Loans
– (3) Partners for Capital Contributions
– Partners Equally for Split of Profits
• What if there is a deficiency in 1,2, or 3?
UPA §§ 18(a) & 40(d) Each Partner Pays
(Suffers Losses) in Same Proportion as
Split of Profits (Default: Equal Payments).
 Dissociation Wrongful?
• Dissociation Wrongful?
– “Not Wrongful”: At Will Partnership RUPA § 601(1)(no term or
task); Death (7); Bankruptcy (6): Court Order (5)
– “Wrongful”:
• Breach of Partnership Agreement (even if partnership at will) or
• Short of Agreed Term or Task
• Effect of Wrongful/Not Wrongful Distinction:
– Can Remaining Partners “Continue Partnership”?? Or Must
Partnership Dissolve?? RUPA § 801.
• At Will Partnership. Dissociation=Liquidation
– Unless wrongful or plus: expulsion on proper grounds by unanimous
vote or, on more general grounds, by court order; bankruptcy of
partner; death or incapacity of individual partner
• Special Rules for Term or Task partnership
– Does Dissociating Partner Pay Damages
 Partner’s Fiduciary Duties
• RUPA § 404
– “only” but see RUPA § 403 on old Duty of Candor
(Information)
– Duty of Care: BJR (gross negligence)
– Duty of Loyalty: account; conflict of interest; compete
– Adds Duty of Good Faith and Fair Dealing
• But RUPA § 103. Agreement may not
– Unreasonably restrict § 403(b)(information)
– Eliminate Duty of Loyalty except for 1) categories of acts if
not manifestly unreasonable or 2) cleansing vote
– Unreasonably reduce Duty of Care
– Eliminate DGFFD but may “prescribe…standards if not
manifestly unreasonable”
 Expulsion of a Partner
• RUPA Rules: Partners Want to Expel a Partner,
Continue Business
– No Express Term In Partnership Agreement
• By Decree of Court RUPA§ 601 (5)
• Very Limited Circumstances: Unanimous Vote RUPA§ 601(4)
– Under Procedure Specified in Agreement. RUPA § 601(3).
Note change from UPA§ 31(6)[“bona fide”], 38(1), &
41(6). But DGFFD in RUPA § 103(5) & 404(d).
• Case: Lawlis v Kightlinger & Gray. “Bona Fide” in
UPA? Held: No cause “guillotine” procedure is
“bona fide” if no “wrongful withholding of money
or property legally due the expelled partner at
the time he is expelled…”
 On-going Capital Contribution
Problem: Firm Needs More Cash
• Start Up Capital (Equity $1 m; Loan $9m)
• New Capital:
– Default Rule: No Obligation to Contribute; No New Partners
Without Unanimous Consent; Majority of Partners Can
Agree to Borrow or Accept New Capital Contributions from
Existing Partners
• Free Rider Problem: Let Others Take Risk of Putting in New
Money; Sit on Initial Capital Contribution.
– Agreements: “Pro Rata Equity Call”; “Penalty Dilution”;
“Pro Rata Loans”; “Sale of Shares to New Partners”;
Promoter Must Make Loan.
• Private Equity Funds: Equity Calls with Caps. Refuse,
Penalties (Option in Manager to Sell Interest or Dilute Interest)
 Partnership Tort Liability
• General Rule: Partnership Liable for
Partner’s wrongful act in “ordinary
course of business” or “with
authority of co-partners” RUPA § 305.
• Indemnification against partner
causing injury? Moren v Jax. Default
Rule. No. Distinguish Agency Law
(indemnification against agent
causing injury is default rule).
 Limited Partnerships
• New Act: ULPA (RULPA) overlays UPA.
UPA applies unless a ULPA provision
changes the rule.
• Holzman v De Excamilla: Limited Partners
can be recast as general partners if they
“take part in the control” of the business
of the firm. Note Change from ULPA to
RULPA.
• Modern Uses: Private Equity Funds
(Hedge Funds; Venture Capital Funds)
 What Entity to Use?
• Small Businesses (Number of Investors is Under 35):
Presumption in favor of an LLC (with a Written Operating
Agreement). If business grows, convert to a C Corporation.
Rebutted
– by industry specific common practice (VCs as LPs)
– if Net Profits are Zero (use a C Corporation)
– If heavy retained earnings
• Medium to Large Businesses (Likely to be Publicly Held): C
Corporation.
• Factors, in order: Tax (Double Tax); Attraction to Investors
(Limited Liability, et al.); Operating Structure (Mandatory
Rules do not get in the way; Default Rules require the
least amount of tinkering in written agreement)
 The Double Tax
• Firm earns $1.00, tax 35%, keeps
$.65
– Note: effective rate is around 18%
• Firm distributes cash to investors,
tax 15%, investors receive $.55.
– Note: The “Bush tax cut” lowered the
tax from 39% (investors receive $.40)
 The Corporate Form
• Legal Person (Entity) with Indefinite
Life
• Limited Liability of Investors
• Free Transferability of Ownership
(equity, stock or shares) Interests
• Centralized, Specialized Management
• Oversight Board Elected by Equity
Investors
 Creation of a Corporation
• Incorporator files an “Articles of Incorporation”
(RMBCA; Ohio) or a “Certificate of Incorporation”
(Del)
• Secretary of State Records the Filing; Effective on
Filing Date (unless explicitly delayed)
• New Corp. Holds an “Organizational Meeting” to
Adopt Bylaws (Regulations in Ohio) that
Empower Agents
• Analogy: Certificate and By-Laws (const.
documents) board resolutions (leg.) exec.
decisions (Pres., agency orders)
 Corporate Charter
(Articles/Certificate)
• Mandatory Provisions
– Name; registered agent; purpose; authorized
amount of common (voting) stock; Del & Ohio,
par value
• Discretionary (Customized Optional)
Provisions
– Complex capital structure: Preferred Stock;
Two-Tier Voting Stock
– Complex Governance Provisions: Board Terms
of up to 3 years, Staggered; Class Voting;
Bylaw Amendments by Board or Lower Majority
 Promoter, Pre-Incorporation
Contracts
• Promoter Signs Agreement with Third Party Before Corporation
Exists (Pre-Incorporation Contracts). Effect?
– Agency Law Controls: Rest.Ag. §§ 320 & 326
• Promoter Liable?
– No: contract; unilateral offer to corporation
– Yes: Contract with promoter
• For “good faith” efforts to get corporate adoption
• Until corporation affirms (promoter then released)
• Survives corporate affirmation (promoter bound; secondary liability)
– But Novation: New contract with corporation replaces old deal
(promoter usually released)
• Can Unincorporated (Defectively Incorporated) Firm Sue on
Contract?
– Yes: De Facto Corporation (Close Enough)
– Yes: Corporation by Estoppel ( Third Party Thought It Was Corp)
Southern-Gulf Marine v Camcraft
 Terms for Shares
• Types: Preferred/Common; Classes;
Convertible
• Authorized/Issued/Outstanding.
“Treasury shares”
• Primary/Secondary Market Sales
 “Limited Liability” and Corporations:
General Rule
• Investors
– Losses limited to capital contributions (or to price paid
for stock in secondary market)
– Not liable to corporate creditors
– Corporate creditors must look solely to corporate
assets
• Distinguish Agency Problems of Executives
– Executives, as agents, bind firm on contracts; agents
are not personally parties (not personally liable) unless
agreed
– Liable for personal wrongful acts; not liable for
wrongful acts of other agents (absent some form of
participation)
 Shareholder Personal
Exposure
• Equitable Subordination: If
shareholder is an 1) officer and 2)
a creditor of firm and misbehaves,
debts subordinated to those of all
other creditors
• Disregard the Registered Legal
Entity (becomes a General
Partnership or Sole Proprietorship)
 Disregard the Entity
• Shareholder (s) 1) “dominates” firm
and 2) acts “unjustly” towards
creditors
– Evidence of domination is commingling of corporate and
personal funds, lack of observance of necessary entity
formalities (board and shareholder meetings)(Note Ohio,
lack of meetings not a factor)
– Courts vary on what is “unfairness or unjustness”

• Also Known as “Piercing the

Corporate Veil” (or Piercing for short)
 Parent / Sub
• Is shareholder control or domination
enough for disregard of entity?
– No, US v. Bestfoods (EPA)
• Distinguish from Disregard of Entity
Other Theories of Shareholder Liability
– Direct Liability: Direct intervention or
participation (In re Silicone, second theory)
– Indirect Liability: Corp is agent of
shareholder (respondeat superior)
 Shareholder Lawsuits
• Distinguish: Derivative Actions/Direct Actions
(Class Actions) To Whom is Duty Owed? Cohen &
Eisenberg & Grimes cases
– Classic Breach of Fiduciary Duty by Board,
Derivative. Cohen facts (personal enrichment).
– Direct:
• Classic: Violation of Federal Securities Laws.
• State Law Voting Rights Violation. Eisenberg
facts. Problem for Plaintiffs, no cash.
• Effect
– Procedural Hurdles, FRCP Rule 23 or Rule 23.1
– Who Collects Damages?
 Real Party In Interest:
Standing in Derivative
Actions
• Fed. R. Civ. P. 23.1 (Ohio Same):
– Plaintiff Must Have Been a Shareholder
at Time of Wrong
– Plaintiff Must be Shareholder For
Duration of Action
– Plaintiff Must “Fairly and Adequately”
Represent the Other Shareholders
The Demand Requirement
• Shareholders Must Make a Demand on the Board
to Sue (Majority of Board “Disinterested”)
– Board’s Choices: It Agrees to Sue, Refuses to Sue, or
Defers to Shareholder Suit.
– If Refuses: Shareholder Suit Dismissed; Sue Board,
Wrongful Refusal? Grimes: BJR unless conflict or lack of
due care
• Demand on Board “Excused”
– Board Creates a Special Litigation Subcommittee (SLC):
SLC Defers or Files a Motion to Dismiss
– On Motion to Dismiss, Court Review on NY or Del test
(BJR/”compelling interest”)
 Demand Excused: Special Litigation
Committees
• Form a Standing Subcommittee of Disinterested
Directors, Delegates Absolute Discretion
• Subcommittee Hires a Top Law Firm, Not on
Retainer, to Investigate the Allegations
• Subcommittee Determines
– Suit is “Not in Best Interests of Corporation” Argue
Legal Merits and Economic Value (Damage to
Reputation)
– Files a Motion to Dismiss
• Court Review:
– Independence of SLC
– Merits of Decision?? Distinguish Del. (de novo) N.Y. (no
oversight), & N.C. (normal BJR, presumption).
 Primary Duty of Board of Directors
(and Appointed Officers) ??
• To Whom??? Firm Collectively, Firm Health. Not
Individual Shareholders or Individual
Constituencies.
• How is Firm Health Measured Legally (to
evaluate performance of fiduciary agents)??
– Shareholder Value (Maximize Residual Profits)
• Long Term/ Short Term
• Stock Market Price Inaccuracies
– Total Firm Capital Value: Shareholders Returns Plus Bondholder Returns
– Total Firm Value: Return to Investors Plus Income Value to Workers
– Total Social Value of Firm??? Firm is better off in the “long run” if
society healthy
 When Can a Board Favor Non-
Shareholder Constituencies??
• Fact Patterns:
– Gifts to Charities, AP Smith
– Distributions of Extra Cash: Higher Wages Or Dividends,
Dodge v Ford
– Community (Culture, Tradition) Over Profits, Shlensky v
Wrigley
• Possible Answers:
– Never: Tie All Decisions to Shareholder Welfare or Do
Not Do It [Milton Freidman: Corporations Social Duty is
to Generate Profits for Shareholders.]
– Yes But Only If Amount is Small and Promotes The Good
(“Ethical”): ALI
– Yes, Full Board Discretion to Act in “Socially
Responsible” Manner: Ohio 1701.59(E).
 Limited Liability Company
(LLC)
• Source of Law: State Codes (Continuum: Partnership to
Contract Principles)
– ULLCA (1995)(Partnership Principles)
– Ohio Ch. 1705 (1994)(Corporate Principles)
– Delaware LLC Act tit. 18 (Freedom of Contract)
• Characteristics
– Public Filing (Sec. of State), abbreviated (single page) (Ohio:
“Articles of Organization”)
– Default Rules
• Depend on Member Managed/Manager Managed Designation
• Most All Can Be Modified by Oral or Written Operating Agreement
(OA), very flexible business form
– Members have complete limited liability
– Bus. Name: “Limited Liability Company”, “LLC”, L.L.C.”,
“Limited”, “Ltd.” or “ltd.”
 Management Structure
Option
• Default: “Member-Managed Company”
– Similar to Partnership (Ohio Ch.1705 §.25; But §.24)
– OA can flesh out details
• Common: “Manager-Managed Company”
– Designation in Filing: Alternate Default Rules Apply,
OA can modify default rules
– Affects Member’s power to bind LLC to contracts
• Limits Member actual and apparent authority (Ohio
§.25(B),ULLCA §301)
– Affects Allocation of Fiduciary Duties (Ohio §.29)
• Note: “Clear and Convincing Test”
• Damages Only For Intentional or Reckless Acts
• No Express Constituency Statute (Incorp. By Inference?)
– Derivative Action for Members (Ohio §.49)
• Demand Requirement (Ohio §.51)
Fiduciary Duties of Members
• Member-Managed : Owed Each Other
(Partners)
• Manager-Managed: Only Managers owe
fiduciary duties (Corporate Boards)
• Ohio
– “except to the extent…the operating
agreement provides otherwise” (§.29(A))
– Compare (B) to (C) & (D). Duty; Action for
Equitable (Injunctive Relief; Action for
Damages (But compare to corp § 1701.51)
– Corp. Style Provisions: Reliance on Reports
(§.30); Conflicts (§.31); Indemnification (§.32)
 Power to Limit Duties in
OAs?
 What Can the Members Waive??
 All Duty of Care Claims Other Than Willful Acts
 Types of Duty of Loyalty Claims
 Duty not to compete
 Court Refusals to Respect Waivers
 Basic Contract Theory:
 Strict Construction of Language
 Mistake; Fraud; Contract of Adhesion etc
 Non-waivable Fiduciary Rights?
 LLC Formalities
• Many LLCs Operate without Any
Formalities
– File One Page Article of Association
– Oral Implied Agreements; Custom & Course of
Practice Evidence.
• Usually Member Managed But Can Be Manager
Managed (mutual unwritten understanding that “only
Beth runs the business”)
• Effect on Integrity of the Entity?
– Court Interprets Any Implied Agreement and
Otherwise Applies Default Rules
 Summary of Ohio ch. 1705
• Corp. Code Model (Derivative Actions; Mergers;
Dissolutions)
• No Constructive Notice on Filing
• No “Freedom of Contract” Language
• Default Rules:
– Profits Divided By Capital Contributions
– No Automatic Capital Calls (Feature of Limited Liability)
– New Members On Unanimous Vote
– Lock In: Members May Not Withdraw But Can Assign
Membership Interest (Assignee Becomes Member Only on
Unanimous Vote of Remaining Members); Ceases to Be a
Member on Death or Insolvency
– Member Authority Depends on Member-Managed/Manager-
Managed Distinction
– Duties of Managers: Corp. Model.
 Common Duty of Care Fact
Patterns
• Takeovers
– Board Sold for Too Little or the Board Refused a Good
Offer (Van Gorkom, Millan and Cede cases)
• Shareholder Dividend Cases
– Board Should (Not) Have Paid a Dividend (American
Express case)
• Duty to Monitor Cases
– Inattention (Francis and Allis-Chalmers cases)
– Lack of Legal Compliance Programs (Caremark case,
pp. 396,398)
• Illegal Act Cases (AT&T case, not in book)
 Duty of Care: Brehm case,
n.66
• Directors Decisions Respected (Presumption)
Unless
– Directors are Interested
– Lack Independence Relative to the Decision
– Do Not Act in Good Faith
– Act Without a Rational (distinguish reasonable)
Business Purpose
– Use Grossly Negligent Process (includes failure
to consider all material facts reasonably
available)
The Business Judgment Rule
• What is it? Basic Standard with Thresholds??
(If good faith, Gross Negligence) Affirmative
Defense?? (Good Faith as a Defense to
Negligence)
• What are the Thresholds (or Elements of the
Defense)??
– Financially Disinterested (no conflicts of interest)
– Reasonably Informed
– Acting in Good Faith (in the firm’s interests)
 Liability Waivers: Delaware
• Waiver Does Not Apply
• to Injunctions (Only To Claims for Damages)
• to Allegations of Bad Faith or Personal
Benefit
• Does Apply to Damage Claims
Against Disinterested Directors
• Unless the “Entire Fairness” Test Applies
(Controlling Shareholder Transactions)
Emerald Partners case.
 Ohio
• Liability Waiver is the Default Rule
• Tighter than Delaware’s:
– Clear and Convincing Standard of Proof
– Best Interests of Corporation includes other
Constituencies
– No “Improper Personal Benefit” Exclusion
– No Unocal Rule
• Loser than Delaware’s
– Culpability includes or “Reckless Disregard for
Best Interests of Corporation”
 Duty of Loyalty
• Distinguish From Duty of Care
– Allegations of Sloth, Inattention or Stupidity
– Disloyalty, Betrayal, Personal Benefit at Firm
Expense, Selfishness
– Care: plaintiffs lose; Loyalty: plaintiffs win
• Alternate Terms for Breach of a Duty of Loyalty
– Bad Faith; “Self-Interested,” “Self-Dealing,”
“Conflicted,” “Interested,” or “Related-Party
Transactions; Conflicts of Interest
 Duty of Loyalty/Conflict of
Interest Classic Cases
• Director/Officer (or Controlling Shareholder, CS) on One
Firm Inks (or Causes) a Deal With a Second Firm that
– Is Owned by the Director/Officer (or CS)(or
Family)(Corp. Codes) Bayer v Beran (wife of
Pres.); BOT v Benihanna (board member
bought convertible perferred stock)
– Has Independently Paid (a Bribe??) the
Director/Officer (or CS)(Agency Law)
• If so, Standard of Review: Entire Fairness, Burden of
Proof on the Conflicted Board. Lewis; Bayer (careful
scrutiny). Met burden in Bayer and BOT.
 Safe Harbor State Statutes:
Introduction
• DGCL § 144; RMBCA §§ 8.60 – 63;
Ohio GCL § 1701.60
• Transaction Not Voidable if
– Details Fully Disclosed and
– Ratified by
• Disinterested Directors or
• Disinterested Shareholders
– Fair
 § 144 Issues
• Are Ratification and Fairness Alternative Tests??
Majority: no (is “or” conjunctive or disjunctive?)
– If no, does ratification affect fairness
test? Split: No v Yes, use weaker test.
– If yes, does ratification end inquiry? No,
BJR on ratification decision by Board, but
Shareholders?? BJR
• Is Full Disclosure Required by the Fairness Test
(as well as the Ratification Test)?? Fair Procedure
and Fair Price?? Majority: Yes (Hayes Oyster,
Wash.)
The Special Committee (Sub-committee
of Independent Directors): The
Transaction Lawyer’s Solution

• Composition: Independent Directors

• Authority: Full Power to Decide; Delegated by
Resolution from Full Board
• Charge: Negotiate Best Price
• Powers: May Hire Outside Lawyers, Bankers
and Accountants
• Effect on Standard of Review?? Kahn v Lynch
Comm. (Del.): Only shifts burden to plaintiff to
show unfairness in controlled shareholder
transactions
 Shareholder Ratification
• Stronger than Board Ratification ??
– Shareholder Ratification of Director/Officer Related
Party Transactions. BJR but Court usually defers.
• But if waste, unanimity required Lewis v Vogelstein.
– But Transaction between corporation and a
controlling shareholder, still entire fairness test,
with burden shifted. In re Wheelabrator
Technologies (Del.)
•
The Duty to Monitor
Distinguish a Breach by Commission from One by Omission.
Dumb decision/Inattention
• Distinguish Excusable Ignorance from Breach
– Director must: understand business; keep informed of
operations; be familiar with financial status; inquire on
“red flags”
• One Standard? Or Standards that Depend on Director’s
Sophistication?
• Statutory Defense: Reasonable Reliance on Experts
– Caselaw
• Old Rule: Graham: The red flag rule: Grounds for
Suspicion? If so Board must check it out. If not, no liability
• Caremark: Requirement of Audit or Compliance Monitoring
Systems
– No system is “lack of good faith”
– Stone v Ritter: breach of duty of loyalty because it is “reckless”
Fits more easily under breach of a duty of care (no conflicts) but no
matter as reckless conduct it is outside the BJR and 102(b)(7)
under either theory.
Duty to Put in Place Monitoring
Systems
• Caremark Duty Adopted by Stone v
Ritter court
• SOX Duties
– 302 Executive Certifications: internal
controls for financial data
– 404 Annual Report: Management
Assessment of Internal Controls Audited
 Corporate Opportunity:
• Issues
What Are They? Broz case
– Distinguish Related Party Transactions
• In re E-Bay: Bribes Not COs
– Standard: Interest or Expectancy Test (ALI) (Stronger:
Line of Business Test: Guth case)
– Can Firm/Officer Stipulate Expectations Ex Ante??
• When Can Officers/Directors/Controlling
Shareholders Take COs Personally??
– Disinterested Board Approves in Good Faith
– No Approval but firm financially unable??
• Old: No Irving Trust case
• New: Heavy Burden of Justification
 Compensation Problems
• Is There Excessive Pay for Corporate Executives?
Pro/Con.
• Law:
– State Law: Disney Case; Ohio §.60.
– Federal Law:
• Tax: Limit Cost Deductions to $1M Cash. Exempt
Performance Pay Bonuses.
• Fed. Sec. Law:
– Rule 16 b-3 (Vote on Stock Bonuses)
– Dodd-Frank: Advisory Vote (“Say-on-Pay”) every 3 yrs.
New Rule 14a-21.
• SOX (2002): Claw Back Rule
• TARP (2009): Pay Czar for Bailout Fund Recipients
– Exchange Rules: NYSE Compensation Committee
• Internal Firm Limits: “Say on Pay” By-Laws.
 Sources of Corporate
Capital
• Borrow Money (Cash for promises to repay principle plus interest)
– Bonds, Debentures, Notes
– Lines of credit, Commercial paper
• Sell Stock (Cash for a % of the equity)
– Preferred
– Common
• Retain Earnings
• Hybrids
– Convertible Bonds (option to exchange bond for stock)
– Convertible Preferred Stock (option to exchange preferred for
common)
– Options in Stock (Warrants)
– Redeemable Bonds/Stock (option to repurchase)
 Debt Covenants
• Self-Help: Collateral
• Financial and Operational Commitments
– Limits on dividends
– Limits on new senior debt
– Veto on Major Business Decisions
• Repayment Terms
– Periodic Payments
• Guarantees (Secondary Liability)
• Default Conditions
– Broad definition
– Acceleration of repayment obligation
 Stock

• Type
– Preferred (Participating / Nonparticipating)
– Common (Voting / Nonvoting)
– Redeemable?
• Dilution Control (effect on existing shareholders)
– Pre-emptive rights
– Rules that prohibit “watered” stock; stock issued for less
that “fair market value” (See also “bonus” stock or
“discount” stock)
• Private / Public
– Private: “Private Offerings”; i.e., Venture Capital
– Public: “Public Offerings”
 Definition of a Security
• Statutory Definition 33 Act § 2(1); 34 Act §
3(10). Ohio § 1707.01 (“title” interests!!!)
• Specific Instruments: Stock, Notes, Bonds
• Catch-Alls: “evidence of indebtedness,”
“investment contracts,” and “any instrument
commonly known as a ‘security’ ”.
– Surprises: worm farming; condos; strips of orange
grove; oil drilling rights; pyramids sales schemes.
Scams.
The “Howey” Four Part Test
• Test:
– Investment of value
– In a Common Enterprise
– With an Expectation of Profits
– Solely (Now “Largely”) from the Efforts of Others
• Application: LLC Memberships?? Robinson v Glynn
(4th Cir.) Member-Managed: Presumption, Not a
Security. Manager-Managed: Presumption,
Security (Overcome on Facts) [Note problem of
causal language – “shares” & “securities” in
Operating Agreement.]
 The Private Placement
Exemption
• Section 4(2) (Ralston Purina test): Applied in Doran v
Petroleum Management (5th Cir.) [could offerees get facts?
Either actually disclosed or by virtue of inside position.
Remand]
• Reg. D: Rules 504, 505 & 506. Safe Harbors.
– 504: Less than $1Million
– 505: Less than $5 Million (35 plus “accredited” investors), no
ads
– 506: 35 sophisticated plus “accredited” investors, no ads
• Big Disadvantage: Resales are Not Exempt (but some
504s). Need a second exemption to resell: Rule 144 (trickle
out rule).
Public Offering: 33 Act Registration

Shares (Secondary Offering)

$$

$$ Under- $$
SH Firm Public
writer
Shares Shares
(Dealer)

First Time? IPO (Initial Public Offering)

 Underwriters
• Type of Offering:
– Firm Commitment, Normal (Dealer; Spread)
– Best Efforts, Shaky (Broker; Commission)
• Negotiate Offering Price
(Firm/Underwriter)
• Due Diligence (Gatekeeper Role)
• Do Not Like Piggyback Sales
• Use Contractual Lock-ups: Stop Insider
Sales for 90 days after IPO
 Public Offering Process
• Decision to Go Public
– Pre-Filing Period (no offers, no sales)
– Negotiate with Underwriter; Prepare Filings
• File Registration Statement with SEC
– Waiting Period (limited offers, no sales)
– Road Shows
• SEC: “Effective”
– Distribution Period (offers, sales with delivery of
“prospectus)
Liability of Participants (Offering Firm,
Underwriter, and Individuals)
• Defective Public Offering (§12, 33 Act)
– No registration, not exempt (Invalid
Private Placement)
– Defective Offering Process
• Fraud (Material Misrepresentations or
Omissions)
– Sections 11, 12 & 17 of 33 Act
– Rule 10b-5 (10(b) of the 34 Act)
 Section 12(a)(2) Misstatements
C/L §10(b) §11 §12(a) §12(a)
(1) (2)
Misstat. yes yes yes no yes
or
Omissio
n
Materiali yes yes yes no yes
ty
State of strict strict
scienter scienter liability (negligenc
Mind liability
e)

yes transactio tracing

Reliance no no
n requireme
causation nt
loss (loss (loss
Causatio yes no
causation causation) causation)
n
offering
Damages unlimited unlimited rescission rescission
price
 Section 11 Liability
•Due Diligence Defense

Expertised Non-Expertised
reasonable
Experts

investigation not applicable

reasonable and actual §11(a)(4)
belief in statements
§11(b)(3)(B)
no investigation reasonable
Experts

investigation
no reason to believe
Non-

untrue reasonable and

actual belief in
§11(b)(3)(C)
statements
§11(b)(3)(A)
 Duty of the Company to Inform the
Market: Mandatory Disclosure Rules
• State Law (All Companies Incorporated in State)
– None Unless Shareholder Vote Needed (In Notice,
Malone)
– Duty to inform shareholders at annual meeting? See
Ohio § .38
– State Blue Sky Law (Exempted Primary Offerings;
Intrastate Exemption)
• Federal Law (Publicly-Traded, Wherever
Incorporated) “Mandatory Disclosure” Rules
– Periodic Filings (10-K, 10-Q)
– Episodic Filings (Events: 8-K; Form S-1; 14d-1)
• Voluntary Disclosures (CEO Statements): Duty to
Be Accurate
 Rule 10b-5
• Face-to-Face Fraud in Securities Transactions
(brother buys sibling's stock in a family
corporation)
• Fraud in the Primary Trading Market:
– Firm/Shareholder Transactions (Primary Market Sales
(Placements or Distributions); Security Repurchases
(Negotiated; Self-Tender Offers)
• Fraud in the Secondary Trading Markets
– Market Manipulation (i.e., Go short, start bad rumors,
close position; Go long, falsely tout, close position)
– Insider Trading/Misappropriation
 Elements of Rule 10b-5 Action

• False or Misleading Statement or Omission

– When is Failure to Disclose Actionable? Must Be Under a
Duty to Speak Basic
• SEC Filings, Mandatory Duty to Disclose
• Voluntary Statements, Duty to be Accurate
• Insider Trading, Duty to Disclose or Abstain from Trading
• Materiality: Basic (probability x magnitude test)
• Scienter: Ernst & Ernst
• Standing: Blue Chip Stamps (Purchasers or Sellers of a
Security)
• Reliance/Causation: Basic (presumption of reliance on
the integrity of the market price in a liquid market)
• Injury/Damage: Ligget & Myers (disgorgement as well as
damages)
 Rule 10b-5 Elements Change if SEC is
Plaintiff
• No Scienter Required (Use 33 Act § 16)
• No Standing Problems
• Enhanced Variety of Remedies
– Civil Fines
– Disgorgement (Trebled for Insider Trading)
– Personal Disqualification of Professionals
– Cease and Desist Orders
 Omission Cases: When is
There a Duty to Disclose?
• The Problem: Defining Actionable Omissions
– Common Law Fraud: Very rare; Is Insider Trading Such a
case?? (GR, no, unless “special facts”)
• Possible Theories of Rule 10b-5:
– Possession of Material, Nonpublic Information by Insiders:
Duty to Disclose (or Abstain) Texas Gulf Sulphur (Now
Rejected)
– Duty to Speak Required. Triggered by:
• Required SEC (Public) Reports
• Voluntary Statements to Public
• Trading in Shares by “Fiduciaries” Violating a Duty (to firm)
Chiarella or (to another firm misappropriation) O’Hagan
 Insider Trading: Potential
Defendants
• Defendants:
– Insiders: Senior Executives, Directors,
Controlling Shareholders
– Quasi-Insiders (Temporary Insiders):
Professionals (underwriters (investment
bankers), accountants, lawyers, consultants)
who get information with an obligation of
confidentiality
– Tippees of Insiders or Quasi-Insiders (or other
Tippees)
 SEC Safe Harbor: Rule 10b5-1 Plans

• Not Trading “On the Basis” of Inside

Info if
• Insider Has Adopted a Written Plan
Before Becoming Aware of Info
– Specifies Mechanics for Periodic
Transactions
– No Subsequent Influence
– Good Faith and not Scheme to Evade
 Short Swing Profits Statute
• 34 Act §16(b): Congress’s Definition of
Insider Trading. A Very Early Strict Liability
Provision (Neutral of Intent)
• Elements:
– Officers, Directors, & 10% Shareholders: Who
Must File Public Reports of All Trades (2 days) in
Firm Shares [Form 4] § 16(a)
– Profits on Any Two Trades in Any Six Month
Period (Match Buys/Sells (Long) or Sells/Buys
(Shorts))
– Shareholder May Sue (Statutory Derivative
Action), Firm Gets Profits
Exception for Employee Benefit
Plans: Rule 16b-3
• Tax Qualified Plans
• Others:
– If Ratified by
• Non-Executive Directors and
• Majority of Voting Shareholders and
– Recipients Hold Shares Six Months
Indemnification and Insurance:
Terms
 Indemnification: Firm Pays
Judgments and Damages Levied
Against Members of the Board
 D&O Insurance: Firm Pays Premiums
to Insurance Company; Insurance
Company Pays Judgments and
Damages Levied Against Members of
the Board
 Indemnification
• Mandatory Versus Optional (Discretionary)
– Statutory:
• Mandatory: Successful Defense, DGCL § 145(c) Waltuch v
Conticommodity Services: Technical Victories Count
• Optional (Ex post):
– Amounts Paid: DGCL §145(a)&(b)
– Advances: DGCL § 145(e) (unsecured promise to repay) Citadel
Holding Corp v Roven: reasonableness requirement
– Contractual (Optional ex ante; Optional ex post
becomes Owed): Ex Ante Agreement that Firm Will
Indemnify to the Full Extent Allowed Ex Post, DGCL§
145(f). But Some Requirements Remain -- Waltuch v
Conticommodity Services: Good Faith Finding for
Indemnification; Citadel Holding: Reasonableness for
Advances.
 Ex Post Indemnification
• Ex Post: DGCL § 145(a)&(b)
– Must Have Acted in Good Faith
– Distinguish Direct/Derivative (a) v (b)
• (a): Limits on criminal actions
• (b): Limits on Judgments (judicial out for expenses on
a judgment); settlement amounts (and expenses on
settled cases) included [huge incentive to settle]
• Procedure: Decision by
– Independent Directors (Majority or
Subcommittee),
– Independent Legal Counsel, or
– Shareholders
 Ohio: §1701.13(E)
• Direct/Derivative Distinction Modeled on Del. §145
– Adds Court of Common Pleas to Procedure
– Adds Court review to Decision by Board or Independent
Counsel
• Advance for Expenses Mandatory (opt out) on
promise to repay unless court finds, under C & C
standard, that director had deliberate intent to
injury corporation or acted with reckless disregard
for interests of corporation
 Basics of a Shareholder Voting Proxy

• Record owner (writer) grants proxy to proxy holder to vote

shares at a physical meeting
• Proxy is an Agency (creature of state law) Ohio § .48; Del. §
212(b)
– Proxy Holder (Agent)
– Proxy Grantor (Principal)
• Not a written or absentee ballot
– Distinguish written consent procedure (MBCA §7.04)
• Terms
– Revocable at will unless
• “coupled with an interest” (e.g., sale of stock after record date but
before meeting)
– Supplemented by federal law if a publicly traded company
 Federal Proxy Rules
• What is a Proxy?
– Grant of Agency
– Distinguish a Written Ballot: “Written Consent” Procedure.
• Why Are They Needed? Low Attendance at Shareholder Meetings.
• What Law Controls?
– State Law: Enables the Use of a Proxy. (Ohio Oddities)
– Federal Law: Regulates the Proxy for Publicly-Traded Firms
Only
• 34 Act §§ 14(a)-(c)
• SEC, Regulation 14A: Contains Rules 14a-1 to 14a-15 &
Schedule 14A.
 Basic Fed Requirements
• Proxy Statement: Form 14A, Items
• Proxy Card: Format Requirements
– Limited Discretionary Grants
– Slates of Directors (yes and abstain
boxes)
• Filing Requirements: General Rule for
Plain Vanilla Proxy Statement and
Form -- File with the SEC on First Use.
 How Is a Ballot Slate
Selected??
• Board or Nominating Sub-Committee Selects Management’s Slate
– Special Rules for Companies Listed on Stock Exchanges:
Nominating Sub-Committee Required and Must Consist of
“Independent” directors. NYSE Listing Req. (Majority on the
NASDAQ)
– Role of CEO?
• GR: One Candidate Per Seat. All Seats In Play
– Exceptions:
• Cumulative Voting. (Ohio Default Rule § .55)
• Staggered Board
• GR: Opponents Do Not Have Access to the Management’s Proxy.
– But New 14a-11: 3% if held for 3 years; 25% of seats or min. one seat. (Currently
stayed by litigation in DC Cir.)
 Seat Voting Oddities
• Choice is Yes or Abstain on Each Seat as Long as There is a
“Quorum”
– Quorum: Usually 50%, can reduce to 25% in articles; Ohio §.51, 1 will
do
– Hypos (Assume 50,000 shareholders):
• 1 Yes; 49,999 abstain. Director Elected
• 1 Yes; No-one else shows up at meeting. Elected in Ohio. Other
states fails for lack of quorum.
• Assume Quorum of 25%: 6,251 yes; 6,249 no. Director Elected
with 12.5% favorable.
• Effect of Majority Vote Bylaws
• Power of ISS in Publicly-Traded Company Elections:
Institutional Shareholder Service
 Proxy Contest for Publicly-
Traded Firm
• Fed General Rule: Insurgents (to Defeat
Management Slate) Must
– Create Their Own Proxy Statement and Card with an
alternative slate of candidates
– File Materials with the SEC and
– Pay to Have the Firm Mail the Material to all
Shareholders (or, if the Firm Elects, Mail the Material
Themselves)
• Who pays costs??
– Of Incumbents: Firm pays all expenses (Levin v Metro-
Goldwyn-Mayer), no shareholder ratification necessary
– Of Insurgents: Firm pays only on victory (Rosenfeld v
Fairchild Engine & Airplane) if ratified by shareholder
vote and if on “policy” dispute.
 Options for Thrifty
Challengers
• Ask Shareholders to Vote “Abstain” on the
Management’s Proxy
– The Disney Election of 2004: Eisner, the CEO, running for the
board had a 45% abstention vote. Stripped of Chairman title.
He resigned in 2006.
• SEC Rule 14a-11 (stayed). Major Shareholders (3%) can nominate
candidates for the Firm’s Proxy; 25% seats (min. of one seat).
• Enact Firm Specific Bylaw Changes:
• Historical Note: Shareholder Resolutions on Management Proxy (Rule 14a-8(i)(8)) that Amend
Bylaws, Creates Procedure to Allow Shareholders to Nominate Candidates for Board. AFSCME v
AIG (2nd Cir) case. Rule Change by SEC (currently stayed) Agrees.
• Convince Board to Adopt “Majority Vote” Bylaws: Director Must Get Majority Affirmative Vote of
Those Voting to Be Seated. If lose…
– Hold-Over Directors or
– Bylaw Stipulates: Must Submit Resignation; Other Board Members Can Chose to Accept or Reject It. If
resignation accepted, seat vacant; board can fill it by appointment.
 Rule 14a-8: Shareholder
Proposals
• The Town Meeting Rule: Qualifying
Shareholders May Include Some
Kinds of Proposals for a Shareholder
Vote in the Company’s Proxy
Solicitation Material
 Types of Proposals
• 13 Types of Proposals are Not Proper. Most
Important:
– Personal Grievance or Personal Interest
– Ordinary Business Operations (Dole proposal, study on
health care; Con Ed proposal on retirement age)
– Election for a Board Seat (e.g., AIG case)
– Materiality (Relevance): less than 5% of
• Total assets or net earning and gross sales
• Exception for “otherwise significantly related to business”
(Iroquois Brands proposal on pate)
– Resubmission in five years: Less than 3% vote once;
Less than 6% twice.
 Shareholder Power??
• Are Rule 14a-8 Resolutions Binding on the Board?
– No!!: Corp. Codes State that Board Has Power to
Manage. Resolution must be “proper subject for action
by shareholders.” Rule 14a-8 (i)(1)
– Possible Exception: Shareholder Power to Amend Bylaws
• Solution: Make Resolutions “Precatory” : Recommend or
Request the Board Act
– Board May or May Not Comply.
– Boards Often Fail to Comply.
– If they do not? Option is to vote them out.
 Special Case: Bylaw
Amendments
• Common Practice: Shareholders Amend and Boards Amend
Bylaws, Unless Charter Reserves Power to Shareholders.
MBCA § 10.20 (Opt-Out).
– But Del.§ 109(a) & Ohio §.11 (Regulations): Board Power to Amend
Must Be in Charter (Opt-In). Good Practice is to Include the Power in
Ohio.
• Can Shareholders Therefore Amend Bylaws with a Rule 14a-
8 Resolution, Making It Binding?
– In Delaware issue is scope of shareholder power. Shareholders do not
have power to manage; directors do. Shareholders can change voting
or decision procedures however. See CA v AFSCME (Del. 2008). See
also Del. §§112,113, & 216 (Access to Firm Proxy; Proxy Expense
Reimbursement; Majority Vote). Answer: Depends on the ByLaw.
– Note Special Limits on Shareholder Votes to Eliminate a Staggered
Board in Ohio. § .11(A)(2) (Double Majority Vote Requirement that
include a Maj. Of Disinterested).
 Shareholder Inspection
Rights
• New York Statute (§1315):
– Crane Co. v Anaconda Co.. Improper Purpose Test
Applied in Takeover exchange offer. Inspection
compelled.
– Sadler v NCR Corp. (NY Law Applies to Maryland Corp.)
Tender Offer/Proxy Contest. Bidder can Demand a Cede
and NOBO list. But N.Y. Leg. Changed Law.
• Delaware Statute (§220):
– Honeywell. Shareholder Wants to Convince Company Not
to Make Bombs. Inspection denied. More careful
argument by shareholder needed and available.
– Gillette (Del.Ch. 1988). Does Not Require a NOBO list.
 Total Effect
• Management
– Controls Proxy Materials
– Controls Nominations to Board
– Plurality Rule for Elections
– Controls Ballot Issue Initiation
• Brokers Vote for Managers If Clients Default
• Institutional Investors Usually Go with Managers
[Except Public and Union Pension Funds;
Universities??]
 Variations on Straight
Voting
• Vote Count:
– Straight v Cumulative
– Class Voting (By Seat)
– Dual Class Common Shares (Divided by Voting
Power)
• Shareholder Meeting Mechanics
– Proxy (meeting) v Written Consents (no
meeting)
– Record Dates; Notice Rules; Open Comment
Rules; Adjournments
 Terms
• Distinguish
– “Close Corporations” (or Ohio: Corporation Formed with a
“Close Corporation Agreement”)
– General Corporations, “Privately-Held” & Controlled
• Shareholders in Small Firms Want to Limit General Powers.
Options…
– Register
• Register a Close Corporation: The Default Rules Include Shareholder
Restrictions on General Powers. Other Options: Use an LLC [open to
contract] orLLP, or LP (LLLP or GP as Corp.) [default rules different].
• Voting Trusts (Must Also Register; Limited Time)
– Unregistered (Private)
• Shareholder (“Vote Pooling”) Agreements: Shareholders Can Contract to
Affect Voting and Alienation Powers
• Employment Contracts
 Shareholder Agreements v
• Trusts
Shareholders Contract Among Themselves to
– Vote as a Unit Based on Majority View (“Block” Voting)
– Buy/Sell Agreements (Redemption Rights)
– Restraints on Sale (“Right of First Refusal” in Firm; Other
Shareholders)
– Elect Stipulated Officers and Payment of Stipulated Salary and
Dividends (only if all shareholders sign) See Ohio §1701.591
(“Close Corporation Agreement”).
• Compare with a Voting Trust Agreement
– Shareholders Transfer Legal Ownership to Trust But Retain
Beneficial Ownership
– Trustee Controls Shares for Benefit of Contributing Investors
– Public Suspicion (Use by Turn of the Century Monopolists):
Statutes Require Disclosure to Public; Limits on Terms
 Ohio
• Default: Cumulative voting (§ .55)
– But: Notice 48 hours before meeting!!
• Amendment of Articles (§§ .69 & .71) to
Eliminate Cumulative Voting. Shareholder vote
required
– Private Company: Veto by Shares Sufficient to Elect One
Director (Depends on size of board)
– Public Company: 2/3 (or less, to an absolute majority, if
in the articles)
– No dissenters rights on vote
 Compare Ohio Close Corporation
Agreement
• Review Ohio § .591
– Unanimity Requirement
– Filed with state (Open to Public Inspection)
• Del.
– Not more than 30 shareholders
– Can Restrict Discretion of Board or Even
Eliminate Board (Shareholder Managed)
– Court Can Appoint Provisional Director
 Buy/Sell Agreement
• Who Holds the Option?
– Pro-Investor: Option to Sell (Put) Interest to Firm (Usually with
Heavy Conditions)
– Pro-Firm: Option to Buy (Call) Interest from Investor on
Conditions (Common/Best Practice)
• Death, Bankruptcy, Withdrawal (Attempted Transfer) or Expulsion
• Exercise Price?
– “Book Value” Penalty.
– “Liquidation Value” (Asset Sale; Neutral of Good Will)
– “Fair Vale” or “Going Concern Value Without Retiring Investor”
(Sale of Business; Includes Good Will)
• Determination? Appraiser; If Disputed: Arbitration.
Buy-Sell Agreements: Issues
• Type
– Put: Right of shareholder to sell (“cross
purchase” or “redemption” agreement)
– Call: Right of firm (other shareholders)
to buy (“one-way” and “wait and see”
agreements) Duff & Phelps
• Trigger (Contingent on…)
• Purchase Price (Disputes?)
• Source of Funds
Courts: Fiduciary Duty in Close
Corporations
• Problem: Minority Shareholders Are More
Vulnerable in Closely Held Corporations Than
in Publicly Held Corporations
– Freeze-In: Take Minority Investors Money and Return Cash
Only to Majority Shareholders
• Pay No Dividends
• Salary Only to Insiders: Family on Payroll (Exclude or Fire
Minority Investor)
• Repurchase only Family Stock
• Sweetheart Deals with Family (Suppliers/Customers)
– Freeze-Out: There is no Market in Stock, Make an Offer at a
Distress Price, No Notice of Good News. Often follows a Period
of Freeze-In Practices
 Judicial Protections
• Compare Massachusetts Practice with
Delaware Practice
• Mass: Fashion Minority Shareholder
Protections Based on an “Equal Treatment
Rule.” High Water Mark: Donahue v Rodd
Electrotype (Mass. ’75). Modified in Wilkes
v Springside, one year later.
• Del: Minority Shareholder Gets What it
Bargained For on Purchase: Nixon v
Blackwell (Del. ’93)
 “Fundamental Changes”
• Amend the Charter (Certificate of
Incorporation)
• Dissolve the Corporation
• Acquisitions
– Merger the Corporation With Another
• Survives/Does not Survive
– Sell “Substantially All” the Assets
• New: “Domestication and
Conversion”
 Definition
• Change (or Potential Change) in the Charter
– Direct: Amendment Procedure
– Ancillary: Merger Statute
• Require Shareholder Ratification (Review)
– State Law on Voting: Notice; Record Date
– Federal Law on Proxy Solicitation
• If Publicly Traded: Proxy Statement; Proxy Card
 Direct Amendments to the
Charter
• Examples:
– Trivial: Name, Registered Agent
– Significant: Stock Designations; Stock Authorization;
Staggered Board; Right to Amend By-Laws; Right to Use
Consent Solicitation Procedure; Liability Waiver; Eliminate
Cumulative Voting
• Procedure: Ohio §§1701.69 to 74 (.71 on Amendments by
Shareholders)
– 2/3rds default (opt in: absolute maj.) Note Class Voting
– Eliminate Staggered Bd.: Two maj. (open maj. plus maj. of
disinterested shareholders)
– Eliminate Cumulative Voting: Supermaj.
– Limited Dissenter’s Appraisal Rights Under §.74 (excludes
cumulative voting amendments)
 Dissolution
• Procedure Ohio §§ 1701.86 to 91
– Voluntary: Shareholder Ratification Procedure, 2/3rds (opt in, less than
maj.vote)
– Judicial: Grounds , .91, “oppression” missing in Ohio
• Problem: Effect on Unpaid Creditors §§ .87 &
– Known: Notice, Right to Sue Remains
• For Two Years: Directors personally liable to firm for distributions to
shareholders without payment of known obligations (§.95(A)(1)(b)) and
shareholders are liable to firm for restitution of illegal distributions (§.95(D))
• Creditors Can Chase Distributions In Hands of Shareholders§.95(G)
– UnKnown: Notice by Publication, “Claim Existing”??
• Follow distributed assets into hands of shareholders (all shareholders are
necessary parties).
– Safe Harbor in .89: Judicial winding up.
 Judicial Dissolution
• Private Suits to Dissolve Company. Use by Minority
Shareholders to Stop Abuse. Freeze-In; Freeze-Out
• Grounds?
– Ohio §.91 Narrow. Term Expired; Insolvent; “Objects… Failed…
Abandoned or …Impracticable” [No Close Corp. Prov.]
• Maj. Shareholder (opt in, less) : “Beneficial to Shareholders”
• Maj. Board : Deadlocked Directors or Shareholders
– Compare with
• Alaska: When acts of those in control are “illegal, oppressive, or
fraudulent” Coppuck (also N.Y. Va etc)
• North Carolina and California: “reasonably necessary for the
protection of …complaining shareholder” Meiselman (N.C.) and
Stuparich (Cal.) Close Corp. Statute Cal § 1800 (35 or less)