Professional Documents
Culture Documents
I.
1.
reverse any common law doctrine or court opinion regarding a common law
doctrine and
2.
overrule any courts interpretation of a state statute, including the Supreme Courts.
B.
1.
2.
Types
Partnership, Corporation, LLC, LP, Professional Corporation (law firms), Corporation Sole (one
person religious)
Nonprofit association, Nonprofit public benefit corporation, etc.
II.
Three study contexts (by the numbers of investors, not the size of the business)
A. Public Companies (thousands of investors). Corporations
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C.
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Meinhard v. Salmon (1928) (most famous of Business Associations cases, fiduciary duties under
partnership) compared the corporate opportunity doctrine in Chapter 20 - the 5 elements test
(which results in a very weak corporate opportunity case refer to the slides of Application of Guth
test to Salmon)
Fact:
Salmon had a joint venture with Meinhard for a lease of 20 years; both contributed half of
investment for a building lease and Salmon managed the building
New owner wants to build a new building in place of the current one
That new owner approaches Salmon with an opportunity to buy the lease
Salmon forms Mid-Point Realty and takes the lease on his own, without telling Meinhard
Decision:
The deal was a joint venture, so Salmon owed fiduciary duties
Salmon had to disclose the partnership opportunity to his co-adventurer.
[Implicit] Meinhard had no right to share in the deal with Salmon because the joint venture as
complete, only a right to compete but the lease deal related to, arose out of the business
opportunity
Court grants Meinhard with 49% of the new company (hold as trustee).
Consequence under current law (RUPA 404(b) & 403(c)):
1.
Salmon derives the new lease in the conduct of the partnership business. Gerry (the
new owner) figured to himself beyond a doubt that the man in possession would prove a
likely customer. Salmon must take Meinhard along.
2.
The new lease opportunity is information concerning the partnerships business and
affairs. Salmon approached in his capacity as a partner.
3.
The new lease opportunity information is not reasonably required for the proper exercise of
(Meinhards) rights and duties. Meinhard cannot exercise partnership rights. Salmon
need not furnish the info to Meinhard but must take him along.
4.
It is 1922. We are attorneys for Salmon when Gerry approaches. What is our advice to
Salmon?
A: Tell Meinhard.
5.
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Partnership cant compete for the lease (20 year limit of the first lease), so Meinhard cant
stop Salmon.
A: Meinhard could compete with Salmon for the lease.
7.
We are attorneys for Salmon before he enters into his next real estate deal. What is our
advice to Salmon? Can Salmon disclaim the obligation to tell Meinhard about lease
renewal opportunities?
A: RUPA103(B). Let Salmon disclaim the obligation to tell Meinhard re the new lease
opportunity.
8.
We are attorneys for Salmon before he enters into his next real estate deal. What is our
advice to Salmon?
A: Do not form a partnership and use Meinhards capital as a loan.
Could Salmon borrow the $100,000 from Meinhard and agree to pay Meinhard half the
profits as interest on the loan?
A: RUPA 202(c). The profit received by Meinhard is for payment of loan interests. It is
an exception of presumed partnership stipulated by the law.
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McConnell v. Hunt Sports Enterprises (1999) (fiduciary duties under LLC members, whether
members can define their fiduciary duties in the operating agreements)
Hunt, McConnell, others form CHL, apply for franchise from NHL.
1.
Hunt starts negotiating with Nationwide on behalf of CHL. NHL deadline is June 4, 1997.
1.6. Why no deal by May 30?
Answer: Hunt says team will lose millions.
2.
On May 30, McConnell told Nationwide If Hunt wont step up and lease the arena,
therefore get the franchise, I will. 1.7. Affect CHLs negotiating position?
Answer: Undercuts Hunt.
3.
4.
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5.
Court: Section 3.3 of the operating agreement of CHL entitles each member (including
McConnell) to compete with the business of the LLC.
Section 3.3: Members may compete. Members shall not in any way be prohibited from
or restricted in engaging or owning an interest in any other business venture of any
nature, including any venture which might be competitive with the business of the
Company.
Q: why have Section 3.3 in the operating agreement?
A: Maximize chances of everyone to make a deal, so the city of Columbus can get the
Franchise.
Q: Does Section 3.3 eliminate the duty of loyalty or does it merely approve specific
categories of activities?
A: It approves a specific category that is almost elimination of the loyalty duty. But Section
3.3 survives.
Q: Since Section 3.3 is a specific category agreed by all members, is it manifestly
unreasonable?
A: In this public spirit context, it is reasonable to agree that members will bid against one
another.
[Thoughts: The court relied on general contract law to justify LLC members to define their
fiduciary duties. If parties agree to be held to a certain set of conditions, courts try not to disturb
the agreement unless there are statutory or strong public policy concerns.]
From
1.
2.
3.
4.
To
Partner
Partnership, partners
Member
Member-managed LLC
Manager
Manager-managed LLC
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V.
Agent
Principal
Directors, Officers
Corporation
Major shareholder
Minority shareholder
Trustee
Beneficiary
Sole Proprietorship
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Basic Concepts
Corporate Categories
(1) "Public" vs. "Close"
Principal requirement: maximum of 30 shareholders (DGCL 342)
(2) Tax status
C Corporations (most public corporations)
Taxed on its income
S Corporations (many close corporations)
Sends a notice to each of its owners informing them of their proportionate share
of income in the corporation
Principal requirement: small number of shareholders
Not-for-profit corporation
Qualifies for and elects that status under state law
Has members, not shareholders
Corporate Characteristics
(1) Separate entity - every corporation is a legal entity that is separate from the investors who
provide it with money and the people who manage its business
(2) Perpetual existence - a corporation has an unlimited life
(3) Limited liability - a corporation's shareholders cannot lose more money than they invested
(4) Centralized management - shareholders elect a corporation's directors, who have the
power to manage and oversee the corporation's business
(5) Transferability of ownership interests - shareholders can transfer to others their ownership
interests in a corporation
Corporate Actors
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Court of Chancery
Greater predictability
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In general, the law of the state of incorporation governs any disputes regarding that
corporations internal affairs (e.g. relationships between owners and managers, litigation
involving the corp.s shareholders and managers may arise)
Internal Affairs: the matters peculiar to the relationship among the corporation and its
officers, directors, and shareholders.
Rationales: certainty on application of choice of law; implied contract
Alternatives to Internal Affairs Doctrine:
General conflicts rule: law of state with the greatest interest applies
Pseudo-Foreign Corporation Doctrine (California Rule):
Real Seat Doctrine: physical location of a corporation determines its charter (generally
accepted in European Union)
Federal incorporation: federal government grants charters.
External affairs are generally governed by the law where the activities occur and by federal
and state regulatory statutes. (For example, a states employment law governs conditions of
employment of all business operations within the state, wherever the business might be
incorporated. When corporations enter into contracts, commit torts, and deal in property, the
internal affairs doctrine does not apply.)
Sometimes corporate activities can be governed by both internal and external rules. (e.g. state
corporation law controls the right to merge and the procedure to be followed, but mergers are
also independently subject to federal antitrust laws and securities laws.)
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DL court upholds the internal affairs doctrine which matters the most in the charter competition.
DL corporation has values only if other jurisdiction applies DL law.
Denial of application of DLGC 160(C): POLICY BASIS directors should not be able to reelect themselves. They could if treasury shares voted. Therefore, treasury shares cannot vote.
RATIONALE: outsiders (shareholders) should control the corporation. Voting treasury shares
interferes with outsider control.
Counter-rationale: non-profit corporation practice, shareholders may sell their shares anyway.
Covers a wide range of corporate internal affairs, but not applicable to public
corporations whose shares are traded on NYSE or Nasdaq National Market.
Organizational Choices
4 Basic Types of Entities
(1) Corporation
(2) GP and LLP
(3) LLC
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Partnership
Corporation
LLC
State charter?***
No
Yes
Yes
Legal entity?***
Yes
Yes
Yes
Minimum persons***
Two
One
One
Limited liability?
No
Yes
Yes
Managed by?
Partners
Board of directors
Members
Partner
Director/Share
Member
Basic changes?
Unanimous
Majority, 2/3s
Unanimous
Pass through
Yes
Pass through
Yes, 801(1)
No
Yes, 701(b)
Interest saleable?
Economic only
Yes
Economic only
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Profits shared by
Partners
Shares
Members
and
other
employees
from
torts
of
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Profitable business, none paid to investors - Corporate tax treatment can save money
Losing business - Pass through treatment can save money if the losses can offset the
income (this is a tax question)
Profitable business, all paid, but salary - corporation and pass through cost the same in
taxation
Although IRS may seek to characterize the salary as a dividend
Choice of Entity Example
Situation: Investor and Manager work for 6 weeks to establish a restaurant. Investor contributed
$500,000 for capital and Manager contributed his labor. One or both of the parties wants to end
their business relationship. What should be done?
Generalization: A business should repay the value of contributions, split the rest per-person or by
level of involvement.
Almost the default deal for Partnership:
1. $500k goes to investors partnership account, RUPA 401(a), paid first 807(b)
2. Each partner has right to dissolution which forces sale. RUPA 801(1).
3. No priority for labor contributed. Considered a soft investment.
What is the default deal for a Corporation?
Answer: Dissolution only by agreement. All distributions are to the shareholders, pro
rata by shares.
Legal tools for committing to return value of investments:
All entities: debt (soft or hard)
Partnership: capital account
LLC: contribution account
Corporation: preferred stock
Selling Charters
Most artificial entities have only a single owner.
The cost of a California entity is $800 to $12,000 in fees to state.
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BUT: Professor thinks this is a slippery slope to lender liability and MacArthur is
an expansive view of partnership based on the court's perception of Stein as a
crook
(2) Contribute something that promotes enterprise
(3) Right of mutual control
(4) Share profits of enterprise
MacArthur Company v. Stein
Facts:
Stein makes a name-sharing contract with Potter and Beebe
Potter and Beebe run up a $39,000 account with MacArthur and abscond
MacArthur sues Stein on a partnership theory
Court: Partnership existed.
Stein intended to contribute something that promoted his enterprise with them
Stein intended to create a right of mutual control for each of the three of them
Stein intended for each of them to share the profits of the enterprise.
Irrelevant whether he intended to form a partnership
Could the bank (MacArthur) have been a partner on the court's theory of partnership?
Factor
Steins deal
Banks deal
Contributes something
Name, leads
Loan proceeds
Oversight, terminate
Inspection, on demand
Share in profits
2% of gross revenues
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Intended to do each?
Yes
Yes
Outcome
Stein is a partner
Is bank a partner?
Conclusions:
1. Loan to partnership is a slippery slope (lender liability).
2. Stein case is an expansive view of partnership (court thinks Stein is a crook)
Partnership by Estoppel
UPA 16(1) - A person who represents himself, or permits another to represent him, to
anyone as a partner . . . with others not actually partners, is liable to any [representee] who
has, on the faith of the representation, given credit to the actual or apparent partnership. See
Young v. Jones
NOTE: Use of term "partner" has become so loose that courts can't really enforce RUPA
308(a) (successor to UPA 16)
Many advertisements of "partnerships" do not refer to actual legal partnerships
e.g. Google or IBM indicates they are "partners" with a particular entity; they mean that
they are working together in some capacity, not that they have formed a legal
partnership
Partnership Accounts - Winding Up
General Rule: absent an agreement, partners share losses as they share gains (equally)
Special Rule: where one partner contributes money against the others labor, neither party is liable
to the other
Kovacik v. Reed (Supplement, p. 66)
Facts:
Kovacik and Reed go into business remodeling kitchens.
They agreed to share profits equally; no agreement re losses
Reed works for nine months without salary remodeling kitchens.
Business loses $8,680. Kovacik sues Reed for half the losses, $4,340.
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Court: general rule is that, absent an agreement, partners share losses as they share gains
(equally)
BUT: there is a special rule. Where one partner contributes money against the others
labor, neither party is liable to the other. Reed wins.
Relative Level of Education and Business Sophistication is irrelevant in these types of cases
Professor thinks it should be relevant
Theory of Start-Up Structure
Situation:
Justin, Kathy and Lorenzo are going into business together; plan to make millions
Justin has expertise, will run JKLs business full time for an estimated three years, then sell it.
Kathy will contribute her going business.
Lorenzo will contribute $150,000 cash.
Deal: The contributions are of equal value; each gets a third of the stock
Three months later, they are squabbling, and the business is dead.
JKL has $100,000 in cash; other assets that liquidate for $50,000.
In a corporation, who gets the $150,000?
Answer: Each gets $50,000 because each owns a one-third interest
In a partnership, who gets the $150,000?
Answer: Each gets $50,000 based on partnership accounts? The deal overrides
401(a), see 103(a ) and 807(b). Is that fair?
Better Approach:
Professor David Herwitz: Business should pay for resources as used.
Each has the right to his/her contribution, plus a third ownership.
1. Justin gets a salary of $50,000 a year, paid or accrued as worked
2. Kathy gets a promissory note secured by the business assets
3. Lorenzo gets a promissory note secured by the cash
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State
Corporation Fees
California
$100
$70
Nevada
$50
$75
$0
Delaware
$89
$90
$75 to $180,000
Connecticut
$150
$120
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organization, and that is likely to result in substantial injury to the organization, then
the lawyer shall proceed as is reasonably necessary in the best interest of the
organization. Unless the lawyer reasonably believes that it is not necessary in the best
interest of the organization to do so, the lawyer shall refer the matter to higher authority
in the organization, including, if warranted by the circumstances to the highest
authority that can act on behalf of the organization as determined by applicable law.
Rule 1.13(c). [I]f (1) despite the lawyer's efforts . . . the highest authority . . . fails to
address in a timely and appropriate manner an action . . . that is clearly a violation of
law, and (2) the lawyer reasonably believes that the violation is reasonably certain to
result in substantial injury to the organization, then the lawyer may reveal information .
. . [despite] Rule 1.6.
NOTE: 5th Circuit case has held that there is a difference between knowing something
and having reason to believe it; only have to act when you know something
Ultra Vires: "Beyond the Powers"
Corporations automatically receive a broad grant of powers
In addition, they can elect any power not contrary to law
DGCL 102(b)(1): The certificate of incorporation may contain: Any . . . provision creating,
defining, limiting and regulating the powers of the corporation . . . if such provisions are not
contrary to the laws of this State.
Corporations can elect to limit their powers (e.g. No derivatives trading)
Acts that exceed the limitations are "ultra vires."
Consequences of Ultra Vires Actions
Ultra vires acts are not invalid. DGCL 124
Powers are public record, but third parties are not expected to discover them
BUT: ultra vires acts can be enjoined or punished
If a corporation is enjoined from performing a contract, the corporation is in
breach and a third party can recover damages.
Example: Investor demands a Certificate of Incorporation prohibition on the corporation owning or
trading in derivatives
The board contracts to purchase derivatives from Goldman Sachs for $10 million. The
contract is ultra vires.
The value of the derivatives contract falls to $3 million.
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Stock Subscriptions
Promoter wants to raise money prior to the incorporation. Is the offer of issuance of
shares being binding to the potential investor?
Explanation: Illusory contract, revocable
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[The Corporation can be sued when it does not pay its filing fees, but cannot initiate
motions.]
(2) Same, but "subject to the rights of any person who reasonably relied to his prejudice
upon the certificate of dissolution." North Carolina Stat. 55-14-22(c)
Agency
The Big Picture
Entities are not real persons, so they cannot act for themselves
Entities can only act through people:
Agents (authority to contract)
Employees (vicarious tort liability)
Boards
Partners
Members
What human actions does law attribute to the entity?
What human actions does law attribute to another human?
Who is an agent?
Elements of Agency
Restatement Third Agency, 101. Agency is the fiduciary relationship that arises when:
(1) one person (a principal) manifests assent to another person (an agent) that
(2) the agent shall act on the principals behalf and
(3) subject to the principals control, and
(4) the agent manifests assent or otherwise consents so to act.
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BUT: Professor says these elements aren't very helpful because they could apply to waitercustomer relationship
Effect of Disclaimer of Agency: Evidence of lack of agency but not dispositive (Hassur)
Dealing v. Finding
If "dealing" with 3rd party on behalf of principal, agent has fiduciary duties
If merely "finding" or "advising", no fiduciary duties
Douglas v. Steele (Supp. p. 99)
Was Steel the Douglas agent? Does their relationship meet the test?
Answer: Yes, but not clear why.
Competing views:
(1) Steel is Douglas agent, as buyer from Total Hawaii
(2) Steel is Total Hawaiis agent, as seller to Douglas
Why should Steele suffer the Total Hawaii bankruptcy? Douglas chose Total Hawaii.
Answer: Steele had a fiduciary duty to tell Douglas what she knew.
Why did it matter whether Steele was Douglas agent? Why couldnt Douglas sue
Steele for negligence?
Answer: Agency created a fiduciary duty to inform (easy case). The alternative
relationship was buyer-seller. Sellers dont have a duty to disclose information.
Was Steele an agent of The Travel Haus, Inc.? Of Total Hawaii?
Answer: Travel Haus, yes. Total Hawaii, Possibly.
Is a waiter in a restaurant an agent of the customer?
Answer: Probably not, even though the words seem to fit.
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Professor: Language of Restatement, Third, Agency 101 doesn't say very much
and isn't very helpful
When applied to the relationship between a waiter and a customer, the
waiter is the customer's agent
Henderson v. Hassur (Supp. p. 103)
Facts:
Henderson agreed to seek out Mexican Pizza Hut sites for Hassur.
Hassur agreed to pay $4k commission plus 1% of gross revenues for each site
acquired for me.
Henderson bought Satellite City site for $56,000, sold it to Hassur for $88,000,
without disclosing what he paid.
No fraud.
Site may have been worth $88,000.
Hassur apparently approved that price.
Court: Henderson forfeits $32,000 profit, $16,000 commissions, 1% of gross, $215,000
punitive damages (missing from edit). Harsh?
Hypothetical 1: Assume Henderson and Hassur have not met. Henderson goes to
Mexico, buys site for $56,000. Henderson sells site to Hassur for $88,000,
without disclosing how much Henderson paid. Does Hassur have a cause of
action against Henderson?
Hypothetical 1 Result: No. Buyer-seller is not a fiduciary relationship.
Hypothetical 2: I do not agree to be your agent. But I will go to Mexico, find
sites, and if you buy them you agree to pay me $4k each and 1% of the gross. Is
this disclaimer of agency effective?
Hypothetical 2 Result: Disclaimer of agency is evidence, but not
controlling.
Sale contracts commonly provide that neither party is the others agent (at
arms length).
Despite that provision, the issue is still whether the relationship meets the
test for agency.
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(5) Estoppel
Mainly tort cases (respondeat superior)
Restatement of Agency Third 2.04. An employer is subject to liability for torts committed
by employees while acting within the scope of their employment.
Scope of Employment: Restatement of Agency Third 7.07(2) An employee acts within
the scope of employment when performing work assigned by the employer or engaging in a
course of conduct subject to the employer's control. An employee's act is not within the scope
of employment when it occurs within an independent course of conduct not intended by the
employee to serve any purpose of the employer.
Paradigm case: Employer hires employee to deliver pizzas.
Employer controls or has the right to control how employee drives.
While driving to deliver a pizza, employee negligently causes an accident that injures
third party.
Tort is in scope of employment
Employee is liable (for his/her own negligence)
Employer is liable (respondeat superior)
Employer of an independent contractor is NOT LIABLE EXCEPT:
1. Strict liability for acts of an independent contractor performing ultra-hazardous
activity (non-delegable duty). (Explosives)
2. Respondeat superior liability for torts of an independent contractor performing
inherently dangerous activity. (Wrecking ball)
3. Liability for torts of an incompetent independent contractor. (Drunk)
Agents, employees, and independent contractors
Overlay (See Slide 8 from Agency Part 2) shows two distinctions:
(1) Employees (yellow) from independent contractors (green plus blue)
(2) Agents (green plus yellow) from non-agent independent contractors (blue). E.g., Douglas
v. Steele; Henderson v. Hassur.
Agents may have three types of authority
(1) Actual Authority
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Principal type
Principal
Agent
Third Party
Restatement of Agency
Disclosed
Yes
No
Yes
6.01
Unidentified
Yes
Yes
Yes
6.02
Undisclosed
Yes
Yes
Yes
6.03
Restatement 6.01. When an agent acting with actual or apparent authority makes a
contract on behalf of a disclosed principal,
(1) the principal and the third party are parties to the contract; and
(2) the agent is not a party to the contract unless the agent and third party agree
otherwise.
Restatement 6.02. When an agent acting with actual or apparent authority makes a
contract on behalf of an unidentified principal,
(1) the principal and the third party are parties to the contract; and
(2) the agent is a party to the contract unless the agent and the third party agree
otherwise.
Restatement 6.03. When an agent acting with actual authority makes a contract on behalf
of an undisclosed principal,
(1) unless excluded by the contract, the principal is a party to the contract;
(2) the agent and the third party are parties to the contract; and
(3) the principal, if a party to the contract, and the third party have the same rights,
liabilities, and defenses against each other as if the principal made the contract
personally . . .
Disclosed Principal
Sears v. Riggs Distiller (Supp. p. 111)
Facts
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Fenwick didnt know about Watteau and so could not have relied on Watteaus credit.
Why should he be able to sue Watteau?
Professor's answer: Because Watteau made Humble appear credit-worthy.
Restatement Example
Supplier extends credit to Contractor on a 30 day account.
Contractor incorporates, transfers assets to the corporation
Supplier doesnt know about the corporation.
A year after incorporation, Contractor doesnt pay. Supplier discovers the corporation
and sues for payment of the account.
Who is liable on the account?
Contractor and Contractor, Inc. as undisclosed principal.
Ratification
Restatement 3d 4.01. Ratification is the affirmance of a prior act done by another, whereby
the act is given effect as if done by an agent acting with authority.
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Restatement 3d 4.03. A person may ratify an act [only] if the actor acted or purported to act
as an agent on the persons behalf.
Restatement 3d 4.05. A ratification is not effective unless it precedes the occurrence of
circumstances that would cause the ratification to have adverse and inequitable effects on the
rights of third parties.
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2. Franchisor and franchisee can each own and control its own business
3. Franchisees supply local knowledge and contacts
4. Franchise form may defeat tort liability
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Florida Supreme Court: In todays world, it is well understood that the mere use
of franchise logos and related advertisements does not necessarily indicate that
the franchisor has . . . control over any substantial aspect of the franchisees
business. Did you understand this?
How much control do you think Mobil has over franchisees operations?
My answer: As much as they want (even as the much control as the
franchisor own the gas station and mart by itself).
Emerson empirical study: Most people think franchises are actually nationally or
dually owned and operated, not locally owned and operated (as they actually are)
Professor Lopucki: Franchisors mislead the public, and courts allow them
to do so.
NOTE: Court used principal/agent language even though this is a tort case, not a contract
case
Trademark owner / franchisor duty to control: NOT A REAL THREAT B/C NOT
ENFORCED
Naked licensing occurs when the licensor fails to exercise adequate quality control over the
licensee. Naked licensing may result in the trademark's ceasing to function as a symbol of
quality and a controlled source. We have previously declared that naked licensing is
inherently deceptive and constitutes abandonment of any rights to the trademark by the
licensor. 9th Circuit case, 2010
To avoid tort liability, the franchisor must not control. To keep its trademark, the franchisor
must control.
But this trademark rule isn't a real threat to companies
Courts pay lip service to it, but do not enforce it
Imputation of Knowledge
[Restatement is not born to be a law unless a court accepts it during its trial, which means the
restatement becomes a case law.]
Refer to the slides [imputation of knowledge summary of general rule and exceptions]
Restatement Third Agency 5.03. [N]otice of a fact that an agent knows or has reason to know is
imputed to the principal if knowledge of the fact is material to the agents duties to the principal,
unless the agent
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Why should
Who can bind in Who can make decisions in Who can make
ordinary course?
the ordinary course?
ordinary course?
decisions
out
Corporation
Partnership
Any partner
301(1)
LLC
Any member
301(a)
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Will you advise Menard to ask for the resolution next time?
Professor's answer: Asking for the resolution is safe for the lawyer.
Lawyers are deal killers. The other approach is to sign the contract and then
negotiate the authority problem.
Proposed rule: If the CEO warrants authority and the third party has no contrary notice, the
corporation is liable.
That is not the law. Should it be?
My answer: Yes. The law over-protects principals.
Actual rule for LLCs
ULLCA 301(c). Unless the articles of organization limit their authority, any member
of a member-managed company or manager of a manager-managed company may sign
and deliver any instrument transferring . . . the companys interest in real property.
Problem Set 8 (p. 88 Supp.)
**View slides 17-21 in powerpoint (Actions Binding the Corporation Part 1)
Actions Binding Partnerships
Stroud v. National Biscuit (Supp. p. 95)
Summary: Partners can bind the partnership when carrying out the ordinary course of
business
Facts
Stroud and Freeman are partners in a Strouds Food Center.
Stroud to National Biscuit: I will not be responsible for bread sold to the store.
Freeman orders bread and National Biscuit sells it.
National Biscuit sues Stroud.
Court: Freeman had actual authority to buy. National Biscuit wins.
Did the court correctly apply RUPA?
Yes
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402(f) Each partner has equal rights in the management and conduct of the partnership
business.
(j) A difference . . . may be decided by a majority of the partners.
301(1) Each partner is an agent of the partnership for the purpose of its business. An
act of a partner . . . for apparently carrying on in the ordinary course the partnership
business or business of the kind carried on by the partnership binds the partnership,
unless the partner had no authority to act for the partnership in the particular matter and
the person with whom the partner was dealing knew or had receive a notification that
the partner lacked authority.
Does Stroud have the authority to cancel the bread order?
Yes. Last to speak rules
If there's a split vote on cancellation, does Stroud have authority to cancel?
Yes. There's just no partnership decision.
What could Stroud have done to prevent Freeman from obligating him?
He could have dissociated and given notice to Freeman and National Biscuit.
601(1) A partner is dissociated from a partnership upon . . . the partnerships having
notice of the partners express will to withdraw as a partner . . . .
703(a) A dissociated partner is not liable for a partnership obligation incurred after
dissociation, except as otherwise provided in (b).
(b) A partner who dissociates . . . is liable as a partner . . . only if . . . at the time
of entering into the transaction the other party . . . did not have notice of the
partners dissociation . . . .
704(a) [A] person not a partner is deemed to have notice of the dissociation 90 days
after the statement of dissociation is filed.
Voting power of Partners and LLC Members
RUPA 402(f) / ULLCA 404(a)
RUPA 402(f) Each partner has equal rights in the management and conduct of the
partnership business.
(j) A difference . . . may be decided by a majority of the partners.
ULLCA 404(a). In a member-managed company
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(1) each member has equal rights in the management and conduct of the
companys business; and
(2) . . . any matter relating to the business of the company may be decided by a
majority of the members.
Binding GPs and LLCs in the Ordinary Course of Business
RUPA 301(1) / ULLCA 301(a)(1)
RUPA 301(1) Each partner is an agent of the partnership for the purpose of its
business. An act of a partner . . . for apparently carrying on in the ordinary course the
partnership business or business of the kind carried on by the partnership binds the
partnership, unless the partner had no authority to act for the partnership in the
particular matter and the person with whom the partner was dealing knew or had
received a notification that the partner lacked authority.
ULLCA 301(a)(1). Each member is an agent of the limited liability company for the
purpose of its business, and an act of a member . . . for apparently carrying on in the
ordinary course the companys business or business of the kind carried on by the
company binds the company, unless the member had no authority to act for the
company in the particular matter and the person with whom the member was dealing
knew or had notice that the member lacked authority.
[ULLCA 301(c) re the transfer of real property by LLC members] refer to
slides [Authority of LLC Members]
Formalities for Board Action
Directors have no authority as individuals by virtue of their position on the board
Individual board members have no authority: The legal effect...was to invest the directors...as
a boardthey have no authority to act, [except] at a board meeting. Baldwin v. Canfield.
Powers of the Board of Directors at a Meeting (DGCL 141)
Authority of Board - The board has full authority to manage: DGCL 141(a). The business
and affairs of every corporation...shall be managed by or under the direction of a board of
directors.
Board can only act at a meeting - DGCL 141(b). The vote of the majority...present at a
meeting at which a quorum is present...shall be the act of the board of directors
When has a meeting taken place?
Quorum - Majority of total number of directors constitutes a quorum. DGCL 141(b)
However, the corporations bylaws may stipulate otherwise.
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Reliance protection: Board and committee members are "protected" from liability in relying
on committee work. DGCL 141(e).
Audit Committee Special Rule - Sarbanes-Oxley requires an audit committee composed
entirely of independent directors (sb. Whose decision-making will not be influenced by the
shareholders or directors upon their voting rights, e.g. Bill Gates as the ID of Facebook).
This deals with the recurring problem of auditors who collude with companies (the
AHERF problem)
Securities exchanges require various other committees to resolve specific problems re
the public company.
Legal Opinions
Relevance to Dage:
Menard contracts to buy land from Dage. Much can go wrong:
Dage was never incorporated and doesnt exist.
Sterling, who signed for Dage, wasnt authorized.
The transaction is contrary to the certificate or bylaws.
The transaction is contrary to statutes or regulations
Menard can have a law firm investigate and confirm that there are no problems with the
transaction
Purposes of Legal Opinion Letters:
(1) Opportunity to fix problems
(2) Comfort for parties and financiers.
(3) The attorney is liable for negligence (NOT just mistakes) and may reimburse
resulting losses
Common Problem With Legal Opinion Letters (refer to the problems on P90 of the
supplement and P194 of the textbook):
The letter addresses all the buyers legal concerns.
BUT: it contains lots of qualifications and limitations.
After qualifications, is there anything left?
Two Views of Opinion Letters
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Intangibles
"Liabilities" includes:
Current Liabilities:
Accounts payable
Notes payable
Accrued expenses
Other liabilities
Long-Term Liability
Long-term notes
"Equity" includes:
Paid-in capital
Retained earnings
How Financial Statements be used?
Balance Sheet Analysis - Overview
Liquidity Analysis: Can the Company pay its current debts?
Current Ratio = current assets divided by current liabilities
Debt analysis: Can the Company take on new debt?
Debt-to-equity ratio
Equity analysis: Does the Company have value to its owners?
Book value
Balance Sheet Analysis
The basic technique: business ratios
Look at businesses of a certain type and look at the ratios successful businesses of that type
usually have
e.g. Look at 100 drug stores; how much cash does it usually keep on hand
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(1) Liquidity Analysis: Can the Company pay its current debts?
(the ability to convert the assets to cash, if bankruptcy, the company has problem to
convert its assets to cash, either cannot sell assets or cost excessively to complete the sale)
Current Ratio = current assets divided by current liabilities
Rule of thumb: ratio should be 2.0 or higher
Example: Widget, Inc. has current ratio of 1.29 in year 1 and 1.62 in year 2
That isn't good, but it is getting better. But why is it getting better?
A/R and inventory are up $440k. Sales are up $500.
That could be good or bad. A/R could be up because you're selling more or
because customers aren't paying. Inventory could be up because you need
more to sell or because you haven't been able to sell what you have while
continuing to buy more. Sales aren't up enough to account for the increased
A/R and inventory, so it's likely that there's a buildup of bad inventory or
bad customer debt.
(2) Debt analysis: Can the Company take on new debt?
(Long-term) Debt-to-equity ratio
"Financial leverage" is the ratio of long-term debt to equity
The trend now is to ignore current liabilities and look at long-term debt
Professor says this is fine as long as you're using same approach across different
companies
Ratio of long term debt to equity should be about 1.0 or less
Example: Widget, Inc. has debt-to-equity ratio of 1.79 in year 1 and 1.32 in year 2
Widget's financial leverage is high but declining
(3) Equity analysis: Does the Company have value to its owners?
Book value of owners equity = book value of assets - liabilities
Book value of assets minus book value of liabilities produces book value of
equity
Requires adjustments because assets are listed at cost, not at market value
Sample Adjustments:
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EBITDA
Example: Widget's operating margin is 12.3% in year 2
Business Valuation
Difficult to value a business accurately, but it must be done
Requires many assumptions
Calculating Interest
To calculate principal plus 20% interest, multiply by one plus the interest rate. (This is annual
rate, annual compounding)
Year
$482.25
*1.2 =
$578.70
$578.70
*1.2 =
$694.44
$694.44
*1.2 =
$833.33
$833.33
*1.2 =
$1,000.00
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(i) Emotionless - Ignores people in a business. Are the people good, stable, and
working together?
(ii) Insensitive: Doesn't encourage detailed investigation. Is the product really
better than the competitors' products? How will the market for the product evolve
in the future?
(iii) Arbitrary: Making assumptions for no good reason. Assumes an ability to
predict the future.
What is Widget, Inc. worth?
Valuation method
Value
$1,910,000
Market comparable 1
$1,000,000
Market comparable 2
$2,691,000
$1,833,333
Conclusion: about
$2,000,000
Valuation Problems
(1) You put $5,000 in the bank at 7% annual interest. How much do you have after 10 years?
Year
Start Amount
End amount
5,000.00
1.07
5,350.00
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5,350.00
1.07
5,724.50
10
9,192.30
1.07
9,835.76
Answer: $9,835.76
(2) You are promised a $80,000 bonus if you stay at the law firm for 5 years. How much is it
worth now? (Bank CDs are paying 8%.)
Year
Start Amount
End Amount
80,000
1.08
74.074.07
74.074.07
1.08
68,587.11
68,587.11
1.08
63,506.58
63,506.58
1.08
58,802.39
58,802.39
1.08
54,446.66
Answer: Divide the bonus by one plus the implicit interest rate, repeating for each
year. The present value is $54,446.66.
(3) Blockbuster is getting into online movie rentals, just like Netflix. Netflixs price to
earnings ratio is 24 (PE = 24). How much should Blockbusters stock trade for if
Blockbusters earnings per share are $3.50?
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Reasoning: The market says Netflix is worth 24 times earnings, so Blockbuster will
be worth 24 times earnings.
If Blockbusters earnings per share are $3.50, then Blockbuster shares should be worth
24 times $3.50. $84.00.
(4) You buy a vineyard that has annual cash flow of $30,000. Its risk is similar to that of an
apple orchard that was discounted at 15% in another transaction. How much is the vineyard
worth?
Reasoning: If the vineyard has the same risk as the orchard, the Market should
discount the vineyards future cash flows at the same rate the Market discounted the
orchards cash flows.
The present value of $30,000 a year in perpetuity, discounted at 15% per year, is the
amount that, if invested at 15% interest, would produce $30,000 a year.
Solution: That amount is $30,000 divided by .15, which is $200,000.
A spreadsheet showing the calculations has been posted to MyLaw.
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Types of Equity:
(1) Preferred (convertible or redeemable): its preference is defined by and strictly subject to the
contract terms. (Preference in dividend, liquidation to the common shareholders)
(2) Common (can be issued in classes and series): the company can define different classes (i.e.
Classes A, B and C) of common shares
Example: Widget, Inc. Sale
Justin, Kathy, and Lorenzo form JKL, Inc. to buy Widget, Inc.
Sale Term Sheet (key terms of a transaction)
Price: $2 million
$1,250,000 in cash at closing
$750,000 by 10-year, interest-only note at 10% interest (at the end of the 10 th year, the
principal will come to due at once) notes to Widget Inc.
Shareholder Agreement ($900,000 cash)
Justin: 40% of the common for $100,000 cash and a $100,000 note secured by stock (like
contribute on credit, he signs a promissory note to the company)
Kathy: 40% of the stock for $200,000 cash
Lorenzo: 20% of the common for $100,000, plus $500,000 preferred for $600,000 cash
Bank Loan Term Sheet
Loan: $500,000
Repayable in 5 annual installments of $100,000 per year
10% interest, payable quarterly
Between Widget Brothers and Bank, who will have priority with respect to repayment?
Whoever gets the first security interest (the Bank it always has the bargaining power.)
Three security interests in this sale:
(1) Bank against the business for $500,000
(2) Widget Inc. against the business for $750,000
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Security Interests
Definition: An interest in property contingent on the non-payment of debt
Features:
(1) Priority in the collateral - Payment in full before anyone else gets anything
(2) Remedy - After default, (judicial or not) foreclosure sale, proceeds are applied to the debt
(3) Encumbrance - Continues in property notwithstanding sale
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Absolute Priority Rule (APR) - The proceeds of liquidation go to liabilities until paid in full, then
to the preferred liquidation preference, then common.
Capital structure conflicts
Directors' fiduciary duties are stronger for common shareholders than they are for preferred
shareholders
Equity Linked Investors v. Adams (p. 275)
Genta Inc. is "on the lip of insolvency" and has its bankruptcy petition ready
In liquidation, the absolute priority rule applies
The directors decide not to liquidate, but instead to borrow $3 million secured from
Paramount
Goal: get money for common stockholders by risking the assets
Strategy: gamble cash on risky investments
Why? Unsecured creditors and preferred stockholders bear risk of loss. Common
stockholders can only benefit.
Paramount bears no risk though because their debt is secured
Court: Business judgment rule applies (directors must act on the best interests of the
corporation). Directors have fiduciary duties to the common shareholders, not the
preferred ones.
There always are transactions bad for the corporation, but good for common
shareholders. Under this circumstances, defining the boards fiduciary duties to the
corporation or the shareholder is the job of the court.
Directors are allowed to decide to borrow $3 million.
Arguments against application of Business Judgment Rule:
(1) Directors were acting for the common stockholders, not for the corporation
(2) The Directors were not "independent" because they were beholden to the
common stockholders (they owned common stock?)
Court's response: "Generally, it will be the duty of the board, where discretionary
judgment is to be exercised, to prefer the interests of the common stock...to the interests
of the preferred stock." p. 276
Questions:
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Outside Leverage
Definition: owners of company borrow money from someone other than themselves
Investors split money with outsiders
Inside Leverage
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If you go too far though, IRS will seek to characterize debt as equity and revoke
tax deductions.
See Deep Rock doctrine equitable subordination (may re-characterize debt as
equity)
But still no harm in trying
Usually the worst that can happen is that you lose your deductions (risk of
jail time is only in egregious circumstances)
Other benefit of this approach is a higher bankruptcy priority
Options
Option definition: the right, but not the obligation, to do something
Stock Option definition: The right to buy (call) or sell (put) a specified number of shares at
the exercise (strike) price on or before the expiration (maturity) date.
Example: An option to purchase 100 shares of Facebook for $49 on or before the third
Friday in December
Stock options generally expire on the third Friday of each month and are typically for
up to nine months
If one person has an option, someone else has an obligation to deliver if the option is
exercised. Who?
For executives option, the corporation is the counterparty.
For other options: A stock owner who sells the option, but still owns the stock.
Equity as an Option
This concept is part of finance theory
Stockholders are not liable for the company's debt
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Theory: For shareholders, stock is an option (1) to pay the debt and own the company, or (2)
to walk away from the investment
Professor's view: Analogy of stock to a stock option is usually confusing.
Why came up with this analogy: under the circumstances of insolvency, bank probably is the
real owner of the company, however, the shareholder has an option to pay off the debt and recontrol the company.
Dilution and Preemptive Rights
Terminology
Authorized Shares: Shares the corporation is authorized to issue
Exist when the AOI say they do
Can authorize more only by amendment to Articles of Incorporation. DGCL 242(b)
(1).
Requires majority vote of shareholders
Issued shares: Shares the corporation has issued to investors
Exist when the certificate delivered, or corporation otherwise acknowledges the
shareholder pursuant to Board of Directors' authority. DGCL 152.
Treasury shares: Previously issued shares the corporation now owns (decrease of legal
capital)
Outstanding shares: Issued shares that are not treasury shares
No preemptive right to subscribe to an additional issue of stock unless granted in AOI
DGCL 102(b)(3)
MBCA 6.30(a)
The legal capital requirement
Terminology
Stated capital: The amount of consideration paid for no-par stock that the board determines
to be capital.
DGCL 154
Capital: An amount fixed by the board. It must be at least the total par value of shares
outstanding or the stated capital for no-par shares.
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DCGL 170(a). The directors . . . may declare and pay dividends upon the shares of
its capital stock . . . out of surplus . . . or . . . out of net profits for the fiscal year and/or
the preceding fiscal year.
DCGL 173. No corporation shall pay dividends except in accordance with this
chapter.
Directors can have personal liability for violations:
DCGL 174(a). In case of any willful or negligent violation of . . . 173 . . . the
directors . . . shall be jointly and severally liable, at any time within 6 years after paying
such unlawful dividend . . . to the corporation, and to its creditors in the event of its
dissolution or insolvency, to the full amount of the dividend unlawfully paid . . . with
interest . . . .
Legal capital cannot be used to redeem or repurchase stock:
DGCL 160(a). Every corporation may purchase, redeem, ... or otherwise acquire
its ... own shares; provided, however, that no corporation shall:
(1) Purchase or redeem its own shares of capital stock for cash or other property
when the capital of the corporation is impaired or when such purchase or
redemption would cause any impairment of the capital of the corporation . . .
NOTE: Legal capital sets no minimum cash requirement
Methods to Avoid the Legal Capital Requirement
(1) Choose a very small amount for the par value of shares or a small amount for stated value
(2) Create capital surplus by revaluing assets.
Klang v. Smith's Food & Drug Centers (p. 285)
SFD owns Cactus Acquisition
Yucaipa owns Smitty's
Yucaipa intends to become the owner of SFD by acquiring a majority of the public
shares
Then Smitty's will merge with Cactus
Transaction:
SFD buys 6 million shares
SFD issues 3 million new shares
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I.
Entity Name
A. Registered Entity Name (DGCL 102)
Entity name shall include: 1) a word of corporateness (exemptions may allowed); and 2)
distinguishing the new name from other corporations registered in the state (a difference in only
the indicator of corporateness is not sufficient to distinguish two corporations; refer to slides
P23).
The corporation codes of Delaware and California provide exemptions for corporations
qualified certain requirements regarding the word of corporateness.
Many corporations may not operate at the state of incorporation. The corporation doing
businesses beyond the state of incorporation may be required to register in the state of operation,
but this is merely identify it as a foreign corporation, but register it as a new corporation.
B.
II.
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Entity Structure: the relationship among two or more legal entities. (A corporate group is one
type of entity structures.)
What is an entity?
The law has two conflicting views of the corporation and switches between them:
(1) An aggregate of individuals - a group of people
The authorized spokesman of a corporation is a human being, who speaks on behalf of
the human beings who have formed that association just as the spokesman of an
unincorporated association speaks on behalf of its members. Citizens United (Supreme
Court 2010)
(2) A person, separate from the individuals
A corporation is an artificial being, invisible, intangible, and existing only in
contemplation of law. Being the mere creature of law, it possesses only those properties
which the charter of its creation confers upon it, either expressly, or as incidental to its
very existence. Dartmouth College (Supreme Court 1819).
Corporations have most of the rights of "persons"
(1) Freedom of speech. Citizens United (Supreme Court, 2010)
Aggregate theory
(2) Freedom of the press. New York Times v. Sullivan (Supreme Court, 1964)
(3) Freedom of Religion. (split of circuits). Aggregate theory. Right to not provide birth control.
(4) Fourteenth Amendment, equal protection of the laws.
The court does not wish to hear argument on the question whether the provision in the
Fourteenth Amendment to the Constitution, which forbids a State to deny to any person
within its jurisdiction the equal protection of the laws, applies to these corporations. We are
all of opinion that it does. Santa Clara County (Supreme Court 1986). Entity theory.
Use and function of artificial entities
(1) Limited liability- Protect owners from respondeat superior
(a) Prevents the entity's creditors from interfering with the owner-controller's affairs
(b) Incorporation confines business liability to the entity (or one of several entities)
Sole proprietor has liability for business contracts and torts by whomever committed.
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wrong name, and service has been made upon the right party, although by a wrong
name. Miller v. Chapman (Mich. 2007)
FRCP Rule 4(h) sets out requirements of service of process for corporations, partnerships,
and other unincorporated associations
NOTE: It does not apply to sole proprietorships
How do we find out the legal name?
Check with County's registry of fictitious names
Corporate Groups
By owning the shares of other corporations, a corporation can form corporate groups
The owner is a "parent" and the owned corporations are "subsidiaries"
To be a "subsidiary," the parent company must have control (i.e. more than 50%
ownership)
The groups can include all kinds of entities (e.g. LLCs, Partnerships, etc.)
Groups are NOT entities
They cannot sue, own property, etc.
Multiple Businesses v. One Business
There are wide differences in the nature of groups. The two extremes are:
(1) Each entity has an independent business.
Example: Time Warner owns HBO, CNN, Warner Brothers, DC Comics
(2) The group has only one business. Each entity has a role in that business.
Example: An airline with separate corporations for bagging, finance, intellectual
property, and aircraft leasing.
Corporation statutes apply to each corporation separately
Some Federal regulatory law applies to corporate groups
e.g. Securities regulation, banking, labor, etc.
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Under these laws, corporations may be liable for acts of their affiliates.
Making a Corporate Group Diagram
1. Distinguish assets from entities
An entity name usually contains words of corporateness
Assets distinguish by context: "Fox Sports Net ('FSN'), a national sports programming
service"aqqa
2. Drafters pick intuitive names and give convenient short names
Could be Chevron, Chevron International, Chevron Holdings, etc.
3. Put entities in boxes (that's the convention)
4. Put the owner (entity) above the owned entity or asset
5. Draw line down ad indicate percentage of ownership beside line
6. "Indirectly owned" indicates an entity between
7. Include relationships other than ownership: leasing, managing, etc.
These relationships can exist in any combination
You most often see large combinations in hotels
Entities and Liabilities - Consumer Awareness of Nature of Entities
Except when using lawyers, economic participants see only trademarks and not entities.
Do customers need to know what entity they are dealing with?
Not for the product or service, but yes for liability purposes.
Will the market take care of the problem?
No.
What change in the law could enable customers to know what entity they are dealing with?
(1) Require that companies use their real names with the trademark
(2) Enforce the fictitious name statutes (although that knowledge might come too late)
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(3) Warning telling the customer that the trademark holder does not manufacture or operate
the business.
Entity Thinking
Deals can be expressed in "contract" or "entity"*
*Think of "entity" as a language that lawyers speak
Examples of Contract v. Entity Thinking:
Contract:
Bank lends $500 million to Rockefeller, a human, without recourse.
Bank cannot sue Rockefeller for nonpayment.
Entity:
Bank lends $500 million to Rockefeller, Inc. (a shell corporation owned by
Rockefeller)
Bank cannot sue Rockefeller for nonpayment
Contract:
I transfer all assets of my business to you.
Entity:
I transfer my stock in Rockefeller, Inc. to you (Rockefeller, Inc. owns all the assets of
my business)
Complex deals often can be stated more simply in entity
e.g. Smith's Food and Drugs
Contract drafting problem 1: A, B, and C will run a supermarket. A and C will run the meat
department.
Solution: Put the supermarket in one corporation and the meat department in another.
A, B, and C are owners and directors of the supermarket corporation. A and C are
owners and directors of the meat department corporation.
Contract drafting problem 2: The bank lenders are to have first priority in the automobile sale
contracts of General Motors.
Solution 1: Lend secured.
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Solution 2: Place the customer contracts in a subsidiary (GMAC). The banks are the
only creditors of that corporation.
"Finance Subsidiary." See Absolute Priority Rule (APR)
Professor: Whether a deal is written in contract or entity can actually determine the outcome
Putnam v. Shoaf (Supp. p. 147)
Charltons and Putnams are partners in the Frog Jump Gin Partnership
Lyle Putnam dies
Carolyn Putnam inherits his interest
A thief steals $68,000
Carolyn sells to the Shoafs
Gin gets the $68,000 back
Carolyn sues Shoafs for $34,000
Court: Putnam loses. She wanted out and out she got.
Judges argument confirms that Putnam did not convey her consent of transfer her interests in the
partnership to Shoaf, but she had to do so.
Lopucki does not agree with this decision. Considering the only exception of restatement of
contract, in the current case, Putnam did not have limited knowledge of the embezzlement, so the lawsuit
sale was voidable for mistake.
Professor: When you start to use entity thinking, it can take you places you would not
otherwise go.
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Court: IBC was either the corporate name or a trading-as name and that
International Blimpie Corporation was the other of these two possibilities.
"No independent business of its own; exclusively performed a service for the parent."
Professor: the court misunderstands the way that subsidiaries function in the U.S.
Most courts do not require a business, but only compliance with formalities
11.10. The court said IBC affirmatively, intentionally and calculatedly led OTR to believe
[IBC] was Blimpie. What is the evidence?
Answer: [T]wo men in Blimpie uniforms who announced that they wanted to open a
Blimpie sandwich shop. (Mobil/Westin did this.)
The lease description (previously discussed)
IBCs use of Blimpie logo letterhead (PwC Bahamas did this.)
IBCs reference to Samyrna as our franchisee.
Court considers logos used by judgment proof entities misleading.
Geigo Properties, LLP v. RJ Gators (Supp. p. 165)
Professor: This is in the reading to offset OTR Associates v. IBC Services, Inc.
RJ Gators is a shell and has no bank account.
RJ Gators signs the lease, makes the initial payment, and never moves in
Court: Mere shell use and subsequent breach is not enough to pierce the veil
Contract drafting possibilities:
Direct contracting: A solvent entity (Timoteo) signs, but the contract says Timoteo is
not liable
Entity contracting: An insolvent entity signs and agrees to be liable.
11.11. Should entity contracting be permitted?
OTR Associates v. IBC Services: Yes (courts decision)
Geigo Properties v. RJ Gators: No (courts decision)
Professor's Answer: Yes, but only with proof the counter-party understood the
provision. Shell owner should have a duty to speak.
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But cases are split on whether shell owners have a duty to speak:
No. Some courts presume that a party dealing with a corporation did
assume the risk of grossly inadequate capitalization. . . . Parties
generally entitled to rely upon certain assumptions . . . including
presumption that the corporation is more than a mere shellthat it
substance as well as form. Fletcher, Cyclopedia of Corporations.
not
are
the
has
Tort cases
Walkovsky v. Carlton (p. 306)
Carlton owns ten corporations
Each corporation owns one or two cabs
Seon cab injures Walkovsky
Walkovsky sues Carlton and each of the corporations as one entity
Reachable money:
$10,000 insurance
Each corporation held only $10,000 insurance policies, the minimum amount
required by the Legislature
Unreachable money:
15 taxis at $5,000 each = $75,000
15 medallions at $10,000 each = $150,000 (held by Carlton)
Garage real estate: unknown
Cash flow from the business: Unknown
Carlton's other wealth: Unknown
Carlton set the corporations up this way knowing the business would injure customers and
pedestrians
Court: complaint is dismissed
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The court using the U.S. law b/c the issue / case is between U.S. nationals.
Contract Cases
NetJets Aviation v. LHC Communications
Summary: Court mistakenly pierces veil of one-person corporation because it thinks the
owner is scum. Owner won in subsequent proceedings even though he withdrew funds at
will, changed his story on capital contribution, and used LLC funds to pay for personal living
expenses because he accounted for all the transfers and thus did not operate as a "single
economic entity".
Facts:
LHC (an LLC) uses $341,000 of private jet rental time and doesn't pay for it
NetJets sues Zimmerman personally, seeking to pierce the LLC veil
Court applies two prong test:
(1) The LLC and owner "operated as a single economic entity"
(2) An "overall element of injustice or unfairness is present"
NetJets's evidence:
Domination: No decision was made without Zimmerman's approval
LLC funds were used to pay personal living expenses (and recorded as "loan
receivable" in the bookkeeping)
Money went in an out based on need, at the eleventh hour
$350,000 for Bentley in year he didnt pay $340,000 to NetJets
Court is willing to pierce the veil (overturns lower court's SJ in favor of LHC)
The court got this decision wrong (see 11.5)
Dual Agency
Parent liability for group action
MBCA 6.22(b): . . . . [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.
The rule applies to shareholders that are corporations.
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federal pollution statute (CERCLA). Under the statute, an operator must manage,
direct, or conduct operations specifically related to pollution, that is, operations
having to do with the leakage or disposal of hazardous waste, or decisions about
compliance with environmental regulations.
Ott II settles
CPC claims that it does not have liability because it was not involved in the
pollution
CPC and Ott II had common officers and directors. They operated the facility.
Issue: Did they operate on behalf of CPC or Ott II?
One CPC employee ("Williams") who was not connected in any way with
Ott II may have "operated" the facility
Court: CPC is not liable on the basis of sharing directors and officers with Ott II as long
as those directors and officers were acting only for Ott II and not for CPC while they
operated the facility. Williams, CPC employee not employed by Ott II may have
operated the facility. Remanded for retrial.
Test for Overcoming Presumption that Officers/Directors Act for Whom they Claim to
Act: The presumption . . . an act is taken on behalf of [a subsidiary] wanes as the
distance from [the norms of corporate behavior] approaches the point of action by a
dual officer plainly contrary to the interests of the subsidiary yet nonetheless
advantageous to the parent.
Page 97 of 203
3. Equitable ownership
(i) Control by a person who is not the legal owner of an interest in the entities; and
(ii) Elements of veil piercing have been met
II. Agency
4. Agency
(i) Manifestation by the principal that the agent shall act for him
(ii) Agent's acceptance of the undertaking
(iii) Understanding between the parties that the principal is to be in control of the
undertaking
(iv) Injury inflicted by the subsidiary was within the scope of the subsidiary's authority
as an agent
Consequence: P is liable to As authorized act.
5. Ratification
Knowing acceptance by the principal of an agent's act after the act occurs
Can be shown by:
Defending the action of the agent
Covering up the action of the agent
6. Aiding and abetting
(i) the party whom the defendant aids must perform a wrongful act which causes an
injury;
(ii) the defendant must be generally aware of his role as part of the overall or tortious
activity at the time that he provides the assistance; and
(iii) the defendant must knowingly and substantially assist the principal violation.
III. Enterprise Liability
7. Enterprise liability (single enterprise, integrated, plain)
Same elements as veil piercing, except that entities are sisters, not parent-subsidiary
Page 98 of 203
NOTE: Only California allows enterprise liability, and it's not really clear if even
California actually allows it
IV. Substantive Consolidation
8. Substantive consolidation (only in bankruptcy)
Either:
(i) creditors dealt with the entities as a single economic unit and did not rely on
their separate identity in extending credit; or
(ii) the affairs of the debtor are so entangled that consolidation will benefit all
creditors
How can consolidation benefit all creditors? If some get more, dont others
get less?
Answer: No. Correction of the accounting could consume the entire
bankruptcy estate.
Agency
Restatement 3rd Agency 101. Agency is the fiduciary relationship that arises when:
(1) one person (a principal) manifests assent to another person (an agent) that
(2) the agent shall act on the principals behalf and
(3) subject to the principals control, and
(4) the agent manifests assent or otherwise consents so to act.
The parent-subsidiary relationship may be a principal-agent relationship
Consequence: The parent is liable for a subsidiary's authorized acts
Supervision v. Domination
Parent can supervise subsidiary without incurring liability, but can be liable if they dominate
Supervision requests coercively, but generally; domination orders specific action.
Spectrum from supervision to domination (from Bowoto v. ChevronTexaco):
CVX: This publicity is a problem. Solve it or well vote you out.
CVX: I want the demonstrators off the platform by morning.
Page 99 of 203
(iv) Daily communications between CNL and Defendants, especially sharp rise in
communications during attacks
(v) Corporate security committee which monitored and planned security operations for
the subsidiaries
Enterprise Liability
Definition: Liability for a business's actions is imposed on all entities that are part of the business.
Limited liability within the corporate group is abolished.
This is what Plaintiff hoped to do in Bowoto v. ChevronTexaco
Requires actual ownership to be imposed
NOT ENOUGH: operations that could have been one business
Other concepts referred to as "enterprise liability": (rational behind: business shall be liable
instead of entity)
(1) Industry wide liability - Liability on all members of an industry for manufacturing a
harmful or defective product, allotted by market share. Asbestos.
(2) Joint enterprise liability - Liability on members of a group that act together. Similar to
partnership liability.
(3) Single business enterprise - Liability on entities for acts of other entities that are mere
business conduits. Gardemal.
Only in Texas, Louisiana, and North Carolina. Has an 18-factor test. See Gardemal.
(4) Single employer doctrine - Labor-related liability on related entities that do not act at
arms length. Integrated enterprise theory. Bowoto.
Problem with enterprise liability: you have to figure out the scope of the enterprise.
e.g. Continental Airlines has several subsidiaries: Finance; Operations; Baggage; and
Ticketing.
Texas Air bought Continental Airlines, which continued to operate on its own, and
Eastern Airlines, which eventually filed for bankruptcy.
Texas Air was owned by a holding company which was owned by Frank Lorenzo.
Are there three businesses (Continental, Eastern, and Texas)?
Or just one (holding company that owns Texas Air)?
What makes a business separate?
Court: To pierce the corporate veil, "it must be shown that there is such a unity of interest and
ownership that the individuality of such corporation and such person has ceased . . . .
Equitable ownership in a corporation, demonstrated by control exercised by an individual
sought to be held liable for corporate debts, may satisfy the unity of interest and ownership
element . . .
The "equitable ownership" doctrine only applies in some states
Substantive Consolidation
Grounds for Substantive Consolidation: "Substantive consolidation is appropriate if:
(1) creditors did not rely on the separate existence of the debtors in extending credit; or
(2) the debtors' financial affairs are hopelessly entangled." In re Augie/Restivo Baking Co.,
860 F.2d 515 (2d Cir. 1988)
Level of Use
The estates are substantively consolidated in approximately 50% of all large public company
bankruptcies
This is entity disregard on a massive scale
Effect of Substantive Consolidation:
"Intercompany" stockholdings and claims are ignored
Cash management system loans are not repaid
In re LLS America (Supplement p. 194)
Facts:
Doris has a small loan business in Canada
Doris starts a small loan business in the U.S.
Doris sets up a business to supply them
Her husband Dennis buys a building and the business rents it
Doris creates a new Note LLC for each lender she borrows from
The Note LLCs allow use of the funds by any of the entities
Doris commingles all the money (she has consent to mix it) to the extent that it cannot
be determined which money has gone where
There are seven kinds of transactions, but only two types of moves:
(1) Merger: two corporations become one, and the shareholders of both own it (the
surviving entity may have either of the former companies names or neither, whatever
kind of shares they want)
(2) Acquisition: The shareholders own one corporation and that corporation owns the
other.
SEVEN FUNDAMENTAL TRANSACTIONS:
(1) Statutory merger (a combination effected pursuant to a corporate statutes merger
provisions). Direct Combination: Shareholders of both must approve; dissenters of
both shareholders get appraised value of their shares.
Objective: Two corporations combine into one.
Procedure:
1. Both boards adopt a plan of merger by majority vote. 251(b)
2. Both shareholder groups approve by absolute majority. 251(c)
3. File certificate of merger (with Secretary of the State of Delaware).
251(d)
4. Dissenting shareholders have appraisal rights. 262(b)
5. Creditors do not vote.
Effect on Surviving Corporation:
1. Owns the assets of both corporations
2. Owes the obligations of both corporations
3. Buys the appraised shares for cash, but market out 262(b)(1)
4. Issues its shares in exchange for non-dissenting Green shares.
5. Files the plan of merger with the secretary of state.
Effect on Creditors
Each retains its claim, but against more assets, with more creditors
competing. Collection may be more or less difficult.
Creditors contract may make debt due on merger.
Effect on Shareholders
Each has a smaller percentage of the shares of a larger corporation.
Shareholders contract may make shares redeemable on merger.
(2) Whale-minnow merger. If Green (Seller) is less than one fifth the size of Blue
(Buyer), Blue shareholders dont vote or have appraisal rights.
Definition: Statutory merger in which Blue and its stock remain the same, and
Blue buys Green for newly issued Blue stock not more than 20% of previously
issued Blue stock. The shareholders of Blue do not need to vote.
Statutory Authorization: DGCL 251(f). Unless required by its certificate of
incorporation, no vote of stockholders of a constituent corporation surviving a
merger shall be necessary to authorize a merger if
(1) the agreement of merger does not amend in any respect the certificate
of incorporation of such constituent corporation,
(2) each share of stock of such constituent corporation outstanding
immediately prior to . . . the merger is to be an identical outstanding . . .
share . . . after the . . . merger, and
(3) the . . . shares of common stock . . . to be issued . . . under the plan of
merger . . . do not exceed 20% of the shares of common stock of such
constituent corporation outstanding immediately prior to the effective date
of the merger.
Effect on Shareholders
Buyer grew by up to 20% in size. Shareholders of Buyer had shares
diluted by up to 20%.
Each shareholder of Seller chose between (1) a smaller interest in a larger
business and (2) the appraised value of their shares.
(3) Short-form merger (Absorb 90%-owned subsidiary). If Blue owns at least 90%
of Green, Blue can absorb Green. Both the shareholders of Blue and Green dont vote,
but the shareholders of Green have appraisal rights.
Starting point. Blue owns 90% of Greens shares.
Step 1. Blue sets a price for Greens shares and merges Green into Blue.
Step 2. Green shareholders choose between the price offered and appraisal
rights.
Implications:
Blue vote
Blue appraisal
Green vote
Green appraisal
1. Statutory merger
Yes
Yes
Yes
Yes
2.Whale-minnow merger
No
No
Yes
Yes
No
No
No
Yes
4. Sale of assets
No
No
Yes
No
5. Tender offer
No
No
No
No
6. Triangular merger
Corp
votes
approval)
Yes
Yes
7. Share exchange
Appraisal Rights
Example of Protection of Appraisal Rights: Blue, Green, and survivors shares are each worth
$100. The terms of merger favor Green shareholders by giving them 1.07 survivor shares per Green
share while giving Blue shareholders .90 shares per Blue share. How much money do Blue
shareholders get?
DGCL 262(h). [T]he Court shall determine the fair value of the shares exclusive of any
element of value arising from the accomplishment or expectation of the merger or
consolidation, together with interest, if any, to be paid upon the amount determined to be the
fair value.
Answer: Blue shareholders opt for appraisal, so they get $100 a share. Appraisal protects
them against merger that is a bad deal.
Market-out exception - No appraisal rights if your shares are listed on a national securities
exchange DGCL 262(b)(1).
FLAW: the exception assumes that the market is more knowledgeable about the stock's value
than a judge would be.
By the time shareholders learn the terms of the merger, the market may already reflect
price depreciation in anticipation of the merger.
From 1991 to 2001, acquiring firms' shareholders lost an aggregate $216 billion
Response of MBCA / Efficient Capital Markets Hypothesis: The market protects Blue
shareholders by not doing bad mergers.
MBCA 13.02, Cmt. 2. Where an efficient market exists, the market price will be an
adequate proxy for the fair value of the corporations shares. After [a merger
announcement] the market operates at maximum efficiency . . . because interested
parties and market professionals evaluate the proposal and competing proposals may be
generated if the original proposal is deemed inadequate.
Professor: this exception is a mistake. It just punishes people who have publicly traded
shares and does not substitute for appraisal rights.
Shareholder Power to Initiate Action
Bylaws (A rule or administrative provision adopted by an organization for its internal governance
and its external dealings)
Who makes them?
(i) Shareholders have inalienable right to adopt, amend, and repeal. DGCL 109(a)
(ii) Directors can make bylaws if so provided in the certificate. DGCL 109(a)
What can be in them?
(1) Anything consistent with law and the certificate of incorporation that relates to:
(a) The business of the corporation;
(b) The conduct of the corporation's affairs;
(c) The corporation's rights or powers; or
(d) The rights or powers of the corporation's stockholders, directors, officers or
employees. DGCL 109(b).
In short, any not in violation of the law and the certificate of incorporation can be
in the bylaw.
(2) Can specify procedure, but cannot commit board to a course of action:
DGCL 141(a). The business and affairs of every corporation organized under
this chapter shall be managed by or under the direction of a board of directors,
except as may be otherwise provided in this chapter or in its certificate of
incorporation.
REMEMBER: Powers of Board that cannot be restricted in bylaws can be
restricted in articles of incorporation.
Reimbursement Bylaws and the "Fiduciary out"
CA, Inc. v. AFSCME held that reimbursement bylaws must provide a
"fiduciary out" for directors
Bylaws can specify the procedure by which directors manage, but
cannot commit the board of directors to a course of action that
would preclude them from fully discharging their fiduciary duties [to
manage]. CA, Inc. v. AFSCME (See below)
BUT: Delaware responded with DGCL 113(a), which appears to allow
reimbursement bylaws without the "fiduciary out"
The bylaws may provide for the reimbursement . . . of expenses
incurred by a stockholder in soliciting proxies in connection with an
election of directors, subject to such procedures and conditions as the
bylaws may prescribe, including [specified conditions and] . . . any
other lawful condition.
UNCERTAINTY: Professor thinks 113 overturns CA, Inc., but many
experts say it is unclear whether courts will read a "fiduciary out"
exception into bylaws passed under 113.
Examples of valid shareholder bylaws procedural things:
14.19.b VentCap wants to use a computer algorithm to weight shareholder votes. Can
VentCap do that? How?
DGCL 151(a). Every corporation may issue . . . stock . . . [with] such voting
powers, full or limited, or no voting powers . . . as shall be stated . . . in the
certificate of incorporation . . . or in the . . . resolutions providing for the issue of
such stock . . . .
Any of the voting powers . . . may be made dependent upon facts ascertainable
outside the certificate of incorporation . . . or . . . resolutions . . . provided that the
manner in which such facts shall operate upon the voting powers . . . is clearly
and expressly set forth in the certificate of incorporation or in the . . . resolutions .
...
Answer: Yes.
resolutions.
1. Stockholder Two moves to remove Pat and Mike, without cause. Stockholder
One casts 100 votes against removal.
Pat and Mike are not removed.
2. Stockholder Two moves to remove the entire board. Stockholder One casts
100 votes against removal; a majority vote for removal.
The entire board is removed.
Stockholder One can then re-elect Pat and Mike.
The majority of shareholder can call for a re-vote whenever they want.
Notice and Opportunity to Defend: If cause is necessary to replace a director, notice and an
opportunity to defend are required. Auer v. Dressel
Cause is not required by the DGCL, but may be provided in the COI of certain companies. So
under such circumstances, notice and opportunity to defend shall be required.
Removing Directors - Process and Strategy
14.20. Can Zuckerberg, as CEO, Chairman, and holder of a majority of the voting
power remove dissident director Hanson?
DGCL 141(k). Any director or the entire board of directors may be removed,
with or without cause, by the holders of a majority of the shares then entitled to
vote at an election of directors . . .
Answer: Yes.
What is the quickest way to remove Hanson?
DGCL 228. Unless otherwise provided in the certificate of incorporation .
. . any action which may be taken at any annual or special meeting . . . may
be taken without a meeting . . . if a consent . . . in writing . . . shall be
signed by the holders of . . . the minimum number of votes . . . necessary . .
. take such action at a meeting . . . and shall be delivered to . . . an . . . agent
. . . having custody of the book in which proceedings of meetings of
stockholders are recorded.
Answer: Deliver a written consent to the Secretary removing him.
What is the best way to remove Hanson?
DGCL 223(a)(1). Vacancies . . . may be filled by a majority of the
directors then in office, although less than a quorum . . .
(1) Vacancies . . . may be filled by a majority of the directors then in office, although
less than a quorum . . .
(c) If, at the time of filling any vacancy or any newly created directorship, the directors
then in office shall constitute less than a majority of the whole board . . .the Court of
Chancery may, upon the application of stockholders holding at least 10% . . . order an
election.
DGCL 211(b). Stockholders may . . . act by written consent to elect directors . . . .
Bylaws can give stockholders the power to fill vacant directorships. They have inherent
power to fill the new ones. Campbell v. Loew's, Inc.
Board Responses to Shareholder Initiatives
Without compelling justification, the Board cannot act for the primary purpose of thwarting the
exercise of a shareholder vote. (Breaches Duty of Loyalty)
No compelling justification in Blasius v. Atlas because:
Not faced with a coercive action taken by a powerful shareholder against the interests
of a distinct shareholder constituency
Board knew it had time to inform shareholders of its views on the merits of the
proposal subject to the shareholder vote
Not enough to say "Board knows best" when the issue is who should comprise the
Board.
LoPucki: Board members are rarely independent. They are loyal to the persons who
elected them. Courts usually maintain the legal fiction that they are independent.
Structural Bias
A minority of courts acknowledge Structural Bias in extreme cases. Clark v. Lomas &
Nettleton Fin. Corp. (1980)
Board responses to shareholder initiatives: Quickturn
Assumes the directors will operate in the best interest of the shareholders (and
aren't just operating in their own interest)
Also assumes that the market is not correctly valuing shares in these situations
Netflix shares were trading at $77
Icahn offered a higher amount for the shares (may have been $90-100)
The law allows the directors to block Icahn's offer because the shares may
actually be worth an even larger amount than what Icahn has offered for
them
Interpretation of 102(a)(4) and 157(a) Enables Use of Poison Pill
Because of an interpretation of DGCL 102(a)(4) and DGCL 157(a), Rights are not
stock that must be authorized by a provision in the certificate of incorporation . This
interpretation enables the use of the Poison Pill.
DGCL 102(a)(4). The certificate of incorporation shall . . . set forth . . . the
designations and the powers, preferences and rights, and the qualifications,
limitations or restrictions [of each class of stock] . . . and an express grant of . . .
authority . . . to fix [the same] by resolution [if] desired but . . . not . . . fixed by
the certificate of incorporation.
DGCL 157(a). [E]very corporation may create and issue . . . rights or options
entitling the holders thereof to acquire from the corporation any shares of its
capital stock of any class or classes . . .
When the corporation does not have enough authorized share, the board cannot give share
to the shareholders who exercised their rights. What can they do?
The court said the corporation can issue debt to the shareholders instead. Other
shareholder then own debt to the corporation; and the board may call on an interim
shareholders meeting to authorize more shares; then no debt to decrease the value the
company but more shares to dilute the Acquiring Person.
Before Dilution
Change
After Dilution
Shares out
55,545,531
50,004,465
105,549,996
Price
$76.37
$38.19
$58.28
Market Cap
$4,242,012,202
$1,909,670,518
$6,151,682,721
Icahn shares
5,541,066
5,541,066
Icahn percent
9.98%
-4.73%
5.25%
Icahn value
$423,171,210
$-100,225,865
$322,945,346
Other shares
50,004,465
50,004,465
100,008,930
Other percent
90.02%
+4.73%
94.75%
Other value
$3,818,840,992
$2,009,896,383
$5,828,737,375
Icahns shares have lost $100 million in value, and he now owns only 5.25%
Special Rule for Takeover Context: The Board cannot prevent future boards from managing the
corporation (under 141(a)) and fulfilling their fiduciary duties.
Quickturn Design Systems, Inc. v. Shapiro (p. 404)
Facts:
Quickturn has a patent injunction barring Mentor from the US emulation market
Mentor makes a cash tender offer for Quickturn; 50% over the pre-offer price;
Mentor solicits proxies for a shareholder-called special meeting to oust the
directors
The Quickturn board recommends that shareholders reject the offer
The Board amends Quickturn's bylaws to let the board control the time of the
special meeting. Board could delay three months
The Board amends its poison pill to prevent the acquirers board from redeeming
for six months. Delayed Redemption Period (DRP)
Court: the bylaw amendment is valid, but the DRP is invalid.
The DRP is invalid because it prevents future board from managing the
corporation (under 141(a)) and so fulfilling its fiduciary duties.
Future shareholders (Mentor) are not protected.
Future boards (Mentor-elected) are protected.
Professor: Bylaw was allowed because Blasius refused to establish a per se rule, so the
court must have thought the Board had compelling justification for its action.
Because the Quickturn rule applies only in the takeover context, the following are NOT
invalid limitations on the board's right to manage:
A contract to buy from a major supplier for three years
A contract to construct and occupy a factory for five-years
The same contract if Mentor is objecting before it is signed
Delaware Supreme Court: [T]o the extent that a contract, or a provision thereof, purports
to require a board to act or not act in such a fashion as to limit the exercise of fiduciary
duties, it is invalid and unenforceable.
Paramount v. QVC: No-shop provision (prohibiting the directors from contacting other
buyers for higher prices) in merger agreement invalid, because it prevented directors from
talking to a potential buyer.
Part 1 - Voting Substance (move to chapter 14 together with the voting procedures)
Three Voting Systems:
(1) Straight Voting
Default rule. DGCL 212(a)
Procedure:
A resolution is made to elect a person or a slate of people
Votes are recorded for and against
Holder of a majority of the voting power always wins
(2) Class Voting. DGCL 151
The certificate divides shares into classes and gives each class the right to elect some
number of directors. (Each class has equal right on electing directors.)
Shareholder A owns Class A shares; Class A has the right to elect four directors.
Motion is to elect, and votes are recorded for and against.
The holder of a majority of the voting power in each class will win all votes in the class
and so elect all board members electable by the class.
Voting control can be substantially separated from share control
(3) Cumulative Voting
Mandatory / Required in California (California Corporation Code 708(a)); option
everywhere else (choice in other states, e.g. Delaware)DGCL 214
Most complex of the three systems
Ensures minority board representation
DGCL 214. The certificate of incorporation . . . may provide that . . . each holder of
stock . . . shall be entitled to as many votes as shall equal the number of votes . . . such
holder would be entitled to cast for the election of directors . . . multiplied by the
number of directors to be elected . . . and that such holder may cast all . . . for a single
director or may distribute them among the number to be voted for . . . .
Formula:
Where:
X = number of shares required to elect number of directors desired
s = number of shares voting
d = number of directors desired
D = number of directors to be elected
Deadlock
In event of deadlock and appropriate application for relief, Delaware Court of Chancery will
appoint a custodian or a provisional director REGARDLESS of contrary provision in Articles
or Bylaws (DGCL 353)
DGCL 226(a) requires application of any stockholder
DGCL 353(a), for close corporations, has more particular application requirements,
including:
Application by half of directors
Application by holders of one-third of stock entitled to vote on directors
Application by holders of two-thirds of one of the classes of stock
Custodian or provisional director is expensive and intrusive.
Shareholder Agreement - DGCL 218(c)
Remedy for Breach of Shareholder Agreement: Damages, possibly plus an injunction and
change of the vote (this is a breach of contract action)
Ringling Bros: disallowed breachers' wrongful votes, but didnt deem them cast as
agreed.
Voting Trust
Irrevocable Proxy
Pooling Agreement
Trust
Stockholders
Stockholders
Trustee
Proxy
Stockholders
Degree of publicity?
(Private)
Stock record
Voting record
Private
Time limit?
None in
Delaware
(usu. 10
years)
None
None
Yes
If on certificate
If on certificate
No
Coupled with an
interests
No
Self-enforcing?
No
Somewhat
No
It is the law permitted business people to do whatever they want to, so there are 3 options though
they are confusing.
Vote Counting
Votes per share:
Default Rule is that each share has one vote.
If so provided, shares can have no votes or multiple votes.
Types of majorities:
Court: The agreement is valid, but Wolfson must pay dividends to the shareholders because,
as a controlling interest, he owed fiduciary duties to the other shareholders and refusing to
pay dividends was a violation of those fiduciary duties.
Court's argument is actually that Wolfson owed fiduciary duties to the shareholders because
he was an ad hoc controlling interest.
LoPucki: Controlling shareholders in a close corp. own fiduciary duties to other shareholders.
Part 3 - Contractual Transfer Provisions - DGCL 202
Stock transfer restrictions: use context when creating
Default rule: Investors cannot withdraw their investment whenever they want and the majority
determines when distributions are made. Capital lock-in.
Typical Restrictions:
Consent: sale only with consent of the directors or shareholders
Rights of first refusal: Shareholder can sell the shares, but only after offering them to the
corporation and other shareholders.
Prohibition: prohibits sale to designated persons or classes of persons if not manifestly
unreasonable (DGCL202(c)(5))
Mandatory redemption. The corporation must redeem the shares for a fixed amount or for their
appraised value.
Mandatory buyout. Other shareholders must buy the shares for a fixed amount or for their
appraised value.
prove
DGCL 219
DGCL 220
Stockholder of record or
beneficial owner of stock
Access to what?
Nature of
access?
Proper purpose
Burden of proof
re purpose?
Remedy for
denial
Stock ledger: a list of all transactions in shares by, or known to, the corporation:
1. Initial issuance of shares
2. Transfer of shares.
Refer to the slides re uncertificated securities, securities intermediaries, Depository Trust & Clearing
Corp. etc.
DTTC will generate a list of shareholders based on the shareholders securities accounts with DTCC
(the CEDE List).
List of Stockholders Entitled to Vote (DGCL 219(a))
DGCL 219(a) The officer who has charge of the stock ledger . . . shall prepare and make, at least
10 days before every meeting of stockholders, a complete list of the stockholders entitled to vote at
the meeting . . . . Such list shall be open to the examination of any stockholder for any purpose
germane to the meeting.
Who is on the list?
Saito can inspect documents received from third parties. (generally, the
source of documents in a corporations possession should not control a
stockholders right to inspection under 220. The issue is whether the documents
are necessary and essential to satisfy the stockholders proper purpose.)
Saito cant inspect wholly owned subsidiary HBOCs documents because Saito
never owned HBOC stock. (Stockholder of a parent company are not entitled to
inspect a subsidiarys books and records in the absent of a fraud or that a
subsidiary is in fact the mere alter ego of the parent.)
(2) no information / disclosure for private corporations (e.g. Chrysler with 400 shareholders);
Disclosure Process:
(1) Corporation determines the issues; drafts a proxy statement (a detailed disclosure
document describing board directors and the matters on which shareholders will vote)
(2) If non-routine, corporation files with the SEC (proxy statement)
(2)(b) SEC comments on the proxy statement.
(3) For all votes, corporation sends definitive proxy statement to shareholder list
(shareholders of record, NOBOs and intermediaries)
(4) Shareholders send proxy cards to management
(5) Management votes the shares in accordance with the proxy statement
Short Selling and Encumbered Shares
Encumbered Shares
Shareholders with encumbered shares have the same right to inspect corporate records as a
regular shareholder
Why? It is usually too difficult to figure out any given shareholder's net position in a
corporation
Deephaven v. United Global (Del. Chancery 2005): On a request for inspection, the court will
not inquire into Plaintiffs net stock holdings.
Two Votes, One Share: Three individuals all think they have shares even though only two
shares exist because of the effect of short selling. Who can vote?
Answer: The bizarre solution to this problem is that brokers allow both shareholders
to vote, and simply reallocate the votes from shareholders who have not submitted
proxies. . . . In essence, a single share can generate multiple votes. Martin & Partnoy
(2004)
DTCC Stock Borrow Program (Short Sale)
The shares the firm borrows can come from:
(1) the brokerage firm's own inventory (not in any customers account);
(2) the margin account of one of the firm's clients; or
(3) another brokerage firm
Naked short selling is selling stock you dont own, but borrowing it and making no attempt to
do so
Delaware Court of Chancery held that an investor that held both long and short positions was
entitled to exercise inspection rights based on its long positions - that is, beneficial
ownership determines shareholder rights, not the investors net financial position.
Whistler alleges that at times fails-to-deliver are not cured for long periods (naked short sale),
which creates more electronic shares in the marketplace than are reflected in the paper share
certificates held by DTC. Whistler argues that Defendants are liable under state law because
this defect in the Stock Borrow Program depressed [Whistler stock value]. Whistler
Investments, Inc. v. Depository Trust & Clearing Corp., 539 F.3d 1159, 1164 (9th Cir. 2008)
Individual
Class
Derivative
Common
Rare
Direct
Common
Common
Answer: Derivative.
17.2. Who gets the recovery in 17.1.g.?
Answer: Logically, the corporation controlled by the defendant. How do we handle that
problem?
Derivative v. Direct in Close Corporations - Avoiding Recovery by Defendant
Possible Problem in Close Corporations:
Holder A has 40% and Holder B has 60%
Holder B embezzles $1 million from the corporation.
Holder A's action is derivative.
Holder A wins the claim
The corporation, controlled by Holder B, gets the recovery.
Two solutions:
(1) Action is derivative, but A recovers
(2) Action is direct, so A recovers
ALI Principles: In the case of a closely held corporation, the court . . . may treat
an action raising derivative claims as a direct action and order a direct recovery if
[that] will not (1) unfairly expose the corporation or defendants to a multiplicity
of actions, (2) prejudice creditors, or (3) interfere with a fair distribution of the
recovery . . .
The Demand Requirement (Relative to Derivative Claims)
The board of directors manages the corporation and is protected by the business judgment rule.
Manage includes deciding whether the corporation should sue (which is protected by BJR).
The shareholders can demand that the corporation sue.
If the board is suing the board members, conflicts of interest may prevent a decision.
When conflicts do, demand is excused and the shareholders can sue on the corporations
behalf.
Ordinarily, it is only when demand is excused that the shareholder enjoys the right to initiate suit on
behalf of his corporation in disregard of the directors' wishes. Kamen v. Kemper Fin. Servs., Inc.,
500 U.S. 90 (1991)
Any such committee, to the extent provided in the resolution of the board of directors, or in
the bylaws of the corporation, shall have and may exercise all the powers and authority of the
board of directors in the management of the business and affairs of the corporation . . . .
Zapata v. Maldonado (Del 1981): [A]n independent committee possesses the corporate power
to seek the termination of a derivative suit.
Must be made up of 1 or more of the directors. DGCL 141(c)(1).
Test for Review of Special Litigation Committee Decisions:
(1) The court should inquire into the independence and good faith of the committee and the
bases supporting its conclusions
(2) the Court should determine, applying its own business judgment, whether the motion
should be granted.
Zapata Corp. v. Maldonado (Del. 1981)
This is the unquestioned law of Delaware today
Facts:
Plaintiff files complaint alleging demand futility
Four years later, corporation appoints a two-member committee
The committee investigates, and then moves to dismiss
Court's two-part test:
(1) The court should inquire into the independence and good faith of the
committee and the bases supporting its conclusions
(2) the Court should determine, applying its own business judgment, whether the
motion should be granted.
Reasoning: Dismissal is analogous to settlement:
In determining whether or not to approve a proposed settlement of a derivative . .
. action [when directors are on both sides of the transaction], the Court of
Chancery is called upon to exercise its own business judgment." Neponsit
Investment v. Abramson (Del. 1979)
Professor: Courts say they won't substitute their business judgment for the business
judgment of the directors, but that's exactly what they're doing in this case
Maybe they're suggesting that litigation decisions aren't business judgment?
Other jurisdictions have generally rejected Zapata on basis that courts should not
substitute their business judgment for that of the directors
e.g. Tennessee, Connecticut
Einhorn v. Culea (Wis. 2000). [T]he court is bound by the substantive decision of a properly
constituted and acting committee.
Einhorn independence test: The test is whether a member . . . has a relationship with an
individual defendant or the corporation that would reasonably be expected to affect the
members judgment with respect to the litigation in issue.
Independence test factors:
1. Is the member a defendant?
2. Did the member participate in or approve the alleged wrong?
3. Members business dealings with any defendant
4. Members personal relationships with any defendant
5. Members business relationships with the corporation
6. Number of committee members (more is better)
7. Does the committee have independent counsel?
Refer to the slide re the M& F Worldwide case.
Standing
Qualification as plaintiff
For class actions (Largest Financial Interest)
FRCP Rule 23(a)(4). One or more members of a class may sue or be sued as
representative parties on behalf of all members only if . . . the representative parties
will fairly and adequately protect the interests of the class.
Who best qualifies as plaintiff?
Most capable of adequately representing the interests of class members
15 U.S.C 78u-4(a)(3). [T]he court . . . shall appoint as lead plaintiff the [class]
members . . . the court determines to be most capable of adequately representing
the interests of class members.
[T]he court shall adopt a presumption that the most adequate plaintiff . . . is
the person or group . . . that
(aa) has either filed the complaint or made a motion . . . ;
(bb) in the determination of the court, has the largest financial
interest in the relief sought by the class; and
(cc) otherwise satisfies the requirements of Rule 23 . . . .
Most Capable = Largest Financial Interest (shareholders have the largest
shareholding ratio, literally)
Professor: Shouldnt the presumption be in favor of the plaintiff that
1. Has the attorney best able to represent?
2. Has the largest ratio of stake to total wealth?
3. By virtue of knowledge, education, or profession is most capable of
making decisions?
For derivative actions (Don't have to know anything as long as you have a competent
attorney)
F.R.C.P. Rule 23.1(a). The derivative action may not be maintained if it appears that
the plaintiff does not fairly and adequately represent the interests of shareholders or
members who are similarly situated in enforcing the right of the corporation or
association.
Surowitz v. Hilton Hotels Corp. (U.S. 1966)
A person with limited grasp of English and almost no under-standing of the
complaint held adequate (helped by son-in-law)
In re Fuqua Industries, Inc. (Del Ch. 1999)
Ill shareholder, confused about her lawsuit adequate (helped by husband)
Multiple plaintiff who barely understands the basic nature of the
derivative claims adequate (he has no interests antagonistic / adverse /
hostile)
Lawyers take a dominant role in prosecuting litigation. In re Fuqua
Qualification as plaintiff's counsel
For class actions
F.R.C.P. Rule 23(g)(1) Appointing Class Counsel. Unless a statute provides otherwise,
a court that certifies a class must appoint class counsel. In appointing class counsel, the
court . . . may consider any other matter pertinent to counsel's ability to fairly and
adequately represent the interests of the class . . .
(2) Standard for Appointing Class Counsel. When one applicant seeks appointment . . .
the court may appoint that applicant only if the applicant is adequate . . . . If more than
one adequate applicant seeks appointment, the court must appoint the applicant best
able to represent the interests of the class.
For derivative actions
FRCP Rule 23.1 imposes no requirement
BUT: a plaintiff can't be adequate if counsel is incompetent or inexperienced. Fuqua
Industries, p. 529
Creditor standing
Since derivative actions seek to enforce a right in the name of the corporation, standing generally
has been limited to those with an equity interest in the corporation.
Generally a shareholder of record or a beneficial owner of stock satisfies the nature of the plaintiffs
holding.
Creditors generally are not allowed to maintain a derivative suit, but when the corporation becomes
bankrupt / insolvent, the creditors may have standing.
Derivative Actions
Creditors do have standing in derivative actions
NACEPF v. Gheewalla 930 A.2d 92, 101 (Del. 2007):
"It is well settled that directors owe fiduciary duties to the corporation.
When a corporation is solvent, those duties may be enforced by its shareholders,
who have standing to bring derivative actions on behalf of the corporation . . . .
When a corporation is insolvent, however, its creditors take the place of
shareholders as the residual beneficiaries of any increase in value.
Consequently, the creditors of an insolvent corporation have standing to maintain
derivative claims against directors on behalf of the corporation for breaches of
fiduciary duties."
Class Actions
Creditors also have standing to file class actions
F.R.C.P. Rule 23(a): One or more members of a class may sue or be sued as
representative parties on behalf of all members only if:
(1) the class is so numerous that joinder of all members is impracticable;
(2) there are questions of law or fact common to the class;
(3) the claims or defenses of the representative parties are typical of the claims or
defenses of the class; and
(4) the representative parties will fairly and adequately protect the interests of the
class.
Creditors recovered in only 3.9% of securities class actions 1996-2005.
BUT: Creditors recovered in the largest securities class action.
Standing Timing refer to the slide Standing Timing re the flowchart
When must an individual be a shareholder to have standing?
Three stages:
(1) Wrongful Act
(2) Wrong Disclosed
(3) Litigation
The "contemporaneous ownership" requirement
Class Actions: Plaintiff must own shares at the time of the wrongful act (Stage 1 only)
Derivative Action: Plaintiff must own shares at the time of the wrong and hold through
the litigation (Stages 1, 2, and 3)
DGCL 327. In any derivative suit instituted by a stockholder . . . it shall be
averred . . . that the plaintiff was a stockholder . . . at the time of the
transaction . . . or that such stockholders stock thereafter devolved upon such
stockholder by operation of law.
Purpose: Shareholder litigation is bad and this rule minimizes it
Derivative Action in California: Plaintiff must be a shareholder before disclosure of the
wrong and hold through the litigation (Stages 2 and 3)
Professor likes this rule better
Settlement Approval
Derivative Actions
Federal
F.R.C.P. Rule 23.1(c) A derivative action may be settled, voluntarily dismissed,
or compromised only with the court's approval. Notice of a proposed settlement,
voluntary dismissal, or compromise must be given to shareholders or members in
the manner that the court orders.
Delaware
The Delaware settlement test is the Court's business judgment:
In determining whether or not to approve a proposed settlement of a derivative . .
. action [when directors are on both sides of the transaction], the Court of
Chancery is called upon to exercise its own business judgment." Neponsit
Investment v. Abramson ( Del. 1979)
Class Actions
F.R.C.P. Rule 23(e) The claims, issues, or defenses of a certified class may be settled,
voluntarily dismissed, or compromised only with the court's approval.
(1) The court must direct notice . . . to all class members.
(2) . . . the court may approve [the settlement] only after a hearing and on
finding that it is fair, reasonable, and adequate.
(3) The parties must [identify] any agreement made . . . .
(5) Any class member may object . . . .
Derivative and Class Action settlement standards are similar:
(1) Derivative: Chancellors business judgment, considering law and public policy in
addition to the corporations best interests. Zapata.
(2) Class action: Fair, reasonable, and adequate
The two different standards mean basically the same thing: the court can do whatever it
wants
Attorney Fee Awards
Problem: In suing directors, shareholders have a collective action problem
Solution: courts award attorneys' fees from the recovery
Derivative action: Plaintiff is entitled attorney fees award if
(1) Deterrence:
Litigation investigates and discloses wrongdoing
Fear of disclosure deters
(2) Incentive for later shareholders to investigate before buying
Professor: This system would work better if directors had to pay
Is Delaware Losing its Cases?
Armour, Black & Cheffins, 9 J. Empirical Legal Studies 605 (2012)
Sample: 25 largest M&A deals each year since 1995
Main findings:
Proportion of deals challenged by litigation is approaching 100%
Proportion challenged by more than one lawsuit is rising sharply
Proportion of shareholder litigation in Delaware is declining
Suing only in Delaware is becoming rare.
What happened in 2001-2002 to cause the decline in shareholder litigation in Delaware?
Pre-2001: [Delaware Chancery Court] usually endorsed the full amount of agreed
attorney fees in class action and derivative suits.
2001: Delaware Chancery Court reduced a $25 million fee to $12 million in Digex.
Other fee cuts followed.
Chancellor Strine: [O]ur judiciary must be vigilant to make sure that the incentives
we create promote integrity and that we do not . . . generate the need for defendants
[who did nothing wrong] to settle.
If you are a plaintiffs lawyer, what do you think?
Finding: the anti-Delaware trend strengthened around the time of the Digex fee-cut
Finding: Delaware abandonment of first to file is class counsel encouraged fastfilers to file outside Delaware.
Delaware is favoring managers over shareholder litigation lawyers.
Two main changes:
(1) Delaware began reducing attorneys fees in class action and derivative suits
(2) Delaware abandoned the "first to file is class counsel" rule, so fast-filers filed
elsewhere
Delaware's Conflict re Shareholder Litigation
(1) Delaware wants to attract incorporations. Incorporators want:
Fewer actions to succeed against Delaware managers
Smaller recoveries with lower fee awards
(2) Delaware wants to attract legal work for Delaware lawyers and judges. Glossy brochures:
advertising that Delaware is a good place to litigate. The plaintiffs lawyers who place these
cases want:
More actions succeeding against Delaware managers
Bigger recoveries with higher fee awards
Delawares solution:
Force the plaintiffs to file their lawsuits in Delaware
Corporations can do this with forum-selection bylaws
Boilermakers Local 154 Retirement Fund v. Chevron Corp., 2013 WL 3191981 (Del. Ch. 2013).
Facts:
Chevron (and FedEx) enacts a forum-selection bylaw that requires certain suits to be
brought in Delaware. The bylaw:
[T]he Court of Chancery of the State of Delaware shall be the sole and exclusive
forum for
(i) any derivative action . . . brought on behalf of the Corporation,
(ii) any action asserting a claim of breach of a fiduciary duty owed by any
director, officer or other employee of the Corporation or the Corporations
stockholders,
(iii) any action asserting a claim arising pursuant to any provision of the
Delaware General Corporation Law, or
(iv) any action asserting a claim governed by the internal affairs doctrine.
Duty of Care: as a duty to act honestly, in good faith, and in an informed manner.
Directors, who behaved unreasonably, or in grossly negligent manner, violated their duty
of care.
Directors should reasonably believe they were acting in the best interest of the
corporation.
Best interest of a corporation shall be considered under the property / entity dichotomy.
1. Whether the company is a device for the maximization of shareholder
profits (a property perspective), or
2. Whether the corporation is a social institution with responsibilities to its
many constituents (an entity perspective)
Stockholder derivative action against directors for negligence (in failing to exercise
reasonable care and prudence in the management of the corporate affairs),
mismanagement
President / director / major shareholder refused to install lights in the baseball field and
schedule night baseball games, because his personal opinions that baseball is a
daytime sport and his concern for the neighborhood.
Facts:
All other major league teams play their weekday games at night.
The Cubs dont play at night due to Wrigleys personal views that
(a) baseball is a daytime sport and
(b) night games would harm the neighborhood.
Do you think the directors were negligent?
Professor's answer: Yes if the objective is to make money for shareholders. No
if boards can consider other constituencies.
Court: Because there is no fraud, illegality or conflict of interest, the decision is one
properly before the directors and beyond our jurisdiction and ability. Dismissal
affirmed. BJR shields Wrigley
Professor: The business judgment rule is bad policy.
Doctors should make medical decisions. Boards should make business decisions.
Both should be liable for negligence.
Courts would decide based on the testimony of expert witnesses
Wheeler v. Pullman Iron and Steel Company court holds that court of equity will not
undertake to control the policy or business methods of a corporation, although it may be seen that a
wiser policy might be adopted and the business more successful if other methods were pursued. The
majority of shares of its stock, or the agents by the holders thereof lawfully chosen, must be
permitted to control the business of the corporation in their discretion, when not in the violation of
its charter or some public law, or corruptly and fraudulently subversive of the rights and interests of
the corporation or of a shareholder. majority shareholder can have its own little business empire.
The BJR as Shapeshifter
Authors: "Although the basic idea behind the BJR seems simple, it is hard to express the
boundaries of the rule using words." p. 543
Six Basic Prongs to decide BJR:
Misconduct Level
Deciding
Becoming Informed
Bad Faith
Liability
Liability
Gross Negligence
Liability
Liability
Negligence
No Liability No Liability
Wrong
No Liability No Liability
DGCL provided exculpation clause to these two liabilities. Refer to the slide
Misconduct Level
Deciding
Becoming Informed
Bad Faith
Liability
Liability
Gross Negligence
Liability
Liability
Negligence
No Liability Liability
Wrong
No Liability No Liability
we hold that the directors of Trans Union breached their fiduciary duty to their
shareholders (1) by their failure to inform themselves of all information reasonably
available to them and relevant to their decision to recommend the Pritzker merger; and
(2) by their failure to disclose to recommend such as reasonable stockholder would
consider importance in deciding whether to approve the Pritzker offer.
Do you think the directors were grossly negligent?
Professor: This was ordinary negligence if any.
The court is substituting its business judgment for the board's, but that is
inherent in the gross negligence standard.
The board should have formally valued the company and discussed
bumping the price up.
Delaware Takes Care of Its Guests
Managers (Delawares customers/houseguests) are distressed about:
1. Liability for gross negligence
Delaware's response: DGCL 102(b). [T]he certificate of incorporation
may also contain . . . (7) A provision eliminating or limiting the personal
liability of a director . . . for monetary damages for breach of fiduciary duty
[of care]
2. Inability to rely on officers, directors, and professionals.
Delaware's response: New 141(e): A [board member] shall . . . be fully
protected in relying in good faith upon the records of the corporation and
upon such information, opinions, reports or statements presented to the
corporation by any of the corporations officers or employees, or
committees of the board of directors, or by any other person as to matters
the member reasonably believes are within such other persons professional
or expert competence and who has been selected with reasonable care by or
on behalf of the corporation.
Van Gorkom interpreted the prior version of 141(e), which covered
"reports", to exclude officers' oral statements; now the case changed in
favor of the management.
Avoiding Directors Liability - 3 ways that director can avoid liability: exculpation, indemnification, and
insurance.
Exculpation
DGCL 145 (b) covers actions brought by the corporation (i.e. derivative
actions or direct actions by corporation) and thus covers a smaller range of
actions and expenses
Both sections require good faith and reasonable belief.
Permissive Wildcard: DGCL 145(f)
Professor: 145(e) should be interpreted narrowly (i.e. purpose is only to
authorize early payment of certain expenses) whereas 145(f) can only be
interpreted in a way that effectively eats 145(a) and (b)
Subsection f could conflict with a and b, but the Delaware courts have yet
to weigh in on this
Restatement Approach:
Restatement 3rd Agency 8.14.
A principal has a duty to indemnify an agent
(1) in accordance with the terms of any contract between them; and
(2) unless otherwise agreed,
(a) when the agent makes a payment
(i) within the scope of the agent's actual authority, or
(ii) that is beneficial to the principal, unless the agent acts officiously
in making the payment; or
(b) when the agent suffers a loss that fairly should be borne by the principal
in light of their relationship.
This provision covers officers, but directors are not agents
This provision is permissive
Permissive Indemnification refer to the slides
145(a) indemnification to other partys actions (somebody Other than the corporation)
145(b) indemnification to actions brought by the corporation
Scope of indemnification is different: 145(a) is much broader; 145(b) excluded
the cost of settlement
145(f) wild card section: not applied to the 145(b) prohibited indemnification
Mandatory Indemnification
Prohibited Indemnification
Insurance
Corporations can buy whatever insurance a company will sell for their directors and officers
CONTRA indemnification, which is subject to prohibitions in 145(b)
DGCL 145(g). A corporation shall have power to purchase and maintain insurance on behalf of
any person who is or was a director, officer, employee or agent of the corporation, . . . against any
liability asserted against such person and incurred by such person in any such capacity, or arising
out of such persons status as such, whether or not the corporation would have the power to
indemnify such person against such liability under this section.
Two types of coverage:
(1) Coverage for Directors and Officers when indemnification is unavailable
(2) Coverage for corporations for their indemnification obligations
Exclusions from a SAMPLE insurance policy:
(1) Any civil or criminal fines or penalties
(2) Claims arising out of, based upon or attributable to the committing of any deliberate
criminal or deliberate fraudulent act by insured person, as evidenced by a judgment, ruling or
other finding of fact in the underlying action or in a separate action . . . or other proceeding
BUT Policy specifically covers:
(i) punitive, exemplary and multiple damages and
(ii) civil penalties assessed . . . pursuant to 2(g)(2)(C) of the Foreign Corrupt Practices
Act.
Ralph Nader claims that directors should not be able to evade criminal fines. Can they evade them
at all?
DGCL 145(a) authorizes corporations to indemnify directors against fines if the directors
acted "in good faith". But who determines whether they acted in good faith? The corp. should
judge their conducts.
DGCL 145(d) states that the corporation determines whether the director met the
applicable standard of conduct.
Though directors cannot be insured against criminal fines, they can be indemnified by the
corporation against them as long as the corporation decides they have met the applicable
standard of conduct.
Cumulative Coverage: Indemnification and Insurance
Refer to the table in the slide cumulative coverage: indemnification and insurance
Derivative Actions move money in a circle
Page 173 of 203
Misconduct degrees
Becoming informed
Deciding
Oversight
Intentional wrong
Bad faith
Bad faith
Bad faith
Gross negligence
Liability
Liability
No liability
Negligence
No liability
No liability
Blamelessness
A failure to act in good faith requires conduct that is qualitatively different from, and more
culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e. gross
negligence).
Takeaway: Directors are only liable for lack of oversight if they commit intentional wrongs.
They are not liable for gross negligence in their oversight.
Three Oversight Rules:
(1) Corporations must have a reasonable internal control system
(2) Any board effort to accomplish (1) is sufficient
(3) Board must respond to "red flags" (i.e. only respond to problems once they have occurred)
(a) Can assume the integrity and honesty of employees as long as no red flags have been
raised
(b) Protected in relying on information from control system by DGCL 141(e).
"A member of the board . . . shall be fully protected in relying in good faith upon . . .
opinions . . . presented . . . by any other person as to matters the member reasonably
believes are within such other persons professional or expert competence." DGCL
141(e).
In re Caremark International, Inc.
Facts:
MF Global Holdings, Ltd. - Weak Internal Controls, But Probably No Oversight Liability
The CEO submitted and signed the Global Annual Report required by Sarbanes-Oxley 404(a)
Internal Controls
Definition: Systematic measures (such as reviews, checks and balances, methods and
procedures) instituted by an organization to:
(1) conduct its business in an orderly and efficient manner,
(2) safeguard its assets and resources,
(3) deter and detect errors, fraud, and theft,
(4) ensure accuracy and completeness of its accounting data,
(5) produce reliable and timely financial and management information, and
(6) ensure adherence to its policies and plans.
COSO: Internal control is broadly defined as a process, effected by an entitys board of
directors, management, and other personnel, designed to provide reasonable assurance
regarding the achievement of objectives in the following categories:
(1) Effectiveness and efficiency of operations
(2) Reliability of financial reporting
(3) Compliance with applicable laws and regulations.
Public Company Accounting Oversight Board (quasi governmental):
Reasonable is a high level of assurance, the understanding that there is a remote
likelihood.
External auditors typically use a range of 5% to 10% for remote likelihood.
Thus if theres less than a 5% to 10% chance of illegal activity, the corporation can
ignore it!
NOTE: Issuance of the preferred stock isn't a breach of the duty of loyalty
even though BOT elected them and they are diluting BOT. This is because
the directors' duty of loyalty is to Benihana, not BOT. The directors weren't
beholden to BOT.
John Abdo is on both sides of the transaction.
Benihana director uses confidential Benihana information to negotiate against
Benihana
Why isnt that a breach of duty of loyalty John Abdo?
Court:
Abdo did not breach his duty of loyalty because there is no evidence Abdo used
confidential information in his negotiation from the other side. Abdo knew the
terms a buyer could expect in a deal like this.
Abdo had a conflict of interest.
The conflict was excused because a majority of the disinterested directors
approved
144 is a safe harbor so the intrinsic fairness rule no longer applies. ( Fliegler
no longer law?)
Business judgment rule applies.
Distinguishing Among Conflicts refer to the slides
Solution to Membership of a Competitor's Director on Your Board
Should we allow Drake, a member of a competitors board, to serve on our board? How do
we keep our secrets?
Answer: Use committees to exclude Drake from sensitive discussions. Cox and Hazen
10:11 (2012) The duty of loyalty places directors under a duty of confidentiality.
Example of Two-Tiered Analysis
Uncertain whether this actually needs to occur
Fliegler v. Lawrence (p. 639)
Facts:
Lawrence controls Agau and USAC
Lawrence causes Agau to acquire USAC
(5) Would RFBC purchase bring Brozs interests in conflict with CIS? No. No
duties . . . inimical to his obligations to CIS. Not competitors.
Court: Presenting to the board is a safe harbor, but not always necessary. Broz wins not a
corporate opportunity.
Farber v. Servan Land Co. (5th Cir. 1981)
Facts:
Serianni and Savin are majority shareholders and principal officers.
Forman (director) tells annual shareholder meeting that Farquhar is willing to sell
another 160 acres. Feasible, should be investigated. transaction pending
Serianni and Savin purchase the 160 acres.
1969. No discussion at annual meeting.
1970. Farber discovers purchase; asks at meeting; court reporter conflicts with minutes
re ratification.
1973. Joint sale of properties, generous allocation by major shareholders
1973 Farber brings derivative action.
Trial Court: This is a corporate opportunity since the corp. does not declined, not ratified;
not cured; so corporation gets all profits. The property bore no substantial relationship to
Servans primary purpose of operating a golf course. Hence the purchase was not
antagonistic to any significant corporate purpose.
Appellate Court: it vacated and remanded the lower court for clarification.
NOTE re Minutes from Case:
Why would a court accept official minutes over a court reporters transcript?
Answer: Because people dealing with the corporation rely on the official
minutes. E.g., Big Machines.
Corporate Opportunity Doctrine
Guvertz: every case involves three relationship, aggreagate closeness should or does determine the
outcome
Close agent is CEO, Intermediate a director, Weak an employee
Close corporae tenants opportunity to buy a leased property, intermediate develop adjacent and
premises (Salmon), Weak develop the adjacent property (Farber)
ULLCA 409(b)
A member's duty of loyalty to a member-managed company and its other
members is limited to the following:
(1) to account to the company and to hold as trustee for it . . . a
company's opportunity . . . .
ULLCA 103(b)(2)
The operating agreement may not . . . eliminate the duty of loyalty under
409(b) . . . but the agreement may . . .
(i) identify specific types or categories of activities that do not
violate the duty of loyalty, if not manifestly unreasonable . . . .
(ii) specify the number or percentage of members or disinterested
managers that may authorize or ratify, after full disclosure of all
material facts, a specific act or transaction that otherwise would
violate the duty of loyalty.
Review Problem (Supplement p. 263)
Facts:
Hypo is insolvent
$1.3 million foreclosure is pending; will become final in two days.
Dan is a Hypo director who owns 7% of shares.
Dan will lend $1.3 million secured to redeem
We represent Dan. Objective: a mortgage authorized by Hypo.
Hypo has about 14 shareholders; 57% of the shares favor the loan; 23% oppose it; the
remainder are unavailable/uninterested.
Certificate of Incorporation: the board shall consist of nine members
The bylaws provide that the board chairman (Dan) may call a special meeting on ten days
notice to all board members.
20.6.a. Can shareholders authorize the security interest? 141(a), 228(a)
Answer: No. The board manages the business.
20.6.b. How many board members are there?
Answer: Eight. Frans resignation is invalid because not upon notice given in writing. Al is
no longer a natural person.
20.6.c. Can Dan call a special board meeting on 24 hours notice?
Answer: No, the bylaws require ten days.
20.6.d. Could a shareholder resolution cure the problems with the board? If so, what should it say?
Answer: A resolution could
(1) change the board meeting notice requirement to 24 hours, or
(2) remove the current board and appoint a new board.
It cant reduce board size because that is in the certificate.
20.6.e. If we could call a board meeting, do we have the votes?
Answer: Probably not. No quorum would exist if Wayne boycotted the meeting.
20.6.f. How many of these new board members are disinterested?
A plaintiff may also challenge a director's independence by alleging facts illustrating that a
given director is dominated through a close personal or familial relationship or through force
of will, or is so beholden to an interested director that his or her discretion would be
sterilized. In re Tyson Foods, Inc., (Del. Ch. 2007)
(1) Virginia, Dans full time assistant.
(2) Edra, spouse of Dan (the lender/board chairman).
(3) Marilyn, spouse of a board member who is employed by Dan.
(4) Mark, board chairmans close friend.
(5) Walter, spouse of another board member.
Answer: Virginia and Marilyn are probably dominated. But more information is necessary to
determine domination
20.6.g. How many of these new board members are legally qualified to be directors?
(1) Edra, college degree, no business experience, no knowledge of Hypo.
(2) Marilyn, homemaker, mother, high school education.
(3) Virginia, executive assistant, college degree, familiar with business
(1) The companys having notice of the members express will to withdraw . . . .
Different Effect of Prohibition on Dissociation in Partnerships and LLCs
Partnership: If dissociation is prohibited by Partnership Agreement, Partner can
dissociate but may be liable for "wrongful dissociation."
LLC: If dissociation is prohibited by Operating Agreement, Member cannot dissociate.
Member can also have liability for "wrongful dissociation."
Dissolution: Termination of an entitys existence
Liquidation: Sale of the entitys assets for cash.
Winding up: Continuation of business operations during liquidation to increase the liquidation
proceeds. (during the winding-up, owner may operate while advertising for sale)
Distribution: Transfer of money or property from an entity to its investors.
Dividend: A distribution from a corporation
Transferrable interest: a partners right to receive distributions from the partnership
Distributional interest: a members right to receive distributions from the LLC
NOTE: Transferable Interest and Distributional Interest are the same concept but applied to
Partnerships and LLCs (respectively)
Buyout Rules
Default Rights of a Minority Investor to Withdraw (w/t otherwise agreed in the COI /
partnership agreement / operating agreement)
Corporation
Partnership
LLC (same as
partnership results)
Yes, 801(1)
No, 801
Mandatory buyout
Court can do anything that is a valid exercise of its discretion as long as it can
assign a reason. (e.g. can order sale of assets by Partner A to Partner B if A
cannot pay for the assets)
Problem with Auctions: when the partners do not have enough to make a decent bid,
the assets can be bought for much less than their value.
Solution: Allow the purchaser to pay part of the bid price by note and mortgage.
Creel v. Lilly (Supp. p. 269)
Facts:
Lilly, Altizer, and Creel are partners in Joes Racing.
Creel dies, and his widow was appointed as personal representative of his
estate.
Lilly and Altizer winded up the partnership, and started a new business
without taking the widow.
Estate sues; Mrs. Creel wants the business sold.
Court: Sale is not required, but the partnership should have paid 52% interests in
the partnership to the widow.
Holding: the default rule is that when a partner died, the partnership
automatically dissolved if the partners did not otherwise agreed.
McCormick v. Brevig (Supp. p. 284)
Facts:
Joan and Clark, brother and sister, are disputing their partnership interests.
The trial court dissolves the partnership, RUPA 801(5), and allows Clark
to buy Joans interest.
Court: reverses, holds that the ranch must be sold for cash and the cash
distributed.
RUPA 807(a) Any [sale] surplus must be applied to pay in cash the net
amount distributable to partners in accordance with . . . (b).
(b) In settling accounts among partners, profits and losses that result from
the liquidation of the partnership assets must be credited . . . to the
partners accounts.
LLCs
Corporation
Partnership
LLC
Who decides to
dissolve?
Unanimous members
Public filing?
Certificate of dissolution,
275(b)
Articles of termination
Sheriff pays sale proceeds to the creditor. Payment reduces the debt.
By bidding the amount of the debt, creditor can always (1) be paid in full or (2) own the
stock.
Execution and sale is available against nearly all kinds of property.
Creditor's Rights in Partners' Interests
Creditors Collecting Judgments Against Partners: Obtain a Charging Order and
Foreclose
RUPA 504(a). A court having jurisdiction may charge the transferable interest of the
judgment debtor to satisfy the judgment. (charging order)
(b) The court may order a foreclosure of the interest subject to the charging order at
any time.
(e) This section provides the exclusive remedy (only available remedy) by which a
judgment creditor of a partner . . . may satisfy a judgment out of the judgment debtors
transferable interest in the partnership.
PB Real Estate v. DEM II Properties (Supp. p. 290)
Facts:
Botwick and Kurzawa practice law through an LLC
PB Real Estate wins judgments against Botwick and Kurzawa.
PB Real Estate obtains a charging order against Botwick & Kurzawas law firm:
Pay Botwick and Kurzawa distributions to PB Real Estate.
The LLC pays $28,000 to Botwick and $28,000 to Kurzawa.
Court: enters judgment against the LLC for $56,000.
Charging Liens and Foreclosure
Step 1. Creditor obtains a judgment against the Partner.
Step 2. Creditor obtains a charging order against the Partnership.
504(b) A charging order constitutes a lien on the judgment debtors transferable
interest in the partnership.
Step 3. Creditor forecloses on the Partners transferrable interest.
504(b) The court may order a foreclosure of the interest subject to the charging order
at any time. The purchaser at the foreclosure sale has the rights of a transferee.
Step 4. Creditor buys the Partners transferrable interest at the sale (via credit bid).
This is only the right of a transferee. 504(b)
No right as a member unless consent is given. 503(a)
No participation in management. 503(d).
Step 5. Can the creditor force dissolution of the partnership?
801 A partnership is dissolved, and its business must be wound up, only upon the
occurrence of any of the following events:
(6) on application by a transferee of a partners transferable interest, a judicial
determination that it is equitable to wind up the partnership business:
(ii) at any time, if the partnership was a partnership at will at the time of
the transfer or entry of the charging order . . . .
Answer: Maybe, depending on the situation and judges attitude (by evaluating the
business of the partnership, whether it is doing well or just holding the money from
distribution).
The provisions and analysis for an LLC are the same as for a partnership.
Charging orders do not reach payments made as salaries (those are paid in partners'
employee capacities)
504(a) [A] court . . . may charge the distributional interest of the judgment debtor to
satisfy the judgment.
101(5) Distribution means a transfer of money, property, or other benefit form a
limited liability company to a member in the members capacity as a member . . . .
Term of Years: If LLC is term company, court cannot dissolve it until end of term. 801(a)
(5)(i).
Problem: LLC can change to term company at any time before foreclosure sale and
court will respect it. This gives LLC plenty time to make change before creditor can
take action.
Different rules apply in Limited Partnership.
802 not reasonable practicable to carry on the activities of the limited partnership [by
application of a PARTNER].
Answer: No
29a.12.f. Could a court order Blixseth to cause a distribution?
Answer: No. Blixseth lacks the power to cause a distribution.
Management LLC is the manager. Blixseth has only a 40% interest.
Desert Ranch