Outline

BA II Outline
Tyler Tarney | Wood

I. Limited Liability Companies_________________________________________________________

A. Generally
Benefits Limited liability for all obligations of the venture, even if members participate in the control of the business Flow through tax treatment Freedom to contractually arrange the internal operations of the business though the operating agreement Can have only one member, foreign ownership, more than 100 members, and more than one class of stock Members make subsequent contributions in order to raise more capital for the LLC

B. Analysis
ULLCA is the law of our jurisdiction Formation Two documents 1. Articles of organization - filed with Secretary of State and serves as public notice 101(1) 2. Operating agreement (most important) 101(13) 103 - Effect of Operating Agreement (a) Need not be in writing, unless otherwise stated this act governs 103(b) lists non-waiveable provisions in the operating agreement Organization 202(a) - May be created by just one person 203(c)(1) - Internally operating agreement prevails, externally the articles of organization prevail Contribution 401. FORM OF CONTRIBUTION. A contribution of a member of a limited liability company may consist of tangible or intangible property or other benefit to the company, including money, promissory notes, services performed, or other agreements to contribute cash or property, or contracts for services to be performed. Describes how one becomes a member/owner Management The choice between member-managed and manager managed is required to be in the articles of organization 404. MANAGEMENT OF LIMITED LIABILITY COMPANY. (a) In a member-managed company: (1) each member has equal rights in the management and conduct of the company's business; and Voting is per capita in a member-managed company with majority decision Many states use a per capita method to determine rights to management In a member managed firm, 404(a)(1) requires only a majority of the members See page 119 problem (2) except as otherwise provided in subsection (c), any matter relating to the business of the company may be decided by a majority of the members. (b) In a manager-managed company: (1) each manager has equal rights in the management and conduct of the company's business; Voting in per capita with majority decision, but voting only applies to managers (2) except as otherwise provided in subsection (c), any matter relating to the business of the company may be exclusively decided by the manager or, if there is more than one manager, by a majority of the managers; and (3) a manager: (i) must be designated, appointed, elected, removed, or replaced by a vote, approval, or consent of a majority of the members; and (ii) holds office until a successor has been elected and qualified, unless the manager sooner resigns or is removed. (c) The only matters of a member or manager-managed company's business requiring the consent of all of the members are: (1) the amendment of the operating agreement under Section 103; (2) the authorization or ratification of acts or transactions under Section 103(b)(2)(ii) which would otherwise violate the duty of loyalty; (3) an amendment to the articles of organization under Section 204; (4) the compromise of an obligation to make a contribution under Section 402(b); (5) the compromise, as among members, of an obligation of a member to make a contribution or return money or other property paid or distributed in violation of this [Act]; (6) the making of interim distributions under Section 405(a), including the redemption of an interest; (7) the admission of a new member; (8) the use of the company's property to redeem an interest subject to a charging order; (9) the consent to dissolve the company under Section 801(b)(2); (10) a waiver of the right to have the company's business wound up and the company terminated under Section 802(b); (11) the consent of members to merge with another entity under Section 904(c)(1); and (12) the sale, lease, exchange, or other disposal of all, or substantially all, of the company's property with or without goodwill. (d) Action requiring the consent of members or managers under this [Act] may be taken without a meeting. (e) A member or manager may appoint a proxy to vote or otherwise act for the member or manager by signing an appointment instrument,

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(e) A member or manager may appoint a proxy to vote or otherwise act for the member or manager by signing an appointment instrument, either personally or by the member's or manager's attorney-in-fact. Authority Examples Taghipour v. Jerez - Taghipour, Rahemi, and Jerez formed an LLC and the articles of organization designated Jerez as the LLC's manager. The operating agreement prevented him from entering into loans. Without verifying his authority, Mt. Olympus entered into a loan with Jerez. They knew he was manager but didn't know he lacked authority. He absconded the money without knowledge by the others and they went into default. As a manager, did Jerez have authority to make the loan on behalf of the LLC without knowledge of the other members and contrary to the operating agreement? 301(c), 301(b)(1) 301. AGENCY OF MEMBERS AND MANAGERS. 301(a) - apparent authority of members in member-managed LLC 301(b) - apparent authority of managers in manager-managed LLC Taghipour - Operating agreement said "no loans may be contracted on behalf of the LLC unless authorized by a resolution of the members" Taghipour - The lack of authority was contained in the operating agreement, rather than the articles of organization In member-managed LLC, manager is an agent and can transfer real property unless power is limited by articles of organization In a manager-managed LLC, manager is an agent and can transfer real property unless power is limited by articles of organization 301(c) The instrument is conclusive in favor of a person who gives value without knowledge of the lack of authority of the person signing and delivering the instrument Taghipour - the restriction was in the operating of agreement rather than the articles of organization Inspection and information Examples Kasten v. Doral Dental USA, LLC - LLC created for creating and administering dental programs. During negotiations Marie made numerous requests to check the books, but only some were granted. The LLC was subsequently sold for $95 million. The operating agreement permitted inspection of company documents. Sought to compel production of emails, drafts of documents, etc. Does an LLC's member's rights of inspection extend to the right to inspect emails and document drafts? SECTION 408. MEMBER'S RIGHT TO INFORMATION. (a) A limited liability company shall provide members and their agents and attorneys access to its records, if any, at the company's principal office or other reasonable locations specified in the operating agreement. The company shall provide former members and their agents and attorneys access for proper purposes to records pertaining to the period during which they were members. The right of access provides the opportunity to inspect and copy records during ordinary business hours. The company may impose a reasonable charge, limited to the costs of labor and material, for copies of records furnished. While the ULLCA was not applied in the case, Kasten did have a reasonableness requirement like 408(b)(2) (get (b)(2)?) Kasten considered whether an email was a "record," and determined that an email is a record if it relates to the business of the LLC Kasten said "upon reasonable request" is to protect the company from member inspection requests that impose undue burden on the company. The court must consider the following factors: 1. Whether the request is restricted by date or subject matter 2. The reason given (if any) for the request, and whether the request is related to that reason Look at the connection 3. The importance of the information to the member's interest in the company, and 4. Whether the information may be obtained from another source

Formation
A. Generally

CORPORATIONS _________________________________________________________

Two basic types of corporations 1. Closely-held corporations (7.32) 7.32(a)(1) - allows a corporation to eliminate board of directors in certain instances (aka treated like a partnership) 2. Publicly traded corporations (1.40 (18(a))

B. Formation of a Closely Held Corporation

7.32(a)(1) - Shareholders can agree to eliminate the board of directors 2.02 - Articles of Incorporation Articles of incorporation must set forth: 1. A corporate name for the corporation that satisfies the requirements of section 4.01 4.01 a. Corporate name must contain the words: corporation, incorporated, company, or limited, or their abbreviations b. A corporate name must be distinguished upon the records of the secretary of state 2. The number of shares the corporation is authorized to issue (2.02(a)(2) 3. Corporation's registered address; and 4. Incorporator's address 4.01 - Name 3.02 - Powers and duration - MBCA assumes perpetual duration, but permits limitations on duration 3.01 - Purpose - of engage in any lawful business (may be limited) Minutes - Record used to reference how a decision has been made Board of directors in a closely held corporation 1. General Powers. The business and affairs of the corporation shall be managed by its board of directors. 8.01
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3. 4. 5. 6.

7. 8.

9.

10.

8.01 Unless under 7.32 you eliminate the board and comply with the requirements Number, Tenure, and Qualifications - 1.43 Number - 8.03(a) - Board must consist of one or more individuals OH requires 3, unless the number of shareholders is fewer Regular Meetings - 8.20 Special Meetings- 8.20 Notice - unless proscribed otherwise, special meetings must be preceded by at least two days notice of the date, time, and place- 8.22(b) Quorum for board of directors - 8.24 Default is 1/2 of the directors - (a)(1) Cannot be less than 1/3 - (a)(2) Other quorums are required for different groups other than the board of directors Board decisions - 8.24(c) - "A majority of those present" Vacancies - 8.10 Vacancy on Board (a)(3) - if the directors remaining in office constitute fewer than a quorum of the board, they may fill the vacancy if it is filled by the shareholders, and only the directors elected by that voting group are entitled to fill the vacancy if it is filled by the directors Compensation - 3.02(11), 801(b) 3.02(11) - to elect directors and appoint officers, employees, and agents of the corporation, define their duties,, fix their compensation, and lend them money and credit 8.01(b) Presumption of Assent - 8.24(d) - "a director present at a meeting of the board of directors . . .is deemed to have assented to the action" unless an exception exists

C. Ultra Vires
3.04 - Ultra Vires (a) Except as provided in subsection (b), the validity of corporation action may not be challenged on the ground that the corporation lacks or lacked power to act (b) A corporation's power to act may be challenged: (1) In a proceeding by a shareholder against the corporation to enjoin the act; Strong power, but subject to limitations in (c) (2) in a proceeding by the corporation, directly, derivatively, or through a receiver, trustee, or other legal representative, against an incumbent or former director, employee, or agent of the corporation; or A corporation may pursue a wrongful action against officers Actions by shareholder may fall under here if acting as an agent of the corporation (3) in a proceeding by the attorney general under section 14.30 (c) In a shareholder's proceeding under subsection (b)(1) to enjoin an unauthorized corporate act, the court may enjoin or set aside the act, if equitable and if all affected persons are parties to the proceeding, and may award damages for loss (other than anticipated profits) suffered by the corporation or another party because of enjoining the unauthorized act The Comment to 3.04 states that an injunction is equitable only if the third party knew about the corporate incapacity. "if equitable" (clean hands) "[U]ltra vires may not be invoked as a sword in support of a cause of action any more than it can be utilized as a defense" 711 Kings Highway Corp v. F.I.M.'s Marine Repair Serv., Inc. - D entered into a contract that called for a 15 year lease of premises which were to be used as a movie theater, however a corporation was formed to marine activities. P alleges K is invalid. If corporation enlists a shareholder to bring an action on its behalf, then shareholder is an agent and action is a 3.04(b)(2) action (which does not permit an injunction)

D. Premature Commencement of Business

Incorporators/Promoters 2.01 - One or more persons may act as the incorporator or incorporators of a corporation by delivering articles of incorporation to the secretary of state for filing 2.02(a)(4) - Name of each incorporator must be in the articles of incorporation An incorporator owes a fiduciary duty to prospective members to disclose material information. Must faithfully make known all facts what might have influenced prospective members in determining whether to pursue memberships Duty to refrain from misrepresenting material facts Duty to make known any personal interest the D's had in any transaction relating to the corporation Defective incorporation Examples Robertson v. Levy - Robertson and Levy entered into an agreement where Levy was to form a corporation which was to purchase Robertson's business. Levy submitted the articles of incorporation, the articles were rejected, but Levy began to operate it. Just prior to when the certificate of incorporation was issued, Robertson sold his business to the corporation receiving a note for installment payments. One payment was made after the certificate of incorporation was issued. Can the president of an association which filed its articles of incorporation, which were first rejected but later accepted, can be held personally liable on an obligation entered into by the association before the certificate of incorporation had been issued? Cranson v. International Business Machines Corp. - Cranson was not personally liable for the debts of his defectively incorporated association, the Real Estate Burea. He had agreed to invest in the Bureau and to become an officer and a director of the new company. Cranson and others hired a lawyer to incorporate but there was a defective filing. Cranson paid for and received stock, set up bank accounts, and maintained corporate records. It incurred a debt to IBM. "knowing there was no incorporation" - not jointly and severally liable under 2.04 In Cranson, the court found a corporation by estoppel because IBM dealt with the Bureau as if it were a corporation and relied on its credit rather than that of Cranson, it was "estopped to deny the corporate existence of the Bureau."

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on its credit rather than that of Cranson, it was "estopped to deny the corporate existence of the Bureau." Frontier Refining Company v. Kunkel's, Inc. - P is suing D for over $6,000 in gas. Kunkle went to Fairfield for a loan. Fairfield objected but did talk with Kunkle about the formation of a corporation. Kunkle was to start it and Fairfield and Beach would purchase it from Griffit (the previous owner of the lease). There is conflicting testimony regarding an alleged conversation between Fairfield and Frontier. A financial statement was obtained from Kunkel, but not from Fairfield or Beach. Frontier then entered into an agreement with "CLIFFORD D. KUNKEL DBA KUNKEL'S INC." Soon after, Kunkel took over and started doing business. Fairfield and Beach invested $11k after Kunkle started doing business. Individual liability could not be imposed upon Fairfield and Beach because they were creditors, not partners. They didn't know that Kunkel had failed to incorporate. "Frontier with full knowledge that a corporation had not yet been formed chose to transact its business with Kunkel as an individual" Frontier was content to look only to Kunkel for performance of its agreements In Frontier, the court said "[n]either Fairfield nor Beach, expressly or impliedly, authorized Kunkel to make such representations or to enter into contracts with Frontier in the name of 'Kunkel's, Inc.'" 2.04 - Liability for Preincorporation transactions All persons purporting to act as or on behalf of a corporation, knowing there was no incorporation under this Act, are jointly and severally liable for all liabilities created while so acting "Purporting to act" Solely contributing money is not purporting to act (Frontier) The court in Robertson said "[t]he corporation comes into existence only when the certificate has been issued." The comments provide for three exceptions Estoppel exception where a third person knows that no corporation has been formed, but insists that his contract be immediately entered into in the name of the corporation (Quaker Hill) Exception where a transaction is entered into after the articles have been mailed or delivered to the filing office but have not been received in the filing office through no fault of the filer Exception where a corporate organizer enters into a transaction in the name of the corporation when he reasonably and honestly believes that articles have been filed but they have not been due to attorney neglect or other cause

Disregard of the Corporate Entity

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Generally Identify a coherent set of factors that every court thinks is important in deciding whether to disregard the corporate entity (test comes from Radaszewski) The fact that a corporation is created for limited liability is not, in and of itself, unfair Examples Baatz v. Arrow Bar - Baatz alleges hat Arrow Bar served alcoholic beverages to McBride prior to an accident while he was already intoxicated. A couple owned the corporation and financed it on a loan in which they personally guaranteed => What counts as capitalization? Bartle v. Home Owners Co-OP - bankruptcy trustee trying to hold D corporation liable for the debts of its subsidiary corporation The law permits the incorporation of a business for the very purpose of escaping personal liability when there is no evidence of fraud, misrepresentation, nor illegality; Dissent - not a piercing case, the subsidiary is the agent. DeWitt Truck Brokers v. W. Ray Flemming Fruit Co. - corporation sold produce as agent for growers Fletcher v. Atex, Inc. - Kodak's subsidiary, Atex, is being sued over keyboards it manufactured Radaszewski v. Telecom Corp. - man seriously injured in car accident, struck by a car driven by an employee of Contrux, with Telecom as the parent company Telecom wanted to reduce the influence of the Teamsters unit in their business so they created a subsidiary, and they obtained insurance. The insurance agent was another subsidiary of Telecom and had gone bankrupt. Analysis The issue is whether the court should disregard the corporate entity and hold the stockholder personally liable for the debts of the corporation Disregard of the corporate entity involves the question whether a specific shareholder is personally liable for a specific corporate obligation Corporation being formed is not, of itself, unfair 6.22 - Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except by reason of his own conduct In determining whether there was "disregard of the corporate entity," one must show ( Radaszewski and OH) 1. Control, not mere majority or complete stock control, but complete domination, not only of finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction had at the time no separate mind, will or existence of its own; and "Complete domination" As shown in Fletcher v. Atex, "complete domination" can be shown if the parent corporation and the subsidiary "operated as a single economic entity." In the case, a cash management system did not show siphoning of funds when "a strict accounting [was] kept of each subsidiary's funds," and was "a function of administrative convenience." Exertion of control over major expenditures or interlocking directors does not meet the standard. Failure to observe corporate formalities weighs toward control,, but Dewitt shows this factor may be given little weight The court may consider if dividends were paid, corporate records kept, officers and directors functioned properly, board held meetings and minutes were kept, stock records Areas of control may be justified Parent and corporation must be reported on the same tax return (but a charge is usually imposed) Legal services; central financing of capital improvements; transferring employees from one subsidiary to another or to or from the parent "in connection with the transaction attacked" - the P must show "complete domination" over the transaction in question
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 "in connection with the transaction attacked" - the P must show "complete domination" over the transaction in question 2. Such control must have been used by the defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or dishonest and unjust act in contravention of plaintiff's legal rights; and Undercapitalization is the most important factor in determining if control was used to commit a wrong To be adequately capitalized, a corporation must have enough unencumbered assets to meet reasonably expected debts of the corporation As discussed in DeWitt, "[t]he obligation to provide adequate capital begins with incorporation and is a continuing obligation thereafter" Loans are not contributions because the debt is encumbered Non payment of dividends In Dewitt, the court said "[n]o stockholder or officer of the corporation . . . received any salary, dividend, or fee from the corporation. The dissent in Bartle noted there was no way the business could profit b/c the setup didn't offer dividends, and the benefits that would otherwise inure to the corporation would go to the parent corporation Siphoning of funds In DeWitt, the D "was withdrawing funds from the corporation at the rate of $15,000 per year." If the claim is tort, Baatz shows liability insurance is a contribution when the insurance will cover the type of claim and the insurance is sufficient As shown in the case, meeting the statutory minimum standards for insurance shows adequate capitalization with respect to claims on that insurance. Undercapitalization provides an inference that the parent either deliberately or recklessly created a business that will not be able to pay its bills or satisfy judgments against it 3. Control and breach of duty must proximately cause the injury or unjust loss complained of. Injury is damages that go unpaid.

Financial Matters and the Corporation______

A. Debt and Equity Capital

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Generally Types of shares Authorized - the maximum number of shares a corporation may issue in any class or series Issued - the corporation itself has traded the shares in exchange for value Outstanding - shares that have been authorized, issued, and remain in the hands of shareholders Treasury shares - shares that have been authorized, issued, and repurchased by the corporation Conversion rights may allow a preferred stockholder to convert preferred shares into common shares Par Value and stated capital Par value - provides a fund for paying creditors at issuance (outdated) Stated capital - amount not distributable, reserved for debtors Par stock has automatic stated capital calculated by the number or shares times the stated par value OH offers low value par or no par. If stating par is necessary, par should be stated as low as possible. In the secondary market, par value is meaningless Debt and Equity considerations Taxes - "S" corp. status, taxable income, taxable income Piercing - undercapitalizing with debt rather than equity "deep rock" Risk - what level of risk is client willing to take, whether client desires an income stream Examples Hanewald v. Bryan's Inc. - retail store issued 100 shares of stock at $1000 par value per share and issued shares for no consideration => stated capital $100k => liable for the amount they said they had contributed Page 301(1) - see the question, too long to write out 1.40(22) - "Shares" means the units in which the proprietary interest of the corporation are divided 2.02(b)(2)(iv) - Par value is optional [par value is value stock cannot be issued below] Par value only applies to the original issue of stock, not the secondary market ( Torres) 6.01 - Authorized Shares (a) The articles of incorporation must set forth any classes of shares and series of shares within a class, and the number of shares of each class and series, that the corporation is authorized to issue. If more than one class or series of shares is authorized, the articles of incorporation must prescribe a distinguishing designation for each class or series and must describe, prior to the issuance of shares of a class or series, the terms, including the preferences, rights, and limitations, of that class or series. Except to the extent varied as permitted by this section, all shares of a class or series must have terms, including preferences, rights and limitations, that are identical with those of other shares of the same class or series (b) The articles of incorporation must authorize: (1) one or more classes of shares that together have unlimited voting rights, and Voting on board of directors, bylaws (2) one or more classes of share (which may be the same class or classes as those with voting rights) that together are entitled to receive the net assets of the corporation upon dissolution Preferred shareholders often have preferred status in liquidation Residual claimants get what is left of a corporation after the debts of the corporation have been paid (c) The articles of incorporation may authorize one or more classes or series of shares that: (1) have special, conditional, or limited voting rights, or no right to vote, except to the extent otherwise provided by this Act; (2) are redeemable or convertible as specied in the articles of incorporation: (i) at the option of the corporation, the shareholder, or another person or upon the occurrence of a specied event;
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(i) at the option of the corporation, the shareholder, or another person or upon the occurrence of a specied event; (ii) for cash, indebtedness, securities, or other property; and (iii) at prices and in amounts specied, or determined in accordance with a formula; (3) entitle the holders to distributions calculated in any manner, including dividends that may be cumulative, noncumulative, or partially cumulative; or (4) have preference over any other class or series of shares with respect to distributions, including distributions upon the dissolution of the corporation 6.21 - Issuance of Shares (After incorporation) (a) The powers granted in this section to the board of directors may be reserved to the shareholders by the articles of incorporation. (b) The board of directors may authorize shares to be issued for consideration consisting of any tangible or intangible property or benet to the corporation, including cash, promissory notes, services performed, contracts for services to be performed, or other securities of the corporation. Shares can be issued for future services Identical shares can be issued for different prices However, in OH, ORC 17.01.18(b)(c) provides that promissory notes and future service contracts are not permitted for consideration (c) Before the corporation issues shares, the board of directors must determine that the consideration received or to be received for shares to be issued is adequate. That determination by the board of directors is conclusive insofar as the adequacy of consideration for the issuance of shares relates to whether the shares are validly issued, fully paid, and nonassessable. This section leaves open an opportunity for shareholders to contest inadequacy of consideration, fraud, or breach of fiduciary duty 6.22 - Liability of Shareholders (a) A purchaser from a corporation of its own shares is not liable to the corporation or its creditors with respect to the shares except to pay the consideration for which the shares were authorized to be issued (section 6.21) or speci ed in the subscription agreement (section 6.20). Hanewald shows that a shareholder's loan is a debt not an asset of the corporation (b) Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct In Hanewald, K & J issued 100 shares at $1000/share and did not pay. K & J was liable to corporation creditors to pay for the shares issued.

B. Issuance of Shares by a Going Concern: Preemptive Rights, Dilution, and Recapitalizations

Preemptive Rights Examples Stokes v. Continental Trust Co. of City of New York - Stockholder has a 4.42% interest and wants to maintain proportionality after a transaction to issue twice as much stock. He wants to protect his voting power and equity/distributions. "[T]he power of the individual stockholder to vote in proportion to the number of his shares is vital, and cannot be cut off or curtailed by the action of all the other stockholders, even with the cooperation of the directors and officers." The court in Stokes stated "a stockholder has an inherent right to a proportionate share of new stock issued for money only . . . and while he can waive that right, he cannot be deprived of it without his consent except when the stock is issued at a fixed price not less than par and he is given the right to take at that price in proportion to his holding, or in some other equitable way that will enable him to protect his interest by acting on his own judgment and using his own resources." Katzowitz v. Sidler - P and D's owed several corporations. Corporation held by P and D's owed each $2500. D's wanted to invest money in other corporations, P objected. In order to freeze P out, the D's sold stock at 1/18th of its book value which caused an immediate dilution of the book value of the outstanding securities. Was the sale of stock in violation of P's preemptive rights? Book value is a corporation's liquidation value, and does not take into account going concern. Lacos - D was officer, director, and shareholder. Although already majority shareholder, D pushed to introduce a new class of stock with 10x voting rights for more control. In his role as officer/director he made a threat that he would not give his support to future transactions => b/c of the breach, the vote to recapitalization was void Preemptive rights apply to shares that are authorized, but not yet issued. Policy - Provides proportionality in voting and distributions by preserving a stockholder's percentage ownership in the corporation 6.30. SHAREHOLDERS PREEMPTIVE RIGHTS (a) The shareholders of a corporation do not have a preemptive right to acquire the corporations unissued shares except to the extent the articles of incorporation so provide. "opt in" clause - no right unless granted by articles of incorporation (b) A statement included in the articles of incorporation that the corporation elects to have preemptive rights (or words of similar import) means that the following principles apply except to the extent the articles of incorporation expressly provide otherwise: (1) The shareholders of the corporation have a preemptive right, granted on uniform terms and conditions prescribed by the board of directors to provide a fair and reasonable opportunity to exercise the right, to acquire proportional amounts of the corporations unissued shares upon the decision of the board of directors to issue them. As shown in Stokes, if a corporation has preemptive rights, a shareholder has the right to preserve their % share in the corporation, rather than the number of shares Even if offered, preemptive rights may be insufficient if, as shown in Kasowitz: The issue price is markedly below book/fair value; and Remaining shareholders directorly benefit from the issuance In Katzowitz, shares were offered at $100/share and book value was $1800/share "The corollary of a stockholder's right to maintain his proportionate equity in a corporation by purchasing additional shares is the right not to purchase additional shares without being confronted with dilution of his existing equity if no valid business justification exists for the dilution." (2) A shareholder may waive his preemptive right. A waiver evidenced by a writing is irrevocable even though it is not supported by consideration. (3) There is no preemptive right with respect to: (i) shares issued as compensation to directors, officers, agents, or employees of the corporation, its subsidiaries or affiliates: (ii) shares issued to satisfy conversion or option rights created to provide compensation to directors, officers, agents, or employees of the corporation, its subsidiaries or affiliates;

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employees of the corporation, its subsidiaries or affiliates; (iii) shares authorized in articles of incorporation that are issued within six months from the effective date of incorporation; (iv) shares sold otherwise than for money. (4) Holders of shares of any class without general voting rights but with preferential rights to distributions or assets have no preemptive rights with respect to shares of any class. (5) Holders of shares of any class with general voting rights but without preferential rights to distributions or assets have no preemptive rights with respect to shares of any class with preferential rights to distributions or assets unless the shares with preferential rights are convertible into or carry a right to subscribe for or acquire shares without preferential rights. (6) Shares subject to preemptive rights that are not acquired by shareholders may be issued to any person for a period of one year after being offered to shareholders at a consideration set by the board of directors that is not lower than the consideration set for the exercise of preemptive rights. An offer at a lower consideration or after the expiration of one year is subject to the shareholders preemptive rights. (c) For purposes of this section, shares includes a security convertible into or carrying a right to subscribe for or acquire shares Recapitalization Recapitalization involves changing the stock structure of a corporation. Shareholders do not owe a fiduciary duty to the corporation, but directors and officers do. In recapitalization, Lacos shows directors owe a duty of loyalty to the corporation and must act in the best interest of the corporation even if that means acting against his personal interests. Distributions by a Closely Held Corporation Generally Distributions only concern the "original issue" Dividend rights can be cumulative, noncumulative, or partially cumulative Cumulative dividends ensure payment of proffered dividends before distributions are made to common shareholders A noncumulative dividend is not carried over from one year to the next. If no dividend is issued, the preferred shareholder loses the right to that dividend A partially cumulative dividend typically is cumulative to the extent there are earnings in the year, and noncumulative with respect to any excess dividend preference Corporate benefits/distributions must be provided to shareholders, rather than society at large. Dodge v. Ford Motor Co. - Ford had its best year ever with an expected profit of $60 million and shareholders wanted dividends, but Henry Ford wanted a quasi-charitable organization and to use the surplus to sell cheaper cars Dividends may be disguised in the form of salary in order to exclude it from the corporation's taxable income. As shown in Wilderman, when considering whether a salary payment is reasonable, the court may consider (1) whether the salary bears a reasonable relation to the success of the corporation, (2) the amount previously received as salary, (3) whether increases in salary are geared to increases in the value of services rendered, and (4) the amount of the challenged salary compared to other salaries paid by the employer The remedy for a breach is repayment back to corporation Wilderman v. Wilderman - D and P each half shareholders in corporation before they divorced. D does most of the labor and P does the bookkeeping. After the divorce D greatly increased his salary and kept P's the same Examples Gottfried v. Gottfried - P own common stock and haven't been paid dividend in 14 years. Closely held corporation w/ no market for this stock. Dividends had been paid on the other classes of stock. P's allege "bitter animosity." Can shareholders compel a board of directors to issue a dividend on common stock? 1.40(6) - Distribution means a direct or indirect transfer of money or other property (except its own shares) or incurrence of inde btedness by a corporation to or for the benefit of its shareholders in respect of any of its shares. A distribution may be in the form of a declaration or payment of a dividend; a purchase, redemption, or other acquisition of shares; a distribution of indebtedness; or otherwise. Note - Proportionate redemption of outstanding shares is a distribution ( Gottfried) 6.40. DISTRIBUTIONS TO SHAREHOLDERS (a) A board of directors may authorize and the corporation may make distributions to its shareholders subject to restriction by the articles of incorporation and the limitation in subsection (c). Ability to make a distribution is not tied to earnings (b) If the board of directors does not x the record date for determining shareholders entitled to a distribution (other than one involving a purchase, redemption, or other acquisition of the corporations shares), it is the date the board of directors authorizes the distribution. (restrictions on distributions that always apply) (c) No distribution may be made if, after giving it effect: (1) the corporation would not be able to pay its debts as they become due in the usual course of business; or The "equity/insolvency test" determines whether a corporation can pay its debts as they become due. (2) the corporations total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise) the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution The "balance sheet/insolvency test" guarantees those with superior rights will receive their distributions before holders of common stock. To compel a dividend, P must show dividend was withheld in bad faith Evidence of bad faith can be shown by considering: Employment from company (if shareholder is excluded from employment) Compensation equity (if some have high compensation) Loans (if some receive loans, or loans with favorable terms) Freeze-out (if someone is pushed out of the corporation for insufficient consideration) Redemptions Generally

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 Generally A redemption is a purchase by the corporation and is a type of distribution. The rules for redemptions require compliance with the rules for distributions. If a corporation redeems stock in the hands of its shareholders it is a redemption. Proportionate redemption of outstanding shares is a distribution (Gottfried) Generally, shareholders do not owe a fiduciary duty to other shareholders. There is an exception for non-public corporations when there is a shareholder agreement under 7.32(a)(1) that eliminates the board of directors or restricts the discretion or powers of the board of directors. 1.40(18A) defines "public corporation" as "a corporation that has shares listed on a national securities exchange or regularly traded in a market maintained by one or more members of a national securities association." If a majority of shareholders take control of a non-public corporation, the director's fiduciary duty shifts and majority shareholder has a fiduciary duty to the minority shareholder Meinhard shows that once a fiduciary duty attaches "[n]ot honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior." Donahue v. Rodd shows the controlling stockholders must offer each stockholder an equal opportunity to sell a ratable number of his shares to the corporation at an identical price "If the close corporation purchases shares only from a member of the controlling group, the controlling stockholder can convert his shares into cash at a time when none of the other stockholders can," thereby operating "as a preferential distribution of assets." Donahue v. Rodd Electrotype - (Wood loves this case) P's husband and Harry Rodd became owners of Rodd Electrotype after it split off from its parent company. Rodd owned 80% of the stock and P owned 20%, and before Harry Rodd transferred management and stock to his sons. P was unaware of the transfer and a few weeks later tried to sell their shares for the same price received by Harry Rodd. Once this breach is found, the remedy is repayment to the corporation.

Management and Control of the Corporation___________________________________________________

Generally MBCA Chapter 8 addresses directors and officers 7.32 - shareholder agreements in closely held corporations (OH 17.08(591)), and does not cut off until the corporation becomes public (7.32(d) Traditional Roles of Shareholders and Directors - (historical development of the general rule) McQuade v. Stoneham - P was treasurer of the Giants and D was the president. P was removed as treasurer despite an agreement for D to use his best efforts to keep him as treasurer. Generally the duty of directors runs to the corporation and not to the shareholders. A contract is illegal and void so far as it precludes the board of directors, at the risk of incurring legal liability, from changing officers, salaries, or policies, ore retaining individuals in office, except by consent of the consenting parties Clark v. Dodge - written agreement where it was agreed that P would continue to manage and in connection would disclose a secret formula to Doge's son that was necessary for the successful operation of the business was NOT not illegal against public policy Where the directors are the sole stockholders, there seems to be no objection to enforcing an agreement among them to vote for certain people as officers; there was no injury suffered by or threatened to any party Galler v. Galler - shareholders made internal agreement with specific instructions addressing who was to manage the corporation Upheld - (1) no apparent public injury, (2) no objecting minority interest, (3) no apparent prejudice to creditors Court examined the duration (now in 7.32(d) and default of 10 yrs) - operative while parties are living, purpose - salary continuation MBCA Chapter 8 - Directors Starting point: 8.01. You can have an exception to 8.01, if you follow the requirements of 7.32. 8.05 - Terms of directors generally 8.08 - Removal of directors by shareholders and whether there needs to be cause for removal (internal) 8.09 - Removal of directors in a judicial proceeding (external) 8.33 - Directors Liability for Unlawful distribution, then go to 6.40, so 6.40 and 8.33 require reference to each other 8.40 - Officers MBCA Chapter 7 - Shareholders 7.07 - Record date for shareholders 7.22 - Proxies 7.23 - Nominees Board of Directors Under 8.01(a), "except as provided in section 7.32, each corporation must have a board of directors. The general rule is that directors owe a fiduciary duty to the corporation 8.40. OFFICERS (a) A corporation has the ofcers described in its bylaws or appointed by the board of directors in accordance with the bylaws. (b) The board of directors may elect individuals to ll one or more ofces of the corporation. An ofcer may appoint one or more ofcers if authorized by the bylaws or the board of directors. (c) The bylaws or the board of directors shall assign to one of the ofcers responsibility for preparing the minutes of the directors and shareholders meetings and for maintaining and authenticating the records of the corporation required to be kept under sectio ns 16.01(a) and 16.01(e). (d) The same individual may simultaneously hold more than one ofce in a corporation. 8.08. REMOVAL OF DIRECTORS BY SHAREHOLDERS (a) The shareholders may remove one or more directors with or without cause unless the articles of incorporation provide that directors may be removed only for cause. Under 8.09(a)(1), cause may be found if the director engaged in fraudulent conduct with respect to the corporation or its shareholders, grossly abused the position of director, or intentionally inicted harm on the corporation. (b) If a director is elected by a voting group of shareholders, only the shareholders of that voting group may participate in the vote to remove him.
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(b) If a director is elected by a voting group of shareholders, only the shareholders of that voting group may participate in the vote to remove him. (c) If cumulative voting is authorized, a director may not be removed if the number of votes sufficient to elect him under cumulative voting is voted against his removal. If cumulative voting is not authorized, a director may be removed only if the number of votes cast to remove him exceeds the number of votes cast not to remove him. (d) A director may be removed by the shareholders only at a meeting called for the purpose of removing him and the meeting notice must state that the purpose, or one of the purposes, of the meeting is removal of the director 8.09. REMOVAL OF DIRECTORS BY JUDICIAL PROCEEDING (a) The [name or describe] court of the county where a corporations principal ofce (or, if none in this state, its registered ofce) is located may remove a director of the corporation from ofce in a proceeding commenced by or in the right of the corporation if the court nds that (1) the director engaged in fraudulent conduct with respect to the corporation or its shareholders, grossly abused the position of director, or intentionally inicted harm on the corporation; and (2) considering the directors course of conduct and the inadequacy of other available remedies, removal would be in the best interest of the corporation. Removal by judicial proceeding can be simpler and less expensive than calling a shareholders meetings to remove a director (b) A shareholder proceeding on behalf of the corporation under subsection (a) shall comply with all of the requirements of sub-chapter 7D, except section 7.41(1). (c) The court, in addition to removing the director, may bar the director from reelection for a period prescribed by the court. (d) Nothing in this section limits the equitable powers of the court to order other relief Shareholder Agreements Generally Historical development of shareholder agreements Zion v. Kurtz - agreement said "no business or activities shall be conducted without the consent of a minority stockholder" and not in compliance with DE's close corporation statute. Enforceable, agreement allows nothing not permitted by statute. Not against public policy, no intervening rights of third parties, all the stockholders agreed Matter of Auer v. Dressel - bylaws obligated President to hold a special meeting upon majority stockholder request but President failed to do so Shareholders may remove director unless articles of incorporation provides otherwisestockholders cannot force a meeting if the board cannot legally do what the meeting is calling for, there must be some legal purpose for meeting If its allowed in their articles of incorporation, then shareholders can remove a director without cause. If there is a director who has violated a duty of care or a duty of loyalty, then cause for removal exists. Standard by which directors can be removed: MBCA 8.08 (internally), 8.09 (externally) Shareholders meetings: 7.01; 7.02-.05 = notification requirements for mtgs Note: Shareholders cannot elect officers 7.32. SHAREHOLDER AGREEMENTS (a) An agreement among the shareholders of a corporation that complies with this section is effective among the shareholders and the corporation even though it is inconsistent with one or more other provisions of this Act in that it: (1) eliminates the board of directors or restricts the discretion or powers of the board of directors; (2) governs the authorization or making of distributions whether or not in proportion to ownership of shares, subject to the limitations in section 6.40; (3) establishes who shall be directors or ofcers of the corporation, or their terms of ofce or manner of selection of removal; (4) governs, in general or in regard to specic matters, the exercise or division of voting power by or between the shareholders and directors or by or among any of them, including use of weighted voting rights or director proxies; (5) establishes the terms and conditions of any agreement for the transfer or use of property or the provision of services between the corporation and any shareholder, director, ofcer or employee of the corporation or among any of them; (6) transfers to one or more shareholders or other persons all or part of the authority to exercise the corporate powers or to manage the business and affairs of the corporation, including the resolution of any issue about which there exists a deadlock among directors or shareholders; (7) requires dissolution of the corporation at the request of one or more of the shareholders or upon the occurrence of a specied event or contingency; or (8) otherwise governs the exercise of the corporate powers or the management of the business and affairs of the corporation or the relationship among the shareholders, the directors and the corporation, or among any of them, and is not contrary to public policy. (b) An agreement authorized by this section shall be: (1) set forth (A) in the articles of incorporation or bylaws and approved by all persons who are shareholders at the time of the agreement or (B) in a written agreement that is signed by all persons who are shareholders at the time of the agreement and is made known to the corporation; (2) subject to amendment only by all persons who are shareholders at the time of the amendment, unless the agreement provides otherwise; and (b)(1,2) require unanimous agreement among shareholders for agreement or amendment to agreement (3) valid for 10 years, unless the agreement provides otherwise. (c) The existence of an agreement authorized by this section shall be noted conspicuously on the front or back of each certicate for outstanding shares or on the information statement required by section 6.26(b). If at the time of the agreement the corporation has shares outstanding represented by certicates, the corporation shall recall the outstanding certicates and issue substitute certicates that comply with this subsection. The failure to note the existence of the agreement on the certicate or information statement shall not affect the validity of the agreement or any action taken pursuant to it. Any purchaser of shares who, at the time of purchase, did not have knowledge of the existence of the agreement shall be entitled to rescission of the purchase. A purchaser shall be deemed to have knowledge of the existence of the agreement if its existence is noted on the certicate or information statement for the shares in compliance with this subsection and, if the shares are not represented by a certicate, the information statement is delivered to the purchaser at or prior to the time of purchase of the shares. An action to enforce the right of rescission authorized by this subsection must be commenced within the earlier of 90 days after discovery of the existence of

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enforce the right of rescission authorized by this subsection must be commenced within the earlier of 90 days after discovery of the existence of the agreement or two years after the time of purchase of the shares. Requires the existence of an agreement to be noted on each certificate (d) An agreement authorized by this section shall cease to be effective when the corporation becomes a public corporation. If the agreement ceases to be effective for any reason, the board of directors may, if the agreement is contained or referred to in the corpor ations articles of incorporation or bylaws, adopt an amendment to the articles of incorporation or bylaws, without shareholder action, to delete the agreement and any references to it. Concerns duration (e) An agreement authorized by this section that limits the discretion or powers of the board of directors shall relieve the directors of, and impose upon the person or persons in whom such discretion or powers are vested, liability for acts or omissions imposed by law on directors to the extent that the discretion or powers of the directors are limited by the agreement. Shareholder Voting and Agreements Generally Proxies Proxy - One who is authorized to act as a substitute for another; esp., in corporate law, a person who is authorized to vote another's stock shares Examples Salgo - record owner was a person different from the beneficial owner; the corporation must determine who had been authorized to vote the shares by the record owner. Registered owner - Pioneer (bankrupt), beneficial owner = Shepard (bankrupt) Protections for beneficial owners - Beneficiary can (1) order a transfer on the books to the beneficial owner, (2) have a proxy from the registered owner to the beneficial owner, (3) action 7.21. VOTING ENTITLEMENT OF SHARES (a) Except as provided in subsections (b) and (d) or unless the articles of incorporation provide otherwise, each outstanding share, regardless of class, is entitled to one vote on each matter voted on at a shareholders meeting. Only shares are entitled to vote Proxies 7.22. PROXIES - (a) A shareholder may vote his shares in person or by proxy. 7.24(a) - Corpration has to accept proxy if name signed on proxy is name of a shareholder 1.40(21) - Beneficial owner is the one with equitable title to the stock, the registered owner is the one who votes (even if in bankruptcy) 7.22(d) - proxies are revocable unless (d)(1) a pledgee (if you use stock as security) (d)(2) a person who purchased or agreed to purchase the shares (ex. If I sell you stock today but it doesn't transfer for 7 days, you could demand an irrevocable proxy to vote the shares until transferred) Proxy separates voting power from beneficial ownership 7.07. RECORD DATE (a) The bylaws may x or provide the manner of xing the record date for one or more voting groups in order to determine the shareholders entitled to notice of a shareholders meeting, to demand a special meeting, to vote, or to take any other action. If the bylaws do not x or provide for xing a record date, the board of directors of the corporation may x a future date as the record date. (b) A record date xed under this section may not be more than 70 days before the meeting or action requiring a determination of shareholders 8.04. ELECTION OF DIRECTORS BY CERTAIN CLASSES OF SHAREHOLDERS If the articles of incorporation authorize dividing the shares into classes, the articles may also authorize the election of all or a specied number of directors by the holders of one or more authorized classes of shares. A class (or classes) of shares entitled to elect one or more directors is a separate voting group for purposes of the election of directors 8.05(e) - director continues to serve until the director's successor is elected and qualifies or there is a decrease in the number of directors Cumulative vs. straight voting 7.28(b) - straight voting is default Straight Voting can cast as many votes as you have shares of stock for each director spot Advantageous for majority 7.28(b) - Corporation can opt-in to cumulative voting if stated in articles of incorporation Cumulative Voting means that the shareholders designated are entitled to multiply the number of votes they are entitled to cast by the number of directors for whom they are entitled to vote and cast the product for a single candidate or distribute the product among two or more candidates (7.28(c)) Advantageous for minority Staggered board can limit the effect of cumulative voting (8.06) A decision to classify the board in this way may be attacked as a breach of fiduciary duty Formula NS = ((ND x TS) / (TD + 1)) + 1 NS = # of shares needed to elect the number of desired directors ND = # of directors desired to elect TS = Total shares TD = Total directors Fractions should be ignored, round down to the nearest whole # Examples How many shares do you need to elect one director? 200 voting shares; 5 directors being elected [(200x1)/(5+1)]+1 = 34 shares needed to elect one director Total number of votes you have = 34 x 5 = 170 Total votes being case = 200 x 5 = 1,000

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 Total votes being case = 200 x 5 = 1,000 Total votes you don't have = 1000 - 170 = 830 How many shares do you need to elect 3 directors? 200 voting shares; 5 directors being elected [(200x3)/(5+1)]+1 = 101 shares needed to elect one director Total number of votes you have = 101 x 5 = 505 Total votes being case = 200 x 5 = 1,000 Total votes you don't have = 1000 - 505 = 495 Voting trusts and voting agreements Generally 7.30 - Concerns property law, and transferring legal title to a trustee and the trustee votes, 7.31 - contract about how to vote Stricter rules for trusts than agreements - worried about trustees not voting in the best interest of the corporation Ringling Brothers -3 stockholders; 2/3 entered voting agreement that they will act jointly in voting; arbitrator cast votes contrary to the terms of the agreement => Court said votes did not count Not a voting trust, voting not separated from equitable title, trust rules didn't apply and agreement is enforceable Under the MBA, the result would be different, they would be cast according to how the arbitrator said Generally, voting buying is discourage and can be voided at the insistence of the corporation Only illegal to sell a vote if it amounts to a fraud on the corporation Examples Humphry's v. Winous Co - the affect of cumulative voting can be diminished by breaking directors into classifications Voting trusts Voting trusts give trustee legal title to shares and you keep equitable title Trustee = record owner 7.30. VOTING TRUSTS (a) One or more shareholders may create a voting trust, conferring on a trustee the right to vote or otherwise act for them, by signing an agreement setting out the provisions of the trust (which may include anything consistent with its purpose) and transferring their shares to the trustee. When a voting trust agreement is signed, the trustee shall prepare a list of the names and addresses of all owners of benecial interests in the trust, together with the number and class of shares each transferred to the trust, and deliver copies of the list and agreement to the corporations principal ofce. (b) A voting trust becomes effective on the date the rst shares subject to the trust are registered in the trustees name. A voting trust is valid for not more than 10 years after its effective date unless extended under subsection (c). (c) duration is 10 years 7.22(d) - in a voting trust, the trustee can appoint a proxy Trustee has a fiduciary duty to vote in beneficial interest of shareholders Trustee can't favor one class at the expense of another when he is trustee of both classes Brown v. McLanahan -trustees made amendment that favored debentures and disfavored preferred stockholders Cannot favor one class at the expense of another such an exercise of power is in derogation of the trust and may not be upheld, even though the thing done be within the scope of the powers granted to the trustees in general terms A power may not be exercised if it constitutes a breach of fiduciary duty A voting trust may arise when a corporation is in bankruptcy Creditors make shareholders put shares into a voting trust (at the threat of forcing bankruptcy) as a way to get company to change management Voting agreements Voting agreements are contracts between parties about how they will vote 7.31. VOTING AGREEMENTS (a) Two or more shareholders may provide for the manner in which they will vote their shares by signing an agreement for that purpose. A voting agreement created under this section is not subject to the provisions of section 7.30. (b) A voting agreement created under this section is specically enforceable Comment states this section "avoids the result reached in the Ringling case." 6.27. RESTRICTION ON TRANSFER OF SHARES AND OTHER SECURITIES (a) The articles of incorporation, bylaws, an agreement among shareholders, or an agreement between shareholders and the corporation may impose restrictions on the transfer or registration of transfer of shares of the corporation. A restriction does not affect shares issued before the restriction was adopted unless the holders of the shares are parties to the restriction agreement or voted in favor of the restriction. (b) A restriction on the transfer or registration of transfer of shares is valid and enforceable against the holder or a transferee of the holder if the restriction is authorized by this section and its existence is noted conspicuously on the front or back of the certicate or is contained in the information statement required by section 6.26(b). Unless so noted, a restriction is not enforceable against a person without knowledge of the restriction. 1. Restrictions authorized by the section 6.27(c) (1) to maintain the corporations status when it is dependent on the number or identity of its shareholders; (2) to preserve exemptions under federal or state securities law; (3) for any other reasonable purpose. Includes provisions designed to enable owners in closely held corporation to remain close (ex. To select the persons with whom they will be associated in business, to permit withdrawing participants to liquidate on some reasonable basis) 2. "Noted conspicuously on the front or back of the certificate" 1.40(3) - "Conspicuous" means so written that a reasonable person against whom the writing is to operate should have noticed it. For example, printing in italics or boldface or contrasting color, or typing capitals or underlined, is conspicuous. Ling and Co. v. Trinity Sav. And Loan Ass'n - corporation may impose restrictions on the transfer of its stock if they

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 Ling and Co. v. Trinity Sav. And Loan Ass'n - corporation may impose restrictions on the transfer of its stock if they are expressly set forth on the articles of incorporation and copied at length or in summary form on the face of each certificate, the articles of incorporation by reference on the face or back of the certificate of the provision of the articles of incorporation which restricts the transfer of stock 3. "Not enforceable against a person without knowledge of the restriction." (d) A restriction on the transfer or registration of transfer of shares may: (1) obligate the shareholder first to offer the corporation or other persons (separately, consecutively, or simultaneously) an opportunity to acquire the restricted shares; Buy/sell agreements (2) obligate the corporation or other persons (separately, consecutively, or simultaneously) to acquire the restricted shares; Right of first refusal (3) require the corporation, the holders of any class of its shares, or another person to approve the transfer of the restricted shares, if the requirement is not manifestly unreasonable; Cross-purchase agreements between shareholders (4) prohibit the transfer of the restricted shares to designated persons or classes of persons, if the prohibition is not manifestly unreasonable. Stock-redemption agreements (e) For purposes of this section, shares includes a security convertible into or carrying a right to subscribe for or acquire shares Deadlocks Generally In creating the corporation important to draft triggers for buyouts Client desires dissolution followed by buyout, he can petition for judicial dissolution if "oppressive conduct is shown" Buyout - 14.32 indicates who has rights to buyout OH does not have a buyout provision Examples In Re Radom & Neirdoff - brother and sister had equal shares and there was a deadlock in whether to dissolve the corporation Majority - Courts are reluctant to dissolve a corporation and will only do so when competing interests "are so discordant as to prevent efficient management" and the "object of its corporate existence cannot be attained." This is not met when there is no stalemate or impasse as to corporate policies, the corporation is flourishing, dissolution is not necessary for the corporation or for either shareholders, and the only grievance is non payment of salary. 14.34 election to purchase in lieu of dissolution (see next case) Dissent - issue is whether there is a deadlock as to the management of the corporation, not whether business is being conducted at a profit or loss Davis - fraud is not necessary to dissolve, but oppressive conduct may be enough to require a remedy. The court defines oppressive conduct as "burdensome, harsh and wrongful conduct," "lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members," "a visible departure from the standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely." Oppressive does not carry an essential inference of imminent disaster, it can contemplate a continues course of conduct The Davis court considered the absence of "malicious suppression of dividends or excessive salaries," Gearing v. Kelly - 4 directors, 1 resigns and needs to be replaced, bylaws required majority (3) for a quorum w/ straight voting, director intentionally refused to attend a meeting in order to avoid a quorum necessary to elect a new director, 2 directors elect a replacement anyway Can the remaining directors elect a replacement director when one of them purposely abstains in order to avoid a quorum? Majority - Yes "associated stockholder could frustrate corporate action until all of their joint demands were met." Dissent - Would force new election Deadlocks as to director vacancies 7.28(a) - directors are elected by a plurality 8.05. TERMS OF DIRECTORS GENERALLY (e) Despite the expiration of a directors term, he continues to serve until his successor is elected and qualies or until there is a decrease in the number of directors Cumulative voting can cure a deadlock by electing a new director, but straight voting cannot cure a deadlock and may result dissolution or buyout Quorum 7.25 - Quorum requirements 8.10. VACANCY ON BOARD. (a) Unless the articles of incorporation provide otherwise, if a vacancy occurs on a board of directors, including a vacancy resulting from an increase in the number of directors: (1) the shareholders may ll the vacancy; (2) the board of directors may ll the vacancy; or (3) if the directors remaining in ofce constitute fewer than a quorum of the board, they may ll the vacancy by the afrmative vote of a majority of all the directors remaining in ofce. (b) If the vacant ofce was held by a director elected by a voting group of shareholders, only the holders of shares of that voting group are entitled to vote to ll the vacancy if it is lled by the shareholders. (c) A vacancy that will occur at a specic later date (by reason of a resignation effective at a later date under section 8.07(b) or otherwise) may be lled before the vacancy occurs but the new director may not take ofce until the vacancy occurs Deadlocks as to dissolution 14.01. DISSOLUTION BY INCORPORATORS OR INITIAL DIRECTORS A majority of the incorporators or initial directors of a corporation that has not issued shares or has not commenced business may dissolve the corporation by delivering to the secretary of state of state for ling articles of dissolution that set forth:

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dissolve the corporation by delivering to the secretary of state of state for ling articles of dissolution that set forth: (1) the name of the corporation; (2) the date of its incorporation; (3) either (i) that none of the corporations shares has been issued or (ii) that the corporation has not commenced business; (4) that no debt of the corporation remains unpaid; (5) that the net assets of the corporation remaining after winding up have been distributed to the shareholders, if shares were issued; and (6) that a majority of the incorporators or initial directors authorized the dissolution 14.20. GROUNDS FOR ADMINISTRATIVE DISSOLUTION The secretary of state may commence a proceeding under section 14.21 to administratively dissolve a corporation if: (1) the corporation does not pay within 60 days after they are due any franchise taxes or penalties imposed by this Act or other law; (2) the corporation does not deliver its annual report to the secretary of state within 60 days after it is due; (3) the corporation is without a registered agent or registered ofce in this state for 60 days or more; (4) the corporation does not notify the secretary of state within 60 days that its registered agent or registered ofce has been changed, that its registered agent has resigned, or that its registered ofce has been discontinued; or (5) the corporations period of duration stated in its articles of incorporation expires 14.30. GROUNDS FOR JUDICIAL DISSOLUTION (a) The [name or describe court or courts] may dissolve a corporation: Note - Comment states "may" preserves court's discretion as to whether dissolution is appropriate even though grounds exist under the specific circumstances (1) in a proceeding by the attorney general if it is established that: (i) the corporation obtained its articles of incorporation through fraud; or (ii) the corporation has continued to exceed or abuse the authority conferred upon it by law; (2) in a proceeding by a shareholder if it is established that: (i) the directors are deadlocked in the management of the corporate affairs, the shareholders are unable to break the deadlock, and irreparable injury to the corporation is threatened or being suffered, or the business and affairs of the corporation can no longer be conducted to the advantage of the shareholders generally, because of the deadlock; In Re Redom shows dissolution is permissive, not mandatory, and the court will only do so when competing interests "are so discordant as to prevent efficient management" and the "object of its corporate existence cannot be attained." "Can't show irreparable injury" was added to address situations such as In Re Redom when the business is flourishing (ii) the directors or those in control of the corporation have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent; Davis defined oppressive conduct as "burdensome, harsh and wrongful conduct," "lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members," "a visible departure from the standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely." The Davis court listed types of conduct that may be oppressive: 1. Conspiring to deprive someone of stock ownership 2. Payment of fees on behalf of one shareholder and not another 3. Converting someone's stock 4. Malicious suppression of dividends 5. Excessive salaries 6. Corporation buying things from a shareholder at greater than FMV 7. Corporation investing in a shareholder's business (iii) the shareholders are deadlocked in voting power and have failed, for a period that includes at least two consecutive annual meeting dates, to elect successors to directors whose terms have expired; or Gearing v. Kelly (iv) the corporate assets are being misapplied or wasted; (3) in a proceeding by a creditor if it is established that: (i) the creditors claim has been reduced to judgment, the execution on the judgment returned unsatised, and the corporation is insolvent; or (ii) the corporation has admitted in writing that the creditors claim is due and owing and the corporation is insolvent; or A corporation is insolvent if its assets are less than its liabilities (4) in a proceeding by the corporation to have its voluntary dissolution continued under court supervision 14.34. ELECTION TO PURCHASE IN LIEU OF DISSOLUTION - (Buyouts) (a) In a proceeding under section 14.30(a)(2) to dissolve a corporation that is not a public corporation, the corporation may elect or, if it fails to elect, one or more shareholders may elect to purchase all shares owned by the petitioning shareholder at the fair value of the shares. An election pursuant to this section shall be irrevocable unless the court determines that it is equitable to set aside or modify the election. Specifically provides for a buyout (c) If, within 60 days of the ling of the rst election, the parties reach agreement as to the fair value and terms of purchase of the petitioners shares, the court shall enter an order directing the purchase of petitioners shares upon the terms and conditions agreed to by the parties. Fair value is intended to be fluid Comments indicate that a court should consider all relevant facts and circumstances of the particular case in determining fair value Under 13.01(4) "Fair value" means the value of the corporation's shares determined:

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 Under 13.01(4) "Fair value" means the value of the corporation's shares determined: (i) immediately before the effectuation of the corporate action to which the shareholder objects; (ii) using customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal; and (iii) without discounting for lack of marketability or minority status except, if appropriate, for amendments to the articles pursuant to section 13.02(a)(5). The 13.01(4) definition of fair value doesn't say whether good will is included (d) If the parties are unable to reach an agreement as provided for in subsection (c), the court, upon application of any party, shall stay the section 14.30(2) proceedings and determine the fair value of the petitioners shares as of the day before the date on which the petition under section 14.30(2) was led or as of such other date as the court deems appropriate under the circumstances. Action by directors and officers Examples In the Matter of Drive-In Development Corp. - subsidiary guaranteed the debt of its parent, nothing in bylaws or resolutions that gave actual authority secretary certified authority "Statements made by an officer or agent in the course of a transaction in which the corporation is engaged and which are within the scope of his authority are binding upon the corporation" When the person authorized by the corporation, usually the secretary, on questions of authorization, that authority will not be questioned. Lee v. Jenkins Bro's - P was allegedly orally promised by D to pay his former pension in exchange for coming to work for D. No actual authority, but apparent? "Employment contracts for life or on a 'permanent basis' are generally regarded as 'extraordinary' and beyond the authority of any corporate executive if the only consideration for the promise is the employee's promise to work for that period." 8.01(b) - All corporate powers shall be exercised by or under the authority of the board of directors of the corporation, and the business and affairs of the corporation shall be managed by or under the direction, and subject to the oversight, of its board of directors, subject to any limitation set forth in the articles of incorporation or in an agreement authorized under section 7.32. 8.20. MEETINGS (a) The board of directors may hold regular or special meetings in or out of this state. (b) Unless the articles of incorporation or bylaws provide otherwise, the board of directors may permit any or all directors to participate in a regular or special meeting by, or conduct the meeting through the use of, any means of communication by which all directors participating may simultaneously hear each other during the meeting. A director participating in a meeting by this means is deemed to be present in person at the meeting 8.21 - Action without meeting 8.41 - Functions of officers - Each officer has the authority and shall perform the functions set forth in the bylaws or, to the extent consistent with the bylaws, the functions proscribed by the board of directors or by direction of an officer authorized by the board of directors to prescribe the functions of other officers. Officers have to have authority to act according to: Articles of incorporation By-laws Resolution of the board As shown in Lee v. Jenkins, the President has authority to bind his company by acts arising in the usual and regular course of business, but not for contracts of an "extraordinary" nature. "Apparent authority . . . depends not only on the nature of the contract involved, but the officer negotiating it, the corporation's usual manner of conducting business, the size of the corporation and the number of its stockholders, the circumstances that give rise to the contract, the reasonableness of the contact, the amounts involved, and who the contracting third party." 1.40(2) defines "secretary"

Modern Corporate Governance_____________________________________________________________

Sarbanes Oxley Regulation G requires disclosure of non-GAPP financial info Ex. Stock options granted for compensation Each registered agency should have a financial expert or explain why they don't Majority of each board must be independent of management Audit committee that is: 1. Independent from management and 2. Has financial expertise CEO has to certify financial reports (quarterly and annually) Internal controls and procedure for financial disclosure Prohibition against loans to many officers Changed audit procedures Mandates electronic filing and posting of stock ownership Note - Housing crisis was from securitization of asset backed securities and credit-default swaps (insurance on loans)

Proxy Regulation_________________________________________________________________________
Generally Major Issues 1. Whether, and to what extent, a corporation must allow a shareholder to use corporation resources to solicit proxies 2. Standards appropriate for proxy statements What must a proxy statement contain to comply with Section 14 - concerned with adequate disclosure to make sure shareholders are not mislead and whether they have enough information

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mislead and whether they have enough information Reports 10k - Required annual report of all registered corporations 8k - Report of any significant change throughout the year Anything material to shareholder in deciding whether to buy or sell(resignation of a director, election of new director, resignation of auditor) 10q - Quarterly reports from the corporation Registration Examples (p. 569 #2 - Wood said would be good MC test question) - Under 12g-1 and 12g-4, how should the following problems be resolved: (a) Company A sells securities under Section 4(2) of the Securities Act of 1933 every year for 3 years. It eventually has total assets of $11 million and 450 shareholders. Does company A have to register under Section 12? => No. Has over $10,000, but less than 500 shareholders. (b) Company B sells securities under Section 4(2) every year for three years. Eventually it has total assets of $9.8 million and 700 shareholders. Does Company B have to register under Section 12? => No. Sufficient shareholders, but insufficient assets. (c) Company C has been registered under 12(g) for four years, and has consistently had $9.8 million in total assets and 450 shareholders. May its registration under Section 12 be terminated? => Yes. Reg. 12 g-4(a)(1). 12(a) - General requirement of registration It shall be unlawful for any member, broker, or dealer to effect any transaction in any security (other than an exempted security) on a national securities exchange unless a registration is effective as to such security for such exchange in accordance with the provisions of this title and the rules and regulations thereunder. The provisions of this subsection shall not apply in respect of a security futures product traded on a national securities exchange. 12(g) - Registration of securities by issuer; exemptions 1. Every issuer which is engaged in interstate commerce, or in a business affecting interstate commerce, or whose securities are traded by use of the mails or any means or instrumentality of interstate commerce shall-A. within one hundred and twenty days after the last day of its first fiscal year ended after July 1, 1964, on which the issuer has total assets exceeding $1,000,000 and a class of equity security (other than an exempted security) held of record by seven hundred and fifty or more persons; and Difference between (A) and (B) effected the initial rolling out of the rule: 750 and larger first, then 500 and more => now we use (B) B. within one hundred and twenty days after the last day of its first fiscal year ended after two years from July 1, 1964, on which the issuer has total assets exceeding $1,000,000 and a class of equity security (other than an exempted security) held of record by five hundred or more but less than seven hundred and fifty persons, register such security by filing with the Commission a registration statement (and such copies thereof as the Commission may require) with respect to such security containing such information and documents as the Commission may specify comparable to that which is required in an application to register a security pursuant to subsection (b) of this section. Each such registration statement shall become effective sixty days after filing with the Commission or within such shorter period as the Commission may direct. Until such registration statement becomes effective it shall not be deemed filed for the purposes of section 18. Any issuer may register any class of equity security not required to be registered by filing a registration statement pursuant to the provisions of this paragraph. The Commission is authorized to extend the date upon which any issuer or class of issuers is required to register a security pursuant to the provisions of this paragraph. Applies to 500 or more shareholders and assets exceeding $10,000,000 if they engage in interstate commerce or a business affecting interstate commerce 2. The provisions of this subsection shall not apply in respect of-A. any security listed and registered on a national securities exchange. B. any security issued by an investment company registered pursuant to section 8 of the Investment Company Act of 1940. C. any security, other than permanent stock, guaranty stock, permanent reserve stock, or any similar certificate evidencing nonwithdrawable capital, issued by a savings and loan association, building and loan association, cooperative bank, homestead association, or similar institution, which is supervised and examined by State or Federal authority having supervision over any such institution. D. any security of an issuer organized and operated exclusively for religious, educational, benevolent, fraternal, charitable, or reformatory purposes and not for pecuniary profit, and no part of the net earnings of which inures to the benefit of any private shareholder or individual; or any security of a fund that is excluded from the definition of an investment company under section 3(c)(10)(B) of the Investment Company Act of 1940. E. any security of an issuer which is a "cooperative association" as defined in the Agricultural Marketing Act, approved June 15, 1929, as amended, [12 U.S.C.A. 1141 et seq.], or a federation of such cooperative associations, if such federation possesses no greater powers or purposes than cooperative associations so defined. F. any security issued by a mutual or cooperative organization which supplies a commodity or service primarily for the benefit of its members and operates not for pecuniary profit, but only if the security is part of a class issuable only to persons who purchase commodities or services from the issuer, the security is transferable only to a successor in interest or occupancy of premises serviced or to be served by the issuer, and no dividends are payable to the holder of the security. G. any security issued by an insurance company if all of the following conditions are met: i. Such insurance company is required to and does file an annual statement with the Commissioner of Insurance (or other officer or agency performing a similar function) of its domiciliary State, and such annual statement conforms to that prescribed by the National Association of Insurance Commissioners or in the determination of such State commissioner, officer or agency substantially conforms to that so prescribed. ii. Such insurance company is subject to regulation by its domiciliary State of proxies, consents, or authorizations in respect of securities issued by such company and such regulation conforms to that prescribed by the National Association of Insurance Commissioners. iii. After July 1, 1966, the purchase and sales of securities issued by such insurance company by beneficial owners, directors, or officers of such company are subject to regulation (including reporting) by its domiciliary State substantially in the manner provided in section 16. H. any interest or participation in any collective trust funds maintained by a bank or in a separate account maintained by an insurance company which interest or participation is issued in connection with (i) a stock bonus, pension, or profit-sharing plan which meets the

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company which interest or participation is issued in connection with (i) a stock bonus, pension, or profit-sharing plan which meets the requirements for qualification under section 401 of Title 26, or (ii) an annuity plan which meets the requirements for deduction of the employer's contribution under section 404(a)(2) of Title 26. 3. The Commission may by rules or regulations or, on its own motion, after notice and opportunity for hearing, by order, exempt from this subsection any security of a foreign issuer, including any certificate of deposit for such a security, if the Commission finds that such exemption is in the public interest and is consistent with the protection of investors. 4. Registration of any class of security pursuant to this subsection shall be terminated ninety days, or such shorter period as the Commission may determine, after the issuer files a certification with the Commission that the number of holders of record of such class of security is reduced to less than three hundred persons. The Commission shall after notice and opportunity for hearing deny termination of registration if it finds that the certification is untrue. Termination of registration shall be deferred pending final determination on the question of denial. 500 shareholders are needed for registration, but if you dip below the corporation will stay registered until under 300 5. For the purposes of this subsection the term "class" shall include all securities of an issuer which are of substantially similar character and the holders of which enjoy substantially similar rights and privileges. The Commission may for the purpose of this subsection define by rules and regulations the terms "total assets" and "held of record" as it deems necessary or appropriate in the public interest or for the protection of investors in order to prevent circumvention of the provisions of this subsection. For purposes of this subsection, a security futures product shall not be considered a class of equity security of the issuer of the securities underlying the security futures product. 240.12g-4 Certifications of termination of registration under section 12(g). (a) Termination of registration of a class of securities shall take effect 90 days, or such shorter period as the Commission may determine, after the issuer certifies to the Commission on Form 15 that: (1) Such class of securities is held of record by: (i) Less than 300 persons; or (ii) By less than 500 persons, where the total assets of the issuer have not exceeded $10 million on the last day of each of the issuer's most recent three fiscal years Proxy Regulation and Disclosure Examples In the Matter of Caterpillar, Inc. - Caterpillar's Brazilian subsidy profited greatly from arbitrage through hyperinflation in Brazil, the corporation knew subsequent reform gov't was going to have a huge negative impact and exceptionally difficult to predict, but nothing in their 10-k described this anticipated effect Under 10b-5, a misleading statement may subject those involved to criminal liability Management's Discussion of Financial Condition and Results of Operations (MD&A) 1. Regulation S-K Item 303 requires corporations to make forward looking statements under certain conditions Discusses registrant's financial condition, changes in financial condition and results of operations A misleading statement can lead to criminal penalties under 10b-5 2. Caterpillar states "[w]here a trend, demand, commitment, event, or uncertainty is known, management must make two assessments: 1. Is the known trend, demand, commitment, event or uncertainty likely to come into fruition? If management determines that it is reasonably likely to occur, disclosure is required. (Likelihood) A modest likelihood such as 30% may be sufficient 2. If management cannot make that determination, it must evaluate objectively the consequences of the known trend, demand, commitment, event or uncertainty, on the assumption that it will come into fruition. (Magnitude) Most situations fall here The magnitude was deemed high in Caterpillar when a subsidiary accounted for 23% of profits, but represented only 5% of revenue As shown in Caterpillar, investors should be provided the opportunity to "see the company through the eyes of management." 3. Safe Harbor Rule Under the safe-harbor rule, forward looking statements are not deemed false or misleading unless they were made or reaffirmed without a reasonable basis or were disclosed other than in good faith There is no personal liability if the statement was 1. Made without actual knowledge that the statements were false or misleading, OR 2. Statement is identified as forward looking, is accompanied by meaningful cautionary language identifying important facts that could prevent the statement from becoming accurate False and Misleading Proxy Statements General Note - most courts have not treated scienter, or intention to deceive, as a necessary element of proxy fraud Examples J.I. Case v. Borak - a shareholder is bringing suit, arguing that merger between Case and ATC resulted from a false and misleading proxy statement. He argues that a merger would not have been approved but for the false and misleading statements in the proxy solicitation material. Santa Fe Indus., Inc. v. Green - P owned 95% of Kirby Lumber who was merged into P without a need for giving minority shareholders a vote (no essential link) with an alleged dramatic undervaluation; however, there is a remedy in state court In the Matter of Caterpillar, Inc. - Caterpillar's Brazilian subsidy profited greatly from arbitrage through hyperinflation in Brazil, the corporation knew subsequent reform gov't was going to have a huge negative impact and exceptionally difficult to predict, but nothing in their 10-k described this anticipated effect "Given the magnitude of CBSA's contribution to Caterpillar's overall earnings, disclosure of the extent of that contribution was required under the MD & A provisions of Regulation S-K since CBSA's earnings materially affected Caterpillar's reported income from continuing operations." TSC Indus., Inc. v. Northway, Inc. - National Industries sought to merge with TSC. Northway is a shareholder of TSC, and shareholders allege that TSC omitted from the proxy statement information relating to National's control over TSC Too low of a standard would unnecessarily expose management to liability - "might" is too low To high of a standard would result in a "blizzard" of info making the important info harder to find

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 To high of a standard would result in a "blizzard" of info making the important info harder to find Mills Electric - involved a proxy statement relating to a proposed merger where the misstatement did not go to the value of the transaction itself but to the manner of approval. The proxy statement dislcosed that that other board had recommended approval of the merger but did not disclose that fact that the board had in fact been selected by the other party to the merger => statement true on its face, but omits fact that board represents party on other side of the merger Note - as long as contains false or misleading info, not necessary to show individual shareholders relied on it Virginia Bankshares, Inc. v. Sandberg - FABI merged into its Virginia, its subsidiary. A 3rd party firm priced the value of the minority shareholders who were to be frozen out at $42/share. FABI's proxy statement described the price as "high" and "fair." P argues that directors did not believe the price was fair and that the only way to remain on board was to recommend the merger. Are statements of reasons, opinions, or belief statements with respect to material facts within the meaning of Rule 14A? A "sue fact" is "a fact which is material to a sue decision." A "sue decision" is a decision by a shareholder whether or not to institute a representative or derivative suit alleging a state-law cause of action Regulation 14A. Solicitation of Proxies. - (Note - use 14a-8 for shareholder proposals) a. No solicitation subject to this regulation shall be made by means of any proxy statement, form of proxy, notice of meeting or other communication, written or oral, containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading. b. The fact that a proxy statement, form of proxy or other soliciting material has been filed with or examined by the Commission shall not be deemed a finding by the Commission that such material is accurate or complete or not false or misleading, or that the Commission has passed upon the merits of or approved any statement contained therein or any matter to be acted upon by security holders. No representation contrary to the foregoing shall be made. Note - The following are some examples of what, depending upon particular facts and circumstances, may be misleading within the meaning of this section. 1. Predictions as to specific future market values. 2. Material which directly or indirectly impugns character, integrity or personal reputation, or directly or indirectly makes charges concerning improper, illegal or immoral conduct or associations, without factual foundation. 3. Failure to so identify a proxy statement, form of proxy and other soliciting material as to clearly distinguish it from the soliciting material of any other person or persons soliciting for the same meeting or subject matter. 4. Claims made prior to a meeting regarding the results of a solicitation. Rule 14a-9 prohibits any proxy solicitation "containing any statement which . . . is false or misleading with respect to any material fact." Borak, which remains good law, is the authority which provides a private federal cause of action for violations of Regulation 14a-9 and courts have interpreted 14a-9 to include four elements to prevail. The elements will be discussed in turn. 1. False or misleading The statement must be false or misleading. Rule 14a-9 applies to any statement in a proxy solicitation (that is "false or misleading"/ "which omits to state any material fact necessary in order to make the statements therein not false or misleading.") Must pick one or the other, cross out inapplicable part of rule, then explain with particularity why it is a misstatement or omission Ex - Virginia Bankshares - Proxy said $42 price was "high" and "fair," when it was not high based on current value of assets is misleading with respect to any material fact; (misleading on its face) Ex - Caterpillar - Properly reported profits, but failed to discuss the impact inflation in Brazil had on operations => omission which makes it misleading 2. Materiality The statement must be material. The Supreme Court established the objective materiality standard in TSC Indus., stating that "[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." Need not show a reasonable investor would have changed his vote, but that he would have considered it important This may proven by expert testimony or by showing trading history of people who knew the truth Virginia Bankshares shows that under 14A, a plaintiff is permitted to prove a specific statement of reason knowingly false or misleadingly incomplete, even when stated in conclusory terms. "Since liability under 14(a) must rest not only on deceptiveness but materiality as well . . . publishing accurate facts in a proxy statement can render a misleading proposition too unimportant to ground liability." However, "[i]f it would take a financial analyst to spot the tension," liability should follow. Book value is an example of an accurate fact that can be provided to help insulate liability from misleading propositions In uncertain events, such as mergers, Basic shows heightened specificity is required Here, materiality "will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event" (Texas Gulf Sulphur). 1. Probability Assess probability by looking at indicia of interest in the transaction by the highest corporate levels, considering (1) board resolutions, (2) instructions to investment bankers, and (3) actual negotiations between principals and their intermediaries 2. Magnitude The Basic court considered "such facts as the size of the two corporate entities and of the potential premiums over market value" 3. Causation A plaintiff must show causation. The "essential link" standard promulgated in Mills states "[w]here there has been a finding of materiality, a shareholder has made a sufficient showing of causal relationship . . . if . . . he proves that the proxy solicitation itself . . . was an essential link in the accomplishment of the transaction." Virginia Bankshares shows that, in order to be an essential link, there can be no recovery if the transaction did not depend on the
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 Virginia Bankshares shows that, in order to be an essential link, there can be no recovery if the transaction did not depend on the vote 4. Damages Finally, the plaintiff must show damages. Mills said "damages should be recoverable only to the extent that they can be shown." Shareholder proposals Generally 14(a) - Solicitation of proxies in violation of rules and regulations => removed 14(a) b/c COA is under 14a-8 Examples Studebaker Corp. v. Gittlin - shareholder challenge to an order enjoining him from the use of other stockholders' authorizations in a NY state court proceeding to inspect the shareholder list. Among other large shareholders constituting over 5% seeking to change the board of directors, and after getting list intend to solicit proxies. Are the authorizations requests solicitations within the meeting of 14(a)? The issue is who pays for the solicitations, and what shareholders can include in proposals Rule 14a-8(a)(1) imposes minimum ownership requirements and holder period qualifications upon shareholders who seek inclusion of a proposal under Rule 14a-8 14a-8(i) -Company may exclude shareholder proposals, even if procedural requirements are met, if: (1) improper under state law (2) Violation of law (3) Violation of proxy law (ex. not misleading, no omissions, etc.) (4) Personal Grievance; special interest If there is a public debate on the topic, then it is not a personal grievance or related to ordinary business Cracker Barrel - proposal to stop compensation discrimination against gays (5) Relevance (6) Absence of power/authority (7) Management functions - If the proposal deals with a matter relating to the company's ordinary business operations A shareholder proposal concerning a company's employment policies and practices for the general workforce is tied to a social issue will no longer be viewed as removing the proposal from the realm of ordinary business operations of the registrant Ex. Executive compensation, Cracker Barrel denying gays to work for their company, producing land mines, producing napalm (8) Relates to Election: If the proposal relates to a nomination or an election for membership on the company's board of directors or analogous governing body or a procedure for such nomination or election A Mobil shareholder proposal was properly rejected in Rauchman that sought to disallow a Saudi Arabian citizen from becoming a member of Mobil's board of directors (9) Conflicts with company's proposal Rauchman - corp could exclude proposal to prohibit Saudi Arabians from being on the board b/c a Saudi was up for re-election and adoption of the proposal would have precluded his re-election Regulation FD ("Fair Disclosure") Regulation FD provides that a company disclosing material, non public information to specified types of securities market professionals must thereafter publicly disclose that information (aka "selective disclosure) The Supreme Court established the objective materiality standard in TSC Indus., stating that "[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." Ex. Material public info - "we have not changed the guidance given in our most recent earnings report" Ex. Non material public info - "in our most recent earnings report we have given the following guidance" Innocently providing a "snippet" of info that is not itself material to a securities professional is not a violation of FD enough though it may enable the professional to infer material non-public information If the selective disclosure is "intentional" the company must simultaneously make public disclosure If "unintentional" the disclosure must be made "promptly" thereafter SOX makes it unlawful for accounting firms that audit public companies to simultaneously provide the company with a variety of non-audit services

Transactions in Shares; Rule 10b-5, Insider Trading, and Securities Fraud___________________________

Generally Causes of action under 14 and 10b-5 are not mutually exclusive Under Rule 10(b), it is unlawful To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act), any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. Primary liability of a secondary party - If someone, other than a primary party, meets all the elements of the rule, then they can be found liable under the rule. (Applies to both COA's) In Re Enron shows a secondary party "can be found liable as a primary violator if he acts with the requisite scienter." The court stated "a person can be a primary violator if he or she writes misrepresentations for inclusion in a document to be given to investors, even if the idea for those misrepresentations came from someone else." Secondary parties includes banks, law firms, and accounting firms Examples include Writing misrepresentations for inclusion in a document to be given to investors Disguising large loans and doing sale/buy back agreements Issuing clean audit reports knowing they were false Lawyer creating a knowingly false report on an employee or creating false companies PSLRA requires class actions to be brought by the "most adequate plaintiff" SLUSA requires 10b-5 claims to be brought in federal court, unless the claim the claim also alleges a fiduciary breach under state law (Securities Act

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 SLUSA requires 10b-5 claims to be brought in federal court, unless the claim the claim also alleges a fiduciary breach under state law (Securities Act 16(d))

Examples Examples SEC v. Texas Gulf Sulphur Co. - geographical survey found largest ore strike in history; meant to be kept confidential; one group acquired an additional 7k shares and 12k calls before the board found out, another group of directors buy options and know about the strike but fail to show supervisors; trades are made before info gets to NYSE => Are the groups liable under 10b or 10b-5 for insider trading? "Tippees" can also be liable, and that the tippers may also be liable on their behalf (check) (Texas Gulf) "Before insiders may act upon material information, such information must have been effectively disclosed in a manner sufficient to insure its availability to the investing public" (Texas Gulf) In Texas Gulf, a nine-minute gap was sufficient to impose civil and criminal penalties (p. 861, #1) (a) Person would be liable under 10b-5. There is a duty (Texas Gulf). (b) Person would not be liable under 10b-5. No duty. Ernst & Ernst- claim against an accounting firm for failing to discover a major fraud in a securities firm; mail was only allowed to opened by a particular individual, which was negligent and didn't show an intent to deceive Chiarella v. United States - printer received info about takeover bid before hit market, but had no connection to the other company and therefore not under a duty The dissent in Chiarella promulgated the misappropriation theory (standard will later be developed in Hagan) O'Hagan - D worked for law firm who represented Grand Met in a merger w/ Pillsbury, O'Hagan bought call options and common stock of Pillsbury stock and made $4.3 million Dirks - D a "tippee" received material non public inf from "a tipper" with which he had no connection, he investigated the claims and passed the info on to other analysts but did not purchase or sell any securities himself Mere possession of material non public info is not enough. There must also be a relationship and a breach (below for tippee duty and breach) Basic Inc. v. Levinson - Combustion was interested in acquiring Basic. Basic denied the merger negotiations 3 times, but eventually made the negotiations public and eventually sold for $46/share. Blue Chip Stamps - provided incentives to customers to induce them to shop in their stores, issued a misleading prospectus and overly pessimistic statements to discourage purchases => must show reliance SEC v. Cuban - SEC alleges after Cuban verbally agreed to maintain the confidentiality of material, non-public information concerned a planned private investment in public equity, he sold his stock in the company without first disclosing to Mamma.com that he intended to trade on this information, and avoiding substantial losses. In Re Enron Corp Securities Derivative & ERISA Litigation - Enron shareholders bring a class action against various banks and accounting firms handling Enron matters for false and misleading statements and a failure to disclose adverse facts Is the conduct by the lawyers, accountants, and banks sufficient to meet the scienter standard required by an action under 10b-5?

Rule 10b-5
Rule 10b-5 states "[i]t shall be unlawful for any person . . . (to make any untrue statement of a material fact/to omit to state a material fact necessary in order to make the statements made . . . not misleading) . . . in connection with the purchase or sale of any security." Private Kardon created a private cause of action for violations of Rule 10b-5 and courts have interpreted 10b-5 to include eight elements to prevail on a private cause of action. SEC To prevail on a 10b-5 action, the SEC must show scienter, a misstatement or omission, materiality, and duty. The elements will be discussed in turn. Elements 1. Standing (SEC always has standing for a 10b-5 action, Private - Yes) Blue Chip Stamps shows that purchasers or sellers of securities have standing for private causes of action Applies to sale of options to purchase securities (Wharf United Int'l) 2. Scienter (SEC - Yes, Private - Yes) Ernst & Ernst shows 10b-5 applies only to activities that involve scienter The words "manipulative or deceptive" used in conjunction with "device or contrivance" suggests 10(b) was intended to proscribe knowing or intentional misconduct Scienter will be found if the defendant knew or was reckless in not knowing of the misrepresentation and intended that the plaintiff rely on the misinformation Negligence or aiding and abetting (ex. Accountants) does not rise to this standard (Ernst) 3. Misstatement or Omission (SEC - Yes, Private - Yes) Santa Fe shows a misstatement or omission is necessary in a private cause of action. In the case, the Supreme Court stated a "breach of fiduciary duty . . . without any deception, misrepresentation, or nondisclosure" is insufficient for a 10b-5 violation. Here, the company said _____ Because _________, the statements is 1. False 2. Misleading on its face 3. True, but with omitted facts that make it misleading Under the PSLRA, a 10b-5 complaint that alleges half-truths must specify which statements are misleading and why they are misleading Caterpillar - properly reported profits, but failed to discuss the impact inflation in Brazil had on operations Basic - court looks to whether the statements are misleading or omissions - both, contains an omission that makes it misleading NOTE - silence, absent a duty to disclose, is not misleading (avoid 10b-5 liability by saying "no comment," but if you lie on MD&A

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4.

5.

6.

7.

8.

NOTE - silence, absent a duty to disclose, is not misleading (avoid 10b-5 liability by saying "no comment," but if you lie on MD&A 10b-5 liability can result) Materiality (SEC - Yes, Private - Yes) The Supreme Court established the objective materiality standard in TSC Indus., stating that "[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." Need not show a reasonable investor would have changed his vote, but that he would have considered it important Proven by expert testimony or by showing trading history of people who knew the truth Texas Gulf shows that objective evidence such as "the time and . . . purchases of short term callspurchases in some case by individuals who had never before purchased calls or even TGS stockvirtually compels" an inference of materiality. Note - Board can insulate themselves from liability when they make opinions if the accurate facts made to form the opinion are in the proxy But, if it takes a financial expert to determine if a statement is false, then it is still material In uncertain events, such as mergers, Basic shows heightened specificity is required Here, materiality "will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event" (Texas Gulf Sulphur). 1. Probability Assess probability by looking at indicia of interest in the transaction by the highest corporate levels, considering (1) board resolutions, (2) instructions to investment bankers, and (3) actual negotiations between principals and their intermediaries 2. Magnitude The Basic court considered "such facts as the size of the two corporate entities and of the potential premiums over market value" Reliance (Reliance is not an element for the SEC b/c the SEC did not buy or sell, Private - Yes) As shown in Basic, the private investor must show reliance on the misstatement or omission Once materiality is shown, under the fraud-on-the-market theory the court will accept a presumption of reliance (Basic) However, Hamilton shows that this presumption does not exist if there is not a market Any showing by the corporation that severs the link will rebut the presumption, such as 1. The misrepresentation did not lead to a distortion of price Ex. If news of true information entered the market and dissipated the effect of the misstatement 2. An individual P traded or would have traded despite his knowing the statement was false Ex. If he had to sell for medical bills Loss Causation (SEC - No, Private - Yes) The Private Securities Litigation Reform Act (21(D)(b)(4)), places the burden on plaintiff to prove that the alleged act or omission caused the loss for which the plaintiff seeks to recover damages (the decline in value was caused by the statement). Duty (SEC - Yes, Private - Yes) The person who made the (misstatement/omission) must have been under a duty Duty to shareholders A corporation is under a duty to speak truthfully to its shareholders Duty to entity Under the classical approach from O'Hagan, duty is satisfied if the person who made misstatement or omission owed a duty to the corporation in which the stock is traded Ex. Employer/employee, A/C Duty to anyone else In O'Hagan, the Supreme Court expanded 10b-5 liability by recognizing the "misappropriation theory" which applies to determine if a duty is owed to someone other than the corporation in which the stock is traded Anything meeting classical will meet misappropriation (employer/employee, A/C) Any person in possession of material, nonpublic information has a duty to disclose the information, or abstain from trading, if the person obtains the information in a relation of trust and confidence. Under 10b-5-2(b) enumerated "duties of trust or confidence" exist 1. Whenever a person agrees to maintain information in confidence; The Cuban court stated "[t]he agreement . . . must consist of more than an express or implied promise merely to keep information confidential. It must also impose on the party who receives the information the legal duty to refrain from trading on or otherwise using the information for personal gain." 2. Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or 3. Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling; provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties' history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information. Note - 10b-5 liability can be avoided if insider discloses to corporation that he will trade on nonpublic information In Carpenter, the Supreme Court upheld a fraud conviction for a D who received his information from a Wall Street Journal journalist in advance of his "Heard on the Street Column," rather than from the company itself. Damages (SEC - No, Private - Yes) Mills also shows that "damages should be recoverable only to the extent that they can be shown." SOL - There is a Statute of Limitations for private 10b-5 actions Sarbanes-Oxley extended the statue of limitations for private securities fraud claims to the earlier of two years after discovery of the facts constituting the violation or five years after the violation

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constituting the violation or five years after the violation Here, there is no indication that the statutes of limitations was not complied with Contribution - D's have an implied right of contribution for a D who becomes liable for more than his share to compel other responsible persons to pay their share of the total liability Insider Trading Generally Note - 10b-5(b) does not apply to insider trading Securities and Exchange Act of 1934 - Short swing sales 16(a)(1) - who it applies to directors, officers, or shareholders who have 10% share in company 16(b) If a purchase and sale (or sale and purchase) by an officer, director, or 10% shareholder takes place within a 6 month period (before or after any trade), the profit is automatically recoverable by the corporation (regardless of intent) Need a sale then a purchase, or a purchase then a sale Acquisition of an option is a 16(b) purchase The exercise of an option is not a purchase, so you can exercise an option and sell it without a 16(b) violation The transaction by which a person becomes a 10% shareholder is not itself a purchase that may be matched with subsequent sales (Foremost-McKesson v. Provident Sec. Co.) All purchases after that increases the holding to above 10% continue to be subject to 16(b) Profit is calculated by matching the lowest purchase price and highest sale price 6 months go both ways Exceptions 1. If part of an employee benefit plan 2. If part of a long term options exercise 3. Officer includes - President, principal financial officer, principal accounting officer, VP in charge of a principal business unit, persons performing policy-making functions Insider trading - if director, officer, or 10% shareholder, can be liable both under 10b-5 fraud and 16(b) PSLRA requires class actions to be brought by the "most adequate plaintiff" Provides heightened pleading standards, required courts to stay discovery pending resolution of motion to dismiss, limited discovery Required lost causation (whether misstatement caused change in price) as necessary element under 10b-5 SLUSA requires 10b-5 claims to be brought in federal court, unless the claim the claim also alleges a fiduciary breach under state law (Securities Act 16(d)) Federal preemption of any claim that: (1) Is a "covered class action," (2) Based on state law, (3) in which the P has alleged either a "misrepresentation or omission of a material fact" or "any manipulative or deceptive device or contrivance," (4) in connection with the purchase or sale of a covered security Examples United States v. Chestman - Waldbaum was being sold to A & P at a substantially higher price, the controlling shareholder told his sister, three children, and nephew about the impending sale. The sister told her daughter and son in law, who told their broker, Chestman. Daughter told her husband, Loeb, who told Chestman. Chestman knew the info came from the granddaughter of the company, made several purchases both for the granddaughter on his own account and for his customers. A familial relationship, standing alone, does not impose a duty of trust or confidence for purposes of the misappropriation theory For Chestman to be convicted: 1. Loeb must have breached duty to Waldbaum's 2. Chestman knew Loeb breached his duty Chestman is the precursor of 10b-5-2(b) Rule 10b-5 states "[i]t shall be unlawful for any person . . . to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person . . . in connection with the (purchase . . ./ . . . sale) of any security." Private - Courts have interpreted 10b-5 to include six elements for a private insider trading cause of action. SEC - Courts have interpreted 10b-5 to include five elements for a SEC insider trading cause of action. Each element will be discussed in turn. Elements 1. Standing (SEC - Yes, Private - Yes) Under Section 20A, any person who trades contemporaneously with the purchase/sale of securities that is the subject of the violation has standing to bring a private cause of action A contemporaneous trade is one within 7 days (before or after) the trade that is subject of the action 2. Scienter (SEC - Yes, Private - Yes) Ernst & Ernst shows 10b-5 applies only to activities that involve scienter The words "manipulative or deceptive" used in conjunction with "device or contrivance" suggests 10(b) was intended to proscribe knowing or intentional misconduct Scienter will be found if the defendant knew of the inside information when he or she traded Negligence or abetting and abetting (ex. Accountants) does not rise to this standard. 3. Person trading had Material Non-Public Information (SEC - Yes, Private - Yes) The person trading must have had material non-public information The Supreme Court established the objective materiality standard in TSC Indus., stating that information is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. Proven by expert testimony or by showing trading history of people who knew the truth Texas Gulf shows that objective evidence such as "the time and . . . purchases of short term callspurchases in some cases by individuals who had never before purchased calls or even TGS stockvirtually compels" an inference of materiality. NOTE - if a tippee trades, tipper can be liable if he received a benefit (giving info to a friend/spouse/parent is like the insider trading and giving proceeds to outsider) 4. Duty (SEC - Yes, Private - Yes)
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4. Duty (SEC - Yes, Private - Yes) The person making the trade must have been under a duty when he or she traded. Corporate insider Under the classical approach from O'Hagan, duty is satisfied if the person who acted upon the material inside information owed a duty to the corporation in which the stock is traded Ex. Employer/employee, A/C A person owes a duty to the corporation even if they are a merely a "temporary insider" (a member of a company being acquired can be a temporary insider of the acquiring company) Corporate outsider In O'Hagan, the Supreme Court expanded the scope of insider trading liability by recognizing the "misappropriation theory" which applies to determine if a duty is owed to someone other than the corporation in which the stock is traded Anything meeting classical will meet misappropriation (employer/employee, A/C) Any person in possession of material, nonpublic information has a duty to disclose the information, or abstain from trading, if the person obtains the information in a relation of trust and confidence. Under 10b-5-2(b) enumerated "duties of trust or confidence" exist 1. Whenever a person agrees to maintain information in confidence; The Cuban court stated "[t]he agreement . . . must consist of more than an express or implied promise merely to keep information confidential. It must also impose on the party who receives the information the legal duty to refrain from trading on or otherwise using the information for personal gain." 2. Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or 3. Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling; provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties' history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information. A tippee's duty to disclose or abstain is derivative from that of the insider's duty "[A] tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach" (Dirks) 1. Tipper had a duty (employer/employee, A/C) 2. Tipper breached duty In determining whether the tipper duty is breached, Dirks states "the test is whether the insider personally will benefit, directly or indirectly, from his disclosure" The court will look to objective criteria, "such as pecuniary gain or reputational benefit that will translate into future earnings," or a relationship that suggests a quid pro quo" (Dirks) Note - disclosure of info itself is not a breach of duty 3. Tippee knew or should have known of the breach NOTE - 10b-5 liability can be avoided if insider discloses to corp that he will trade on nonpublic information 5. Trade on the Basis of Inside Info (SEC - Yes, Private - Yes) The trade must have been on the basis of material inside information Under 10b5-1 (b) "on the basis of" is satisfied "if the person making the purchase or sale was aware of the material nonpublic information when the person made the purchase or sale." Generally, if a person has inside info, then the trades are based on it However, safe harbors under 10b-5-1 include 1. Trades made pursuant to a qualified pre-planned program 2. Trade make pursuant to a contract, plan entered into prior to obtaining inside information Anyone in possession of material inside information must either disclose it or abstain from trading Before insiders may act upon material information, such information must have been effectively disclosed in a manner sufficient to insure its availability to the investing public 6. Loss Causation (SEC - No, Private - Yes) The P must show loss causation. SLUSA requires a P to show the inside information caused the price change. Here, when the market received the inside information the price changed from __ to ___. Therefore, under SLUSA, because the P has suffered a loss of __, the P has shown loss causation. Note - Can only show loss causation if he sold the stock and then it went up or if he bought the stock and then it went down (Can't show loss causation if bought stock before it went up) 14e-3 Under Rule 14e-3, the SEC prohibited trading by those with inside information about a tender offer The rule prohibits, during the course of a tender offer, trading by anybody who has material, nonpublic information about the offer that he knows (or has reason to know) was obtained from either the bidder or the target. There is no need under 14e-3 to prove that a tipper breached a fiduciary duty for personal benefit

Duty of Care & The Business Judgment Rule___________________________________________________

Generally Duty of care is about process Derivative actions vs. direct actions A direct action involves a shareholder alleging injury to his shares as a shareholder

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 A direct action involves a shareholder alleging injury to his shares as a shareholder A derivative action is a suit asserted by a shareholder on the corporation's behalf against a third party because of the corporation's failure to take action against the third party. 8.30 & 8.31 together are MBCA's corollary to the BJR 8.30 is effectively the job description of the directors and is an objective standard of conduct 8.31 is used to get damages resulting from conduct Subjective standard - intentional recklessness Higher level of culpability than 8.30 Under the ALI's version of the business judgment rule, A director or officer who makes a business judgment in good faith fulfills his duty if he: Is not interested in the subject of the business judgment Is informed with respect to the subject of the business judgment to the extent the director or officer reasonably believes to be appropriate under the circumstances; and Rationally believes that the business judgment is in the best interests of the corporation Examples Van Gorkom - RR car leasing business with insufficient taxable income to exercise tax credits, sought a leveraged buyout and offered to finance its own purchase; CFO ran numbers and preliminarily determined purchaser (Prinsker) could retire debt with a cash out merger @ $50-60/share; however, no analysis was ran to calculate value of company as a whole. Opened company for bidding an agreement but an agreement with Prinsker (1) could not actively solicit bids, (2) couldn't release proprietary information. Prinsker gives 3 days to accept offer and determine value of company The minimal calculations and valuation opinions sought by the board in deciding to sell constituted gross negligence => In DE, gross negligence is the standard Litwin v. Allen - Alleghany sold bonds to trust company, which allows Alleghany to repurchase the bonds at the end of 6 months Was there a breach of duty of care? Analyzed under negligence standard => over time began to require more stringent requirements Limited damages to 6 month period of repurchase agreement, no damages available after that point Shlensky v. Wrigley - stockholders derivative suit for negligence and mismanagement for not installing lights enabling the team to play night games. Cubs are the only team who doesn't play night games, and lose a lot of $ doing so. D alleges baseball is a daytime sport and night games would have an adverse effect on the surrounding neighborhood => absent an allegation of fraud, no breach of fiduciary duty In Re Caremark - Caremark was a health care company who was involved in some shady Medicare kickbacks in violation of federal law. Caremark was criminally indicted and ended up settling for $250 million with various gov't agencies, and shareholders filed a derivative suit. Motion to approve a proposed settlement by shareholders as fair and reasonable Francis v. United Jersey Bank - sons of the founder of a corp, an "insurance reinsurance" business, siphoned large sums of money from the corp in the form of shareholder loans and other improper payments to family members. Widow of founder literally did nothing in her role as a director and instead drank heavily. => She was held liable for her children's actions for failure to monitor, a director "can not merely be an ornament" Stone v. Ritter - P's suing D corporation for $40 million in fines and $10 million in civil penalties arising from failure to comply with the Bank Secrecy Act and Anti Money Laundering Regulations Audit report shows Board enacted written policies and procedures designed to ensure compliance with the regulations => no basis for an oversight claim seeking to hold the directors personally liable for such failures by the employees Malone - complaint alleges corp breached their duty of disclosure and that KPMG aided and abetted the breaches for intentionally overstating the financial condition of Mercury for 4 years. Is there a cause of action in DE for making a material misstatement? Analysis The issue is whether there was a breach of fiduciary duty. The law of our jurisdiction is the MBCA. Derivative actions Generally Note - Derivative actions usually occur in public corporations, not close corporations Reasons: (1) close corporations are less likely to have directors, (2) injury is likely to be more direct Examples Gall v. Exxon Corp. - P's allege over $59 million in illegal political payments by Exxon. Exxon established a Special Committee and decided not to file a suit against the directors. Should a decision by the board of directors not to bring a derivative suit be respected? Absent allegations of fraud, collusion, self-interest, dishonesty or other misconduct of a breach of trust nature, and absent allegations that the business judgment exercised was grossly unsound, the court should not at the instigation of a single shareholder interfere with the judgment of the corporate officers Held - The decision of (disinterested?) corporate directors whether to assert a cause of action held by the corporation rests within the sound business judgment of the management Aronson v. Lewis - (DE 1984) (demand excused case) - Shareholder of a subsidiary alleges that a board improperly entered into transactions (for employment contracts w/ Fink) and these would not have been entered into without Fink's director selection. Shareholders initiate derivative suit. Are facts sufficient to excuse demand? P must show state facts with particularity that create a reasonable doubt of whether directors breached duty of loyalty or duty of care Zapata Corp. v. Maldonado - (DE 1981) (demand excused case) - Directors offered stock options and decided to exercise them by accelerating the date they were able to buy before a tender offer in order to avoid taxes before prices rose. Shareholders initiated derivative action. Corp hired 2 new directors to launch investigation, and they elect to dismiss. Does committee have the power to dismiss an action that was properly brought? Not 7.44 - Court used two-part test (1) inquire into independence and goof faith of the committee and bases of conclusions, (2) the challenged transaction was otherwise the product of a valid exercise of business judgment Within the independent business judgment of the court Directors have management authority and their decision to terminate a derivative action will only be overturned when they do not exercise this authority in accordance with their fiduciary duties Cukar v. Mikalauskas - minority shareholder institutes derivative action for mismanagement of collections. Soon after, another complaint was filed. Does the BJR allow directors to terminate a derivative action? Yes. In Re Oracle Corp. Derivative Litigation - P's bring derivative suit alleging insider trading (based on state law) by 4 of Oracle's directors. Committee was formed and it was decided that no action should be taken. The Special Litigation Committee members were Stanford law professors who had

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was formed and it was decided that no action should be taken. The Special Litigation Committee members were Stanford law professors who had significant ties to the company, and who under-reported ties. 7.40 - "'Derivative proceeding' means a civil suit in the right of a domestic corporation." 7.41 - Standing A shareholder may not commence or maintain a derivative proceeding unless the shareholder: 1. Was a shareholder of the corporation at the time of the act or omission complained of or became a shareholder through transfer by operation of law from one who was a shareholder at the time (Operation of law - divorce or inheritance) 2. Fairly and adequately represents the interests of the corporation in enforcing the right of the corporation 7.42 - No shareholder may commence a derivative proceeding until: 1. A written demand has been made upon the corporation to take suitable action; and Although some states allow demand excused, the MBCA requires a written demand in all cases 2. 90 days have expired from the date the demand was made unless the shareholder has earlier been notified that the demand has been rejected by the corporation or unless irreparable injury to the corporation would result by waiting for the expiration of the 90-day period 7.44 - Dismissal of derivative actions (a) A derivative proceeding shall be dismissed by the court on motion by the corporation if one of the groups speci ed in subsection (b) or subsection (e) has determined in good faith, after conducting a reasonable inquiry upon which its conclusions are based, that the maintenance of the derivative proceeding is not in the best interests of the corporation. Comment states the word "inquiry" rather than "investigation" has been used to make it clear that the scope of the inquiry will depend upon the issues raised and the knowledge of the group making the determination with respect to the issues. In some cases, the issues may be so simple or the knowledge of the group so extensive that little additional inquiry is required. In other cases, the group may need to engage counsel and other professionals to make an investigation and assist the group in its evaluation of the issues. (b) Unless a panel is appointed pursuant to subsection (e), the determination in subsection (a) shall be made by: (1) a majority vote of qualied directors present at a meeting of the board of directors if the qualied directors constitute a quorum; or Under 1.43(a), a qualied director is a director who, at the time action is to be taken under: (1) section 7.44, does not have (i) a material interest in the outcome of the proceeding, or (ii) a material relationship with a person who has such an interest; 7.44(b)(1) material relationship means a familial, nancial, professional, employment or other relationship that would reasonably be expected to impair the objectivity of the directors judgment when participating in the action to be taken; and 7.44(b)(2) material interest means an actual or potential benet or detriment (other than one which would devolve on the corporation or the shareholders generally) that would reasonably be expected to impair the objectivity of the directors judgment when participating in the action to be taken. (2) a majority vote of a committee consisting of two or more qualied directors appointed by majority vote of qualied directors present at a meeting of the board of directors, regardless of whether such qualied directors constitute a quorum. 1.43 - qualified director Material interest Material relationship (e) Upon motion by the corporation, the court may appoint a panel of one or more individuals to make a determination whether the maintenance of the derivative proceeding is in the best interests of the corporation. In such case, the plaintiff shall have the burden of proving that the requirements of subsection (a) have not been met 7.45 - Discontinuance or Settlement 7.46 - Payment of Expenses If a derivative suit is not dismissed under 7.44, go to 8.31 (damages) or 8.30 (equitable relief) and evaluate the conduct of the director on the substantive claim. Direct Actions Damages - 8.31 STANDARDS OF LIABILITY FOR DIRECTORS (a) A director shall not be liable to the corporation or its shareholders for any decision to take or not to take action, or any failure to take any action, as a director, unless the party asserting liability in a proceeding establishes that: (1) no defense interposed by the director based on (i) any provision in the articles of incorporation authorized by section 2.02(b)(4) or, (EXCULPATION CLAUSES) 2.02(b)(4) states "[t]he articles of incorporation may set forth a provisions eliminating or limiting the liability of a director to the corporation or its shareholders for money damages for any action taken, or any failure to take any action, as a director, exception liability for (A) the amount of a financial benefit received by a director to which he is not entitled." (B) an intentional infliction of harm of the corporation of the shareholders." (C) a violation of section 8.33." 8.33 - liability for unlawful distributions (D) an intentional violation of criminal law." If articles of incorporation limit liability of directors, P must show why his or her cause of action is not limited by the articles (ii) the protection afforded by section 8.61 (for action taken in compliance with section 8.62 or section 8.63), or 8.61(b) - (three primary defenses directors have for breaches of duty of care and loyalty) (b) A director's conflicting interest transaction may not . . . give rise to an award of damages . . . in a proceeding by a shareholder or by or in the right of the corporation, on the ground that the director has an interest respecting the transaction, if: (1) directors' action respecting the transaction was taken in compliance with section 8.62 at any time."; or 8.62(a) - after disclosure, transaction was authorized by majority of qualified directors (2) shareholders' action respecting the transaction was taken in compliance with section 8.63 at any time."; or 8.63 - mechanism for shareholders to ratify a conflicting interest transaction to avoid liability (3) the transaction, judged according to the circumstances at the relevant time, is established to have been fair to

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 (3) the transaction, judged according to the circumstances at the relevant time, is established to have been fair to the corporation "Relevant time" is defined in 8.60(3) as (i) the time at which directors' action respecting the transaction is taken in compliance with section 8.62, or (ii) if the transaction is not brought before the board of directors or the corporation (or its committee) for action under section 8.62, at the time the corporation (or an entity controlled by the corporation) becomes legally obligated to consummate the transaction "Fair to the corporation," as defined in 8.60(6), means "the transaction as a whole was beneficial to the corporation, taking into appropriate account whether it was (i) fair in terms of the director's dealings with the corporation, and Fair dealing (ii) comparable to what might have been obtainable in an arm's length transaction, given the consideration paid or received by the corporation." (iii) the protection afforded by section 8.70, precludes liability; and (2) the challenged conduct consisted or was the result of: (i) action not in good faith; or A lack of good faith requires a conscious or intentional disregard for a known duty or responsibility As shown in the comments, a lack of good faith is presented where a board "lacked an actual intention to advance corporate welfare." Fraud - As shown in Malone, directors who knowingly disseminate false information that results in corporate injury or damage to an individual stockholder violate their fiduciary duty and may be held accountable in a manner appropriate in the circumstances. (ii) a decision (A) which the director did not reasonably believe to be in the best interests of the corporation, or (B) as to which the director was not informed to an extent the director reasonably believed appropriate in the circumstances; or Van Gorkom shows directors may be liable if grossly negligent in failing to act with informed reasonable deliberation. In the case, directors were liable when they approved a sale of a company in less than three days without reading documents, getting reports, or verifying numbers. Note - if directors know consequences of their decision, then there is no breach of duty of care (iv) a sustained failure of the director to devote attention to ongoing oversight of the business and affairs of the corporation, or a failure to devote timely attention, by making (or causing to be made) appropriate inquiry, when particular facts and circumstances of signicant concern materialize that would alert a reasonably attentive director to the need therefore; or As shown in Caremark, "it is important that the board exercise a good faith judgment that the corporation's information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations." 8.30(d),(e),(f) - Directors defenses to care - entitled to rely on the performance or information of . . . (b) (1) If money damages are sought, causation between the breach and damages must be shown Equitable relief If derivative action - 7.40, 7.41, 7.42, 7.44 8.30(a) A lack of good faith requires a conscious or intentional disregard for a known duty or responsibility As shown in the comments, a lack of good faith is presented where a board "lacked an actual intention to advance corporate welfare." Fraud - As shown in Malone, directors who knowingly disseminate false information that results in corporate injury or damage to an individual stockholder violate their fiduciary duty and may be held accountable in a manner appropriate in the circumstances. 8.30 (b) - The members of the board of directors or a committee of a board, when becoming informed in connection with their decision-making function or devoting attention to their oversight function, shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances Negligence does not rise to this standard 8.30(d), (e), and (f) - Directors defenses to care As shown in Brehm v. Eisner, the plaintiff can rebut by showing (a) the directors did not in fact rely on the expert; (b)their reliance was not in good faith; (c) they did not reasonably believe that the expert's advice was within the expert's professional competence; (d) the expert was not selected with reasonable care by or on behalf of the corporation, and the faulty selection process was attributable to the directors; (e) the subject matter that was material and reasonably available was so obvious that the board's failure to consider it was grossly negligent regardless of the experts advice or lack of advice; or (f) that the decision of the Board was so unconscionable as to constitute waste or fraud Waste is "an exchange that is so one sided that no business person or ordinary, sound judgment could conclude that the corporation has received adequate consideration." This was not found in Eisner after the President received extraordinary compensation in order to lure him from his previous company. Court may compare compensation packages of similarly situated companies (Menard's) As shown in Heller, the court may inquire whether the compensation is for services rendered, or a gift. "If a bonus payment has no relation to the value of services for which it is given, it is in reality a gift in part, and the majority stockholders have no power to give away corporate property against the protest of the minority." NOTE - DO NOT GO TO 8.61!

Duty of Loyalty__________________________________________________________________________
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 Examples Marciano v. Nakash - Two groups of directors own stock during liquidation. One side argues a loan made to the other group, involved conflicting interests so is therefore voidable. Although self-dealing/loyalty claim, there is no breach if it is fair => court determines the transaction is within the CL safe harbors Heller v. Boylan - 7 shareholders of American Tobacco Company seeks recovery for allegedly improper enormous payments to officers Is excessive executive compensation fair to the corporation? Sinclair Oil Corp. v. Levien - derivative action sought to require Sinclair to pay damages incurred by its subsidiary. The P argues that the parent caused the subsidiary to breach a contract entered into by the subsidiary. Not analyzed under MBCA, but applies Self Dealing test "Self-dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary" Under MBCA would be: 7.40, 8.61(a), 8.60(1), 8.60(5), 8.61(b)(3), 8.60(3), 8.60(6) Weinberger v. UOP, Inc. - Class action of shareholders challenge a merger between UOP and Signal. Two companies had overlapping directors. Two of the directors who were on the board on both boards analyzed UOP data for the benefit of Signal and calculating up to what price would be deemed a good investment for Signal in a "feasibility study." Signal made a very fair deal to UOP but never disclosed the price range in the "feasibility study" to the outside directors in UOP. Northeast harbor- President of golf course was contacted in her capacity as President about purchasing abutting property to the course. The board had discussed developing property casually, but not seriously. Without disclosing to the Club she immediately bought for $45k. She told the board at the annual meeting. 5 years later while playing golf at the course she found out about another abutting property which was landlocked and bought it. She told the board she had no present plans to develop the property. She soon bought the property that made it un-landlocked Corporate opportunity case => MBCA 8.31(a)(2)(v) Brehm v. Eisner - Ovitz lured from other company with very lucrative employment offer and severance package; no job description established. Derivative suit brings two claims: (1) Old BOD failure to calculate his potentially excessive employment agreement and severance, and (2) New Board's agreement to terminate the contract "without cause" which amounted to waste of assets The issue is whether there was a breach of fiduciary duty? Wood says this case stands mostly for good faith Analysis The issue is whether there is a breach of fiduciary duty Damages If derivative action - 7.40, 7.41, 7.42, 7.44, 7.45, 7.46 8.31 - if damages are sought , go here (a) A director shall not be liable to the corporation or its shareholders for any decision to take or not to take action, or any failure to take any action, as a director, unless the party asserting liability in a proceeding establishes that: (1) No defenses good authorized in articles under 2.02(b)(4), no protection afforded by 8.61(b) 8.60(1) defines director's conflicting interest transaction 8.61(b) - Three situations where directors conflicting interest transaction is not subject to award of damages (2) the challenged conduct consisted of or was the result of: (i) action not in good faith; or Good faith is a conscious or intentional disregard for a known duty or responsibility As shown in the comments, a lack of good faith is presented where a board "lacked an actual intention to advance corporate welfare." Fraud - As shown in Malone, directors who knowingly disseminate false information that results in corporate injury or damage to an individual stockholder violate their fiduciary duty and may be held accountable in a manner appropriate in the circumstances. (iii) a lack of objectivity due to the directors familial, nancial or business relationship with, or a lack of independence due to the directors domination or control by, another person having a material interest in the challenged conduct (A) which relationship or which domination or control could reasonably be expected to have affected the directors judgment respecting the challenged conduct in a manner adverse to the corporation, and (B) after a reasonable expectation to such effect has been established, the director shall not have established that the challenged conduct was reasonably believed by the director to be in the best interests of the corporation; or Duty of loyalty 8.61(a) - limits 8.31(a)(2)(iii) to directors conflicting interest transaction (v) receipt of a financial benefit to which the director was not entitled or any other breach of the director's duties to deal fairly with the corporation and its shareholders that is actionable under applicable law Corporate opportunities Since there is ambiguity within the MBCA as to the meaning of "benefit to which the director was not entitled," the court may look to the ALI Principles of Corporate Governance. Northeast Harbor Section 5.05 of the ALI states (a) A director . . . may not take advantage of a corporate opportunity unless: (1) The director . . . first offers the corporate opportunity to the corporation and makes disclosure concerning the conflict of interest and the corporate opportunity; (2) The corporate opportunity is rejected by the corporation Subsection (b) defines a corporate opportunity as (1)Any opportunity to engage in a business activity of which a director or senior executive becomes aware, either: (A) In connection with the performance of functions as a director or senior executive, or under circumstances that should reasonably lead the director or senior executive to believe that the person offering the opportunity expects it to be offered to the corporation; or (B) Through the use of corporate information or property, if the resulting opportunity is one that the
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 (B) Through the use of corporate information or property, if the resulting opportunity is one that the director or senior executive should reasonably be expected to believe would be of interest to the corporation; or (2) Any opportunity to engage in a business activity of which a senior executive becomes aware and knows is closely related to a business in which the corporation is engaged or expects to engage 8.31(b) - party seeking to hold the director liable (1) for money damages must show (i) harm to corporation has been suffered, and (ii) the harm was proximately caused by directors challenged conduct Equitable If derivative action - 7.40, 7.41, 7.42, 7.44 8.30(a) - Each member of the board, when discharging duties, shall act: (1) in good faith, and Good faith is a conscious or intentional disregard for a known duty or responsibility As shown in the comments, a lack of good faith is presented where a board "lacked an actual intention to advance corporate welfare." Fraud - As shown in Malone, directors who knowingly disseminate false information that results in corporate injury or damage to an individual stockholder violate their fiduciary duty and may be held accountable in a manner appropriate in the circumstances. (2) in a manner the director reasonably believes to be in the best interests of the corporation 8.61 - Judicial Action (a) a transaction effected or proposed to be effected by the corporation (or by an entity controlled by the corporation) may not be the subject of equitable relief, or give rise to an award of damages or other sanctions against a director of the corporation, in a proceeding by a shareholder or by or in the right of the corporation, on the ground that the director has an interest respecting the transaction, if it is not a director's conflicting interest transaction. Director's conflicting interest transaction is defined in 8.60(1) as "a transaction effected or proposed to be effected by the corporation (or by an entity controlled by the corporation) (i) to which, at the relevant time, the director is a party; or Relevant time is defined in 8.60(3) (ii) respecting which, at the relevant time, the director had knowledge and a material financial interest known to the director; or Material financial interest is defined in 8.60(4) as a "a financial interest in a transaction that would reasonably be expected to impair the objectivity of the director's judgment when participating in action on the authorization of the transaction." (iii) respecting which, at the relevant time, the director knew that a related person was a party or had a material financial interest Related person is defined in 8.60(5) Sinclair, UOP (b) - conflicting interest transaction may not be the subject to (equitable relief/damages) in three instances. Each will be discussed in turn. (Note - shareholders has burden of proving the process was flawed under (1) or (2), and if so, (3) burden shifts to the directors to show that it was fair) (1) Under 8.61(b)(1), a directors conflicting interest transaction cannot be the subject to (equitable relief/damages) if the "directors' action respecting the transaction was taken in compliance with section 8.62 at any time."; or 8.62(a) 1.43(a)(3) defines qualified directors. (essentially means disinterested) Here, the qualified directors were ____. 8.60(7) "Required disclosures" - describes what disclosures are required Comment states that if the board's approval complies with this provision, the court's only inquiry is whether the contract was "manifestly unreasonable" (2) Under 8.61(b)(2), a directors conflicting interest transaction cannot be the subject to (equitable relief/damages) if the "shareholders' action respecting the transaction was taken in compliance with section 8.63 at any time." 8.63(a) - (mechanism for shareholders to ratify a conflicting interest transaction to avoid liability) 8.63(c)(2) defines qualified shares as "all shares entitled to be voted with respect to the transaction except for shares . . . held by (A) a director who had a conflicting interest respecting the transaction or (B) a related person of the director." 8.60(7) defines required disclosure. (3) Under 8.61(b)(3), a directors conflicting interest transaction cannot be the subject to (equitable relief/damages) if "the transaction, judged according to the circumstances at the relevant time, is established to have been fair to the corporation." "Relevant time" is defined in 8.60(3) "Fair to the corporation," as defined in MBCA 8.60(6), means "the transaction as a whole was beneficial to the corporation, taking into appropriate account whether it was (i) fair in terms of the director's dealings with the corporation, and (ii) comparable to what might have been obtainable in an arm's length transaction, given the consideration paid or received by the corporation." (i) fair dealing As shown in Weinberger, fair dealing involves timing, structure, negotiation, disclosure, how approval is obtained, and how the transaction is initiated. Ex. Director fails to disclose hidden defects known to him regarding the transaction Look at how quickly the transaction took place (Van Gorkham) (ii)Fair price Court may look at the market interest rate Executive compensation - (Note - Same analysis as care w/ equitable relief) 8.30(a) Good faith is a conscious or intentional disregard for a known duty or responsibility As shown in the comments, a lack of good faith is presented where a board "lacked an actual intention to advance corporate welfare." Fraud - As shown in Malone, directors who knowingly disseminate false information that results in corporate injury or damage to an individual stockholder violate their fiduciary duty and may be held accountable in a manner appropriate in the circumstances. 8.30(b) - Board is not required to be informed of every fact, but is required to be reasonably informed 8.30(d) - board is entitled to rely on the performance of those in (f)(1) or (f)(3) in delegating duties
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8.30(d) - board is entitled to rely on the performance of those in (f)(1) or (f)(3) in delegating duties 8.30(e) - board is entitled to rely on the information of those in (f)(1), (f)(2), or (f)(3) 8.30(f) As shown in Brehm v. Eisner, the plaintiff can rebut by showing (a) the directors did not in fact rely on the expert; (b)their reliance was not in good faith; (c) they did not reasonably believe that the expert's advice was within the expert's professional competence; (d) the expert was not selected with reasonable care by or on behalf of the corporation, and the faulty selection process was attributable to the directors; (e) the subject matter that was material and reasonably available was so obvious that the board's to consider it was grossly negligent regardless of the experts advice or lack of advice; or (f) that the decision of the Board was so unconscionable as to constitute waste or fraud Waste is "an exchange that is so one side that no business person or ordinary, sound judgment could conclude that the corporation has received adequate consideration." This was not found in Eisner after the President received extraordinary compensation in order to lure him from his previous company. Court may compare compensation packages of similarly situated companies (Menard's) As shown in Heller, the court may inquire whether the compensation is for services rendered, or a gift. "If a bonus payment has no relation to the value of services for which it is given, it is in reality a gift in part, and the majority stockholders have no power to give away corporate property against the protest of the minority."

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