BUSINESS ASSOCIATIONS-Grimes OUTLINE

I. Agency
a. List of business entities (you should know by the end of the semester)
i. sole proprietorship
ii. company
iii. partnership
iv. lp
v. lllp
vi. s corporation
vii. llc
b. section 1-agency theory
i. Gorton v. Doty p. 1 (1937)
1. Father is suing the lady who lent her car to the driver.
2. Facts that triggered agency:
a. she lent the car
b. specifically conditioned the loaning of the car based on
that the coach would drive.
3. 2nd restatement of agency § 1 agency; principal; agent
a. (1) agency is the fiduciary relation which results from
the manifestation of consent by one person to another
that the other shall act on his behalf and subject to his
control, and consent by the other so to act.
b. (2) the one for whom action is to be taken is the
principal.
c. (3) the one who is to act is the agent.
4. If you are trying to find someone liableuse agency theory
5. Effect: principal is responsible for the acts of his/her agent.
6. Does not have to involve business
7. it can occur naturally and without a formal agreement
a. hypo/ I walk over to you and give you $5 to buy me a
sandwiche. You are, now, my agent.
8. 3 principal forms of agency:
a. principal/agent
b. master/servant
c. employer OR proprietor/independent contractor
9. holding: there was an agency because doty had exercised
control over the coach by making a condition precedent to the
lending of the vehicle.
10. how the principal could have avoided liability in this
situation
a. sign a release or make a contract that would enable the
principal to indemnify the agent.
ii. Gay jenson farms 1981
1. 86 farmers brought suit against Cargill who was the principal of
Warren b/c Warren failed to pay the farmers.
2. Facts that triggered agency

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 a. warren got financing from Cargill, provided Cargill with
access to warrens’ books for inspection
b. Cargill knew of warren’s shady business practice
c. Cargill knew of warren’s indebtedness
3. how could have Cargill remedied this?
a. buy out Cargill and change the management.
4. Holding: Cargill, THROUGH ITS COURSE OF DEALING
WITH WARREN, became a principal by exercising its control
and influence over Warren.
iii. steps on exam
1. identify the action as a tort/contract
2. agency?-rule
a. elements:
i. fiduciary relation which results
ii. from manifestation of consent by a principal
1. element usually at issue.
2. Circumstantial evidence usually used to
show this.
iii. to the agent to act on the principal’s behalf
iv. and subject to the principal’s control
1. the above cases demonstrate this.
v. consent by the agent to do so.
b. ways to create an agency
i. there MUST be an agreement, but the agreement
does not have to be a contract
ii. an agreement may result in the creation of an
agency relationship although the parties did not
call it an agency AND did not intend the legal
consequences of the relationship to follow.
c. ways to prove agency
i. circumstantial evidence.
3. policy arguments?
4. Ways to have remedied this/prevented liability.

c. Section 2-liability of principal to third parties in contract

i. Authority
1. authority § 7 of 2nd restatement of agency: authority is the
power of the agent to affect the legal relations of the principal by
acts done in accordance with the principal’s manifestations of
consent to him.
2. mill st. church of Christ v. Hogan (1990)
a. the church needs to be repainted and hires Bill Hogan.
b. Bill Hogan hires Sam who gets injured.
c. Did Bill have authority to hire Sam?
d. Def; implied authority-actual authority circumstantially
proven which the principal actually intended the agent to
possess and includes such powers as are practically
necessary to carry out the duties actually delegated.
i. Factors to determine implied authority
1. agent’s understanding of his authority

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 a. does the agent reasonably
believe that the principal has
extended him authority
b.
2. nature of the task/job
a. implied authority may be
necessary in order to implement
the express authority
3. existence of prior similar practices
4. specific conduct by the principal in
the past permitting the agent to
exercise similar powers.
e. Def; apparent authority-authority the agent is held out
by the principal as possessing
f.
3.
ii. apparent authority
1. Lind v. Schenley Industries, inc. (1960) p. 16
a. 3 different types of authority
i. actual authority
1. authority that the principal expressly or
implicitly gave the agent
ii. implied authority
1. actual authority given implicitly by a
principal to his agent
2. authority arising solely from the
designation by the principal of a kind of
agent who ordinarily possesses certain
powers.
iii. apparent authority (§ 8-inherent agency)
1. occurs when the principal acts in a
manner as to impress to a 3rd party that
an agent has certain powers which he
may/may not possess
2. there is uncertainty as to whether the
third party must have relied upon the
principal’s manifestation.
b. Ways to avoid liability:
i. Bureaucratic system
ii. Employee manual.
2. Three Seventy Leasing Corp. v. Ampex Corp. (1976) p. 22
a. What could have ampex done to protect itself?
i. better supervision.
ii. more strict rules in regards to this sale
iii. put certain clauses on the form/contract of sale
that limit the authority
b. Definition of apparent authority-an agent has apparent
authority sufficient to bind the principal when the
principal acts in such a manner as would lead a
reasonably prudent person to suppose that the agent has

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 the authority he purposes to exercise. Also, an agent has
the apparent authority to do those things which are
usual/proper to the conduct of the business.
c.
3.
iii. inherent agency
1. Watteau v. Fenwick p. 25 (1892)
a. Because there was no manifestation by the principal,
inherent authority is a new classification.
b. Scenario: undisclosed OR partially disclosed
principal
c. 2nd R § 8A inherent agency power; inherent agency
power is a term used in the restatement of this subject to
indicate the power of an agency which is derived not
from authority, apparent authority OR estoppel, but
solely from the agency relation and exists for the
protection of the persons harmed by OR dealing with a
servant OR other agent.
2. Notes p. 27
a. § 194 of 2nd R-undisclosed principal is liable for acts of
an agent done on his account, if usual or necessary in
such transactions, although forbidden by the principal.”
b. § 195 of 2nd R-an undisclosed principal who entrusts an
agent with the management of his business is subject to
liability to 3rd persons with whom the agent enters into
transactions usual in such business and on the principal’s
account, although contrary to the directions of the
principal.
c. incur obligations on behalf of the partnership.
3. Kidd v. Thomas A. Edison, Inc. (1917) p. 28
a. RESERVE INHERENT AUTHORITY FOR CASES
INVOLVING UNDISCLOSED PRINCIPAL OR
PARTIALLY UNDISCLOSED PRINCIPALS.
b. what could Edison have done?
i. expressly stated in the contract that is both
written/printed
c. elements of inherent authority
i. undisclosed principal
ii. to determine the scope of authority, look to the
customary/normal/traditional duties in a
business
4. Nogales Service Center v. ARCO (1980) p. 31
a. Rationale of inherent agency-comment b to § 8A-this
type of authority is NOT based on consent by the
principal NOR upon a principal’s manifestation. This
authority arises in 3 situations 1) agent does something
similar to what he is authorized to do, but in violation of
orders, 2)agent acts purely for his own purposes in
entering into a transaction which would be authorized if
he were actuated by a proper motive, and 3)agent is

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 authorized to dispose of goods and departs from the
authorized method of disposal.
b.
5.
iv. ratification
1. Botticello v. Stefanovicz (1979) p. 36
a. Ratification requires: 1)acceptance of the results of the
acts with 2)an intent to ratify and 3)full knowledge.
b. Def: ratification-affirmance by a person of a prior act
which did not bind him but which was done or
professedly done on his account. 1st R § 82 (1958)
c. Ratification requires: 1)acceptance of the results of the
acts with 2)an intent to ratify with 3)full knowledge of
all the material circumstances.
d. Policy of ratification-both parties have knowledge of
the facts, and if the facts drastically change btw/ the
deal and the acceptance of the offer, then it becomes
risky/not beneficial for one party.
e.
2.
v. estoppel
1. Hoddeson v. Koos Bros. (1957) p. 40
a. Estoppel argument-similar to apparent agency; they are
estopped from denying an agency relationship exists
because they did not do enough to protect the consumer.
b. Holding: The court stated that although an agency
theory is probably lacking, the plaintiff could still use an
estoppel argument to find that the imposter was an agent
for the department store.
c. Policy driven: the court stated that they wanted to put
down a policy that would place liability on the dept.
store to ensure that the customers would not be
tricked/hustled by imposters.
d. Elements for estoppel; prof’s words-
i. 1) the principal must allow either actively or
tacitly allow that this person has authority,
ii. 2) the 3rd party must in good faith reasonably
rely on that,
iii. 3) the 3rd party must have changed position
based on this reliance.
e. Effect: If the principal knows of the agent’s misuse of
the authority and does nothing otherwise, the principal
MAY BE ESTOPPED from using the defense that the
agent does not have authority.
f. Scenario: This occurs where the principal knew of this
wrong belief and could have prevented the harm.
g. The doctrine of authority by estoppel is that a
principal may nevertheless become subject to liability on
the transaction to a person who has changed his position

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 because of the belief that the transaction was entered
into when he carelessly permitted such belief to exist,
OR when, knowing of the belief, he did nothing to notify
the other party of the erroneous belief.
2.
vi. agent’s liability on the contract
1. Atlantic Salmon A/S v. Curan (1992) p. 43
a. This is the only case where the plaintiff is going after the
agent. This is a new wrinkle.
b. when do you think we go after the agent?
i. obviously, you do not go after the principal if
the principal does not exist OR insolvent.
ii. Other circumstances if the agent fails to disclose
OR accurately disclose who the principal was.
Other circumstances are if the agent acts beyond
his authority.
c. 2nd R of Agency § 4(2)-if the other party has notice that
the agent is or may be acting for a principal but has no
notice of the principal’s identity, the principal for whom
the agent is acting is a partially disclosed principal
d. Holding: whether or not a 3rd party has the means to
ascertain the identity of a principal, if an agent wants to
avoid liability, the agent MUST disclose the identity of
his principal.
e. Various situations
i. 3rd party sues principal
1. principal will be liable if the agent acted
within his authority
2.
ii. 3rd party sues agent
1. if the agent fails to properly disclose
who the principal is
2. agent disclosed false information about
a principal, making the agent liable to
the 3rd party under a misrepresentation
theory.
iii. principal sues agent
1. if the agent acts beyond his authority
2.
vii.
d. Section 3-Liability of Principal to Third Parties in Tort
i. Servant Versus Independent Contractor p. 47
1. case where a master is held liable for the act of his employee, not
an independent contractor-respondeat superior.
2. elements for master/servant relationship ( 2nd R of A §§1,2)
a. servant agrees to work on behalf of the master; AND
b. servant has agreed to be subject to the master’s control
OR right to control the “physical conduct” of the servant
3. 2 types of independent contractor
a. agent i.c.

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 i. one who has agreed to act on behalf of another,
the principal, but not subject to the principal’s
control over how the result is accomplished
b. non-agent i.c.
i. one who operates independently and simply
enters into arms’ length transactions with
owners.
4. Humble Oil & Refining Co. v. Martin (1949) p. 48
a. Key difference btw/ master servant and ic is the
amount of control involved/used.
b. Analysis-facts-humble oil dictated the hours of
operation, agreement, paid 3/4s of the utility bills, little
business discretion left up to Schneider …
c. does it/should it matter that the tort arose out of
repairing, while humble oil is really in regards to oil?
i. A: it did not matter to the court, IN MY
OPINION, I THINK IT SHOULD HAVE
MATTERED.
d. LOOK AT THE NATURE OF THE TORT AND
THE NATURE OF THE BUSINESS

5. Hoover v. Sun Oil Co (1965) p. 50

a. rule: the test to determine whether a person is an
employee or an i.c. is whether the defendant has retained
the right to control the details of the day to day operation
of the service station
b. holding: sun never controlled the day to day operation
of Barone, so Sun’s motion for summary judgment was
granted.

6. Murphy v. Holiday Inns, Inc. (1975) p. 53

a. Murphy sues Holiday Inn for damages sustained, while
she was a guest of the hotel.
b. plaintiff slipped and fell on an area of a walk where
water draining from an air conditioner had been allowed
to accumulate.
c. holding: holiday inn was not a master b/c it did not
control the other party. Factors listed on p. 56
d. analysis and planning p. 57
i. 2nd R of Agency § 219(1) A master is subject to
liability for the torts of his servants committed
while acting in the scope of their employment.
ii. The comments make it clear that a principal is
NOT LIABLE for the torts of his non-servant
agents.
e. in analyzing whether a contract establishes an agency
relationship, the critical test is the nature and extent
of the control agreed upon.
f. how should they have protected themselves?

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 i. Made an insurance provision in the contract with
patrons and with the franchiser.
ii. Tort liability and apparent agency
1. Billops v. Magness Construction Co. 1978 p. 58
a. Guy rents a room from a hotel. He rents the room based
on the name of the hotel.
b. The director of the hotel wrongfully asks for additional
payment and locks the patrons/bangs on the door/and
more.
c. Court analyzed the case under an actual agency theory
and did not use apparent agency
d. Actual agency-authority which a principal expressly or
implicitly grants to an agent.
e. Apparent agency-focuses not upon the actual relation
of the principal and agent, BUT the apparent relation
i. Manifestation by an alleged principal which
creates a reasonable belief in a third party that
the alleged agent is authorized to bind the
principal create an apparent agency, from which
spring the same legal consequences as those
which result from an actual agency.
f. In order to find liability based on an apparent
agency, this court decided that reliance by the 3rd party
on the authority represented by the principal must be
demonstrated.
2.
iii. Scope of employment
1. Ira S. Bushy & Sons v. United States (1968) p. 61
a. Drunken sailor opens valves that floods a dry dock,
damaging a ship that was docked.
b. Traditional test: conduct of a servant is within the
scope of employment if the act is done by a purpose to
serve the master.
c. New test: if the servant’s conduct is foreseeable, then
attaching liability to the principal/master is fair.
d. POLICY ARGUMENTS-loss spreading/deterrence

2. Manning v. Grimsley (1981) p. 66

a. Pitcher is heckled, so he loses his temper and throws the
baseball directly at the fan. Issue is whether the baseball
club is liable.
b. When a plaintiff seeks to recover damages from an
employer for injuries resulting from an employee’s
assault, the employee’s assault must be in response to
the plaintiff’s conduct which was PRESENTLY
INTERFEREING with the employee’s ability to perform
his duties successfully.
i. According to this court, words can be considered
conduct.

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 c. Notes p. 69: 2nd restatement § 228(2)-a servant’s use
of force against another is within the scope of
employment if the use of force is not unexpectable by
the master.
3.
iv. Statutory claims
1. Arguello v. Conoco, Inc. (2000) p. 69
a. Conoco attendant says racial epithets to patrons of the
service station.
b. Title 2-all persons shall be entitled to the full and equal
enjoyment of the goods, services, facilities, privileges…
without regard to race, color, religion, or national origin.
c. Still analyzed the existence of an agency and the scope
of employment.
d. 2nd restatement § 219-factors for deciding within the
scope of employment
i. time, place, and purpose of the act
ii. similarity to acts which the servant is authorized
to perform
iii. whether the act is commonly performed by
servants
iv. extent of departure from normal methods
v. whether the master would reasonably expect
such act would be performed
e.
2.
v. Liability for torts of independent contractor
1. Majestic Realty Associates, inc. v. Toti Contracting Co. (1959)
p. 76
a. Guy demolished a house and accidentally damaged an
adjacent house.
b. General rule- conduct of an independent contractor
does NOT affect a principal’s liability
c. Exceptions:
i. Principal retains control of the manner and
means of the work of an agent.
ii. Principal hires an incompetent i.c.
iii. The activity is inherently dangerous (i.e.
nuisance per se)
d.
2.
e. Fiduciary obligation of Agents
i. Duties during agency
1. Reading v. Regem (1948) p. 81
a. Servant gets money from drugs. Whether the servant is
accountable to the master for the money received.
b. Generally, if a servant takes advantage of his service
and violates his duty of honesty and good faith to make a
profit for himself, then he is accountable for it to his
master.

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 i. The advantage must come not from solely the
service that gave the opportunity, but from the
position of the service, facilities he controls, real
cause.
ii. Whether the servant is exercising the authority
given to him.
iii. Common practice
iv. Violates statute-exp/ insider trading
v. Court looked at the facts that he wore a king’s
uniform/position of a soldier.
c. Examples of violation of duty-financial benefit with
out the consent of the principal
i. Kickback
ii. Bribe
iii. gift
d.
2. general automotive manu. V. singer p. 84 1963
a. He acts as a broker for other firms and does not give the
commission to GA. GA sues him for his breach of his
duty as an agent to General automotive.
b. Result: they found that there was a breach of the duty.
He was not acting in good faith and had a duty to inform
the company of the money coming in.
c. It does not matter whether general automotive would
have benefited from this conduct, it is clearly a brach of
te agent’s fiduciary obligation not to disclose it and
quietly take the profits for himself.
ii. Duties during and after termination of agency: herein “grabbing and
leaving”
1. Town & Country House & Home Service, Inc. v. Newbery
(1958) p. 88
a. The three people who have worked for this company left
to start a rival company. They get sued for unfair
competitive activity, but we can think of this as a breach
of an agency theory, since they had been employees of
town and country.
b. Seems more policy based decision
i. We want to discourage the cheapest form of
freeriding.
c. The court said that they breached this fiduciary duty
although the agency was terminated. They still owed
certain duties.
2.
iii.
II. PARTNERSHIPS
a. Section 1-What is a partnership? And Who are the partners?
i. Section A-Partners Compared with Employee
1. partnership characteristics-notes 01/14/04
a. partnerships can be created without documentation.

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 b. in regards to taxation, partnerships are not taxed, but
the income that the partners receive are taxed (flow-thru
taxation)
c. partnerships do not have limited liability.
d. management of a partnership is more decentralized
than a corporation and have more voices that could
decide how the partnership is to be run/controlled.
e. longevity
i. traditional partnership, this was a problem b/c if
one partner died, then you have to start over
with a new partnership (this is changing b/c the
new partnership act is allowing a partnership to
live after a partner dies/leaves)
f. transferability of ownership
i. partner cannot transfer his partnership share..
this is a problem.
2. Fenwick v. Unemployment Compensation Commission p. 92
(1945)
a. Court has to decide whether a partnership was set
up or not. Has a hair salon and hired Cheshire as a
receptionist. Apparently, she does a good job as a
receptionist.
b. if you share profits, then you have prima facie
evidence of a partnership-general rule (not
conclusive)
c. 2 factors for finding that this was not a partnership:
i. She didn’t share any of the losses.
ii. she did not control any aspects of the business
iii. she was not a co-owner
d. definition: UPA § 6(1)-partnership is an association of
2 or more persons to carry on as coowners a business for
profit.
e. Upa § 7-rules for determining the existence of a
partnership: (gist)
i. Except as provided in § 16
ii. Sharing of title does not solely establish a
partnership
iii. Sharing of gross returns solely does not establish
a partnership.
iv. Receipt by a person of a share of the profits in
the business is prima facie evidence that he is a
partner, but this inference will not be drawn if
the profits were received as
a. A debt by installment, or
otherwise
b. Wages of ee/or rent to Landlord
c. Annuity to widow OR rep to
deceased
d. Interest on a loan.

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 e. Consideration for the sale of a
good-will of a business
f.
3. Martin v. peyton (1927) p. 97
a. KNK has engaged in financial trouble. Ppf has loaned
money to KNK with some conditions. Ppf’s rights in
return include receiving 40% of the profits of the firm
until the return was met.
b. Issue: whether PPF is a partner so that the creditors can
go after them.
c. Result: No.
d. Analysis:
e. What could they have done differently?
i. make the loan more explicit-sate in the
agreement that the loan does not subject the two
firms to be partners
ii. could have incorporated.
iii. they should have just loaned the money for
interest and not for a share of profit of
1. prima facie evidence when you share in
the profit-look at the upA
f.
4. Southex exhibitions, inc. v. rhode island builders association,
inc. (2002) p. 102
a. We have 2 firms that might have formed a partnership.
These 2 firms are SEM and RIBA. They were putting
on these home exhibition shows in the convention
center, and the RIBA is the power behind the scene-
representative of all the rhode island builders.
b. Result; they are not a partnership
c. Analysis: because partnerships can be created without
any written formalities, its existence must be analyzed
under a totality of circumstances approach.
i. Pro partnership
1. profit sharing
2. sharing of control
3. contributions to property shared
ii. Con partnership
1. agreement was titled agreement, not
partnership agreement
2. fixed renewable term, rather than
indefinite duration
3. did not share cost/loss
4. conducted business in their own name
5. testimony that each regarded as own co.
ii. Section B-Partners Compared with Lenders
1. Young v. jones (1992) p. 107
a. South Carolina bank goes belly up; plaintiff loses its
money-500k. the south Carolina transferred the money
to swiss American.

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 b. So they sue price waterhouse-question is whether pw
Bahamas is co-partners with pw us?
c. You could also analyze this in terms of agency-is price
water house us the principal, and the pwb the agent.
d. Generally, persons who are NOT partners as to each
other are NOT partners as to third persons.-upa §
7(1)
e. A person who represents himself, OR permits
another to represent him, to anyone as a partner in
an existing partnership OR wit others not actual
partners, is liable to any such person to whom such a
representation is made who has, on the faith of the
representation, given credit to the actual or apparent
partnership. –upa § 16(1)
f. Result-no partnership
i. there was no reliance; the plaintiffs did not even
see the brochure, so how could they say that
they relied on it. The primary thing is that they
failed to demonstrate a level of reliance on a
holding out of them.
2.
iii. Section C-Partnership by Estoppel

b. Section 2-the fiduciary obligations of Partners

i. A-introduction- current event 01/21/04-Cingular buys out AT & T
wireless-possibility of anti-trust law of monopoly.
1. Meinhard v. Salmon (1928) p. 111
a. Salmon was a property mogul and got with Meinhard
who had a lot of money. They are coadventurers-
partners. They agree to lease the property and split the
property, with Salmon as the manager.
b. Salmon, later, does a new property deal with someone
else.
c. Meinhard wins under the theory of fiduciary obligation
of partners/joint adventurers.
d. Joint adventurers and partners are used
interchangeably; joint adventurers is considered
narrower than partners, but the UPA is still triggered for
joint adventurers.
e. Rule: partners are held to the highest degree of duty as
a fiduciary to each other. As a fiduciary, Salmon had a
duty to disclose to Meinhard the opportunity of another
business opportunity
f. Would it have made a difference if salmon did this
after the partnership ended?
i. Yes, seems less disingenuous.
g. How to remedy: For partnership, you should explicitly
write what the share of the profits are/is in the
partnership agreement. If not, then common law would
specify what the share would be.

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 h. All Salmon had to do was disclose the deal to Meinhard.
2. p. 116 revised uniform partnership act (1994) § 404- general
standards of partner’s conduct
(a) the only fiduciary duties a partner owes to a
partnership and the other partners are the duty of loyalty
AND the duty of care set forth in (b) and (c).

(b) a partner’s duty of loyalty to the partnership and the

other partners is limited to the following:
(1) to account to the partnership AND hold as
trustee for it any property, profit, or benefit derived by
the partner IN THE CONDUCT AND WINDING UP of
the partnership business OR derived FROM A USE BY
THE PARTNERSHIP of partnership property, including
the appropriation of a partnership opportunity;
(2) to refrain from dealing with partnership in
the conduct OR winding up of the partnership business
as OR on behalf of a party HAVING AN INTEREST
ADVERSE TO THE PARTNERSHIP; and

(3) to refrain from COMPETING with the

partnership in the conduct of the partnership business
before the dissolution of the partnership.

(c) a partner’s duty of care to the partnership and the

other partners in the conducting AND winding up of the
partnership business is limited to refraining from
engaging in grossly negligent OR reckless conduct,
intentional misconduct, OR a knowing violation of the
law.

SKIPPED D, E, F

ii. B-After dissolution

1. Bane v. Ferguson (1989) p. 117
a. Bane is a partner in this firm, and he retires. Part of the
plan, he OR his wife is supposed to get retirement
payments. Bane was a retired partner; not a partner.
b. His firm merges, and the result is that the entire firm
dissolves.
c. The theory is that the fiduciary duty was violated b/c
they did not take care of the retirement account.
d. Result: he loses.
e. His theory was negligent mismanagement b/c there was
no issue as to whether there was a failure of disclosure-
court rejected—side issue. Upa 9(3)(c)
f. Rule: After dissolution, a person who is no longer a
partner is not owed a fiduciary duty from the partnership
or the partners.

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 g. How could you resolve this? Should have a separate
trust fund established by the partnerships; vested
retirement fund. To protect retired persons, Congress
has passed laws that will enable them to get retirement
benefits-applies to blue collar worker, factory workers,
NOT partnerships.
2.
iii. C-Grabbing and leaving
1. Meehan v. Shaughnessy (1989) p. 119
a. Partners leave a firm to create another law firm.
b. Lawyers are allowed to keep their clients (unlike the
laundry case) b/c clients may want a particular attorney
c. The partners lied when asked if they were planning on
leaving.
d. Lying seems contrary to the highest degree of
fiduciary duty imposed on partners.
e. The only breaches were: 1)failure to be honest about
their leaving 2)fair about the way they notified their
clients, 3) secretly competing with the partnership.
f. by secretly setting up another firm, the partners did
NOT breach their fiduciary duty not to compete,
PROVIDED that they do not act in violation of their
fiduciary duties.
g. Upa § 20 duty of partners to render information;
parties shall render on demand true and full information
of all things affecting the partnership to any partner OR
the legal representative of any deceased partner OR
partner under legal disability. this was the
breachlied
h. To avoid this: more precisely outlined the procedures
for partners leaving the firm.
2.
iv. D-Expulsion
1. Lawlis v. Kightlinger & Gary (1990) p. 127
a. Told that he will be expelled, and he is given one
partnership share. He is expelled, and the partnership
agreement details the procedures for this.
b. Basis for lawsuit
i. Dissolution of partnership by removing files
ii. Contravened the duty of fair dealing
c. Professor feels that the partnership acted correctly b/c
the partners properly acted pursuant to the partnership
agreement.
d. Removing partnership files from a partner’s office
does NOT constitute dissolution.
e. UPA § 31 Causes of dissolution.
Dissolution is caused:
(1) without violation of the agreement btw/ the partners,

15
 (a) by the termination of the definite term or
particular undertaking specified in the
agreement,
(b) by the express will of any partner when no
definite term or particular undertaking is
specified,
(c) by the express will of all the partners who
HAVE NOT assigned their interests OR suffered
them to be charged for their separate debts,
either before OR after the termination of any
specified tem or particular undertaking,
(d) by the expulsion of any partner from the
business BONA FIDE in accordance with such a
power conferred by the agreement btw/ the
partners. ….
Skipped 2-6
f. Expulsion must be done in good faith for a
dissolution to occur without violation of the
partnership agreement.
g. Partnership agreement is violated if the expulsion is
exercised in bad faith OR for a predatory purpose
(more money).
h. Hint: look at the procedure set out in the partnership
agreement for this analysis.
2.
c. Section 3-Partnership Property
i. Putnam v. Shoaf (1981) p. 134
1. Mr. Putnam dies in 1974, and his wife wants to exit the business
and arranges to sell to the Shoaf.
2. She’s paying $21k to get the Shoaf’s to come in and take over ½
interest; after she pays her interest, they discover that the
bookkeeper has been swindling her.
3. Now, Ms. Putnam reappears wanting her cut by alleging that she
is still a partner b/c she did NOT sell her partnership interest,
but only property interest.
4. The Court agreed with Ms. Putnam.
5. This was probably a policy decision;
6. significance: a partner cannot convey a personal, specific
interest in partnership property.

UPA § 24 Extent of property rights of a partner

The property rights of a partner are
(1) his rights in specific partnership property and
(2) his interest in the partnership, and
partner’s interest in the partnership defined as “his
share of the profits and surplus and losses”

It is a right to share in the profits and distributions of

surplus. That is personal property of the partner, and
that CAN BE assigned.

16
 (3)his right to participate in the management.

Sec. 25 (explains the rights in specific partnership

property)… nature of a partner’s right in specific
partnership property

1) A partner is a co-owner with his partners of specific

partnership property holding as a tenant in partnership.
Undivided interest as cotenants. this section allows a
partner to possess and use specific partnership property
for specific partnership purposes, but not for personal,
own purposes. You could use the warehouses, widges
over to that warehouse. You have a right of possession,
equal to the co-partners. You cannot, however, store in
that warehouse your personal stash of weed.

(2) the incidents of this tenancy are such that:

(2)(a) a partner, subject ot the provisions of this act and

to any agreement between the partners, has an equal
right with his partners to possess specific partnership
property for partnership purposes, BUT he has no
right to possess such property for any other purposes
without the consent of his partners.

(2)(b) A partner’s right in specific partnership property

is NOT assignable except in connection with the
assignment of rights of all the partners in the same
property.

Another problem that comes up is whether some item is

really partnership property or a partner’s property.
Consequently, the partner would have a fee simple,
opposed to a tenancy in partnership.

ii.
d. Section 4-Raising Additional Capital
i. Businesses often need additional funds to finance their activities, but
they also consider the lowest method of achieving this.
ii. the partnership borrows 9 million, and 1 million is sold to 40
investors=24k. however, the partnership needs another 500k to build a
house worth 10 million. NO ONE WOULD OFFER THE additional
500k b/c that would be a loss.
iii. READ IT IN THE CASEBOOK-PROF WAS CONFUSING.
iv.
e. Section 5. The Rights of Partners in Management
i. UPA § 18 (e) subject to any partnership agreement, all partners have
equal rights in the management and conduct of the partnership
business.

17
ii. UPA § 18 (h) subject to any partnership agreement, any difference
arising as to ordinary matters connected with the partnership business
may be decided by a majority of the partners, but no act in
contravention of any agreement between the partners may be done
rightfully without the consent of all his partners.
iii. National Biscuit Company v. Stroud p. 142 (1959)
1. Mr.Stroud could not change the partnership agreement b/c he
only had 50%, not a majority.
2. Each partner has the authority to act as an agent of the
partnership as carrying out the normal acts of the partnership-
UPA § 9
3. partner did an act that was for the ordinary matter connected
with the partnership business, so the court held the partnership
liable.
4. result; partnership was liable.
5. apparent agency is lingering behind the scene
6. UPA § 9 Partner Agent of Partnership as to Partnership
Business ability of an agent to bind the principal, partnership,
in a contract situation.
1) Every partner is an agent of the partnership for the
purpose of its business, and the act of every partner,
including the execution in the partnership name of any
instrument, for apparently carrying on in the usual way
the business of the partnership, of which he is a member
binds the partnership, UNLESS the partner so acting, has in
fact, no authority to act for the partnership in the particular
matter, and the person with whom he is dealing has
knowledge of the fact that he has no such authority.
Knowledge=actual knowledge, not what should he have
known.
2) An act of a partner, which is not apparently for the
carrying on of the business of the partnership in the usual
way DOES NOT bind the partnership UNLESS authorized
by the other partners.

Skipped 3-4
7.
iv. Summers v. Dooley p. 144 (1971)
1. summers and D are partners
2. Summers wants a 3rd guy, and he begins working for the
partnership. Summer pays him out of his own personal funds
and demands that the partnership pays the 3rd guy.
3. issue: Whether the partnership is obliged to pay for the salary of
the 3rd guy although Dooley never authorized this.
4. result: The court held that the plaintiff CANNOT recover;
partnership NOT liable b/c it did not benefit the partnership,
rather benefiting the individual, Summers. Also, there was no
majority.

18
 5. solution: better partnership agreement, assign the jobs/tasks
to the better suited partner, have a provision that allows an
arbitrator/mediation, rather than dissolution.
6. Problem under summers
a. the partners can outvote him.
b. better partnership agreement
v. Day v. Sidley & Austin p. 146 (1977)
1. Mr. Day was first associated with S & A in 1938, and he was
instrumental in establishing a Washington Office, in 1963. He
was a senior underwriting partner.
2. S & A merged with Liebman, in 1972, and the 2 firms relocated
and consolidated the chairmen of both firms as co-chairmen.
3. Mr.Day alleges loss of income, damage to his professional
reputation and personal embarrassment, which resulted from his
forced resignation.
4. law firms create an executive committee in regard to the
rainmakers (persons who bring in business/clients)
5. underwriterpartners are the persons who have given the
greatest capital contribution.
6. fraud
a. Mr. Day alleges fraud due from the merger & acquisition
agreement that provided “no sidley partner would be
worse off in any way….”
b. court rejects this because 1) the partnership agreement
never specified Mr. Day’s position and his legal rights,
and 2) S & A agreement implicitly authorized the
executive committee to create, control, or eliminate firm
committees, putting Mr. Day on notice of a possible
relegation.
7. breach of contract, conspiracy and wrongful dissolution OR
ouster of partner
a. The court viewed the merger as similar to admission of
new attorneys or severance of current ones, which
requires only a majority vote, pursuant to S & A
agreement.
b. UPA provides that its laws are subject to a
partnership agreement.
8. breach of fiduciary duty.
a. Mr. Day alleges that the partners breached their
fiduciary duty by beginning on the merger without
notifying/consulting the other partners.
b. Court states that fiduciary duty is primarily concerned
with partners who make secret profits at the expense of
the partnership.
c. 3 basic fiduciary duties
i. partner must account for any profit acquired in
an injurious manner to the interests of the
partnership

19
 ii. a partner CANNOT without the consent of the
other partners, acquire for himself a partnership
asset
iii. he must NOT compete with the partnership
within the scope of the business.
d. Court rejects this b/c they did not feel that disclosing
internal structure of a partnership is encapsulating in a
fiduciary duty. Moreover, there was no secret profit
NOR any financial loss for the partnership as a whole.
9. conclusion: summary judgment granted.
10. what could Mr. Day have done to protect himself?
a. That he would continue to be the managing partner of
the WA office, rather than be a co-partner.
b. He may have been able to get the other partners to agree
to these terms, if he had good rainmaking skills.
11. Policy – for not extending fiduciary duty to this type of case
 there may be an imposition of too much duties, and this
would constrain business.
vi. Notes p. 152
1. When a partner retires, under the UPA (1914) §§ 29 and 31, the
old partnership is dissolved by the retirement and when the
remaining partners continue working, a new partnership is
formed.
2. if the remaining partners have an agreement that contains a
provision specifying that the remaining partners will continue as
partners, this provision is a “continuation agreement”-agreement
obligating the remaining partners to continue to associate as
partners under the existing agreement.
3. Under UPA (1997), if a partner retires pursuant to an appropriate
provision in the partnership agreement, there is a dissociation (§
601) rather than a dissolution (§ 801)… p. 153
vii.
f. section 6. partnership dissolution
i. right to dissolve
1. owen v. cohen (1941) p. 154
a. the two enter into an partnership for a bowling alley.
Plaintiff loans the partnership about 7k.
b. after about 4 months, the 2 partners begin to bicker in
regards to the management of the partnership and their
respective rights and duties under the agreement.
c. Plaintiff brings suit to dissolve the partnership/sell its
assets b/c he’s scared of losing his 7k investment.
d. Issue: whether the evidence warrants a decree of
dissolution of the partnership
e. Rule: courts of equity MAY order the dissolution of a
partnership where there are quarrels and disagreements
of such a nature and to such extent that all confidence
and cooperation between the parties has been destroyed
OR where one of the parties by his misbehavior

20
 materially hinders a proper conduct of the partnership
business.
f. UPA § 32 Dissolution by decree of court
(1) on application by or for a partner the court shall
decree a dissolution whenever:
(a) a partner has been declared a lunatic in any judicial
proceeding OR is shown to be of unsound mind
(b) a partner becomes in any other way incapable of
performing his part of the partnership contract
(c) a partner has been guilty of such conduct as tends to
affect prejudicially the carrying on of the business—this
was satisfied b/c the other partner demeaned the other
partner and was unwilling to work.
(d) a partner willfully or persistently commits a breach
of the partnership agreement, OR otherwise so conducts
himself in matters relating to the partnership business
that it is not reasonably practicable to carry on the
business in partnership with him-same as above.
(e) the business of the partnership can only be carried on
at a loss.
(f) other circumstances render a dissolution equitable.
g. UPA ( 1997) § 801(5)
On application by a partner, a judicial determination
that:
(i) the economic purpose of the partnership is LIKELY
to be UNREASONABLY frustrated;
(ii) another partner has engaged in conduct relating to
the partnership business which makes it not reasonably
practicable to carry on the business in partnership with
that partner; OR
(iii) it is not otherwise reasonably practicable to carry on
the partnership business in conformity with the
partnership agreement; OR
h. Analysis: court finds that the deprecating treatment by
the defendant to the plaintiff disrupts the proper conduct
of the partnership business.
i. Conclusion: dissolved.
j. UPA § 29 Dissolution defined; The dissolution of a
partnership is the change in the relation of the partners
caused by any partner ceasing to be associated in the
carrying on as distinguished from the winding up of the
business.
k. If you wrongfully dissolve a partnership, you WILL
NOT have control of the winding up affairs.
l. Good will value of the customer loyalty/value of
intangible aspects.
m. Under the 1914 UPA, the partner who wrongfully
dissolves, he does not get the good will value

21
 n. Under the 1997 UPA and CA, the partner who
wrongfully dissolves DOES get the good will value, but
the other partners is entitled to damages.
2. Collins v. Lewis (1955) p. 157
a. Lewis (Appellee) approached Collins to start a
partnership. Collins would contribute money, while
Lewis would contribute his expertise and management
ability of operating a cafeteria.
b. The court refused to order a dissolution b/c Collins
was acting unreasonable by lending additional monies
and that Lewis is competent to manage/work. As a
result, there exists a potential for money in the business
c. The court was probably protecting the partnership from
preventing Collins buy the partnership at a reduced sale
and have Lewis still have an outstanding debt.
d. POLICY prevent one partner from becoming a victim
of a judicially enforced dissolution.
e. How to protect Collinslimit the money asked for.
f. How to protect Lewisput in provisions in the p.a.
3. page v. page (1961) p. 162
a. plaintiff and defendant are partners in a linen supply
business. Plaintiff owns a corporation that is the
partnership’s major creditor.
b. Plaintiff wishes to dissolve the partnership
c. Rule: a partnership may be dissolved by the express
will of any partner WHEN NO definite term OR
particular undertaking is specified.—upa 31 (b)
i. A partnership for a term can be implied from
fact.
ii. This court recognized that when a partner
advances a sum of money to a partnership and
was to be repaid as soon as feasible from the
prospective profits of the business, the
partnership is for the term reasonably required to
repay the loan.
iii. Still subject to a fiduciary duty of good faith.
d. Analysis: the court rejected the lower court’s finding
that the partnership was for a term (when they would
make money) b/c there was no evidence to suggest this.
The court also stated that a hope to make a profit is not
equal to an implied understanding that the partnership is
for a term to repay the loan.
e. When there are no implicit or explicit intentions
otherwise, a partnership at will is presumed by the
courts.
f. The fiduciary duty still continues even during winding
up phase of a partnership.
4.
ii. The consequences of dissolution

22
1. Prentiss v. Sheffel (1973) p. 165
a. Issue: whether 2 partners in a 3-man-partnership at will,
who have excluded the 3rd partner, should be allowed to
purchase the partnership assets at a judicially supervised
dissolution sale.
b. Conclusion: yes
c. The court found that there was a partnership at will, and
although the other partners excluded the one partner-
appellant, this was done in good-faith and instituted a
dissolution of the partnership.
d. How could he protect himselfkeep bidding with new
investment buddies.
e. Consequences of dissolution other partners are
allowed to purchase the partnership assets
2. Monin v. Monin (1989) p. 168
a. Partnership for a milk hauling. They have a falling out,
and they dissolve.
b. Partner signs a negative covenant not to compete, but he
does. Sues for breach of partnership agreement.
c. Result: Charles prevailed.
d. Rule: a partner’s fiduciary duty extend beyond the
partnership to persons who have dissolved the
partnership, and have not completely wound up and
settled the partnership affairs.
e. Rationale: the purpose of the fiduciary duty is to
prevent a partner from benefiting at the partnership’s
expense. By selling his interests and actively pursuing a
contract with the milk company, Sonny benefited both
ways at the expense of the partnership.
f. Why sue under fiduciary duty, rather than covenant
theory?
i. He could recover more money
ii. He was not confident that he could win on the
covenant not to compete.
g.
3. Pav-Saver Corporation v. Vasso Corp. (1986) p. 171
a. Partners are both corporations. The partnership
agreement calls for dale’s corporation to give the
exclusive license to give the patents of the partnership.
b. Permanent licenseopen ended, not terminable at will.
c. The conflict, here, is between the p. agreement and the
general provisions of the upa (non-wrongfully dissolving
partner is entitled to continue running the partnership)
d. Conclusion: general provisions (default provisions) of
the upa PREVAILED over the partnership agreement.
e. How to protectbetter written p.a. if they get to keep
the patents, then dale would get to keep some money.
f. LOOK AT UPA A § 38

23
 g. GENERALLY, provisions in a partnership agreement
WILL PREVAIL over the default provisions of the
UPA.
i. Exceptions:
1. if the partnership agreement is not clear,
then the court will defer to the default
provisions of the UPA
2.
4.
iii. The Sharing of Losses –Section C
1. Kovacik v. Reed (1957) p. 177
a. 1952, Kovacik (K) approaches Reed (R) and asks him to
become a superintendent for possible remodeling jobs.
K would provide the financing.
b. The 2 never discussed possible losses.
c. There was a loss, and K demanded that R contribute the
amount that K had advanced.
d. General rule: in the absence of an agreement to the
contrary, the law presumes that partners and joint
adventurers intended to participate equally in the profits
and losses of the common enterprise, irrespective of any
inequality in the amounts each contributed to the capital
employed in the venture, with the losses being shared by
them in the same proportions as they share the profits
e. Exception to the general rule: when one joint partner
or joint adventurer contributes the money capital as
against the other’s skill and labor, neither party is liable
to the other for contribution for any loss sustained.
Upon loss of the money, the party who contributed it is
not entitled to recover any part of it from the party who
contributed only services.
f.
2. LOOK AT PAGE 179
3. UPA § 18 Rules determining Rights and Duties of Partners
The rights and duties of the partners in relation to the partnership
shall be determined, subject to any agreement between them, by
the following rules:
(a) each partner SHALL BE REPAID his contributions, whether
by way of capital OR advances to the partnership property AND
share equally in the profits and surplus remaining after all
liabilities, including those to partners, are satisfied; and must
contribute towards the losses, whether of capital OR otherwise,
sustained by the partnership according to his share in the profits.
SKIPPED (b) (c)
4. § 701 of the UPA (1997), a partnership does NOT dissolve IF a
partner withdraws from a partnership in contravention of the
partnership agreement.
5. § 701if a partner has rightfully withdrawn from a partnership,
the partnership must buy out the withdrawing (dissociated)

24
 partner for an amount equal to his/her share of the value of the
assets of the partnership.
iv. Buyout Agreements
1. buyout=agreement that allows a partner to end her or his
relationship with the other partners and receive a cash payment,
OR series of payments, or some assets of the firm, in return for
her or his interest in the firm.
2. details of a buy/sale
a. triggeryou should describe the triggering events for a
buy/sale event in a partnership agreement.
b. obligation to buypartnership/other partners/other
investors
c. pricefair market value/capital account/
i. book value=accounting-what was paid for the
business; usually lower than appraisal value.
ii. appraisal
iii. formula (e.g. 5x earnings)
iv. set price each year
v. relation to duration
d. method of payment
i. cash OR installments (with interest?)
e. protection against debts of partnership
f. procedure for offering either to buy OR sell
i. first mover sets price to buy/sell (set pricethen
buy/sell)
ii. first mover forces others to set price.
3.
4. G & S Investments v. Belman (1984) p. 181
a. Issue: whether the surviving general partner is entitled
to continue the partnership after the death of Nordale,
and HOW the value of Nordale’s interest in partnership
property is to be computed.
b. Century Park=limited partnership with Nordale and G &
S.
c. In 1979, Nordale began using cocaine, and acted
improperly. He also lived in one of the apartments and
sexually solicited an underage female.
d. Due to his erratic behavior and unreasonable requests (p.
182-change it to condos, raise rents), G & S decided to
dissolve the partnership.
e. Time of dissolution: Court found that the time for
dissolution was when Nordale acted in contravention of
the partnership agreement, (NOT when the dissolution
was filed)
i. UPA § 32- authorizes the court to dissolve a
partnership when a partner’s conduct affects the
carrying on of the business. (gist). Look at the
(2)(3)(4)

25
 f. In order to carry on the partnership, after Nordale’s
death: the court looked at Article 19 of the Partnership
agreement
i. Upon the death, retirement, insanity OR
resignation of one of the general partners, the
surviving or remaining general partners MAY
continue the partnership business. Should the
surviving OR remaining general partners desire
to continue the partnership business, they must
purchase the interest of the retiring OR resigning
general partner.
g. Partnership agreements are binding, and the rights and
liabilities of the partners among themselves are subject
to such agreements.
h. Ways of buying out fair market value OR capital
account (represents the amount of equity each partner
has in the business)=lower estimate than f.m.v.
i. The mere filing of a dissolution of a partnership in
the court DOES NOT constitute wrongful
dissolution.
5.
v. Law Partnership Dissolutions
1. jewel v. Boxer (1984) p. 185
a. holding: in the absence of a partnership agreement, the
UPA requires that attorneys’ fees received on cases in
progress upon dissolution of a law partnership are to be
shared by the former partners according to their right to
fees in the former partnership, regardless of which
former partner provides legal services in the case after
the dissolution.
b. 12/2/1977, the law firm of Jewel, Boxer, and Elkind was
dissolved by the mutual agreement of its 4 partners-
Jewel, Boxer, Elkind, and Leary.
c. Rules: a dissolved partnership continues until the
winding up of the unfinished partnership business. No
partner except a surviving partner is entitled to extra
compensation for services rendered in completing
unfinished business… look at holding, now.
d. Holding(gist) rule against extra compensation to law
partnerships
i. Policy justifications
1. rule prevents partners from competing
for the most remunerative cases during
the life of a partnership in anticipation
of a dissolution.
2. discourages former partners from
scrambling to take physical possession
of files and seeking personal gain by
soliciting a firm’s exiting clients upon
dissolution.

26
 e. Court reiterates that partners are free to put into a
written partnership agreement provisions for completion
of unfinished business.
f. Profit=received amount that exceeds 1)any reasonable
overhead expenses and 2)the fair charge that is owed
under a partnership agreement.
g. Dissolution = (upa § 31 of 1914) comes first, then
winding up.
h. to protect against a long winding up period=probably
not desirable put provisions in the partnership
agreement OR negotiate a partnership agreement
2. Meehan v. Shaughnessy (1989) p. 190
a. they had a partnership agreement that stated dissolution
and an instant winding up of the partnership.
b. Bop the party that took the cases have to prove
that the clients would have consented if they were
fairly notified of their option to stay with them.
c. The client still has the freedom and final decision as to
who they want to represent them.
d. Assuming that the cases were wrongfully removed, they
still get to keep their overhead expenses and their share
of the profits. –UPA § 21
e. a partner’s capital account=account of a partner’s initial
investment of cash OR property, increased by later
contributions, increased by profits over the years,
decreased by the losses, and decreased by the amounts
withdrawn.
f. Illustrates how one court shaped a decision concerning
partners who wrongfully removed cases, pursuant to
UPA § 21 (fiduciary obligation statute).
3.
vi.
g. limited partnership
i. Holzman v. De Escamilla (1948) p. 196
1. There was a limited partnership that went into bankruptcy, and
the trustee brought this action against 2 limited partners to hold
them accountable as general partners.
2. There must be AT LEAST one general partner who has
unlimited liability and other limited partners who have limited
liability.
3. Court found that the limited partners were general partners based
on their conduct.
a. Took part in the control of the partnership business
b. Money could be withdrawn from the partnership’s
account on the signatures of any 2 of the 3 partners.
c. Forced the general partner to resign and selected his
successor.
4. The point of limited liability if everything is done upfront
and the creditors know who the general partner is. There is
nobody with unlimited liability.

27
 5. DO NOT MIX UP WITH A LLC and a LP.
ii.
h.
III. THE NATURE OF THE CORPORATION
a. PROMOTERS AND THE CORPORATE ENTITY
i. Key distinction btw corporations and partnership:
1. formation (not much distinction)
a. corporationtake very specific/formal steps; get
certificate of incorporation and file it with the secretary
of state (wherever you want to inc. in)
i. need certificate of inc., articles of incorporation,
and bylaws.
ii. File name with secretary of state, do a name
search.
iii. Articles of incorporation are analogized to a
constitution
iv. Bylaws are analogized to statutes pursuant to the
constitution.  get a form book with samples of
articles/use it as a model.
v. Buy/sell agreement-urge client to draft.
b. Partnershipif partnership agreement, then amount of
time to make it will be same… however, there are no
requirements
2. taxation (not much distinction)
a. corpdouble taxation
i. avoid this by pay no dividends, PAY a lot of
salary to make 0 profit.
ii. If have less than 75 shareholders, then you can
make a sub-chapter S corporation that has flow
through taxation
b. partnershipflow through taxation
3. liability (major difference)
a. corporationlimited liability
b. partnership DOES NOT have limited liability
4. longevity
a. corplast forever—pass the shares
b. partnershipnot long b/c dissolve, but not anymore with
1997 UPA (dissociation – last indefinitely)
5. management
a. corpcentralized management: CEO is in charge
b. partnershipdecentralized
6. client perception
a. corpsome clients prefer it to the sound of --, inc
7. cost of formation
a. corporationgeneally, more expensive than
partnership
ii. promoter-refers to a person who identifies a business opportunity and
puts together a deal, forming a corporation as the vehicle for investment
by other people.

28
 1. examine the fiduciary obligations of promoters to 3rd persons for
pre-incorporation
2. hypos-book p. 199
a. promoter is liable for any obligation of a corporation that
is going to be formed.
i. Exp/ joe makes a contract for corp to be. Joe is
liable until corp is made.
b. no corporation-fraudliable
c. no corporation/ no fraud/did not disclose profit (agent
has duty to disclose to principal profit) agent liable.
d. Promoter/sets up corporation/do not tell the other owners
of the corporation that he bought the land for 100k and
sell to corp for 200ka promoter is not an agent of a
corporation, but the promoter is, generally, held to owe a
fiduciary duty to a corporation.
i. Disclosure is critical.
e.
3. if nothing is said about liability, the formation of the corporation
does not terminate the promoter’s liability. The point is that you
have to do something more in order to have the promoter escape
liability.

iii. Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc. (la. App.
1982)
1. plaintiff makes a contract to purchase a ship from defendant.
Plaintiff, initially, plans to incorporate in texas, but plaintiff,
later, incorporates his organization in the Cayman Islands, and
the defendant ratifies the previous contract for the sale of a ship.
2. defendant defaults, and plaintiff seeks specific performance and
damages, while defendant asserts a defense of legal status.
3. holding: a defendant, having given its promise to construct the
vessel, should not be permitted to escape performance by raising
an issue as to the character of the organization to which it is
obligated, unless its substantial rights might thereby be affected.
4. rule: one who contracts with what he acknowledges to be and
treats as a corporation, incurring obligations in its favor, is
ESTOPPED from denying its corporate existence, particularly
when the obligations are sought to be enforced. Corporation by
estoppel.
a. Hypo/ plaintiff asks secretary to mail a letter that would
incorporation, but secretary fails to do so difference—
de facto corporation.
i. Difference btw/ this and corporation by
estoppel:
1. good faith effort to form a corporation
2. provides limited liability.
ii.
b. d

29
 5. analysis: the fact that both parties relied on the contract shows
that each party acknowledge and treated the plaintiff as a
corporation.
6. business planning:
a. if represent defendant wait until the corporation is
formed/ whether or not the corporation is formed, make
sure that the guy who is behind the deal signs it and is
liable for the contract.
b. if represent plaintiff, did not set up corp1) set up the
corporation first, then you will not have to sign as an
individual, 2) make a provision that (if sign as
individual), liability will transfer to the corporation, once
it is set up.
iv.
b. The corporate entity and limited liability-section 2
i. Walkovsky v. Carlton (n.y.s. 1966) p. 206
1. plaintiff was run down by a taxi cab in New York city.
2. the taxi cab is owned by defendant Seon Cab Corporation, and it
was driven by defendant Marchese.
3. Carlton is claimed to be a stockholder of 10 corporations,
including Seon, each of which has 2 cabs registered in its named.
4. the minimum automotive liability insurance required by law is
10k.
5. plaintiff asserts that he all 10 corporations should be named as
defendants because they are operated as… a single entity, unit
and enterprise with regard to financing, supplies, repairs,
employees, and garaging. Plus, he is also entitled to hold their
stockpersons personally liable for the damages sought b/c the
multiple corporate structure constitutes an unlawful attempt to
defraud members of the general public.
6. pierce the veil, then go after Carlton, then reverse pierce the
other corporations to get more money enterprise theory.
7. 3 theories asserted:
a. piercing the corporate veil
b. enterprise theory-requires piercing the corporate veil and
reverse piercing.
c. Agency-problem-this goes against the principles of
corporation; the purpose of a corporation is limited
liability, unless you can establish piercing the veil.
Agency theory, generally, cannot trump the limited
liability of corporations.
8. really just wanted to leave it up to the state legislature to decide
this.
9. rules:
a. law permits the incorporation of a business for the very
purpose of enabling its proprietor to escape personal
liability, but there are limits to this rule.
b. Courts will “pierce the corporate veil” whenever
necessary to “prevent fraud or to achieve equity.”

30
 c. Agency theory applies whenever anyone exercises
control of the corporation to further his own interest
rather than the company’s business, he will be liable for
the corporation’s acts upon the principle of respondeat
superior.
10. two theories of recovery for the plaintiff
a. there was a larger corporation that controlled the smaller
corp.
b. the defendant was carrying on the business in his
personal capacity for personal ends by using the
corporation as a dummy.
11. court rejected the claim b/c the facts do not suggest that the
defendant was doing this for his own personal interest, and the
fact of using minimum liability insurance does not mean this.
12. the fraud would be the intentional undercapitalization of
these corporations to avoid liability.
13. why does a corporation have limited liability? Limited
liability for persons who do not have control over a corporation
is an incentive for this type of investment and business
association. Also, equitable/fair—protect the passive investor.
14. ALL the piercing the veil cases involve investors who control.
15. scenarios for piercing the veil:
a. closely held corporation-almost all the stock is owned by
an individual shareholder.
b. parent subsidiary case-almost all the stock is owned by
the parent corporation.
16. business planning: increase insurance amount rather than
primarily relying upon the limited liability characteristic of the
corporation; provide adequate capitalization to ensure that the
courts do not view the corporation formation as fraud.

ii. Sea-Land Services, Inc. v. Pepper Source (7th Cir. 1991) p. 211
1. Appellee Sea-Land Services (ocean carrier) shipped peppers on
behalf of The Pepper Source (ps).
2. PS did not pay the freight bill. On Dec. 2, 1987, the district
court entered a default judgment in favor of Sea-Land, but PS
had dissolved in mid 1987.
3. PS has no assets, so Sea-Land could not recover.
4. rule: a corporate entity will be disregarded, and the veil of
limited liability will be pierced when 2 requirements are met.
a. Unity of interest and ownership that the separate
personalities of the corporation and the individual (or
other corporation) no longer exist.
b. Circumstances must be such that adherence to the fiction
of separate corporate existence would sanction a fraud
or promote injustice.
i. Does honoring the defendants’ separate
identities promote injustice?

31
 1. is there evidence to support the
contention that the defendant schemed
to commit fraud?
2. requires some element of injustice
ii. examples/ 2 partners sue another, adverse
possession case, corporate façade to avoid its
responsibilities to its creditors.
iii. plaintiff claimed that the injustice was that the
defendant failed to pay its bill. Because almost
every contract case deals with a failure to pay a
bill, the court did not want this to be considered
as an injustice to prevent a floodgates of
litigation.  policy
5. factors in finding that the corporation was controlled by
another to justify piercing the veil.
a. Failure to maintain adequate corporate records OR to
comply with corporate formalities
b. Commingling of funds or assets
c. Undercapitalization
d. One corporation treating the assets of another
corporation as its own.
6. sealand satisfies prong 1 because: 1) no corporate meeting,
2)no articles of incorporation, bylaws, or other agreements of the
corporation, 3) marchese runs all the corp out of the same, single
office, with the same phone line, same expense account, 4)
borrows from the other corp. without interest, 5)pays personal
bills with the accounts.

iii. Kinney Shoe Corporation v. Polan (4th Cir. 1991) p. 217

1. in 1984, Polan formed 2 corporations, Industrial and Poland.
2. Nov, 1984, Polan and Kinney negotiated a sublease. However,
Polan defaulted on his rent payments. Under-capitalized
corporation.
3. terms of the lease=Kinneypolandindustrial
4. rules:
a. piercing the corporate veil is an equitable remedy, and
the burden rests with the party asserting the claim.
b. Totality of the circumstances test is used to determine
whether to pierce the veil.
c. Piercing the corporate veil requires:
i. Unity of interest and ownership such that the
separate personalities of the corp and the
individual shareholders no longer exist
ii. Would an equitable result occur if the acts are
treated as those of the corporation alone.
iii. New third prong-DISCRETIONARY OF
COURT-if a party fails to conduct an
investigation that would disclose that the
corporation is grossly undercapitalized, then that
party has assumed the risk of loss.

32
 d. Grossly inadequate capitalization combined with
disregard of corporate formalities, causing basic
unfairness, are sufficient to piece the corporate veil in
order to hold them liable. Court suggests that
undercapitalization is equal to fraud or
injusticeprof.
5. conclusion: yes, the court found polan liable.
6. business planning: do not undercapitalize your corporation, run
credit check, insurance, implement formalities in your plan.

iv. In re Silicon Gel Breast Implants Products Liability Litigation (n.d.

Ala. 1995) p. 221 (situation-first corporation is generally referred to as a
parent corporation and the second as a subsidiary)
1. Bristol-Myers Squibb is a parent corporation of Medical
Engineering Corp that produces breast implants.
2. parent subsidiary case. Tort case, and it seems that courts take a
more lenient approach in piercing the veil of corporations in tort
cases as opposed to contract cases.
3. factors on page 225
4. Piercing the corporate veil requires
a. Unity of interest test, supra
b. DOES NOT require the equitable result prong.
5. conclusion: summary judgment denied.
v. Frigidaire Sales Corporation v. Union Properties, Inc. (Wash. 1977) p.
229 [limited partnership with a corporation as a general partner]
1. petitioner entered into a contract with Commercial Investors, a
limited partnership.
2. respondents were limited partners of commercial and were
officers, directors, and shareholders of Union Properties.
3. Union properties was the general property of commercial, and
the respondents through U.P. exercised the day to day control of
Commercial.
4. courts have had difficulty with this because the essence of a
limited partnership is that there is 1 general partner who has
unlimited liability with limited partners who have limited
liability. However, when the general partner incorporates, the
general partner, now, has limited liability.
5. petitioner arg: limited partners should incur liability as a
general partner for the limited partnership’s obligations because
they exercised the day-to-day control and management of the
limited partnership.
6. conclusion: Court refused to extend the liability of the limited
partners because petitioner had knowledge that Union
Properties was the only party with general liability. The court
focused on the fact that the petitioner was NOT DECEIVED.
7. if you are worried about abuse of the limited partnership, the
doctrine of piercing the corporate veil s an answer to this
concern. This remedy is still available if there is injustice/fraud
AND a unity of interest.
vi.

33
c. shareholder derivative actions
i. introduction
1. Cohen v. Beneficial Industrial Loan Corp (u.s. sc. 1949) p.
232
a. Issue: whether a federal court, having jdx. Based solely
on diversity, MUST apply a statue of the forum state
which makes the plaintiff, if unsuccessful, liable for the
reasonable expenses, including attorney’s fees, of the
defense and entitles the corporation to require security
for their payment.
b. Plaintiff is a stockholder of Beneficial Industrial Loan
Corporation, a Delaware Corp. Plaintiff is 1/16,000
stockholders and owns 100/2,000,000 shares… his
shares+ intervenor= 150 shares=0.0125% of the
outstanding stock and about $9k market value price.
c. Defendants=corporation and certain of its managers and
directors who allegedly engaged in fraud over 18 years
to get about $100 million.
d. Significance: this is an action that lies in a court of
equity. It was not unreasonable to apply the statute that
would make the plaintiff liable for reasonable expenses.
e. This case would really deal with a breach of a fiduciary
duty.
f. Holding: a federal court with diversity jdx must apply a
state statute providing security for costs if the state court
would require the security in similar circumstances…
g. Shareholders own title to a corporation, and the
shareholders elect a board of directors that chooses a
CEO.
h. The shareholders derive their power to sue from the
corporation; the shareholder brings the suit on behalf of
the corporation and on behalf of all the shareholders of
the corp—def of derivative lawsuits.
i. Plaintiff’s lawyers usually bring/construct these types of
lawsuits.
j. Strike suits-plaintiff’s attorney does not have much of a
case, but brings this suit in order to get a quick
settlement.
k. Point of this case—in diversity suit, use forum state’s
law for Substantative law and procedural law, use FRCP.
They used new jersey’s law—permit the plaintiff to
bring the suit.
2. Eisenberg v. Flying Tiger Line, Inc. (2d Cir. 1971) p. 236
a. Max Eisenberg=resident of New York=stockholder of
The Flying Tiger Line, Inc. commenced this action in
the Supreme Court of New York to enjoin the plan of a
reorganization and merger.
b. Flying Tiger=Delaware Corporation with its ppb in CA,
removed the action to the District Court for the Eastern
District of New York.

34
 c. Holding company-usually does not have its own
business, it just owns the stock of another corporation.
d. After the merger, the former corporation deprived him
and other minority stockholders of any voice in the
affairs of their previously existing operating company.
e. Issue: whether Eisenberg should have been required to
post security for costs as condition to prosecuting his
action. ---is this suit derivative (corp) or personal
f. Conclusion: we find Eisenberg’s cause of action to be
personal and NOT derivative within the meaning of §
627. Reversed.
g. Test:
i. Gravamen of the complaint is injury to the
corporation, the suit is derivative, but if the
injury si one to the plaintiff as a stockholder and
to him individually and NOT to the corporation,
the suit is individual in nature and may take the
form of a representative class action. --- little
use
ii. Court overruled this test whether the object
of the lawsuit is to recover upon a chose in
action belonging directly to the stockholder, or
whether it is to compel the performance of
corporate acts which good faith requires the
directors to take in order to perform a duty
which they owe to the corporation, and through
it, to its stockholders.
1. LIMITED ONLY TO THE FACTS
OF—stockholder seeking to force
directors to call a stockholders’ meeting.
iii. New test: suits are derivative ONLY IF
BROUGHT in the right of a corporation to
procure a judgment in its favor.
h. Personal suit-suit on behalf of individual person.
i. Derivative suit—individual does not get the money, but
the corporation gets the money damages. Individuals
who have breached their duty to the corporation has to
pay money damages to the corporation.
j. Why did it do this? They wanted to diversify, and in
order to do so, they have to create a holding co.
k. Difference btw/ class action and derivative action:
derivative suits are brought to enforce the rights of the
corporation, ALL of the shareholders. Class actions are
brought to enforce the independent rights of a particular
group of persons.
3. notes:
a. if a derivative actionsettled a corporation CAN pay
the legal fees of the plaintiff and defendant.

35
 b. If a judgment for money damages is imposed
defendant is required to pay those damages and pay the
cost of their defense.
c. Together as a whole, corporate managers who have
harmed the corporation will be relieved of risk of
personal losses if the corp. pays large attorney fees in
return for their willingness to accept a settlement,
especially one other than money damages.
d. In re general tire 1984-defendant paid hefty attorney
fees to plaintiff and did an equitable remedy that really
did not do anything.
4.
ii. The requirement of Demand on the directors
1. Grimes v. Donald (del.supp.ct. 1996) p. 241
a. Issues:
i. Distinction btw/ direct claim and a derivative
claim?
ii. Direct claim of alleged abdication by a bd. of
directors of its statutory duty.
1. court-abdication claim can be stated by
a stockholder as a direct claim.
iii. When a pres-suit demand in a derivative suit is
required OR excused?
iv. What are the consequences of demand by a
stockholder and the refusal by the board to act
on such a demand?
1. court-stockholder MAY NOT,
thereafter, assert that the demand is
excused.
b. GrimesDonald (CEO) and DSC for an award of
damages, based on the allegation that the Board has
breached its fiduciary duties by abdicating authority
c. Claim is that there are potentially severe financial
penalties which the company would incur in the event
that the Board attempts to interfere in Donald’s
management of the company, and this would deter the
Board from exercising its duties, under § 141(a).
d. As a matter of law, the board is responsible for the
corporation, but, in reality, the CEO controls the day to
day activities of a corp.
e. Look at § 141(a) (delaware code)-the board is ultimately
responsible for a corporation’s activities.
f. P. 185 801(b)-same thing; all corporate power shall be
exercised by… board of directors.
g. Test for direct or derivative
i. To pursue a direct action, the stockholder
plaintiff MUST ALLEGE more than an injury
resulting from a wrong to the corporation.
1. the injury MUST BE separate and
distinct from that suffered by other

36
 shareholders OR wrong involving a
contractual right of a shareholder…
ii. if the plaintiff is only asking for an injunction
(look at remedy pursued), then the court tends
to label the suit as a direct action.
h. rules:
i. directors may NOT delegate duties which lie at
the heart of the management of the corporation
ii. an informed decision to delegate a task is as
much an exercise of business judgment as any
other; consequently, business decisions ARE
NOT an abdication of directorial authority
merely b/c they limit a board’s freedom of future
action.
iii. business judgment rule-the court follows and
gives a board of directors from a corp. deference
to make business judgments. Only in clear
abuse or violation of laws will the court step in.
BOP is on the plaintiff.
iv. for derivative suits a stockholder MUST
allege either that the board rejected his pre-suit
demand that the Board assert the corporation’s
claim or allege with particularity why the
stockholder was justified in not having made the
effort to obtain board action.
1. one ground for alleging with
particularity that demand would be futile
is that a reasonable doubt exists that the
board is capable of making an
independent decision to assert the claim
if the demand were made.
a. Basis for a claim would be –
i. board has a material
financial or familial
interest, OR
ii. majority of board is
incapable of acting
independently, courts
interpret this pretty
loosely b/c realistically,
it is very difficult. OR
iii. or underlying
transaction is not the
product of a valid
exercise of business
judgment. (exp/show
fraud or corporate
bribery)
2. if a demand is made and rejected, the
board rejecting the demand is entitled to

37
 the presumption of the business
judgment rule UNLESS the stockholder
can allege facts with particularity
creating a reasonable doubt that the
board is entitled to the benefit of the
presumption. difficult to do
v. Policy for demand requirement: 1) let the
corporation deal with it, 2)minimize the burden
on the court by first requiring the plaintiff to
resolve the problem with the corporation.
i. Under the model business act, demand is universal.
DEMAND is required as a condition for suiing. A
plaintiff does not have to wait for a response IF the corp
is in risk of harm.
j. CA law (kind of easier than NY or DEL)
i. Stockholders must allege in particularity the
reasons for not making such effort
1. MAKE a demand, OR explain to the
court why you didn’t make an effort;
AND
2. deliver a copy of the complaint to the
corporation before filing suit.
ii.
k. PROBLEM—Does plaintiff choose to make a demand
or not.
2. marx v. Akers (n.y.s. 1996) p. 249
a. plaintiff (shareholder derivative action) IBM and
IBM’s board of directors
b. during a decline in profitability, 15/18 members of the
board voted for excessive compensation.
c. Suit for waste-violated the business judgment rule by
paying too much to the employees.
d. Rule: Demand is required before initiating a derivative
suit, unless the demand would be futile.
i. Purpose of the rule: 1) relieve courts from
deciding cases that should be better left for the
directors, 2) provide corporate bd. with
protection from harassment by lawsuits,
3)discourage strike suits commenced by
shareholders for personal gain.
ii. Demand is excused b/c of futility when a
complaint alleges with particularity
1. that a majority of the board of directors
is interested in the challenged
transaction
2. that the board of directors did NOT fully
inform themselves with the challenged
transaction to the extent reasonably
appropriate under the circumstances.—

38
 different from Delaware law that
requires managers to be independent.
3. that the challenged transaction was so
egregious on its face that it could NOT
have been the product of sound business
judgment of the directors.
iii.
e. conclusion for not outside directors: defendant’s
motion to dismiss for failure to make a demand as to the
allegations concerning the compensation paid to IBM’s
executive officers was properly granted.
i. Failed to allege particular facts in contending
that the board failed to deliberate or exercise its
business judgment.
ii. Only 3 directors got excessive compensation out
of the 18== not equal to majority
f. Conclusion for outside directors: demand was
excused b/c 13/18=majority. Demand was futile in
regards to prong 1.
g. Conclusion for excessive compensation does NOT
state a claim upon which relief can be granted.
3. prof dislikes excessive corporate compensation-consider that
other nations are being paid less-argue well.
4. problems p. 255
a. the damages will go to the corporationderivative
b. would be excused (whenever a violation of the duty of
loyalty, this is NOT protected by the business
judgment rule)
c.
iii. The Role of Special Committees
1. Auerbach v. Bennett (n.e.2d 1979) p. 256
a. After reports that numerous multi-national companies
had made questionable payments to public officials OR
political parties in foreign countries, GT & E Corp.
directed that an internal preliminary investigation.
b. An audit revealed that between 1971 and 1975,
corporate funds had been 1)paid directly or indirectly to
any political party OR person OR to any officer,
employee, shareholder OR director of any governmental
or private consumer OR 2)used to reimburse any officer
of the corp. or other person for such payments.
c. After this, Auerbach filed suit against this company and
Arthur Anderson & Co. for breach of their duties to the
corp. (fiduciary duty???)
d. A disinterested group was elected to see what was in the
corporation’s best interest-decided that it would NOT be
in the best interest of the corporation for the present
derivative action to proceed. P. 257
e. Federal securities laws prevent US corporations from
paying bribes to foreign persons/country.

39
 f. Business judgment rule- shields the deliberations and
conclusions of the chosen representatives of the board
only if they possess a disinterested independence AND
do not stand in a dual relation which prevents an
unprejudicial exercise of judgment.
g. Conclusion: the court defers to the board’s
methodologies and procedures b/c they find it to be
adequate.
h. Difficult to argue for money damages b/c the bribes
probably helped the corporation to make more money
OR positively affected a rise in the stock of the
corporation.
i. KNOW difference of derivative/direct lawsuits,
differences for demand requirements (remember
Delaware and model rule requirement of universal
demand and CA) & UNDERSTAND POLICY behind
the disputes.
j. Standard for assessing whether the court should grant
that motion the business judgment rule had been
complied with. Was there sufficient independent/care
given that was within the discretion of the board of
directors.
2. Zapata Corp. v. Maldonado (Del. 1981) p. 261
a. In june 1975, Maldonado, stockholder of Zapata,
instituted a derivative actions in the Court of Chancery
on behalf of Zapata against 10 officers and/or directors,
alleging breaches of fiduciary duty.
b. Maldonado did not make a demand, but stated that it
would be futile.
c. Four of the def, were no longer on the board, so the
remaining 6 appoint 2 new outside directors to the board.
This board created an independent investigation
Committee, and the Committee concluded that each
action should be dismissed.
d. Issue: whether the Committee has the power to cause
the present action to be dismissed
e. case brought as derivative and that demand was excused;
f. issue: whether the corporation can appoint a board of
independent directors to decide whether the suit should
be dismissed and whether it is in the corporation
standard.
g. Rule:
i. Business judgment rule DOES NOT confer
power to a corporate board of directors to
terminate a derivative suit.
ii. Two ways to initiate a derivative suit
1. demand is made and wrongfully
rejected; or
a. falls under the business
judgment rule (b/c this is a

40
 presumption), unless the
plaintiff can show that the
rejection was wrongful.
2. a stockholder may initiate a derivative
suit without prior demand, when
demand would be futile (must show)
iii. if a committee composed of independent and
disinterested directors, conducted a proper
review of the matters before it, considered a
variety of factors and reached, in good faith, a
business judgment that the action was not in the
best interest of the corporation, the action
MUST be dismissed.
h. holding:
i. an individual stockholder DOES NOT
exclusively have the power to control a
derivative lawsuit.
ii. A committee with properly delegated authority
would HAVE the power to move for dismissal
OR summary judgment if the entire board did.
1. the motion should include a thorough
written record of the investigation and
its findings and recommendations
2. two step process
a. does the committee have both
independent and good faith
acted to supports its conclusion
i. yesstep 2=b
ii. nodeny motion to
dismiss
b. court determines, by applying
its own BJR; this is in the
court’s discretion.
i. Delaware courts
discretion is given to
the court
ii. NYdiscretion with
the corp.
iii. Many corporations incorporate in Del. b/c
lenient laws in Del., well established corporate
law, supreme courtformer corporate attorneys,
and more.
i. conclusion: the court remanded this to see whether the
committee was independent.
j. Q: do you think the fact that they will be in the same
litigation and were appointed by directors support a lack
of independent? Not really b/c they are in the same
litigation.
k. To show that they are independent, you need to show
something very direct. (ex/ family relations).

41
 3. p. 268 and 269
a. because alleging with particularity the reasons why
demand would be futile is a higher burden on the
plaintiff than a rejected demand.
b. Business planning: step 1, see if there are any
suspicious relationships involved, and make sure that at
least the appearance of impartiality, hire big named law
firm as independent committee. In regards to step 2, see
whether there are some conduct that are so atrocious;
look to see if any persons were disciplined or dismissed.
c. New york BJR is more favorable than Del.
4.
iv.
d. The Role and Purposes of Corporations
i. A.P. Smith Mfg. Co. v. Barlow (1953) p. 270
1. Company incorporated in 1896 and manufactures/sells valves,
fire hydrants, and special equipment, mainly for water and gas
industries.
2. The company donated $1500 to Princeton, and this was
questioned by stockholders.
3. plaintiff’s argument
a. plaintiff’s certificate of incorporation does not expressly
authorize the contribution, and, under common law, the
company does not possess any implied OR incidental
power to make it
b. new jersey statutes which expressly authorize the
contribution MAY NOT constitutionally be applied to
the plaintiff, since the co. was created long before the
statute. All corporations exist based state law, so state
amendments can be made.
4. conclusion: the court sustained the validity of the donation.
5. policy: encourage corporations to give donations. Although the
primary purpose of corporations is to make money, there is an
indirect benefit from donating to a university by helping the
community.

ii. An argument of a violation of a Duty of care can be extinguished by the

business judgment rule.
iii. Dodge v. Ford Motor Co (mich. 1919) p. 276
1. The Dodge brothers owned 10% of the Ford stock and received
120k annually, and had a share of the special dividend of $1
million.
2. in 1916, Ford announced that n the future, there would be no
special dividends. Profits would be reinvested in the business;
based on this, the Dodge brothers offered to sell their shares for
35 million, at which Ford expressed no such interest.
3. rule: there must be fraud OR a breach of that good faith which
directors are bound to exercise toward the stockholders in order
to justify the courts entering into the internal affairs of the
corporation.

42
 4. conclusion: has to pay a dividend of 19.3, and can build the
smelting plant.
5. A business corporation is organized and carried on primarily for
the profit of the stockholders. The discretion of the directors is
to be exercised in the choice of means to attain that end, and
does not extend to a change in the end itself, to the reduction of
profits, OR to the nondistribution of profits among stockholders.
6. smelting plant bjr
7. pay the 19.3 million dividend violation of duty of care
8. business planning: should have said that the temporary loss of
profits would be to encourage investment and increase future
profitability.

iv. Shlensky v. Wrigley (Illinois 1968) p. 281

1. Appeal of a stockholders’ derivative suit against the directors for
negligence and mismanagement.
2. plaintiff=minority shareholder of defendant corporation, Chicago
National League Ball (inc.), and defendant Wrigley is president
of the corp and owner of 80% of the shares.
3. 19/20 major league teams schedule night games.
4. The Cubs operated at a loss, during 1961-1965, and the plaintiff
attributes those loses to inadequate attendance at Cubs’ home
games. He concludes that if lights were installed, then the night
games may help the financial situation.
5. plaintiff alleges that night lights were not installed because
Wrigley views that baseball is a daytime sport AND that the
night games will have a deteriorating effect upon the
surrounding neighborhood.
6. rule:
a. in order to inquire into a board’s decision, the decision
must be showed to be fraudulent, illegal or a conflict of
interest in their making the decision.
b.
7. holding: court felt that although the corp. was not concerned
with the financial interest and welfare of the corp, the concern
for the surrounding neighborhood was enough.
8. conclusion: not a violation of the business judgment rule. Even
if he was holding out for a new attractive stadium, this would
probably be in the best interest of the corporation, and this would
not be a violation of BJR.
9. Trend: Courts do not like to second guess board of directors
(exp/ Ford case and Chicago Cubs); there is a reluctance to
second-guess the decision of CEOs and directors.
v.
IV. The Limited Liability Company
a. Formation
i. Characteristics (limited liability company AND limited liability
partnership)
1. type
a. LLC mix of the corporate form and general partnership

43
 b. LLPlike llc, desirable b/c maintains the partnership
structure.
2. management
a. LLC may be managed by all its members (like
partnership) OR by non-member managers (like
corporation) more leniency than corporation.
3. tax
a. investors in an LLC are taxed, like partners, only once
on the profits.
b. Investors in an LLC can account, on their individual tax
returns, of any losses of the LLC ( losses “pass thru”)
c. Same for LLP
4. liability
a. LLC limited liability for members, similar to
corporations.
b. LLP limited liability in regards to only contracts,
NOT tort.
c. CA LLP only allowed to lawyers and accountants.
5. insurance (malpractice)
a. requires proof of adequate insurance for establishing a
LLP in CA.
6. creation
a. requires some paperwork and filings with a state agency,
like a corporation. Secretary of state.
i. File articles of organization, and operating
agreement
ii. CA file both Articles of organization AND
operating agreement.
iii. Operating agreement can have provisions for
buy/sell agreement (when they would be
triggered).
b. Some states impose fees and taxes on LLCs
c. LLP file a document with a state official.
ii. Water, Waste & Land, Inc. d/b/a Westec v. Lanham (Colo. 1998) p.288
1. issue: whether the members or managers of a limited liability co
are excused from personal liability on a contract where the other
party to the contract did NOT have notice that the members or
managers were negotiating on behalf of a limited liability
company at the time the contract was made
2. Lanham and Clark approached Westec to perform engineering
work. Clark gave a business card to Westec, and on this
business card, there were no representations that their company
was a LLC.
3. There was an oral agreement, and Westec completed the
engineering work and sent a bill for $9,183.40 to Lanham. No
payments have been made.
4. rules:
a. where a 3rd party seeks to impose liability on an LLC’s
members OR managers simply due to their status as

44
 managers OR members of the LLC, the filing of the
articles of organization serve as a constructive notice of
a company’s status as a LLC.
i. Different with agent who is liable if he does not
fully disclose the identity of the principal.
b. To get Lanham, the court used agency theory.
i. The undisclosed principal would be the
LLC/Lanham.
ii.
c.
5. conclusion: the LLC Act’s notice provision WAS NOT
intended to alter the partially disclosed principal doctrine.
Lanham was found liable.
6. business planning: they could have put it on a business card
LLC/document/sign/advertisement. How about Westec? 
check the credit rating, make Clark and Lanham personally liable
on the contract.
7.
iii.
b. The Operating Agreement
i. Elf Atochem North America, inc. v. Jaffari (del. Sup. Ct. 1999) p. 293
1. issues:
a. whether the LLC, which DID NOT execute the LLC
agreement in this case defining its governance and
operation, IS nevertheless BOUND by the agreement
b. whether contractual provisions directing that all disputes
be resolved exclusively by arbitration OR court
proceedings in CA are valid under the act.
2. conclusion:
a. the agreement is binding on the LLC as well as the
members
b. since the Act DOES NOT prohibit the members of an
LLC from vesting exclusive subject matter jdx in
arbitration proceedings, the contractual forum selection
provisions MUST govern.
3. plaintiff-Elf-makes/distributes solvent-based masks to the
aerospace and aviation industries throughout the world.
4. Defendant Jaffari-president of Malek, Inc./CA corp.-developed
an innovative, environmentally-friendly alternative to the
solvent-based maskants that presently dominate the market.
5. because the EPA categorized the masks as hazardous, ELF
approached Jaffari. The 2 created Malek LLC.
6. They, also, entered into an agreement in which Elf would be the
worldwide distributor for Malek LLC, and the agreement
provided that Jaffari will be the manager of Malek, LLC. Jaffari
would also be the CEO.
7. Elf sued Jaffari and Malek LLC, alleging that Jaffari pushed
Malek LLC to the brink of insolvency by withdrawing funds for
personal use, interfered with business opportunities, failed to

45
 make disclosures to Elf, and threatened to make poor quality
masks.
8. rules:
a. where the agreement is inconsistent with mandatory
statutory provisions, the members’ agreement will be
invalidated.
b. § 18-101(7) defines the limited liability company
agreement as “any agreement, written OR oral, of the
member OR members as to the affairs of a limited
liability company and the conduct of its business.”
c. A derivative action can be brought on behalf of the
LLC’s behalf.
d. Default rules are used if the members DO NOT decide
otherwise.
e. Raise unconscionability argument; courts take the
position of allowing freedom of contract, concerning
operating agreements.
9. significance: court upheld an arbitration clause in the llc
agreement.
ii.
c. Piercing the LLC Veil
i. Kaycee Land and Livestock v. Flahive (p.3d 2002) p. 300
1. issue: in the absence of fraud, is a claim to pierce the LLC an
available remedy against Wyoming Limited Liability Company
2. Flahive=Wyoming LLC
3. Kaycee-contract-Flahive to use the surface of its real property
4. Roger Flahive-is and was the managing member of Flahive
5. Kaycee alleges that Flahive Oil & Gas caused environmental
contamination.
6. Kaycee and Livestock seeks to pierce the LLC veil; no allegation
of fraud
7. holding: if the members and officers of an LLC fail to treat it as
a separate entity as contemplated by statute, they should not
enjoy immunity from individual liability for the LLC’s acts that
cause damage to third parties.
8. rationale: court speaks of the similarities between corporations
and LLC
9. significance: piercing the LLC veil is permitted as an equitable
remedy.
10. to pierce the corporate veil (review)
a. unity of interest (alter ego), AND
b. fraud or injustice
11. to pierce the LLC veil
a. unity of interest (alter ego)—difficult to show
b. fraud or injustice.

Courts are still working on this.

Counterargument-legislative expressly mandates piercing in the

corporate context, BUT they are silent in the LLC context.-Court

46
 Rejected—b/c when Wyoming made the LLC statute, they were
the first, so this silent does not mean that they wanted to exclude
this equitable remedy.

Cannon of Construction-if the legislature does NOT want to

follow Common Law, then they will expressly state this;
consequently, silence may be seen as accepting/mandating the
common law.

12.
ii. Tom Thumb Food markets, Inc. v. TLH Properties, LLC p. 303
1. they try to pierce the LLC.
2. The court, in this case, says that there is no piercing of the veil,
but they say that the LLC is liable for its failure to fulfill the
contract.
iii.
d. Fiduciary Obligation
i. McConnell v. Hunt Sports Enterprises (Ohio App. 1999) p. 305
1. wealthy group of persons created CHL. They needed to get an
arena, but Hunt, another investor, found a lease agreement to be
unacceptable.
2. on the other hand, McPherson liked the lease agreement, and,
ultimately, his group was awarded a franchise.
3. later, McPherson filed a suit to establish its legal right to the
franchise without the inclusion of Hunt or CHL.
4. rules
a. construction of written contracts is a matter of law
b. only where the language of a contract is unclear OR
ambiguous OR when the circumstances surrounding the
agreement invest the language of the contract with a
special meaning, extrinsic evidence will be considered.
c. Test for determining whether a term is ambiguous is that
common words in a written contract will be given their
ordinary meaning UNLESS manifest absurdity results
OR unless some other meaning is clearly evidenced from
the face or overall content of the contract.
5. conclusion: they look at the agreement, and the court concluded
that the exclusion was not a breach of the fiduciary duty b/c the
operating agreement allowed such acts. NOTE: this conclusion
was reached by taking into consideration the context of
members’ ability, pursuant to operating agreement.
a. Rationale: McPherson did NOT act in a secretive
manner.
b. Also, there was NO tortuous interference with a
business relationship.
6. holding:
a. a llc, like a partnership, involves a fiduciary relation.

47
 b. An operating agreement of a llc MAY limit OR define
the scope of the fiduciary duties imposed upon its
members.
c. To find that a member was an operating member
(operating members can be liable for willful
misconduct), look at the operating agreement, number of
units/shares. –court found that McPherson engaged
in willful misconduct by filing the actions at issue.
7. tortuous interference with a business relationship occurs
when a person, without a privilege to do so, induces OR
otherwise purposely causes a third person not to enter into OR
continue a business relationship with another….
ii.
e. Dissolution
i. New Horizons Supply Cooperative v. Haack (wis. Unpub. 1999) p. 311
1. there is a trucking arrangement and made a contract regarding
fuel.
2. the llc does not pay, and, later, becomes defunct. Haack
promises to pay, but she does not.
3. New Horizons sues Haack.
4. conclusion: The court orders her to pay.
5. Theory used:
a. Lower court used piercing the corporate veil, but
appellate court rejected this.
b. Because she did not use the proper steps to make a LLC,
the court found it to be…???? READ book.
c. Proper dissolution requires giving notice in order to
liquidate your assets….???
d. Other theories available-prof-
i. Piercing the veil
ii. Failure to dissolve properly
iii. Operating member (have one person who is in
charge of the day-to-day operations)
e.
6.
ii. To sum up
1. llc are popular, now.
2. they are the most flexible to have limited liability and pass thru
taxation, but based on the few cases, there is a risk that the
characteristic of limited liability may be set aside.
3.
iii.
V. THE DUTIES OF OFFICERS, DIRECTORS, AND OTHER INSIDERS
a. The Obligations of Control: Duty of Care
i. Kamin v. American Express Company (n.y.s. 1976) p. 316
1. duty of care is owed by officers, directors, and other insiders.
Already, spoke about the duty of loyalty.
2. American express bought Donaldson, lufken and Jenrette, inc.
the company did bad, so they wanted to get rid of it.

48
 3. American Express chose to spin off the corporation by giving
each American Express shareholder a proportionate number of
shares of Donaldson.
4. as a practical matter, CEOs and board of directors are concerned
with short term stock rises and dips;
5. business planning: don’t give stock options to CEO b/c they
will want to manipulate the stocks in order to make more of a
profit for themselves.
6. business judgment rule-the courts will accord the maximum
amount of discretion in how directors and the boards run a
corporation.

ii. Smith v. Van Gorkom (Del. Sup. Ct. 1985) p. 320

1. leveraged buy out-when managers try to buy out a corporation;
you put up a small amount of capital (may be a few %) and
borrow the rest of the money to put up with what you need to
take over the company.
a. use the company’s own assets to do a deal.
2. the corporation had a lot of tax losses, which would be attractive
to another corporation that had a lot of profit b/c they could use
the tax losses as write offs.
3. class action brought by shareholders of the defendant Trans
Union Corporation defendant member of the Board of
Directors
4. there were merger talks. The director who would face
mandatory retirement actively sought to merge his company,
without the board’s knowledge.
5. later, there were board meetings, and the board agreed to the
merger.
6. issue: whether the directors reached an informed business
judgment in agreeing to sell the Company, pursuant to the terms
of the 9/20 agreement.
a. Whether the directors reached an informed business
judgment on 9/20/1980.
b. Whether the directors’ actions taken subsequent to 9/20
were adequate to cure any infirmity in their action taken
on 9/20.
7. rules:
a. directors are fully protected in relying in good faith on
reports made by officers.
b. The discovered failure of the board to reach an informed
business judgment in approving the merger constitutes a
voidable, rather than a void act.
i. Therefore, the merger can be sustained,
notwithstanding the infirmity of the board’s
action, if its approval by majority vote of the
shareholders IS FOUND to have been based on
an informed electorate.
1. was the information inaccurate?
2. was the information inadequate

49
 ii.
c.
8. conclusion
a. board’s decision, reached 9/20/1980 to approve the
proposed cash-out merger was NOT the product of an
informed business judgment
b. the board’s subsequent efforts to amend the merger
agreement and take other curative action were
ineffectual, BOTH legally and factually; and
c. that the Board did NOT deal with complete candor with
the stockholders by failing to disclose all material facts,
which they knew OR should have known, before
securing the stockholders’ approval of the merger.
d.
9. analysis
a. the directors 1) did not adequately inform themselves as
to Van Gorkom’s role in forcing the “sale” of the
company AND in establishing the per share purchase
price, 2) were uninformed as to the intrinsic value of the
company, 3) given these circumstances, at a minimum,
they were grossly negligent in approving the “sale” of
the company upon 2 hours consideration.
b. The court emphasizes the fact that the board of directors
relied entirely and primarily on Van Gorkom’s
representations.
i. No written documents before them
ii. Should have had more information/evidence.
c. The court also notes that the board knew that the shares
were undervalued and had no other information as to the
intrinsic value of Trans Union.
d.
10. seems like the major beef was that this was a forced merger,
and the company COULD have received a better offer, but
was denied this b/c of the forced nature of the merger.
a. Is there an implied duty of care to get the highest
possible price for the company
11. significance of the case (ALL DUTY OF CARE)
a. directors of a corporation have a fiduciary duty to their
stockholders to inform themselves of all information
reasonably available to them AND relevant to their
decision regarding mergers/acquisitions.
b. Directors of a corporation have a fiduciary duty to their
stockholders to disclose all material information such as
a reasonable stockholder would consider important in
deciding whether to approve a merger/acquisition.
c. A corporation’s board MUST get adequate information
and adequate deliberation in regards to
mergers/acquisitions, based on its duty of care to its
shareholders.
d.
12. business judgment:

50
 a. hire an investment banking firm to issue an opinion as to
the fairness of the price that has been offered.
b. Amend a corporation’s certificate of incorporation to
have limited liability for the directors.
c. Director would care that senior managers would care
about their opinion b/c 1) their approval would help in a
potential lawsuit, 2) liability insurance for the directors,
3)
iii. Fiduciary duty is a broad umbrella for a duty of loyalty and duty of care

iv. P. 337-DIFFERENCE between intrinsic value and market price

v. Technicolor case
1. distinguished from Van Gorkom b/c
a. CEO had hard bargained the raising of the stock price
(no real possibility of more money)
b. Thorough job of investigation

vi. Brehm v. Eisner (de.supp.ct. 2000) p. 339

1. allegations
a. board of directors breached its fiduciary duty in
approving an extravagant and wasteful employment
agreement of Michael s. Ovitz as president of Disney
b. board of directors breached its fiduciary duty in agreeing
to a “non-fault” termination of the Ovitz employment
agreement
i. the employment agreement was structured to
give an incentive to Ovitz to seek an early non-
fault termination.
c. directors were not disinterested and independent.
2. employment contract of Ovitz had a provision that would allow
him to get full payment of his 5 year contract, if he were
terminated for good cause.
3. rules:
a. directors of a corporation have a fiduciary duty to their
stockholders to inform themselves of all information
reasonably available to them AND relevant to their
decision regarding mergers/acquisitions.
i. DOES NOT mean that the board MUST be
informed of every fact.
b. A board member can escape liability by, in good faith,
relying on an expert.
i. Exception:
1. directors did not, in fact, rely on the
expert
2. reliance was NOT in good faith
3. did not believe that the expert was
competent

51
 4. expert was not selected with reasonable
care, and this was attributeable to the
directors
5. board’s failure to consider subject
matter that was material and reasonably
available was so obvious grossly
negligent.
6. decision of the board was so
unconscionable as to constitute waste
OR fraud.
c. due care in the decisionmaking context is process due
care ONLY.
4. conclusion: case was properly dismissed

vii. Francis v. United Jersey Bank (n.j. 1981) p. 349

1. duty of director to 3rd party
a. directors owe some type of duty of care to outside
creditors.
2. P & B were in the business of acting as a reinsurance broker.
a. A reinsurance broker acts as an intermediary between
an insurance company who cedes the premium and the
risk to another company.
3. Lillian Pritchard inherited a 48% in P & B from her husband,
Charles P. She was also the largest shareholder and the director.
4. the remaining shares were owned by Charles, Jr. and William,
who were also directors.
5. After Charles, Sr. died, Charles, Jr. dominated the management
of the corporation.
6. The 2 sons misappropriated about $12 million that was taken
from funds that the corporation was supposed to hold in trust for
its clients. Later, Mrs. P. died.
a. She was physically incapacitated and had no idea about
how the corporation worked, but she was put on notice
that her son had an unscrupulous character by her
husband’s statement “my son would take shirt off my
back.”
7. trustee in bankruptcy (interests of the various creditors) Mrs.
P’s estate.
8. it is VERY RARE for a plaintiff to win a claim based on a
breach of the fiduciary care. –van gorkum???
9. procedural steps are similar: 1) lack of action or 2) substantative
decision.
10. significance: total inaction can be a violation of the duty of
care; a related duty of care, not only extends, to shareholders, but
to creditors.
11. rules
a. director should acquire at least a rudimentary
understanding of the business of the corporation.

52
 b. Accordingly, a director should become familiar with the
fundamentals of the business in which the corporation is
engaged.
c. Because directors are bound to exercise ordinary care,
they cannot set up as a defense lack of knowledge
NEEDED TO exercise the requisite degree of care.
i. The director should either acquire the
knowledge by inquiry OR refuse to act.
d. Generally, a corporate director has a fiduciary duty to
the corporation and its stockholders.
e. However, WHETHER a corporate director owes its
creditors a fiduciary duty depends on the facts
f. Usually, a director can absolve himself of liability by
informing the other directors AND voting for a proper
course of action.
g. A director who votes for or concurs in certain actions
may be liable to the corporation for the benefit of its
creditors OR shareholders to the extent of any injuries
suffered by such persons, as a result of any such action.
i. A person who is silent at a meeting is held to
have concurred.
ii. Dissenting director is absolved from liability.
h.
12. holding/conclusion:
a. court found that mrs.P had a fiduciary duty to its
creditors b/c the business acted more like a bank than a
small family business because the corp. was in charge of
millions of dollars. (duty of care)
b. she had a duty to protect the clients of P & B against
policies and practices that would result in
misappropriation of money they had entrusted to the
corporation. (duty of care)
c. to establish a duty of care violation—
i. there was a duty owed
ii. breach of the duty was the proximate cause of
the injury.
d.
13.
viii. p. 355 hypo: point is that you owe a duty of care to multiple persons
(stockholders, employees, creditors, and more).
ix.
x. In re Caremark International Inc. Derivative Litigation (del.ch. 1996)
p. 355
1. case: caremark’s board of directors BREACHED their fiduciary
duty of care to Caremark in that the directors exposed the
corporation to enormous legal liability.
2. conclusion: there is a very low probability that it would be
determined that the directors of Caremark breached any duty to
appropriately monitor and supervise the enterprise.

53
 3. Caremark’s predecessor had contracts with physicians to refer
Caremark’s products to patients for a referral fee.
4. after the DOJ subpoenaed caremark’s predecessor, the directors
adopted a new plan to prohibit a referral fee type of service.
5. rules:
a. potential liability for directorial decisions
i. when a board makes a decision that results in a
loss b/c that decision was ill advised OR
negligent.—usually BJR protects
ii. Liability to the corporation for a loss arose from
an unconsidered failure of the board to act in
circumstances in which due attention would
have prevented the loss.
1. absent grounds to suspect deception,
neither corporate boards NOR senior
officers can be charged with
wrongdoing simply for assuming the
integrity of employees and the honesty
of their dealings on the company’s
behalf.
iii.
b.
6. conclusion: a director’s obligation includes a duty to attempt in
good faith to assure that a corporate information and reporting
system, which the board concludes is adequate, exists, and that
failure to do so, under some circumstances, may render a director
liable for losses caused by non-compliance with applicable legal
standards.
a. Breach of their fiduciary duty of care requires
i. Duty of care
1. knew or should have known that
violations of law were occurring
ii. breached that duty of care by failing to take
steps that in good faith would have prevented or
remedied that situation
iii. breach proximate cause of the injury/losses
b.
7. the court was used to determine whether or not the settlement
was fair; the court decided this because they might determine
that the plaintiff’s lawyers had a different stake in it.
8. p. 360-benefits (list of settlement)
9.
xi. p. 366
xii. if breach of duty of loyalty then breach of duty of care
1. although separate and distinct, a duty of loyalty is considered to
be a subpart of the duty of care, and a duty of loyalty is, also,
considered higher than a duty of care.
b. duty of loyalty
i. directors and managers

54
1. breach of the duty of loyalty usually arises when there is a
conflict of interest.
2. Bayer v. Beran (n.y. sup. Ct. 1944) p. 368
a. Action was brought b/c the corporation thought that the
director had engaged in waste by paying $1 million
dollars in 1943 for a radio advertisement.
b. Moreover, the singer of the advertisement was the wife
of a director who allegedly breached his duty of loyalty.
c. Rules
i. It is not improper to appoint a relative of an
officer or director to responsible positions within
a corporation, but the motives of the director
will probably be questioned.
ii. Breach of duty of loyalty-court inquired as to
whether the evidence showed that the
designation of the president’s wife fostered or
subsidized his wife’s career as a singer.
iii. Factors
1. other singers
2. evidence that another singer would have
enhanced the business
3. cost disproportionate
4. legitimate end?
iv.
d. Conclusion: there was no breach of the fiduciary duty of
loyalty
e. If the director can show that the decision was fair
and reasonable, then the court will find that there WAS
NOT a breach of the duty of loyalty.
f. Business judgment: ask approval from the other
directors.

3. Lewis v. S.L. & E., Inc. (2nd Cir. 1980)

a. Lewis, Sr. was the principal shareholder of SLE and
LGT. LGT was a tire dealership. SLE owned the land
and complex.
b. there was a lease agreement that LGT would pay SLE
14, 400 per year, but SLE would pay the rental tax.
c. Lewis, SR. gives his stocks to his children (6)
d. All 6 of the children entered into a shareholders
agreement with LGT, under which each child who was
not a shareholder of LGT would be required to sell his or
her SLE shares to LGT.
e. As rental tax increased to about 11k, but the lease
remained at 14,400, SLE was not making a profit.
f. Lewis, Jr. brought this suit that his brothers who were
pursuing the shareholders agreement breached their duty
of loyalty by causing waste, undervaluing the SLE stock.
g. Rules:

55
 i. Director and officers have the burden of proving
that their business decisions were fair and
reasonable.
h. Conclusion: defendants failed to prove that the rental
paid by LGT to SLE was fair and reasonable.
i. Analysis: defendants gave no evidence and made no
effort to determine what rental fee would be fair during
the years between 1966 and 1972.
j. Business judgment: could have renegotiated the lease,
rescind the lease as being unconscionable, buyout LGT,
better buy/sell agreement.
4. problem p. 377;
a. shareholders will probably not be too thrilled to give 1/5
of the company’s worth to start a business; this would
probably be a violation of the duty of loyalty.
b. One could argue that there is a conflict of interest
although there does not seem to be an apparent direct
benefit to the singer.
c. If kane owns 100%, then it does not matter (not a
problem b/c he owns all the stock).
d. this would be ok.
ii. corporate opportunities
1. corporate opportunity is a smaller sub-part of the duty of
loyalty; it is improper to take advantage of an opportunity, when
you owe a corporate duty to another corporation that could take
advantage of this opportunity.
2. Broz v. Cellular Information Systems, Inc. (Del. 1996) p. 377
a. Broz=president and sole stockholder of RFB
CELLULAR (RFBC)-provides cellular telephone
service in Midwestern U.S.
b. Broz was also a member of the board of directors, CIS-
competitor of RFBC
c. RFBC owns and operates a FCC license area, known as
Michigan 4.
d. Another company wanted to sell Michigan 2, so they
consulted a brokerage firm who decided that RFBC
might be interested in purchasing Michigan 2.
e. CIS sells some 15 separate cellular license systems, and
4 more areas.
f. Broz calls a bunch of CIS persons who tells him that CIS
is not interested in the purchase.
g. However, when Broz tries to buy Michigan 2, a
company that began acquiring CIS, also, expressed an
interest in Michigan 2.
h. Broz talks to CIS’s CEO who tells Broz that CIS is not
interested in buying Michigan 2.
i. Rules
i. Doctrine of corporate opportunity-a corporate
fiduciary agrees to place the interests of the

56
 corporation before his or her own in appropriate
circumstances.
ii. Corporate opportunity to be triggered
requires
1. Has to be in the same line of business
OR
2. must have acquired the knowledge of
the opportunity, as a result of your
employment with the corporation.
AND
3. firm has the interest or a reasonable
expectancy
4. financially able to undertake the
opportunity—p. 380
5. conflict with the interests of the corp.
and the self interest of the officer OR
director.
iii. Corporate opportunity (when corp. does not
have the finances to take advantage of the
opportunity)
j. Conclusion: Broz DID NOT breach his fiduciary duties
to CIS.
k. Business planning: could have formally presented the
opportunity to the board.
3.
iii. dominant shareholders
1. Sinclair Oil Corp. v. Levien (del. 1971) p. 385
a. Sinclair oil-holding co.-business of exploring for oil
AND of producing and marketing crude oil and oil
products-owns 97% of the Sinven’s stock.
b. Plaintiff owns 2.5% of the public stock. (3000/120,000)
c. Sinclair elects Sinven’s board of directors; all the
officers, directors, or employees of the corporations in
the Sinclair complex held the same position in
Sinclair.
d. Allegation:
i. Sinven paid out excessive dividends (did not
have the means to pay these dividends; paid
more than they earned).  breach of duty of
loyalty
ii. Breached duty of loyalty late payment of oil
that Sinclair purchased from Sinven.
e. Holding:
i. Court finds that Sinclair owed Sinven a
fiduciary duty.  test of intrinsic fairness
ii. Intrinsic fairness
1. high degree of fairness
2. shift in the burden of proof.

57
 iii. When parent/subsidiary with the parent
controlling the transaction and fixing the terms
1. test of intrinsic fairness is applied.
a. situation: parent receives a
benefit to the exclusion and at
the expense of the subsidiary.
(requires self-dealing)
i. all the money goes to
Sinclair, not to any
minority shareholder.
b. fiduciary duty
iv. intrinsic fairness test CAN BE applied in cases
of dividend payments that are of a parent
corporation’s self-dealing.
v.
f. conclusion
i. court finds that the lower court erred in applying
the intrinsic fairness test b/c Sinven DID NOT
give the excessive dividends to only Sinclair
(also gave it to the minority shareholders)
ii. should have used the business judgment rule
iii. court DOES FIND that Sinclair breached its
contract when Sinclair failed to pay for products,
under a contract between Sinvent (court found
that this was self-dealing)
g. business planning: could draft the contract more open-
ended (more flexibility for the payments), structure the
transaction to get the minority shareholders to benefit,
buy out the minority shareholders.

2. Zahn v. Transamerica Corporation (3rd cir. 1947) p. 389

a. Zahn holds stock common stock of Axton-Fisher
Tobacco Co.
b. Z sues Transamerica Corp. in a derivative suit, alleging
that he should have gotten $240 per share instead of
$80.80.
c. Transamerica purchased about 80k shares of Axton-
Fisher’s Class B.
d. Because Transamerica had a majority of the stocks, they
controlled and dominated the management, directorate,
financial policies, business and affairs of Axton-Fisher.
e. Majority shareholder owes a fiduciary duty to the
minority shareholder
i. If more than one class of shareholders, you must
take that into account. It is not just a duty owed
to one particular class of shareholders, but you
owe a duty to all the classes of shareholders.
ii. The problem is that they did NOT disclose
information as to whether it was a good idea to

58
 convert—the failure to disclose was the
shortcoming of this case
iii.
f.
g.
3.
iv. ratification
1. Fliegler v. Lawrence (del. 1976) p. 395
a. Another corporate opportunity case-think of broz.
b. Defendants personally acquire the mining property; they
are also in control of the mining property.
c. They form a new corporation called USAC-the
shareholders of auga approve it; think of this as will this
shareholders approval save this transaction?
i. Fiduciary duties.
ii.
d. Anything that is a violation of the duty of loyalty, may
be lawful, if there is some sort of ratification.
i. Usually, ratification means that it is after-the-
fact acceptance/approval.
ii. Sometimes, there could be shareholder approval
before the transaction/board of directors
approval
e. Issue: why was this ratification NOT effective
i. There WAS NOT a ratification by a majority of
disinterested shareholders
ii. A majority of those who voted were the
defendants, themselves, so they, obviously were
not disinterested
f. § 144 of the Delaware corp. code-conflict of interest is
not avoidable solely for that reason if it is ratified by
disinterested shareholders OR informed shareholders
i. (informed shareholders) this DID NOT apply
b/c READ THE STATUTE
ii.
g. Defendant did succeed in showing the intrinsic fairness
of this… defendant wanted the easy victory of
ratification, but they did win.
h. Ratification is easier
i. What is the point of ratification b/c it did not help them
here
2. In re Wheelabrator Technologies, Inc. Shareholders Litigation
(del ch. 1995)
a. Waste and Wheel are the 2 corporations
b. Waste owns 22% of the stock of Wheel—not enough to
exert absolute control.
i. In some situations, 22% ownership of the stock
MAY be a strong control (exp/ you own 22%,
but everyone else owns like 1%)
c. Rules:

59
 i. Shareholder ratification is an absolute
defense to a duty of care claim.
ii. A valid ratification (if there is a controlling
shareholder), it only shifts the burden of proof
(intrinsic fairness test still applies, but the
burden of proof shifts to the plaintiff to prove
that that the intrinsic fairness test WAS NOT
satisfied)
iii. De facto controlling shareholder??? (LOOK UP)
iv. Effect of ratification by minority shareholder
(not 51%) business judgment rule (the
standard)
v. Ratification matters AND could be achieved by
asking disinterested shareholders OR directors
OR both to ratify.
d. Conclusion: court says that they are not controlling
shareholders (b/c not 51% ownership)
3. p. 402 dream team hypo
a.
4.
v.
c. Disclosure and Fairness
i. Definition of a security
1. primary market-governed by the security act of 1933
a. 1933 governs primary issues (original sale of the
corporation).
b. when you have a new public offering (IPO), OR
c. New stock is being issued by a corp
d. Primary market-issuer of the securities, the company that
created the securities-sells them to investors.
e. 2 goals of the securities act: 1) mandating disclosure of
material information to investors and 2) prevention of
fraud.
f. As to disclosure, the securities act follows a
transactional disclosure model (i.e. mandating
disclosures by issuers in connection with primary market
transactions).
g. Underwrite the issuance of a security—buy the security
from the issuer and resell them to another buyer.
h. Prospectus-usually written by security lawyers and
investment bankers. prospectus (disclosure statement
i. Problem with IPO (initial public offering): when a new
corporation, which has never before sold a share to the
public, issues its shares to the public.
2. secondary secondary-governed by the security EXCHANGE
act of 1934
a. any other sale of the stock, after the initial sale of the act.
(subsequent sale of primary issue)
b. tend to be far more numerous than primary issues.

60
 c. A lot of issues fall within its purview, including: insider
trading AND other forms of securities fraud, short-swing
profits by corporate insiders, regulation of shareholder
voting via proxy solicitations, regulation of tender
offers, AND periodic disclosures by publicly held
corporations.
d. This is also important b/c it created the securities and
exchange commission.
e. § 10(b) –consumer protection-anti-fraud-applies to any
security
f. bond is ALWAYS a security.
g. Secondary market, in which investors trade securities
among themselves without any significant participation
by the original issuer.
3. Sarbanes oxley act (enron legislature/bipartisan bill)-passed
to try to deal with the Enron problem.
a. Requires both the CEO and CFO’s signature for a
corporation’s financial statement.
b. Security law is an area that federal government has
regulated; while before, it was state law.
4. securities-
a. can start with the proposition that any stock sold is a
security.
b. Partnership interest is NOT a security-
i. RATIONALE: profits do NOT come from
others’ efforts (profits come from your own).
c. Bond is always a security
d. Stock is always security, whether it is closely held or
major corp.
e. Members’ Interest in llc=security?--- depends on the
facts of a case.  maybe a security
i. What kinds of factors
ii. Howie test of investment contract-security
1. contribution investment of money
2. common enterprise
3. profits-solely from the efforts of others
f.
5. great lakes chemical corp. v. Monsanto co. (del. 2000) p. 405
a. 5/3/1999, great lakes purchased NSC technologies
company, LLC from Monsanto and STI.
b. Great Lakes alleges that Monsanto & STI violated §
10(b) of the Securities Exchange Act of 1934 by failing
to disclose material facts in connection with the sale of
securities.
i. 10(b) consumer protection act that you cannot
mislead or omit material information from
investors.
c. Issue: whether the interests sold to Great Lakes were
NOT “securities.”

61
 d. Monsanto and STI created NSC LLC; they each
contributed, respectively assets totaling 81.5% AND
18.5%. they are members.
e. Analysis
i. Howey (supreme court) test-(define
“investment contract” OR “investment
known as a security”)
1. investment of money-yes
2. in a common enterprise—no
a. no pooling of money btw/ great
lakes and Monsanto and sti.
3. with profits to come solely from the
efforts of others. --no
a. Generally, partnership interests
ARE NOT securities
b. Generally, limited partnership
interests are securities, unless
the limited partner has exercised
substantial control over the
management of the partnership.
c. There is really no standard for
LLCs, so they look at the
operating agreement.
d. Great lakes had a lot of control,
so this cannot be.
ii. Forman (“stock”)
1. right to receive dividends contingent
upon an apportionment of profits-yes
2. negotiability-yes
3. ability to be pledged or hypothecated-
yes
4. voting rights in proportion to the
number of shares owned--yes
5. ability to appreciate in value--yes
iii. rejected forman application b/c not traditional
stock.
f. conclusion: case dismissed b/c it’s not an investment
contract, stock, or an investment known as a security.
g.
6.
ii. the registration process
1. The securities act prohibits the sale of securities UNLESS the
company issuing the securities has “registered” them with the
SEC. § 5 of the act requires that 1)a security may NOT be
offered for sale through the mails or by use of other means of
interstate commerce UNLESS a registration statement has been
filed with the SEC, 2)securities MAY NOT be sold until the
registration statement has become effective, 3)the prospectus

62
 (disclosure statement) MUST BE delivered to the purchaser
before a sale.
2. to register securities, the issuer must give the commission
extensive information about its finances and business.
3. when the SEC reviews a registration statement, the SEC analyzes
whether the registration statement contains the disclosures
required by the statute and the SEC rules thereunder and whether
that information appears to be accurate. The core of the
registration statement thus is the “prospectus.”
4. until the SEC has approved the prospectus, companies cannot
sell the new securities.
5. The securities Act includes 2 types of exemptions to the
registration requirement:
a. Some securities entirely
b. Exempts some transactions in securities NOT otherwise
exempt.

6. Doran v. Petroleum Management Corp. (5th cir. 1977) p. 417

a. Issue: whether the sale of a limited partnership in an oil
drilling venture was part of a private offering exempted
by § 4(2) of the securities act of 1933, from the
registration requirement.
b. Conclusion: it is NOT a private placement.
c. PMC organized a CA limited partnership for the purpose
of drilling and operating 4 wells in Wyoming.
d. Doran then agreed to contribute $125k toward the
partnership. Doran was to pay PMC $25k, and assumed
responsibility for the payment of a $113, 643 note owed
by PMC to Mid-Continent.
e. Analysis
i. Private offering exemption: no registration
statement was filed with any federal or state
regulatory body in connection with the
defendants’ offering of securities.
ii. District court correctly concluded that the
limited partnership interest was a “security.”
iii. § 5 unless a registration statement is in effect as
to a security, it shall be unlawful for any person,
directly or indirectly 1) to make use of any
means OR instruments of transportation or
communication in interstate commerce OR of
the mails to sell such security through the use or
medium of any prospectus or otherwise….
1. satisfied b/c there was no registration
2. satisfied b/c defendants used interstate
transportation OR communication in
connection with the sale or offer of sale.
iv. Defendants raise an affirmative defense-
offering of securities was NOT a public
offering; D’s have the bop to show that the

63
 offering was private. Private placement
exception

v. relevant factors 1933 act § 4(2)

1. number of offerees and their relationship
to each other AND the issuer
a. rule: the more offerees more
likelihood that it is public.
b. 1-8 offerees, in this case.
c. Relationship: “access to the
kind of information which
registration would disclose”
analyze both “availability of
information” AND “effective
access”
2. number of units offered (how many
shares of stock)
a. yes
b. larger the number  public
3. size of the offering
a. yes/modest stakes
b. larger the offering public
4. manner of the offering.
a. Yes, had intermediary-Offering
characterized by personal
contact btw/ the issuer and
offerees free of public
advertising or intermediaries.
b. Public ads OR intermediaries
public

f. Conclusion: court remanded to examine the relationship

of the offerees to the issuer.

7. Note on other exemptions

a. Regulation d-(only initial sales)
i. issuer raises NO MORE than $1 million, it
generally may sell them to an unlimited number
of buyers without registering the securities
(Rule 504)
ii. if raises no more than $5 million (5 million and
less), it may sell the securities to a maximum of
35 buyers. (rule 505)
iii. if raises more than $5 million, it may sell the
securities to a max. of 35 buyers, AND each
buyer must pass various tests of financial
sophistication (rule 506).
iv. in most cases, the issuer CANNOT widely
advertise the security, AND IN ALL CASES,

64
 must file with the SEC a notice of the sale
shortly after it issues the securities.
v. the limits on the number of buyers does not
apply to “accredited investors”-in general,
banks, brokers, and other financial institutions
and wealthy buyers. ???? what is the limitation?
vi. because Regulation D (and § 4(2)) generally
exempts only the initial sale, most buyers CAN
RESELL the securities only if they find another
exemption.
b. § 4(1) exemption-“transactions by any person other than
an issuer, underwriter, or dealer”
i. problem this is that § 2(11) defines an
underwriter as someone who buys the security
“with a view to” resell it.

c. To deal with resale problems, Regulation D provides

that issuers CAN PROTECT the exemption by using
“reasonable care” to make sure the buyers are planning
to hold the stock themselves.
i. they should exercise reasonable inquiry into
the buyer’s plans, disclose to the buyers that the
stock is unregistered and subject to various
resale restrictions, and print those restrictions
directly on the stock.

d. Safe harbor rule 144; subject to various qualifications,

the rule ALLOWS buyers to resell stock they acquire in
a Regulation D offering if they first hold it for two years
and then resell it in limited volumes.

8. note on securities act civil liabilities

a. Securities Act § 11 is the principal express cause of
action directed at fraud committed in connection with
the sale of securities through the use of a registration
statement.
i. NOTE: b/c the misrepresentation is in the
registration statement, THIS WILL NOT apply
to exempt offerings.
ii. § 11 has no privity requirement, so the list of
potential defendants is expansive; everyone who
signed the registration statement (by statute, has
to be issuer, principal executive officers, and a
majority of its board of directors… expert, p.
424).
iii. Defense: due diligence

b. securities act § 12 (a)(1)

65
 i. liability may arise where the seller improperly
fails to register the securities AND where the
seller registers but fails to deliver a statutory
prospectus, violates gun-jumping rules, or
commits any other violation of § 5.
ii. Under § 12(a)(1), the main remedy is rescission:
buyer can recover the consideration paid, plus
interest, less income received on the security.
iii.
c. securities act § 12(a)(2)
i. imposes PRIVATE CIVIL LIABILITY on any
person who offers or sells a security in interstate
commerce, who makes a material
misrepresentation OR omission in connection
with the offer OR sale, AND cannot prove he
did not know of the misrepresentation OR
omission and could not have known even with
the exercise of reasonable care.

ii. Defense: defendants who conduct a reasonable

investigation CANNOT be held liable.

iii. Plaintiff’s prima face case has 6 elements (note:

plaintiff does not have to prove reliance)
1. sale of a security
2. through instruments of interstate
commerce OR the mails
3. by means of a prospectus OR oral
communication
4. containing an untrue statement OR
omission of a material fact
5. by a defendant who offered or sold the
security; and
6. which defendant knew OR should have
known of the untrue statement.
iv. Supreme court held that liability arises, under §
12 (a)(2) ONLY with respect to material
misrepresentations OR omissions made in
written documents OR oral communications
used in connection with public offerings.
1. DOES NOT arise in secondary market
transactions OR private placements.
d. Due diligence, as a defense
i. Applies to § 12(a)(2) AND § 11.
ii. Due diligence is usually delegated to lawyers.
iii. Issuer’s officers an directors delegate their due
diligence the lead underwriter’s counsel.
iv. If the lawyers fail to carry out an adequate due
diligence review, any defendants who delegated

66
 their due diligence tasks to that counsel will lose
the defense.
1. can sue for legal malpractice
v.

9. Escott v. Barchris Construction Corp. (SDNY 1968) p. 426

a. Example of what goes wrong when you file the initial
prospectus; someone sues you for failing to make full
and honest disclosure
b. Barchris specialized in constructing bowling alleys
c. Before Barchris went bankrupt, it issued bonds to raise
money; while doing this, they made a filing with the
SEC and made a prospectus.
d. Plaintiffs allege that the registration statement with
respect to these debentures filled with the SEC contained
material false statements and material omissions.
e. Suit is brought, under § 11 of the 1933 act against 1)
persons who signed the registration statement, 2)
underwriters, and 3) auditors accountants, lawyers, and
directors.
f. Issue:
i. Did the registration statement contain false
statements of fact, OR did it omit to state facts
which should have been stated in order to
prevent it from being misleading;
ii. If so, were the facts which were falsely stated
OR omitted “material” within the meaning of
the act.
iii. If so, have defendants established their
affirmative defense.
g. Analysis
i. Material-what a reasonably prudent investor
ought to be informed of before purchasing
security. court found to be material b/c they
were overstatements of sales and gross profit.
ii. § 11 p. 431 (copy)
iii. due diligence defense-
1. part of the registration statement NOT
purporting to be made on the authority
of an expertafter reasonable
investigation, reasonable ground to
believe AND… the statements were
true.
2. any part of the registration statement
purporting to be made upon his
authority as an expert after reasonable
investigation, reasonable ground to
believe… such effective.
h. Every defendant can raise a due diligence defense
except one: corporation (must always answer for the

67
 shortcomings in the registration statement; not an
excuse; they put their name on it must be responsible
for what was said in the registration statement)
i. Due diligence defense: make a reasonable
inquiry to ensure that the information in the
registration statement is correct (applies to each
person).—not a single one satisfied this defense.
1. steps
a. reasonable investigation
ii. Accounting firms: the auditing firm was
responsible for auditing material and gave their
stamp of approval on. The firm MUST SHOW
that it has to make a reasonable effort to inquire
into the facts OR that the inaccuracies … are not
due to them.
iii. To calculate damages: one measure may be
the difference that was paid AND the price that
would be resold.
1. money they paid+interest-money that
they received.
2. how about? – difference of what they
paid and what the bonds would have
been worth (if there was full and
accurate disclosure).---prof’s answer
3. lack of education is not a defense, not
knowing the law is not a defense.
iv.
i. p. 440 questions
i. usw-register with the SEC-when one person
owns all of the stock-no.
1. what about the sale agents/manager-
(change of the facts) maybe/maybe
not.
2.
ii. can the buyer recover yes
iii. the buyer NEED NOT read …
iv. damages “difference btw/ investor paid and what
investor would have paid if full disclosure was
made”
v. buyer successful against accounting firm that
audited the statement distinguish
expert/nonexpert—yes, b/c they would be
experts.
1. auditing firm is expert on past numbers,
but not on future numbers (future
technology); legitimate issue—could
argue.
j. Note on integrated disclosure and exchange act
disclosures
i. 2 different disclosures (33) and (34)

68
 ii. under the 33 act
1. requires disclosures with respect to
particular transactions, such as new
issues of stocks OR bonds to the public,
iii. under 34 act
1. imposes a system of periodic disclosures
on certain companies
2. any publicly traded company, under the
1934 act, has to disclose a 10k, 10Q, and
8k report (of any company that is
publicly trade).
3. covered corporations MUST register
with the SEC by filing an initial Form
10, which is required only once under
the Act.
4. 10k-has to be filed annually with the
SEC, always includes at least a
summary (incorporate the entire
auditing report; make it public).—on the
sec’s website, edgar—makes public the
10k report.
5. 10Q-quarterly report and has to be filed
only 3x a year, b/c by the 4th, it is a 10k
report.
6. 8k report-special events (i.e. change of
control, purchase of additional assets,
sale of assets; affecting the corporations
operations OR financial condition),
within 15 days.
7.
iv. integrated disclosure system
1. an issuer planning a registered offering
first looks to the various registration
statement forms to determine which
form it is eligible to use.
2. the forms then direct the drafter to
regulation S-K for the Substantative
disclosure requirements.
3. each of the main registration statement
forms requires disclosure of 2 basic
types of info: information about the
transaction AND information about the
issuer.
v.
k.
l.
10.
iii. rule 10b-5--- based on the 1934 Act § 10(b) of / SEC promulgated the
rule.
1. § 10(b)5-

69
 it shall be unlawful for any person, directly OR indirectly, by the
use of any means or instrumentality of interstate commerce, OR
of the mails OR of any facility of any national securities
exchange,
(a) to employ any device, scheme, or artifice to defraud

(b) to make any untrue statement of a material fact OR to omit

to state a material fact necessary in order to make the
statements made, in the light of the circumstances under
which they were made, NOT misleading, OR

(c) to engage in any act, practice, or course of business which

operates or would operates as a fraud or deceit upon any
person,

in connection with the purchase OR sale of any security.

Applies to any security, including securities of closely held

corporations that generally ARE NOT subject to the exchange
act and to transactions in government securities.

10b-5 governs any fraud by any person in connection with the

purchase or sale of any security.

Policy: consumer protection Act.

NOTE THAT 10B-5 IS NEVER A DERIVATIVE ACTION:

shareholder is suing the corporation; derivative action: minority
shareholder on behalf of the corp. suing the officer.

2. Basic, Inc. v. Levinson (us sc 1988)

a. Combustion is interested in acquiring Basic.
b. During 1977 and 1978, Basic made 3 public statements
denying that it was engaged in merger negotiations.
c. 12/18/1978, Basic asked the NYSE to suspend trading
its shares and issued a release stating that it had been
“approached” by another company.
d. 12/19, the board endorsed Combustion’s offer of
$46/share.
e. Respondents are Basic Shareholders who are angry b/c
they sold their stocks at a depreciated value, based on
the 3 public statements; consequently, they are alleging a
violation of Rule 10(b)-5
f. Issue: whether the 3 public statements denying it was
engaged in merger negotiations, when the corp was, is a
10b-5 violation.
g. Holding:
i. Private cause of action exists for a violation of
10b-5.

70
 ii. Material-substantial likelihood that a reasonable
shareholder would consider it important in
deciding how to vote. - fact based/specific
1. material-probability x importance
2. if make an untrue statement, an
obligation exists to correct the
statement.
iii. Preliminary merger discussions SHOULD NOT
be excluded from the materiality prong of 10b-5.
iv. Although reliance is an element of a 10b-5
claim, the court DOES NOT require a positive
proof of reliance, where a duty to disclose the
material information had been breached… p.
450
v. Because most publicly available information is
reflected in market price, an investor’s reliance
on any public material misrepresentations,
therefore, MAY BE PRESUMED for purposes
of a rule 10b-5.—rebuttable presumption – (can
show that the stockholder DID NOT rely by
showing that he/she sold the stock based on
other reasons). Fraud on the market theory
plurality (only applies to class action suits,
NOT personal suit-requires showing of
reliance)
h. Analysis:
i. Conclusion: remands to see if the information was
material.
j.
3. West v. Prudential Securities, Inc. (7th cir. 2002) p. 457
a. Broker who worked for prudential securiteis lied and
said that a stock would rise.
b. This is NOT insider information b/c this was a
lie/outright fraud, although if it were true, then it would
have been insider info.
c. Issue: whether the action may proceed, not on behalf
those who received the false information, but on behalf
of everyone who bought the stock.
d. Analysis: since the information was only disseminated
to a few persons, only those persons could demonstrate
reliance. Also, since the information was not made
public, this is counter to the fraud on the market theory.
e. Rule:
i. Fraud on the market theory—from basic
1. public information reaches professional
investors, whose evaluations of that
information and trades quickly influence
securities prices.
ii.

71
 f. Holding: fraud on the market theory CANNOT be
extended to persons who did not receive the false
information.
i. Demand for individual company shares are not
equal to information.
g. Conclusion: DID NOT WIN
h. Distinguish btw/ this and Basic: the information goes to
the professional investors/public, while this was
information that went to a few.
i.
4. Pommer v. Medtest Corporation (7th cir. 1992) p. 462
a. Manning 31% and West 26%; manning sells 3% of the
shares to Pommer. The stocks are of Medtest Corp.
b. Alleged 10b-5 violation that they got false information
in connection with the sale of the stocks.
c. The court talks about what Medtest could have told
Pommer in inducing them to buy stock, and this could
have been material.
d. Rule:
i. Material means a substantial likelihood that the
disclosure of the omitted fact would have been
viewed by the reasonable investor as having
significantly….
ii. This standard is done in an ex ante perspective;
even if the materially false statement becomes
true, it is still to be determined at the time the
statement was made.
e. conclusion: found the statement to be materially
misleading. misleading that the takeover was imminent
f. calculating damages: difference between the value of
the stock and the price of the stock on the day of when
the stock was purchased if there had been full disclosure.
g.
5. notes on judicial limitations on actions under rule 10b-5 p.
466---
a. standing; Blue Chip Stamps v. Manor Drug Stores (us
sc 1975)
i. a potential buyer or seller DOES NOT have
standing to assert a 10b-5 cause of action.

b. Scienter; Ernst & Ernst v. Hochfelder (us sc 1976)

i. A person who has issued a false or misleading
statement MUST BE proven to be reckless, or
had an intent to deceive, manipulate, or defraud.
ii.
c. Secondary liability AND scope of Interpretation
i. Central Bank of Denver v. First Interstate
Bank (us sc 1994)

72
 1. no implied private right of action against
those who aid and abet violations of
Rule 10b-5.-limits secondary liability.
2.
ii.

6. santa fe industries, inc. v. Green (us sc 1977)

a. santa fe acquired Kirby by an increase from 60-95%.
b. short form merger/cash out merger from Del. Law.
i. Under this, you could force shareholders to sell;
you have to make a filing in court to have the
court supervise the appraisal of the stock.
ii.
c. defendants followed the statute; no violation.
d. conclusion: NOT a violation of 10b-5 b/c there was no
manipulative/fraud.
e. Rationale: did not want to extend 10b-5 to other types
of abuse/other breaches of fiduciary duties.
f. Significance: you CANNOT extend 10b-5 beyond the
fraud disclosure area; does NOT cover breaches of
fiduciary duty.

7. deutschman v. Beneficial Corp. (3rd cir. 1988) p. 472

a. requires us to know what options are:
i. call option—essentially an agreement to buy a
security at a fixed price with the anticipation of
an increase in the stock price.
ii. put option—an agreement to sell a security at a
fixed price with the anticipation of a decrease in
the security price.
b. Plaintiff never bought shares or owned shares.
c. Conclusion: the court stated that the plaintiff DID have
standing, BUT the court REMANDED to see whether a
violation occurred.
d. Holding: call/put options are securities subject to the
10b-5 rule.
8.
d. inside information
i. prof notes:
1. when the SEC investigates insider trading, the SEC would look
for unusual trading activity in a stock in the last 24 hours before
a public offering was made.
2. insider trading gives an unfair advantage to those who are privy
to the information.
3.
ii. Goodwin v. Agassiz (mass. 1933) p. 477
1. before the 1934 act (pre-federal law; state common law)

73
 2. Goodwin sold stocks to Agazzi, after a published article stated
that explaratory operations on Cliff Mining Company were to
cease.
3. defendant was the director of the company.
4. Unknown to plaintiff, defendant knew that there may be possible
copper deposits, so the defendants bought the plaintiff’s shares
over the NYSE.
5. neither defendant, nor plaintiff knew that they sold/purchased the
stock from the other.
6. rules:
a. generally, directors DO NOT occupy a position of
trustee toward individual stockholders.
i. Accurate dicta:
b. Where a director personally seeks a stockholder for the
purpose of buying his shares without making disclosure
of material facts, within his peculiar knowledge AND
not within reach of the stockholder, the transaction will
be closely scrutinized and relief may be granted in
appropriate instances. (may set aside the transaction)
i. Directors did not personally seek the shareholder
—over the NYSE
ii. Requires a finding of fraud
1. no fraud in this case
iii. And a material fact
1. no material facts, just wishes/hopes and
theories that there would be copper
deposits.
c. Special effects doctrine: exception to the rule (no
unlawful behavior in insider trading); if you could show
that you personally dealt with the owner of a stock, the
courts were willing to impose liability.
d.
7. conclusion: defendants win/plaintiff loses

iii. fraud v. insider trading

1. fraud-basic
a. no corporate official was accussed of profiting (no
allegations of insider trading)
b. fraud-failure to release necessary information
c. still a violation if the court finds that the information was
material (info. that was not released; and all the other
factors are showed).
d. Now, we see cases of insider trading (people with the
knowledge—making trades for their own benefit based
on the inside information).
e.
2.
iv. SEC v. Texas Gulf Sulphur Co. (2d cir-us sc-cert denied 1969) p. 480
1. after 10b-5; applying federal law, now.

74
2. defendant engaged in exploratory drilling and seemed to find
some ore; however, they kept it secret
3. after an unauthorized newspaper report that the company found
substantial amounts of ore, the company released a press
statement that refuted the account.
4. while not disclosing the information to the public, numerous
TGS employees bought stock and call options.
5. after the newspaper report, the company confirmed the discovery
of a vast mineral strike.
6. SEC brought an action against them.
7. issue: is it unlawful to trade on material inside information
UNTIL such information has been disclosed to the public AND
has had time to become equally available to all investors?
8. holding:
a. yes, it is unlawful to trade on material inside information
UNTIL such information has been disclosed to the
public AND has had time to become equally available to
all investors.
b. Such material fact must be effectively disclosed to the
investing public prior to the commencement of insider
trading in the corporation’s securities.
9. rule:
a. 10b-5
i. essence of the rule: anyone who, trading for his
own amount in the securities of a corporation,
has “access, directly or indirectly, to info.
intended to be available ONLY for a corporate
purpose and NOT for the personal benefit of
anyone” MAY NOT take “advantage of such
information knowing it is unavailable to those
with whom he is dealing…”
ii.
b. material—situations which are essentially extraordinary
in nature AND which are reasonably certain to have a
substantial effect on the market price of the security if
[the extraordinary situation is] disclosed.
i. Test: whether a reasonable person would attach
importance to the information… p. 484.
c. Anyone who has material inside information MUST
either disclose it to the investing public, OR, must
abstain from trading in OR recommending the securities
concerned while such inside information remains
undisclosed.
i. Duty to disclose information or to abstain from
trading depends on whether the information is
material.
d. “in connection with the purchase…”
i. the court states that congress’s intention behind
this statement was that whatever that might be
relied upon by reasonable investors.

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 e.
10. conclusion: all stock purchases were done in violation of 10b-5.
a. Court remanded to see whether the april 12 release
violated 10b-5.
11. rationale:
a. Rule 10b-5 is based on the justifiable expectation of the
securities marketplace that all investors have equal
access to material information.
b. Anyone in possession of material nonpublic information
CANNOT properly trade on that information, even if he
is forbidden by the company from disclosing it to the
public, UNTIL it has been publicly disseminated.
c.
12. significance:
a. either disclose the material information OR don’t trade
(cady Roberts)
b. no fiduciary duty when a person sells land to another
c. directors owe a fiduciary duty to the shareholders.
13. business planning: set a standard period of buying/selling once
a year or set a window to buy/sell stock.

v. Chiarella v. U.S. (us sc 1980) p. 492 (note case)

1. print shop that printed materials of mergers.
2. how did they protect the information of merger?
a. Left the name/address/phone number out, and at the last
minute, they would fill in the blank.
3. he figured out who the company was and purchased some shares.
4. supreme court let him off the duty b/c there was no fiduciary
duty owed to the shareholders.
5. holding: a corporate insider MUST abstain from trading in the
shares of his corporation UNLESS he has first disclosed all
material inside information known to him.
a. Chiarella DID NOT violate sec. 10b-5 b/c he was not an
“insider” of the corp.
b. Duty to abstain from trading in the shares arises from the
relationship of trust between Chiarella and the
shareholders.
6.
7.
vi. side notes
1. Congress passed sec. 10b-5, but it was pretty clear that Congress
considered it a violation.
2. if you identify a person who is an insider trader, you could sue
and collect damages.
3. ability to make a private recovery can be eliminated/offset by the
damages collected by the SEC.
4.
vii. Dirks v. SEC (us sc. 1983) p. 493
1. Dirks learned that equity funding, which he had no connection
with, was a fraudulent corporation.

76
 2. afterwards, Dirks’ clients sold a lot of the shares/stocks.
3. Seacreasts’ motivation in this fraud was to help unfurl the
massive fraud.
4. The SEC was not happy with this case; the SEC was not going to
delicense him/reprimand him, but they gave him a written
record. However, Dirks fought this all the way.
5. issue: whether Dirks violated the antifraud provisions of the
federal securities laws by this disclosure.
6. holding: because he did not have a pre-existing duty to Equity
Funding, he did not have a duty to abstain from trading or
disclose the material information publicly.
a. Dirks is a tippee- does not have a pre-existing
interest/fiduciary duty
i. Tippee-Can be liable for insider
information(assumes a duty to abstain… or to
disclose) if the tippor discloses the information
for the wrong reasons.
ii. Test: has the TIPPER disclosed the information
for PERSONAL GAIN.
b. Seacrest-tipper-
i. Disclosed this information FOR NO personal
gain.
c.
7. significance: SEC is NOT happy with the outcome.
8.
9.
viii. state of the law as of dirks
1. 3 categories of persons who can be punished for insider
trading
a. insiders (persons who have the fiduciary themselves,
directors, employees)
b. temporary insiders (lawyers, accountants, PR)
c. tippees (liable only if the insider who disclosed the
information was acting on an improper motive).
2. regulation FD (full disclosure??)
a. it makes insider liable for selective disclosure to
analysts:
b. you CANNOT have private meetings with stock
analysts, anymore; you have to make the meetings
public.
3.
ix. United States v. O’Hagan (us sc 1997) p. 501
1. issue
a. is a person who trades in securities for personal profit,
using confidential information misappropriated in breach
of a fiduciary duty to the source of info, guilty of 1(b)?
b. did the commission exceed is rulemaking authority by
adopting rule 14e-3(a)?
2. holding
a. yes, he is guilty

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 b. no, the commission did not exceed their rulemaking
authority. – really admin law.
3. O’Hagan was a partner at a law firm of Dorsey & Whitney. This
law firm represented Grand Metro, which went public later that
year.
4. Before the IPO, O’Hagan began purchasing call options for the
stock AND regular stocks.
5. when the stock went public, O’Hagan sold the stock and made a
profit of more than $4.3 million.
6. rules
a. Rule 10b-5 is violated when a corporate insider trades in
the securities of his corporation ON the basis of material,
nonpublic information.
b. Classical theory: The relationship of trust between the
shareholders of a corporation and those insiders who
have obtained confidential info. by reason of their
position with that corporation GIVES RISE to a duty to
disclose OR to abstain from trading b/c of the necessity
of preventing corporate insider from taking unfair
advantage of uninformed stockholders.
i. Targets a corporate insider’s breach of duty to
shareholders with whom the insider transacts
c. Misappropriation theory: a person commits fraud “in
connection with” a securities transaction, and thereby
violates § 10(b) AND rule 10b-5, when he
misappropriates confidential information for securities
trading purpose, in breach of a duty owed to the source
of the information.—deception is required.
i. Protect the securities markets from abuses by
outsiders to a corp. who have confidential
information.
d.
7. conclusion: guilty of violating 10(b) b/c O’Hagan was found to
have committed fraud, under the misappropriation theory.
8.
x.
e. short-swing profits
i. in addition to § 10(b) of the 1934 SE Act, there is a prophylactic rule
against insider trading.
1. § 16(b): officers, directors, and 10 percent shareholders MUST
PAY to the corporation ANY PROFITS they make, within a 6-
month period, from buying and selling the firm’s stock.

ii. Reliance Electric Co. v. Emerson Electric Co. (us sc 1972) p. 512
1. june 16, 1967, Emerson Electric Co. acquired 13.2% of the
outstanding common stock of Dodge Manu. Co. at a purchase
price of $63.
2. august 28, pursuant to counsel’s recommendation to avoid 16(b),
Emerson sold 37,000 shares of Dodge common stock at

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 $68/share, whereby Emerson reduced its holdings in Dodge to
9.96%.
3. On Sept. 11, Emerson sold the remaining shares.
4. issue; must Emerson return the profits of the second selling?
5. conclusion: no.
6. rule
a. § 16(b) provides that a corporation MAY RECOVER for
itself the profits realized by an owner of more than 10%
of its shares from a purchase and sale of its stock within
any six month period, provided that the owner held more
than 10% “both at the time of purchase and sale.”
7. rationale:
a. they did not own the statutory requisite of 10% of the
shares at the time of the second sale.
b.
iii. Foremost-McKesson, Inc. v. Provident Securities Co (us 1976) p. 515
1. issue: whether a person purchasing securities that put his
holdings above the 10% level is a beneficial owner “at the time
of the purchase,” so that he must account for profits realized on a
sale of those securities within six months.
2. conclusion: no
3. statute provides “shall not be construed to cover any transaction
where such beneficial owner was NOT such both at the time of
the purchase AND sale, or the sale and purchase, of the security
involved…
4. Provident Securities decided to liquidate its assets, and
Foremost-Mckesson emerged as a potential buyer.
5. on 9/25/1969, Foremost decided to buy 2/3 of Provident’s assets
for $4.25 million and ownership of foremost stock.
6. on 10/24, Provident distributed the $15 million and Foremost
stock to its shareholders, whereby reducing the company’s
holding to less than 10%.
7. holding: in a purchase sale sequence, a beneficial owner MUST
ACCOUNT for profits ONLY IF he was a beneficial owner
before the purchase.
8.
9.
iv. Kern County Land Co. v. Occidental Petroleum Corp. (us 1973) p. 517
1. issue; is it a 16(b) sale when the target of the tender offer
defends itself by merging into a third company and the tender
offeror then exchanges his stock for the stock of the surviving
company and also grants an option to purchase the latter stock
that is not exerciseable within the statutory 6 month period.
2. Occidental wanted to merge with Kern County, but this was
unsuccessful; as a result, occidental decided to buy Kern stock.
3. by may 10/11, Occidental bought more than 10% of Kern’s
stock.
4. on may 19, the board of directors announced that it had approved
merger proposal advanced by Tenneco.
5. on august 30, the merger was closed.

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 6. The shareholders of Old Kern would receive a share of Tenneco
at 1:1 ratio.
7. between may 30 and june 2, to protect itself, Occidental made an
agreement to sell its Tenneco share in exchange for Old Kern
stock, after dec. 9 (6 months and 1 day after expiration of
Occidental’s tender offer).
8. the complaint is that the june 2 agreement was a “sale” covered
by § 16.
9. holding:
a. mere execution of an option to sell is NOT, generally,
regarded as a sale.
i. Rationale: look for facts that suggest insider
trading or unfair advantage.
b. Generally, an exchange in stock is not considered a sale
subject to 16(b).
10.
v. notes
1. § 16(b) applies ONLY to companies that register their stock
under the 1934 Act;
a. these include companies with stock traded on a national
exchange, and companies with assets of at least $5
million and 500 or more shareholders.
2. officers: § 16(b) applies to trades by directors and officers.
a. 16a-1f provides “officer” shall mean an issuer’s
president, principal financial officer, principal
accounting officer, any vice president of the
issuer….and other officer who performs a policy-making
function, OR any other person who performs similar
policy-making function for the issuer.
3. deputization: a firm’s employee who was asked to serve on
another firm may be held liable under 16b as a deputized officer.
4. stock classes and convertible debentures: to determine the
10% stock requirement under § 16(b), courts consider classes of
stock separately (class A v. class B).
5. politics of § 16(b): b/c recovery of the profits is distributed to
the corporation, stockholders may enforce this derivatively. As a
result, many lawyers are active in this area.
6. matching stock: the court uses the lowest priced purchases and
the highest priced sales.  example p. 523
vi.
f. indemnification and insurance
i. most states have detailed statutory provisions covering the authority or
obligation of a corporation to indemnify officers and directors for any
damages that they might incur in connection with their corporate
activities, and for the expenses of defending themselves.
ii. Although the risk of liability may be remote, the amount of damages can
be large and the expenses of defense may be a lot.
iii. Insurance may be available to corporations to cover damages and the
expense of defense.

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 iv. Under what circumstances could a corporation reimburse officers whom
have been sued.
v. 145(a) deals with permissive/discretionary reimbursements????
vi. 145(b)???  LOOK AT THE STATUTE BOOK.
vii. 145(c) deals with mandatory reimbursement—must reimburse when the
officer, director is successful on the merits OR otherwise.
viii. Waltuch v. Conticommodity Services, Inc. (2nd cir. 1996) p. 526
1. Waltuch was vice president and chief metals trader for
Conticommodity Services Inc. He traded silver for the firm’s
clients.
2. In late 1979 and early 1980, the silver price skyrocketed.
3. just as quickly, the price fell, and he was manipulating the
market.
4. Waltuch is bringing suit to indemnify Conticommodity for 2.2
million in unreimbursed legal fees.
5. civil suit was settled for 35 million.
6. § 145(a)-A corporation SHALL HAVE power to indemnify any
person who was OR is a party… by reason of the fact that he is
OR was a director, officer, or employee OR agent of the
corporation… if he acted in good faith and in a manner he
reasonably believed to be in or not opposed to the best interests
of the corporation
7. § 145(f)-the indemnification and advancement of expenses
provided by, OR granted pursuant to, the other subsections of
this section SHALL NOT be deemed exclusive of any other
rights….
8. claims
a. how to interpret §§ 145(a) & (f) of the Delaware general
corporation law, assuming that Waltuch acted with less
than good faith?
b. Does § 145(c) require Conti to indemnify him b/c he was
successful on the merits OR otherwise, in private
lawsuits?
9. holding
a. 145(f) DOES NOT permit a corporation to bypass the
“good faith” requirement of § 145(a). 
i. Conti’s article 9, which would require
indemnification of Waltuch even if he acted in
bad faith, is inconsistent with § 145(a) and thus
exceeds the scope of a Delaware corporation’s
power to indemnify.
b. Conti MUST indemnify Waltuch under § 145(c) for the
$1.2 million in unreimbursed legal fees that he spent in
defending the private lawsuits.
10. analysis:
a. article 9 exceeded the scope b/c (a) limits
indemnification to good faith, so article 9, which allows
indemnification for bad faith, obviously exceeds the
scope.

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 b. § 145(c) allows indemnification when a director, officer,
employee or agent of a corporation HAS BEEN
successful on the merits in defense of any action…. 
court declined to give the statute a narrow reading,
which would limit indemnification to only successful
suits that were solely attributeable to the director or
officer’s efforts--
11. significance:
a. 145(f)--indemnification rights MAY BE broader than
those set out in the statute, BUT they cannot be
inconsistent with the scope of the corporation’s power to
indemnify, as delineated in the statute’s Substantative
provisions.
b. Court reads § 145(a) as a limitation on a corporation’s
ability to reimburse to situations when the director,
officer is in good faith.
i. 145(f) is still subject to the 145(a) requirement
of “good faith.”
ii. 145(f) provides other rights…. LOOK UP.
c. As long as the director, officer is successful as a
defendant in a suit, then del. § 145(c) will allow
indemnification from the corporation.
i. Policy: to provide security to a director OR
officer by allowing indemnification concerning
actions against them.
12. conclusion: he does not get the legal fees for the first claim of
145(a), but he gets reimbursement of the civil suit.
ix. Citadel Holding Corp. v. Roven (del. 1992) p. 534
1. separate agreement to indemnify.
2. conclusion: court upholds the reimbursement of sums paid or
incurred by Roven to defray (settle) litigation expenses. (roven
wins/corporation loses)
3. Citadel=savings & loan holding company=delaware corporation.
4. roven=director of citadel from 4/1985 to 7/1988.
5. 5/1987, roven and citadel entered into an indemnity agreement
that provided more protection than Citadel’s certificate of
incorporation, by laws.
6. the agreement provided:
a. corporation shall indemnify the agent…
b. corporation shall not be obligated for indemnification in
regard to any liability or expense FOR an accounting of
profits made from the purchase or sale by the agent of
securities of the corporation… within § 16(b) of the
SEA. Court one deals with profit
c. Costs/expenses shall be paid in advance of the final
disposition of such matter, provided that the agent shall
undertake in writing to repay any such advances in the
event that it is ultimately determined that the Agent IS

82
 NOT entitled to indemnification under the terms of the
agreement. Court deals with legal expenses/fees.
7. roven’s claim of indemnification was prompted when Citadel
brought suit against him alleging violation of § 16(b).
a. citadel does not want to advance funds for the expenses
of this action and states that the agreement does not
apply to federal violations court rejects
8. analysis:
a. cites General Corporation Law of Delaware (corporation
“may” pay an officer or director’s expenses in advance);
notice that this is permissive.
b. Noting the permissive authority of the code, the court
looks at the language of “shall” in the agreement, and
the court feels compelled that Citadel meant to allow an
advance payment of funds, rather than taking the
permissive approach.
9. significance
a. better drafting of the agreement
b. corporations frequently use agreements to provide more
indemnification rights for its officers, directors.
c.
10.
x. KNOW § 145 OF DELAWARE CODE
g.
VI. PROBLEMS OF CONTROL
a. Proxy Fights-sec. 1
i. Strategic uses of proxies
1. background info:
a. proxy-under corporate law, shareholders may appoint an
agent to attend shareholder meetings and vote on their
behalf.
b. like tender offers, proxy fights are subject both to 1934
Securities Exchange Act and to state corporate statutes.
c. Scenario: fight from an outside group to take over a
corporation.
2. Levin v. metro-goldwyn-mayer, inc. (s.d.n.y. 1967) p. 541
a. Plaintiffs=6 stockholders of MGM
b. Defendant=MGM and 5/13 members of the board of
directors
c. There’s a power struggle between “O’Brien group”
AND “Levin group.”
d. Each group intends to nominate a slate of directors at the
MGM stockholder annual meeting, which is to be held
on 2/23/1967.
e. Each has been actively soliciting proxies for this
meeting.
f. Complaint:
i. Manner of solicitation of proxies: wrongfully
committed MGM to pay for the services of

83
 specially retained attorneys, public relations firm
and proxy soliciting organizations
ii. improperly used the offices and employees of
MGM in proxy solicitation and good-will and
business contacts of MGM to secure support for
the present management.
iii.
g. holding: the court DOES NOT find that illegal OR
unfair means of communication, such that would
demand judicial intervention, are being employed by the
present management.
h. conclusion: court lifts the temporary injunction and
finds that the amounts recited to be paid ARE NOT
excessive OR that the method of operations disclosed by
MGM management is unfair or illegal.
i. IF the fight is over personality, then there’s no
reimbursement; however, if it is over policy, then it is
ok.  REREAD….LOOK FOR THIS….
3.
ii. reimbursement of costs
1. Rosenfeld v. Fairchild Engine & Airplane Corp. (n.y 1955) p.
543
a. Another proxy fight for control of the corporation.
Asking that none of the reimbursements should have
been paid.
b. Majority is saying that this a fight over policy, NOT
personality.
c. Plaintiff, an attorney, who owns 25/2,300,000 shares,
brings a shareholder’s derivative suit.
d. In this suit, the plaintiff seeks the return of $261,522,
paid out of the corporate treasury to reimburse both sides
in a proxy contest for their expenses.
e. Old board reimbursed itself $106,000
f. Later, the new board reimbursed the old board with
$28,000.
g. New board reimbursed itself $127,000.
h. Holding:
i. In a contest over policy… corporate directors
have the right to make reasonable and proper
expenditures, subject to the scrutiny of the
courts when duly challenged, from the corporate
treasury for the purpose of persuading the
stockholders of the correctness of their position
and soliciting their support for policies which
the directors believe, in all good faith, are in the
best interests of the corporation.
ii. Stockholders have the right to reimburse
successful contestants for the reasonable and
bona fide expenses incurred by them in any such
policy contest, subject to like court scrutiny.

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 iii. However, corporate directors CANNOT disport
themselves in a proxy contest with the
corporation’s money to an unlimited extent.
i. Dissent-the distinction between policy and personality
does not seem strong.
2. notes on the regulation of proxy fights
a. § 14(a) of the 1934 securities exchange act prohibits
people from soliciting proxies in violation of SEC rules.

b. Solicitation-studebaker corp v. gittlin (2nd cir. 1966)

shareholder is held to have solicited proxies when he
asked selected shareholders to join him in demanding the
shareholder list, even though his purpose in getting the
list was THEN to ask the shareholders for their proxies.
i. 14(a-3), (a-4), (a-5), and (a-11) require people
who solicit proxies to furnish each shareholder
with a “proxy statement,” which must disclose
information relevant to a shareholder’s decision.
ii. 14(a-6) requires the parties soliciting the proxies
to file copies of this material with the SEC.

c. economics failure in a proxy fight requires you to

bear the full cost of the solicitations, and, consequently,
most people do not find the slight advantage of winning
a proxy fight to overcome this economic burden. Net
effect is people tend not to engage in proxy fights.
3.
iii. private actions for proxy rule violations
1. § 14 of the 1934 Securities Exchange Act
a. the SEC has issued rules, based on § 14.
b. 14(a-7)—gives management a choice:
i. it can either mail the insurgent group’s material
to the shareholders directly and charge the group
for the cost, OR it can give the group a copy of
the shareholder list and let it distribute its own
material.
ii. Most would just send out the materials.
c. 14(a-9)—consumer protection rule, similar to 10b-5
i. regulates false, or misleading statements in
regards to proxy statements
ii. parallels 10b-5’s regulation of false or
misleading statements in regard to purchase/sale
of stocks.
d.
2. J.I. Case Co. v. Borak (us sc 1964) p. 550
a. Stockholder of JI case brought this suit, alleging that the
merger between Case and American Tractor Corp. was
effected through the circulation of a false and misleading
proxy statement.

85
 b. Allegation of violation of § 14(a) of the Securities
Exchange Act of 1934.
c. Issue: whether § 27 of the SE Act authorizes a federal
cause of action for rescission OR damages to a corporate
stockholder with respect to a consummated merger
which was authorized pursuant to the use of a proxy
statement alleged to contain false and misleading
statements violative of § 14(a) of the act.
d. Analysis:
i. Purpose of § 14(a) is to prevent management or
others from obtaining authorization for
corporate action by means of deceptive OR
inadequate disclosure in proxy solicitation.
ii.
e. holding: derivative and direct (private) actions are both
subject to § 14(a); federal courts have the power to grant
ALL necessary remedial relief to victims of deceptive
proxy statements.
i. There was an implied private right of action,
under § 14(a).
ii. Could have not found the implied right and left
it to the SEC, but that would be too burdensome.
iii. Policy: without private actions, there would be
no way of enforcing § 14(a-9).

3. Mills v. Electric Auto-Lite Co. (us sc 1970) p. 553

a. Issue: what causal relationship MUST BE SHOWN
between a false/misleading proxy statement AND the
merger to establish a cause of action, based on the
violation of the act?
b. M owns 54% of Auto-Lite; with this 54% ownership, M
nominates all the directors.
c. Now, the directors want to merge Auto-Lite into M
corporation.
d. The directors of Auto-lite send out a proxy statement
urging them to approve the merger.
e. Complaint: minority shareholders state that the proxy
statement was fraudulent and deceptive, violative of
14(a-9).
i. Conflict of interest directors of Auto-Lite.
f. Holding
i. This misstatement was material.
ii. To put aside the appointment, examine the
materiality of the proxy statement AND the
necessity of the election…???? LOOK UP
iii.
g. conclusion: the plaintiffs DO NOT get damages.
h. Significance: courts will usually take a broad approach
concerning causation in order to receive damages
because the courts want to deter 14(a-9) violations.

86
 i.
4. Seinfeld v. Bartz (n.d. cal. 2002) p. 561
a. Stock options for directors
b. Directors of the cisco corporation were paid 32k AND
got stock options for $396,000, WHICH LATER rose to
$1 million.
c. Because the directors are approving their own conflict of
interest, they want ratification from the shareholders, so
the directors issue a proxy statement.
d. Alleged deception=failed to indicate the price of the
stocks, at the time/ did not state the value of the stocks.
e. Black shoales formula-formula for determining the
value of stock options.
i. Value-difference between future worth and
present worth.
ii. Exp/ 60 now, 60 later=value is 0.
f. Conclusion: this information was NOT material.-teacher
DOES NOT LIKE.
g. P. 564, unless the market literally correct.
5.
iv. shareholder proposals
1. 14(a-8) Shareholder Proposals-rule issued by the SEC
a. this means that you could put a proposal on the ballot for
the next shareholder election.
b. You will see sometimes the things that shareholders put
on the ballot.
c. Look on p. 275 of statutory supplement—who is eligible
to submit a proposal—anyone who owns $2k of the
stock OR 1% of the shares.
i. This costs nothing; corporation must cover the
cost.
ii.
d. generally, shareholders proposals are used for valid
reasons, rather than used to promote your personal
feelings about certain things. Shareholder proposals can
be used for valid reasons, and making social policy
statements.
e. Prof social policy statements should not be made in
proposals.
2. Lovenheim v. Iroquois Brands, Ltd. (d.d.c. 1985) p. 565
a. Lovenheim (P) sought an injunction barring Iroquois
Brands (D) from excluding from its proxy statements as
proposed resolution he intended to offer at the upcoming
shareholders meeting.
b. Plaintiff owns 200 shares of the common stock of the
Iroquois and wants to put on the shareholder proposal to
study how a French chef cooks patte.
c. Holding: a shareholder proposal can be significantly
related to the business of a securities issuer for

87
 noneconomic reason, including social and ethical issues,
and therefore MAY NOT be omitted from the issuers
proxy statement even if it relates to operations which
account for less than 5% of the issuer’s total assets.
i. Social and ethical issues It still has to be
related to the business
d.
3. The New York City Employees’ Retirement System v. Dole
Food Company, Inc. (s.d.n.y. 1992)
a. Dole (D) omitted NYCERS’ (P) proposal for action at an
upcoming shareholders’ meeting from its proxy
materials on the basis that it was properly excludeable
within three of the exceptions listed in Rule 14(a-8)(a)
b. Concise rule: corporations MAY OMIT shareholder
proposals from proxy materials ONLY IF the proposal
falls within an exception listed in Rule 14(a-8)(c).
4. Austin v. Consolidated Edison Co. of NY, inc. (s.d.n.y. 1992)
p. 575
a. Shareholders (P) sued to compel Consolidated Edison
(D) to include a proposal in his proxy materials
endorsing a change in the company’s (D) pension
policies.
b. Concise rule: in attempting to exclude a shareholder
proposal from its proxy materials, the burden of proof is
on the corporation to demonstrate whether the proposal
relates to the ordinary business operations of the
company.
5. p. 578 problems
a. question 1 (proposals are exempt or not)
i. a exclude under the ordinary business
exception and losing money (3%); if it is a
money loser
1. if the proposal forces the discontinue
and is inconsistent with the state
lawexception.
ii. bharder to get an exception for proposal B;
easier to get on the ballot.
iii. C could be under ordinary business…
b. d
6.
v. shareholder inspection rights
1. this relates to 14(a-7) b/c any shareholders can ask for the right
to have a statement distributed at the shareholders own cost or
have the list given to him.
a. Most CEOs will not give you the list, but the corporation
will distribute it.
b. Why would the shareholder want the shareholder’s list?
i. b/c he would want to do a proxy take over.

88
 ii. State corporation law may enable the
shareholder to get the list AND sometimes a
right to inspect corporate documents.
c.
2.
3. Crane Co. v. Anaconda Co. (n.e.2d 1976) p. 579
a. Applying new york law
b. Crane Co (P), a stockholder, demanded access to
Anaconda’s (D) shareholder list for the purpose of
informing other shareholders of a pending tender offer.
c. Crane wanted the list b/c they wanted to take over
Anaconda.
d. Rule: a shareholder wishing to inform others regarding
a pending tender offer SHOULD BE permitted access to
the company’s shareholder list UNLES it is sought for
an objective adverse to the company OR its
stockholders.
e.
4. State ex rel. Pillsbury v. Honeywell, Inc. (minn. 1971) p. 582
a. There were 2 companies, during the Vietnam War,
which were the target of Anti-war protests.
b. Honeywell made bombs, and Dao made napalm.
c. Mr. Pillsbury purchased shares in Honeywell for the sole
purpose of persuading Honeywell to cease its production
of munitions.
d. Concise rule: in order for a stockholder to inspect
shareholder list and corporate records, the stockholder
must demonstrate a proper purpose relating to an
economic interest.
e. DIFFERENT standards for shareholder list AND
inspecting the corporate doc.
f. Burden of proof for improper business purpose:
i. Burden for shareholder list corporation;
ii. inspect the corporate documents
shareholder.
g. Honeywell did this because he was anti-war.
h. Conclusion: he lost; the court looked at his intention.

5. Sadler v. NCR Corporation (2nd cir. 1991) p. 585

a. Mr. and Mrs. Sadler (P) and At&T (P) attempted to
obtain shareholder lists from NCR (D) in an effort to
execute a tender offer.
b. They ask for a CEDE list and a NOBO list. These are
particular types of shareholder lists:
i. Cede: street names of clients?????
ii. Nobo: list of beneficial owners of shares who
do not object to disclosure of their name
c. Concise rule: A state may require a foreign corporation
with substantial ties to its forum to provide resident

89
 shareholders access to its shareholder list AND to
compile a NOBO list, in a situation where the
shareholder could NOT obtain such documents in the
company’s own state of incorporation.
6. p. 590
a. must McWindsor give the list? Under new york law,
defendant wants to prove improper purpose;
i. if can prove improper purpose fail
ii. establish that was just doing it for a marketing
purpose fail
b.
vi.
b. Shareholder Voting Control
i. Stroh v. Blackhawk Holding Corp. (n.e.2d 1971) p. 592
1. state law
2. Shareholders (P) of Class B stock in Blackhawk Holding Corp
(D) claimed that a limitation on their rights at dissolution
rendered their shares invalid.
3. concise rule: A corporation MAY PRESCRIBE whatever
restrictions or limitations it deems necessary in regard to the
issuance of stock, provided that it not limited OR negate the
voting power of any share.
4. different classes with different voting rights OR different
prices OR different directors.

ii. Everywhere, you can sell different class stocks different types of
vote; this is allowed b/c it allows greater flexibility is part of your
tools of setting up the corporation.

iii. State of Wisconsin Investment Board v. Peerless Systems Corp. (del.

Ch. 2000) p. 597
1. Plaintiff=state of Wisconsin investment board that invests the
assets of the Wisconsin Retirement System.
2. SWIB was the beneficial owner of 950,000 shares of Peerless
common stock, representing between 7-9% of the total
outstanding shares.
3. Peerless=del. Corp. with its ppb in el Segundo, CA.
4. Peerless issues a proxy statement with 3 proposals: 1) reelect 4
members of the Peerless Board, 2) increase by 1,000,000 the
number of Peerless shares available for issuance through the
Company’s existing option plan, 3) ratify PWC as the company’s
auditor.
5. SWIB expressed discontent with proposal 2, and, therefore, sent
a solicitation letter to all Peerless shareholders urging them to
vote against proposal 2.
6. standing
a. although SWIB did NOT attend the annual shareholders
meeting and the reconvened meeting, the court found
that SWIB did have standing.

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 i. If attendance was mandatory in order to preserve
the right to bring suit, the court found this to be
contrary to the public policy of widespread
ownership of corporate securities.
7. blasius standard v. business judgment review
a. blasius std-defendants have the burden of proof to show
a compelling justification for their actions.
i. 2 part test
1. plaintiff must establish that the board
acted for the primary purpose of
thwarting the exercise of a shareholder
vote.
2. the board has the burden to demonstrate
a compelling justification for its actions.
ii. Duty of loyalty bjr
b. Distinction btw/ Void acts & voidable acts
i. Look up
ii. Voidable acts can be enforced after
ratification by the shareholders. This case
would be voidable act. ( LOOK UP THE
RELATIONSHIP OF BLASIUS AND
VOIDABLE)
c.
8. analysis:
a. primary purpose thwart-yes, b/c Peerless only
informed shareholders who would have voted in favor of
proposal 2, rather than all the shareholders.

b. Compelling justification-court rejects all the

justifications.
9. conclusion; denial of both the plaintiff’s and defendants’
motions for summary judgment.

10. cumulative voting: accumulate all the votes for a particular

candidate.
a. exp/ 3 directors; A-33%, B-67%,
b. when would you want to engage in cumulative
voting?
i.
c.
iv. Control in Closely Held Corporations
1. Ringling Bros. Barnum & Bailey Combined Shows v. Ringling
(del. Sup. Ct. 1947) p. 606
a. Issue: what is the effect of an agreement between 2 out
of 3 present stockholders with relation to the exercise of
voting rights by these 2 shareholders?
b. Edith Conway Ringling had 315 shares.  plaintiff
c. Aubrey B. Ringling Haley had 315  def.
d. John Ringling North had 370.  def.

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 e. The agreement was entered in 1941 and stated that they
were to act jointly and if there were any disagreements,
Karl D. loos would be the arbitrator.
f. The disagreement was about who were to be voted as
directors for the board (7 needed).
g. Analysis
i. Court seems to think that the parties were to
agree in accordance with the arbitrator’s
decision and that no decision of the arbitrator
could ever be enforced.
ii.
h. issue: whether this was an enforceable agreement.
i. Argument:
i. Under DE law, Voting trusts are legal, but the
code is silent concerning voting agreements.
1. because there is express authorization
for voting trusts, the argument is that
voting agreements ARE NOT allowed.
ii. Voting trusts deposited with a trustee and they
have legal title to vote.-- § 18 of DE. code
iii.
j. concise rule of law: voting agreements are LAWFUL
in DE; just b/c they are not mentioned in the code DOES
NOT mean they are not authorized.
k. Conclusion: did not get specific performance; ringling
got 3 directors and north got 3 directors.

2. McQuade v. Stoneham (n.y. 1934) p. 613

a. Action is brought to compel specific performance of an
agreement btw/ the parties, entered into to secure the
control of the National Exhibition Company.
b. Defendant Stoneham became the owner of 1306 shares,
or a majority of the stock of National Exhibition
Company.
c. Plaintiff and defendant McGraw each purchased 70
shares of his stock.
d. As part of the transaction, they made an agreement.
e. The shareholder agreement said that they would
maintain Stoneham as the CEO/president, McGraw as
the VP and that McQuade would be Treasurer, AND the
agreement agreed to the amount of compensation.
f. Conclusion: court finds that the agreement is NOT
enforceable because it takes away from the directors the
ability to run the corporation according to their best
business judgment; viewed as an unlawful attempt to
limit the governing power of the directors.
g.
3. Clark v. Dodge (ny 1936) p. 618
a. Dodge agrees to retain Clark as general manager and
will get 25% of profit of the corporation and in return,

92
 Clark has to reveal a secret formula to maintain the
corporation.
b. Clark does everything he was supposed to do, but Dodge
fires him; as a result, Clark is suing for specific
performance.
c. Conclusion: the court gives specific performance to the
shareholder agreement.
d. Rationale: because there were no other shareholders
that may be injured, the court upheld the agreement.
Reconcile with McQuade.
e. Business planning: should have had an employment
contract that specified the duration of employment, AND
buy/sell agreement.

4. easy way to distinguish closely held firms from publicly

owned: is it publicly traded?
a. Important b/c if you are a minority shareholder and the
corporation is NOT paying dividends or benefits, then
you can be frozen out.
b. The distinction does not really lay in how many persons
own stock, but whether the stock in the corp. is publicly
traded.

5. Galler v. Galler (Illinois 1964) p. 624

a. 1919-1924, Benjamin and isadore galler, brothers, were
equal partners in Galler Drug company.
b. 1924, the business was incorporated under Illinois
business corporation act, which each owning ½ of the
outstanding 220 shares of stock.
c. They come up with a shareholder’s agreement and that
there will be 4 directors (2 chosen by each of the
brothers OR by their surviving spouse).
d. Also, they had an agreement about salary to a spouse of
a deceased shareholder.
e. Next, there is a provision providing for reimbursement.
f. Analysis: b/c the corporation was so closely held, they
had discretion.
g. Conclusion: the shareholder agreement SHOULD BE
enforced.
h. Rule: shareholders in a closely held corporation are free
to contract regarding the management of the corporation
absent the presence of an objecting minority, and threat
of public injury.
i. Holding
i. Duration???
ii. Electing persons to the board see rule
iii. dividends
j. significance: you can enforce shareholder’s agreement
even with fairly extensive limitations on what the board

93
 of directors can do (shift in the change of opinion
concerning shareholder’s agreement).
k. Business planning: get advice from lawyers about the
shareholder agreement, put in a buy/sell agreement
(would end a fight), better shareholders agreement that
ensures an alternative when there is a deadlock, make
odd number of directors, could have set up a LLC (has
the benefits of limited liability with a partnership set up).

6. Ramos v. Estrada (cal. 1992) p. 632

a. There is a broadcast group that owns 50% of the shares
+ 2; the Ventura group has 50%.
b. The broadcast group is owned by 6 different people.
i. Ramos owns 50% of the broadcast group, and 5
other own 10% (including Estrada).
c. There is a shareholders agreement that binds everyone in
the Broadcast group. the bottom line was that they
would all vote the same on the issue of the board of
directors in order to maintain control.
d. Issue: did Estrada violate the shareholders agreement
when she voted for the ventura’s group for CEO?
e. Holding (concise rule): voting agreements binding
individual shareholders to vote in concurrence with the
majority constitute valid contracts.
f. Business planning: sue for specific performance,

7. NOTE
a. Zion v. Kurtz (n.y. 1980) p. 636
i. Holding: this was an enforceable shareholders
agreement by showing that Delaware law is
following CA trend.
ii.
b.
8. p. 636
a. it is enforceable
b. enforceable ringling bros.
c.
9. SKIPPED TO 660
10. Sugarman v. Sugarman (1st cir. 1986) p. 651
a.
11. Smith v. Atlantic Properties, Inc. (mas. 1981) p. 655
a.
12. Jordan v. Duff & Phelps, Inc. (7th cir. 1987) p. 660
a. Duff & Phelps evaluate the risk and worth o firms and
their securities. It sells the credit ratings, investment
research, and financial consulting services.
b. Jordan started to work there in May 1977.
c. In 1981, Jordan was offered some stock; nov. 1983,
Jordan purchased 188/20,100 shares.

94
 d. Before Jordan was sold any stock, there was an
agreement that mandated a sale of all stock owned by an
employee whose employment is terminated.
e. He decided to switch jobs, and he did. As a result,
pursuant to the agreement, he received $23k.
f. However, 1 month later, there was an announcement of a
merger, making his old stock worth $452k. as a result,
he demanded his stock back.
g. Rules:
i. Close corporations that purchase their own stock
MUST DISCLOSE to the sellers all information
that meets the standard of “materiality.”
ii.
h.
13.
v. control, duration, and statutory dissolution
1. Alaska plastics, inc. v. coppock (Alaska 1980) p. 673
a.
2. pedro v. pedro (minn. App. 1992) p. 682
a.
3. stuparich v. harbor furniture mfg., inc. (cal. App 2000) p. 688
a. lack of meaningful participation.
b. this corporation was in 2 lines of business:
i. mobile home park—wanted to keep
ii. furniture—wanted to get out of the furniture
business—lost 2.5 million dollars
c. prof: could the lawyer have used the other facts to make
a stronger case?
i. The fact that they lost so much money
ii. Animosity
iii. Could have argued conflict of interest
1. duty of loyalty  inherent fairness test
a. can prevail if you ratify
(independent shareholders who
do not have this conflict of
interest)
b. prove that the transaction is
inherently fair, but the burden is
on the def.
2. prof: duty of loyalty still applies in
closely held corporations.
iv.
d. there was animosity between the shareholders.
e. Issue: is statutory dissolution of a close corporation
reasonably necessary for shareholder protection on the
grounds of animosity among the corporate directors?
f. concise rule: statutory dissolution of a close
corporation is NOT reasonably necessary for shareholder
protection on the grounds of animosity among the
corporate directors--- § 1800(b)(5)???

95
 g. Prof—thinks that the court should have ordered a buy
out
h. Business planning: buy/sell agreement,
4.
vi. transfer of control
1. frandsen v. Jensen-sundquist agency, inc. (7th cir. 1986) p. 695
a. frandsend had right of first refusal. If Jensen wants to
sell his stock, he has to offer it to frandsen at the same
price.
b. If frandsen declines to buy the stock, then the majority
had to buy frandsen’s stock at the same price.
c. Issue: in a transfer of control of a company, are the
rights of first refusal to buy shares at the offer price to be
interpreted narrowly?
d. concise rule: in a transfer of control of a company, the
rights of first refusal to buy shares at the offer price are
to be interpreted narrowly.
e. The agency owns an insurance company and the bank.
f. Right of first refusal: allows one to meet the terms of a
proposed contract before it is executed.
i. Gives him a chance to buy control of the
corporation before anyone else.
ii. Gives him a chance to buy control.
g. Take me along: if J are selling to some one else, F has
right ot have his stock be sold at the same price as the
stock which the J is selling. J has to buy F’s stock at the
same price the J is selling. J has to take F along and pay
for him the same price as they are getting.
i. Anything that is negotiated.
ii. If they sold a controlling interest in their
corporation, F was allowed to have been taken
along.
iii. Rationale: this would prevent F from being
stuck owning his minority share when someone
new comes along operating the company as
majority shareholder.
h. Business planning: should have had a buy/sell
agreement.
i. Tort-interference with contractual relations: an
intentional tort whereby a defendant intentionally elicits
the breach of a valid contract resulting in damages.

2. Zetlin v. Hanson Holdings, Inc. (n.y.s. 1979) p. 700

a. Zetlin (P) had a 2% interest in Gable ndustries. Hanson
(D) and members of the Sylvestri family (D) owned 44%
of Gable’s shares.
b. Sylvestri family and Hanson sold their controlling
interest at a premium price per share, so Z brought suit
contending that minority stockholders were entitled to an

96
 opportunity to share equally in any premium paid for a
controlling interest in the corporation.
c. Defendants sell their shares for $15/share, but the market
price is $7.30.
d. Concise rule: absent looting of corporate assets,
conversion of a corporate opportunity, fraud OR other
acts of bad faith, a controlling stockholder is free to sell,
AND a purchaser is free to buy, that controlling interest
at a premium price.
e. Conclusion: Z loses

3. lotta confusion in this area; look at social policy

4. Perlman v. Feldman (2nd cir. 1955) p. 703

a. After Feldman (d) sold his controlling interest in the
Newport steel corp (37%), Perlman (P) and other
minority shareholders (P) brought a derivative action to
compel accounting for, and restitution of, allegedly
illegal gains accruing to Feldman (D) as a result of the
sale.
b. Background: Korean war, government fixed steel prices
c.
d. Concise rule; directors and dominant shareholders stand
in a fiduciary relationship to the corporation and to the
minority stockholders as beneficiaries thereof.
e. Conclusion: plaintiff (perlman) wins. Majority—you
cannot do that; if you are going to extract a premium
f. Issue: Should this be a direct suit or derivative suit?
i. It should be a derivative suit, then everyone
shares equally.
ii. If it is a direct suit, then the plaintiff gets their
money accordingly.
g. Prof: prof thinks that the facts are NOT compelling, so
he believes that the courts are not happy with the Zetlin
rule.

5. Essex Universal Corporation v. Yates (2nd cir. 1962) p. 707

a. Yates owns 28% of the corporation and agrees to give
his shares to Essex.
b. Issue: may a sale of a controlling interest in a
corporation include immediate transfer of control?
c. Concise rule: a sale of a controlling interest in a
corporation MAY INCLUDE immediate transfer of
control.
d. Prof: when a director resigns, the remainder of the
boards vote to replace the directors.
i. Hypo/ 14 directors, 8 resign; there is 6. (point,
Yates has 9 directors, essex has 6)
1. What can you do?

97
 a. Seriatim resignation: in order,
successive.
2. he wanted more money, he was not
happy with the money.
3. essex-unlawful to sell the directorship.
ii.
e. prof holding: it is LAWFUL to sell the directorship, but
the right of control runs with the right to sell shares.
f. Rationale:
i. In order to get instant change to get majority
control, this should not be unlawful.
1. gives example of 50%+1=legal
ii. to analogize this, he uses 28% is legal b/c it is de
facto control, in this case
1. burden is on the plaintiff to prove
that 28% is not de facto control.
g. Staggered boards: a percentage of a board being voted
on every year; staggered elections in time.
i. Rationale:
1. greater stability for the controlling
group.
2. want to minimize the effect of
cumulative voting, then you can use
staggered boards.
h. Classified boards: one for which different classes of
stock elect different sets of directors.
i. Example; class A gets to elect 5 directors, class
b gets to elect 3 directors; BUT HAVE to put it
in the articles.
6. notes
a. Yates-was the incumbent-had control of the board of
directors AND of the management of the corporation.
i. Perks of control: access to the corporation’s list
of shareholders and its funs (for waging a
campaign in a proxy fight).

b. P. 712-715; statutes
7. d

VII. Mergers, Acquisitions, and Takeover

a. mergers and acquisition- section 1 p. 716
i. the De Facto Merger Doctrine
1. introduction
a. acquisition- can be accomplished by allocating shares
pursuant to the proportion of a company’s worth

b. merger: 2 corporations merge/fold into one. The parties

agree which the surviving corporation will be (could
continue under the present corporation OR a new firm).

98
c. stock acquisition: one corporation acquires another
corporation by acquiring the stocks of the other.
Generally, a stock acquisition requires over 50% of the
share. However, there may be times when less than 50%
ownership of all outstanding shares can be de facto
control.

d. statutory merger-combination accomplished by using a

procedure prescribed in the state corporation laws.
i. Under a statutory merger, the terms of merger
are spelled out in a document called a merger
agreement, drafted by the parties, which
prescribes, among other things, the treatment of
the shareholders of each corporation.
ii. If this is used, approval by votes of boards of
directors AND shareholders OF EACH OF THE
2 corporations would have been required.
iii. Shareholders who voted against the merger
WOULD HAVE BEEN entitled to demand that
they be paid in cash the fair value of their
shares. (appraisal right).

e. practical mergers-do not use the statutory procedure.

i. Exp/ co. offer its shares to the shareholders of
another co. in return for their shares.
ii. there are no votes b/c this is a transaction btw/
one corp and the individual shareholders of the
other.

f. assets acquisition- one corporation buys all the assets of

the other corporation for cash; this is good b/c the corp
buying DOES NOT assume any liability of the old corp
since the purchase price would include this.
g. State laws vary on the requirement of a shareholder
vote and on the availability of an appraisal right where a
combination is accomplished by an asset acquisition.
i. DE requires approval of majority of
shareholders/ no appraisal rights
ii. Penapproval of majority of glen alden
shareholders/have appraisal rights.

h. Pennsylvania law
i. sale (assets acquisition) appraisal right
ii. merger—appraisal right (allow a dissenting
minority shareholder to get the fair value of their
share).

i. Delaware law
i. sale (assets)—no appraisal
ii. merger-------- appraisal rights.

99
 iii. shareholder election-majority must approve of a
sale (asset)—rationale.. no injustice if majority
agrees… so no appraisal right

j. Farris v. Glen Alden Corp. (PA 1958) p. 718

i. Glen Alden-penn corporation. They are not
doing so well and have tax loss carryovers of
$14, 000,000.
ii. List-DE corp. purchased 38.5% of Glen Alden’s
outstanding stock.
iii. this acquisition enabled List to place 3 of its
directors on the board.
iv. the 2 corporations entered into an
“reorganization agreement” subject to
stockholder approval p. 719
v. at the meeting, a majority voted in favor of a
resolution approving the reorganization
agreement.
vi. complaint: the notice of the meeting did not
conform to the business corporation law by 1)
did NOT give notice to the shareholders that the
true intent/purpose of the meeting was to effect a
merger OR consolidation of Glen Alden and
List; 2) failed to give notice to the shareholders
of their right to dissent to the plan of merger OR
consolidation and claim fair value for their
shares, and 3) it did NOT contain copies of the
text of certain sections of the business
corporation law as required.
vii. rules
1. in order to determine the nature of the
corporation transactions, the court looks
at 1) provisions of the agreement, 2)
consequences of the transaction, and 3)
purpose of the provisions of the
corporation law that is to be applicable.
2. Penn business corporate law—
shareholder who dissents to a merger
shall be entitled to fair value of his
shares.
3. What is relevant is the true market value
of the stock before and after the
acquisition.
4. Lauman test: when a corporation
combines with another SO AS TO lose
its essential nature and alter the original
fundamental relationships of the
shareholders among themselves and to
the corporation, a shareholder WHO
DOES NOT wish to continue his

100
 membership therein may treat his
membership in the original corporation
as terminated and have the value of his
shares paid to him.  merger
viii. analysis
1. used lauman test
2. nature of the corp. changes from coal
mining to textile company.
3. New co—assets of $169 million and
debt of $38 million… old one was much
less
4. New administration would be List since
they would have 11/17 directors
5. Present day worth of his stock is $38,
while after it would be worth $21.
ix. conclusion: it was a merger, so under Penn law,
he does have an appraisal right. The
shareholders of glen alden should have been
notified accordingly and advised of their
statutory rights to dissent and appraisal.
Although the defendants thought it was a sale
assets, it was a de facto merger, so the plaintiff
DID get appraisal rights.

x. Could use asset acquisition to avoid liabilities.

1. exp/ phillip morris sells all its assets to
windows, then dissolves. Plaintiff cannot sue phillip
morris b/c they have sold all their assets—sometimes de
facto merger is used in this context.

xi. Hariton v. Arco Electronics, inc. (del. 1963) p.

725
1. defendant ARCO and Loral Electronics
Corporation, a New York corporation, are both engaged,
in somewhat different forms, in the electronic equipment
business.
2. the 2 companies negotiated for a
mixture of the companies and entered into a
“reorganization agreement and plan.”
3. 80% of the shareholders approved the
plan, and it was therefore consummated.
4. complaint: plaintiff sued to enjoin the
consummation of the plan on the grounds that 1) it was
illegal.
5. conclusion: the reorganization was
legal. There are 2 ways that you could combine under
DE law 1) sale of assets, 2) merger, and 3) sale of
stocks.
6. if you do not want the stock, then you
can sell it--- court is saying.

101
 7. DID NOT REALLY UNDERSTAND

xii. If you want to exercise your appraisal right, then

you must vote AGAINST the merger.

xiii. Problems 726

1. to prevent from being frozen out from
an unwanted merger, 1) buy/sell agreement, 2) set value, 3)
have an outsider appraiser ready, 4) “take me along”
agreement (right of first refusal), 5) no merger unless all 3
agree agreement,

xiv.

ii. freeze- out mergers OR short form mergers

i. short form merger
1. do have appraisal right
2. requires 85%????? Not sure.

ii. Weinburger v. UOP, inc. (del. Supp. 1983) p.

727
1. class action plaintiff brought this case.
He challenged the elimination of UOP’s minority shareholders
by a cash-out merger btw/ UOP and its majority owner.
2. the material significance was the amount
worth and paid of stock to the UOP shareholders… 21 v/s 24
& the return on the investment.
3. signal had 51% of the shares of UOP. It
was not a matter of controlling UOP, but they wanted to
acquire UOP.
4. UOP directors who were appointed by
Signal made a study about the appraisal price, using UOP.
They use UOP’s data and give it to Signal. They SHOULD
HAVE shown it to UOP, as well.
5. holding
a. in order to demonstrate the
unfairness of the challenged merger, the plaintiff must
allege specific acts of fraud, misrepresentation, OR
other items of misconduct.
b. Where corporation action has
been approved by an informed vote of a majority of
the minority shareholders, the burden entirely shifts to
the plaintiff to show that the transaction was unfair to
the minority.
c. Business purpose requirement
of these cases IS NO longer the law of Delaware.
d. Remedy for minority
shareholders in a cash-out merger is an appraisal.

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 e. Court rejects that “Delaware
Block” or weighted average method of valuation
SHALL be exclusive valuation of stocks.
6. analysis
a. part b of holding--- court did
not find that the minority stockholder vote was an
informed one.
b. Violates fiduciary duty
c. NOT inherently fair: inherent
fairness means 1) fair dealing and 2) fair price.
d. Fair dealing requires candor
(honesty)—NOT HERE b/c did not know of 24 price.
e. Fair price requires
consideration of ALL relevant factors
7. business planning: get someone who is
NOT on the UOP board to do the appraisal; get an independent
party to do this; have the signal directors recuse themselves
and have the independent directors negotiate a fair price.
8. the standard that the Delaware court
applies to a freeze out merger is the fairness test: fair dealing
(requires honesty, full disclosure, btw/ the parties of the
transaction) and fair price.

iii. Notes p. 738--- READ

1. Delaware eliminated dissenters rights
when shares are publicly traded.
a. Dissenters rights are the rights
when all the shares are purchased at the same price.
b. Rationale: DE has preserved
appraisal rights, which occurs in short-form mergers.
2.

iv. under de law, there is no longer dissenters right

(if publicly traded firm and dissent-as long as there is no
discrimination in price)

v. Coggins v. New England Patriots Football

Club, inc. (mass 1986) p. 739
1. freeze out case
2. Sullivan buys an American Football
League (AFL) franchise
3. he sold 10,000 voting shares to 9 other
persons for 25k.
4. another 4 months later, the corp. sold
120k of nonvoting common stock at $5.
5. Sullivan had 23, 718 shares, but the
voting stockholders ousted him.
6. he ends up buying all 100,000 shares at
about $102/share and used his 100% control to elect a new
board. He got this through a loan.

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 7. he merged the Old Patriots to the New
for 100% of the shares
8. the merger agreement was approved by
a majority vote of each class.
9. problem is that he is pledging the
income of the company for his own personal loans.
10. problem: a nonvoting stock owner
disapproved of the merger
11. conclusion: the merger was illegal and
RECISSION is usually the appropriate remedy, but since it has
been 10 years, he should just get money damages discounted to
today’s monetary value (court rejects appraisal rights of 1976).
12. rules
a. DE: merger is ruled is subject
to the inherent fairness rule: 1) fair dealing and 2) fair
price.
b. Controlling stockholder bears
the burden of showing that the transaction DOES NOT
violate fiduciary obligations. (step 1: prove legitimate
business purpose) DE eliminated in a previous case
(del. Superior court)
c. Can rebut an abuse of fiduciary
duty by showing that the freeze-out was for the
advancement of a legitimate corporate purpose. (step
2: that it was fair to the minority) inherent fairness test
13. analysis: defendant provided no
legitimate business purpose, and the court believes that the
merger was done in order to repay the loans.

vi. Rabkin v. Philip A. Hunt Chemical Corp (del.

1985) p. 746
1. hunt was a delaware corporation, while
olin was incorporated in virginia.
2. Olin bought 63.4% of the outstanding
shares at $25/share, pursuant to a stock purchase agreement.
3. there an agreement that they have to pay
$25/share for the minority share if purchased within a 1 year.
4. olin had a shareholder meeting to
effectuate the merger---purchase the remaining minority shares
at $20/share.
5. hunt decided to accept the 20/share
merger.
6. issue: is it legal in DE to pay a premium
for the majority then pay the minority a lower amount?
7. complaint: breach of the inherent
fairness doctrine- olin unfairly manipulated the timing of the
merger to avoid the 1 year commitment.
8. holding: yes

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 a. fairness doctrine again;
manipulated to wait until the year was over.
(misleading statements of not wanting to buy stock by
that they were planning to buy the stock)
9. significance: the only options for the
minority shareholders were appraisal rights (sucks b/c they
bear the cost/risk of legal rights). Minority shareholders may
be able to do more than just restricted to appraisal rights, can
use fairness doctrine.

iii. de facto non-merger

1. Rauch v. RCA corporation (2nd cir. 1988) p. 752
a. Delaware law
b. GE acquires RCA.
c. issue: there was some preferred shareholders; told that
they could redeem them for $100/share.
d. preferred shareholders sued.
e. the shareholders ONLY GET $40/share b/c they
effectively merged.
f. this was a cash buy out
g. complaint: merger constituted a liquidation OR
dissolution OR winding up of RCA.
h. § 251 of del. General corp. law: a conversion of shares
to cash that is carried out in order to accomplish a
merger is legally distinct from a redemption of shares by
a corporation.
i. § 151(b) a corporation MAY subject its preferred stock
to redemption by the corporation at its option OR at the
option of the holders of such stock OR upon the
happening of a specified event.
j. Conclusion: court says that this was NOT a redemption.
The preferred shareholders LOSE b/c the shareholders
DID NOT redeem the shares; they just cashed out upon
the merger.
k. prof: if you called this redemption, then the
shareholders would have won. However, the court DID
NOT call this case redemption they called it a merger
and thus the shareholders lose.
l. significance; you have either appraisal rights OR sell it.
i.
iv. LLC mergers
1. VGS, inc. v. Castiel (del. Suppr. 2001) p. 756
a. We have Castiel through his corporate entity has 63% +
ownership in the LLC.
b. Ellipso, Castiel owns, has 12% in the llc
c. castile owns holdings and ellipso, which in effect own
75% of the llc.
d. Sahagen has 25%.
e. as majority shareholder, he could appoint/remove 2/3 of
the board of managers.

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 f. board of managers: castile, sahagen and quinn.
g. Castiel and Sahagen get into a fight, and Sahagen thinks
that Castiel is a terrible manager.
h. together they convince Quyn to stop helping Castiel, so
secretly they decide to make the LLC become a public
corporation in which Castiel would NOT have firm
control
i. Castiel is pissed, so he sues. One of his complaint is that
you CANNOT sell this LLC without a unanimous vote
(court rejects b/c the LLC agreement said majority vote)
j. § 18-404(d) permits managers to take an action with
prior notice and without notice, provided that a majority
votes in favor of it, UNLESS a llc agreement provides
otherwise.
k. analysis; court looked at the duty of loyalty and the
intent of the managers.
l. conclusion; court finds that the 2 managers who failed
to provide notice breached their duty of loyalty to the
original member and their fellow member by failing to
act in good faith. HOWEVER, the court finds the
merger to be valid.
m. business planning: should have disclosed the business
enterprise.
n. default rule of DE is that majority vote in approval of the
operating agreement; HOWEVER, the LLC agreement
took overridden.
i.
o.
b. takeovers—section b
i. introduction
1. hostile takeover: incumbent managers resist the takeover

2. incumbent managers can use in a defense to a takeover (prob.

Lose jobs)
a. stock buy back
i. in defense to a takeover, an incumbent manager
buys back shares at a higher value than fair
market value.
ii. Effect: increased debt OR less available cash.
iii. Rationale: less desirable, and may deter a
takeover b/c the price paid for the share has been
increased.
iv. Exp/ fair market value is $50, but they offer to
buy it $65.
v. One form: scorched earth: buy back stocks at
a significantly higher price, which leaves little if
any revenue/assets.

b. crown jewel defense

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 i. in defense to a takeover, the corporation sells its
most important asset that it has to make the
acquiring firm lose interest.

c. buy another corp

i. in defense to a takeover, the corporation uses its
assets to buy another corporation. The effect is
that it has less assets and is now a bigger/more
complex corporation.

d. pac man defense

i. in defense to a takeover, a corporation that is to
be acquired actually acquires the other
corporation.

e. white knight
i. in defense to a takeover, a corporation finds
another corporation to acquire them, and this
allows them to have a better deal.
ii. Exp/ golden parachutes; CEO gets a better deal.

f. poison pill
i. most common
1. defense to poison pill: rule 14a-8 can
be used to eliminate the threat of a
poison pill
ii. in defense to a takeover, a corporation
iii. flip in (triggered by a percentage)
1. they bend the by-laws of the corporation
permitting other shareholders to get 2
shares of the corporation for the price of
one EXCEPT for a company/person
who has a percentage of the shares.
2. effect: diminishes the value and power
of the percentage shareholder
3. exp/ own 20%... other 80% get 2 shares
for one.
4. board could decide to waive the
triggering event; the problem for the
target corporation is that if an acquiring
corporation is able to make a quick
strike and replaced the current board. to
get around this, there is 1) dead hand
poison poill and 2) no hand (both struck
down by Delaware court)
5. dead hand— only persons who could
waive the triggering event is the board
of directors who resided at the time of
the negotiations

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 6. no hand: after a certain period of time
when the percent rate was reached, NO
ONE can waive it (the poison pill);
Delaware said not allowed b/c they need
to have the power to run the corporation.
iv. flip over (triggered by a merger AND
percentage threshold)
1. if there is ever a merger, then the event
is triggered..?????
v. effect:
3. cheff v. mathes (del. 1964) p. 763
a. del. Law.
b. Holland furnace co-co of Delaware manufactures warm
air furnace, air conditioning equipment, and other home
heating equipment.
c. Chef—ceo; matthes—shareholder
d. Maremount kept buying shares of Holland. Chef
approached the other directors to repurchase their shares
at a significantly higher prevailing market price.
e. Complaint: shareholder filed a derivative action arguing
that the directors effected the sale solely to preserve their
positions.
f. Concise rule of law: corporate fiduciaries MAY NOT
use corporate funds to perpetuate their control of the
corporation.
g. Court distinguishes between direct and indirect benefits
on the corporate directors.
i. If the benefit is incidental, then the use of
corporate funds to perpetuate their control would
be permissible.
ii. Prof: permissible use of corporate funds in
proxy fight (could analogize).
iii. Test: Look at purpose (preserve jobs for
directors)
h. Analysis:
i. The repurchase would have been subject to good
faith and self-dealing, but the court found that
the director’s fear of the corporate takeover was
a legitimate business decision.
i. This is known as “ GREEN MAIL”—
REPURCHASING SHARES AT A PREMIUM (person
who receives benefit has to pay tax)
j. Conclusion; Holland co. won this case.

4. problem p. 773:
a. this would prevent the payment of green-mail
b. would you recommend this to the corporation, as a
lawyer?
i. pros:

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 1. protect other shareholders by not paying
a premium to a certain person
2. promotes the longevity of the
corporation
ii. cons
1. limits the flexibility by the board
2. lose assets (cash) or increase
indebtedness
ii. development
1. front-end loaded two tier tender offer
a. tender offer-outside party tenders a certain amount of
money for the corporation’s offering a number of shares.
b. Two tiers/two levels of offers (exp/ 1-50/share, 2nd-
35/share)
i. one offer for a certain amount for the first 51%
ii. 2nd offer for a lower amount for the 49%.
c. this is controversial b/c this would force shareholders to
sell their shares as soon as possible due to the fact that
the first 51% gets a higher price.

2. unocal corp. v. mesa petroleum co. (del. 1985) p. 775

a. front-end loaded two tier tender offer
i. tender offer-outside party tenders a certain
amount of money for the corporation’s offering
a number of shares.
ii. Two tiers/two levels of offers (exp/ 1-50/share,
2nd- 35/share)
1. one offer for a certain amount for the
first 51%
2. 2nd offer for a lower amount for the
49%.
iii. this is controversial b/c this would force
shareholders to sell their shares as soon as
possible due to the fact that the first 51% gets a
higher price.
1. coercive b/c it forces shareholders to try
to sell their shares ASAP to receive the
higher price.
b. Issue: is a selective tender offer effected to thwart a
takeover in itself invalid?
c. Concise rule of law: a selective tender offer effected to
thwart a takeover IS NOT in itself invalid.
d. Unocal was faced with a hostile takeover by mesa.
e. Mesa did a front-end loaded two tier tender offer, BUT
Unocal defended by buying its own stock at a higher
price.
f. Analysis
i. Acts of the directors to defeat a takeover MUST
BE shown to have been done b/c the takeover

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 represented a danger to corporate policy AND
effectiveness.
g. Reverse of matthes case b/c they are threatening to buy
out everyone else (not to the party who is trying to
takeover).
h. Significance: new test: 1) apply the business judgment
rule, then 2) assess the reasonableness of the defensive
tactic employed (BALANCE-whether it was
reasonable).
i. Conclusion: unocal won.

3. Revlon, inc. v. MacAndrews & Forbes Holdings, Inc. (del.

1985) p. 787
a. Concise rule of law: lockups AND related defensive
measures are permitted where their adoption is untainted
by director interest OR other breaches of fiduciary duty.
b. Pantry pride wanted to buy Revlon and offered 45/share.
c. Basically, pantry pride persistently tries to buy them out
and offers high price/share (56.25/share).
d. In response, the board then announced a leveraged
buyout a “white knight” at 57.25/share
i. Lock up sale of the crown jewel
ii. Cancellation fee
iii. Exclusive dealing promise
e. Pantry pride wanted to enjoin the agreement between
Revlon and the “white knight” corp.
f. Conclusion: Revlon loses b/c they did not meet the
standard of the concise rule of law.
g. Delaware supreme court says that these 3 do NOT meet
the unocal test because
i. They should have maximized shareholder value
ii. Should have been concerned with getting the
highest value for the shareholder
iii. Court seemed to suggest that they should have
taken the role of an auctioneer selling the
corporation to the highest bidder.
h. Significance: first case that a court invalidates a defense
action by a corporation to a takeover. Court states that
under the conditions of this case, the 3 agreements (d)
were invalid. Suggestion that primary duty of the
directors is to the shareholder.
i. Lurking in the background: concern of discriminatory
methods.

4. front-ended loaded two tiered is NOW OUTLAWED by the

SEC… have to be proportional
a. exp/ 54/share to the first 51%; if you have 100 shares,
you can sell 51 shares (51%) at the tender price.

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5. unocal’s response is OUTLAWED by the SEC, now.
a. Has to be open proportionately to all shareholders.
b. Unocal can offer to buy back shares, but it has to offer
the buy back proportionately to all shareholders.

6. paramount communications, inc. v. time incorporated (del.

1989) p. 797
a. concise rule of law: directors of a corporation involved
in an ongoing business enterprise MAY TAKE into
account all long-term corporate objectives in responding
to an offer to take over the corporation.
i. A board’s decision to reject a takeover offer will
be upheld under the b.j.r. if the directors CAN
SHOW that their decision was NOT dictated by
a selfish desire to retain their jobs.
b. Times wanted to get into tv, so they begin discussion
with warner brothers to do a merger.
c. Unexpectedly, paramount announced an all cash-offer of
175/share.
d. Time’s board continually rejects paramount’s proposal.
e. Later, paramount increases the offer to 200/share….
Probably makes the shareholders happy b/c the market
value was only 110.
f. The original time-warner agreement had included a no-
shop clause which prevented time’s board from
considering other options.
g. Paramount AND other shareholders filed suit alleging
breach of the fiduciary duty by time’s board.
h. Defense: times defends by stating that they DID NOT
want to lose the times’ culture.
i. Conclusion: times wins.

7. Paramount Communications Inc. v. QVC Network Inc. (del.

1994) p. 806
a. concise rule: the directors of a corporation targeted by 2
or more suitors may not institute tactic that favor one
suitor in such a manner as to allow the favored suitor to
offer less than it otherwise would have.
i. although director’s decisions are subject to the
business judgment rule, a director’s decision
regarding a takeover/merger may involve the
duty of loyalty
ii. the duty of loyalty triggers the inherent fairness
test.
iii. directors have a fiduciary duty to seek a
transaction that gives the shareholders the best
value possible.
iv. a director’s act that decreases the value that
shareholders would otherwise receive is a breach
of their fiduciary duty.

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 b. paramount communications instituted talks with Viacom
for a friendly merger.
c. paramount and Viacom had a negotiations for defense to
a possible other merger
i. no shop agreement barring paramount from
discussing mergers with other suitors.
1. look at the circumstances to determine if
it is lawful
2. unlawful ONLY DUE to the
circumstances of this case.
3. this is justified b/c the company spends
money on legal fees to do the merger
ii. fee of 100 million to pay if the agreement was
terminated
1. helps to get the fees
iii. stock option
1. breach of fiduciary duty b/c they could
have received more.
d. qvc announced a tender offer and filed an action seeking
to have the defensive measures declared invalid.
e. issue: may the directors of a corporation targeted by 2 or
more suitors institute tactics that favor one suitor in such
a manner as to allow the favored suitor to offer less than
it otherwise would have?
f. under the circumstances of this case, the court said
that all 3 are unlawful. – fact specific

8. prof’s tips
a.
9.
iii. extension of the unocal/Revlon framework to negotiated acquisitions
1. Ace Ltd. v. Capital re corp (del. 1999) p. 824
a. concise rule of law: a corporate merger suitor
CANNOT prevent the target board of directors from
entering into a deal that effectively prevents emergence
of a more valuable transaction OR that disables the
target board from exercising its fiduciary
responsibilities.
b. capital rey planned to merge with Ace.
c. the merger negotiation involved
i. “no talk” agreement which prohibits the
directors from a corp taking any action to
facilitate the inquiry of another merger
1. no talk is more stringent than no shop
b/c a director is prohibited from even
talking to another party.
2. court suggests that this is almost
NEVER permissible by the DEL
courts

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 3. note: no shop provisions will probably
be upheld by the Del court.
ii. shareholder lock up
1. a percentage of the shareholders agreed
to vote for the merger because they
probably received some extra
compensation.
2. non-participating shareholders is
probably hurt by this.
d. ace’s stock fell, so capital rey solicited merger offers
from different firms
e. conclusion: court refused to enforce the ace provision;
court applies similar standard and refuses to enforce the
no talk provision.
f. analysis
i. court talks more about the contractual agreement
btw/ ace and capital.
ii. conflict btw/ fiduciary duty and those contract
duties.
iii. “it is not proper for a board to enter into a
merger agreement that precludes the board from
considering any other offers unless a lawyer is
willing to sign an opinion indicating that his
client is required to consider that offer.”
g. significance: the court has applied “enhanced scrutiny”
to defensive steps taken by a corporate board that might
shield the corporation from a takeover attempt.
i. this stands somewhere in between the business
judgment rule AND the inherent fairness
standard that is applied in duty of loyalty cases.
ii. similar to QVC.
iii. business judgment plus more. do a balancing.

2.
iv. extension of the unocal/Revlon framework to shareholder
disenfranchisement
1. Hilton hotels corp. v. itt corp (district of nev. 1997) p. 834
a. concise rule: a board has power over the management
AND assets of a corporation, but that power is limited
by the right of shareholders to vote for the members of
the board.
b. Hilton offered $55/share to ITT, which later goes up to
$70.
c. issue: whether ITT’s defense to this takeover was lawful
d. probably did this to avoid shareholder vote.
e. the Nevada court applies Nevada law (they looked to
some of Del. case law to fill in the tests and help them
determine whether this conduct was helpful)
f. Hilton tries to get an injunction of an annual shareholder
meeting, but fails.

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 g. conclusion: court strikes down the poison pill plan. a
white knight came, and the shareholders ratified the
merger.
h. significance:
i. side note: anything unlawful for staggering the election
of the directors?  NO (lawful everywhere); they can
do it without shareholder approval.

2.
v. state and federal legislation
1. CTS corp. v. Dynamics Corp. of America (us sc 1987) p. 845
a. concise rule of law: a law permitting in-state
corporations to require shareholder approval prior to
significant shifts in corporate control is constitutional.
b. Indiana enacted a statutory scheme whereby large
Indiana public corporations could require any entity
requiring either a 20%, 33.33%, or 50% interest to be
subjected to a shareholder referendum wherein voting
power of those shares could be withheld.
c. requirements: 1) inc. in Indiana AND 2) ppb in Indiana
d. issue: is a law permitting in state corporations to require
shareholder approval prior to significant shifts in
corporate control constitutional?
e. holding: a law permitting instate corporations to require
shareholder approval prior to significant shifts in
corporate control IS CONSTITUTIONAL (consistent
with the commerce clause AND is not preempted by the
Williams Act).
f. this statute is known as incumbent board of directors
protection statute
g. dissent: the law UNDERMINES the policy of the
Williams Act by effectively preventing minority
shareholders, in some circumstances, from acting in their
own interests.
h. internal affairs doctrine: which state law applies to the
internal document. as long as it is an internal affair, you
apply the law of incorporation.
i. work as well for LLC (where registered),
partnership (ppb).
i. if fight btw corp and outside contractors, then a
different choice of law would apply.

2. Williams Act of 1968

a. by 1968, the country began to see hostile takeovers.
b. congress amended this act
c. purpose: control hostile takeovers
d. this was carefully negotiated with investment bankers on
one hand AND business round table (did not like hostile
takeovers b/c they were disruptive, threatened their job,

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 and sometimes damaged the long term interests of the
corporation)
e. there is a 5% threshold; when you acquire 5% of the
shares of any publicly traded corporation, you have to
make a disclosure, and this disclosure requires 1) the
identity of the purchaser, 2) what your financing and 3)
the purpose of the purchase (acquisition is), at the time
you buy it.
f. when you do a tender offer: 1) establish right to
withdraw (so if shareholder tenders their shares, they
have a certain amount of days to withdraw; can
withdraw before 15 days); 2) offer must be opened for at
least 20 days, 3) you must buy pro rata from every
shareholder (ex/ 51%-- buy 51% of every share), 4)
same price is tendered to every shareholder.
g. this was an attempt to protect shareholders in response
to shepp v. matthos case; it was a result of a compromise
between investment bankers (who liked takeovers b/c
they make a lot of money)

3. Delaware law:
a. if you acquire 15% of the outstanding shares of a
corporation, then you cannot do business with the
corporation in which you have acquired 15% until 3
years has passed (exp/ mergers-prohibited);
b. if you acquired 85%, then you could do short-form
merger (cut corners, excused from the 3 year waiting
period);
c. exceptions for target company waive provisions (board
of directors waives the 15% threshold before it was
acquired, then they are not subject to the threshold);
d. opt out provision: option to protect board of directors,
but can opt out.
vi.

VIII. corporate debt

a. introduction
i. debentures
1. long term unsecured debt obligations
ii. bonds
1. long term debt obligations secured by property of the debtor
2. but the term of bonds usually applies to both bonds and
debentures.
iii. indenture
1. contract between the lending company and the bond/debenture
holder
2. enforced on behalf of the debt holders by trustee.
3. the trustee is usually some bank or financial institution that acts
as a proxy to protect the investments
4. tells the bond holder his rights

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 5. most indenture agreements say that they will be enforced under
New York law b/c 1) most are sold on Wall St. 2) most are
underwritten by new york investment banks 3)
iv. zero coupon bond
1. coupon-interest; no interest payments, but the interest and the
principal is paid off at the end in one lump sum payment
v. covenant
1. provisions in the indenture that are to protect the buyers of the
bond and the debentures
vi. callable bond
1. the issuer of a bond has the right to call back the bonds in and
pay off principal and unpaid interest as of that date.
vii. significance:
1. bonds (debt) always get paid before stock; as a result, junk bonds
would be paid off before stock.
b. debtor’s sale of substantially all its assets
i. Sharon Steel Corp. v. Chase Manhattan Bank, N.A. (us sc-cert denied
1983) p. 862
1. concise rule of law: a clause in a debt instrument preventing
accelerated maturity in the event of a sale of all or substantially
all the debtor’s assets is inapplicable IF THE assets are sold
piecemeal.
2. Sharon is acquiring UV industry (Mueller brass, debt, and cash)
3. the debt involved debentures.
4. rationale; the fact that they sold off other divisions would be a
circumvention of the indenture agreement.
5. somebody who sells debentures using false information OR
omitted information 10(b-5)
6. UA gave these debentures at a certain interest rate. Later, the
interest rates went up. This was appealing to Sharon b/c the
interest rate was only 5% when the current interest rate was 10%.
7.
ii.
c. incurrence of additional debt
i. metropolitan life insurance company v. RJR Nabisco inc. (s.d. ny.
1989) p. 868
1. leveraged buy out; management of RJR Nabisco got together and
bought out the shareholders at 109/share. in order to finance all
the payments, the management sole a lot of debentures.
2. this angered the life insurance company b/c they were already
holding debentures, which were sold previously to them.
3. the problem is that RJR sells more debentures of the same
grade/quality; as a result, the increased supply of the same
debenture would make the value of the already held debentures
to be decrease. consequence: rating will go down.
4. conclusion: no implied covenant of good faith and fair dealing
a. usually a contract claim.
b. looked at previous transactions

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 5. prof: why didn’t metropolitan life insurance co. put a provision
in the contract prohibiting RJR to increase debt?
a. b/c RJR would probably not agree to do this at the
high rate of interest rate it gave.
ii.
d. exchange offers
i. katz v. oak industries, inc. (del. 1986) p. 883
1. there’s a large amount of outstanding corporate debt in the form
of debentures owed to various persons and organizations.
2. as the corporation is doing poorly, the difficulty of paying back
its bond becomes more difficult.
a. effect: $100 bond decreases to $40.
3. basically, there’s a deal
a. if the debenture holders give back to the corporation, the
corporation would give a certain amount (lil higher than
the fair market value but lower than the face value)
4. complaint: some plaintiffs sued alleging that this was coercive
saying that this was a breach of the implied covenant of good
faith and fair dealing.
5. conclusion: plaintiffs lose
6. rationale
a. most of the big institutional organizations who own
debentures went along with this deal b/c they thought
that this deal is better than nothing.
b. look at the sophistication of the plaintiff.
7.
ii.
e.
IX.

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